Antitrust Analysis of Frand Licensing Post-ftc v. Qualcomm

• Jurisdiction: United States,Federal
• Author: By Aminta Raffalovich and Steven Schwartz
• Publication year: 2021
• Citation: Vol. 31 No. 1

ANTITRUST ANALYSIS OF FRAND LICENSING POST-FTC v. QUALCOMM

By Aminta Raffalovich and Steven Schwartz¹

A great deal of recent attention is being paid to the Ninth Circuit's decision in Federal Trade Commission ("FTC") v. Qualcomm.² On one side of the debate are those, like the FTC and various amici, who reject the view expressed by the Ninth Circuit and consider the licensing behavior by Qualcomm as a quintessential antitrust violation. That argument views Qualcomm's licensing behavior as a blatant example of the illegal exercise of monopoly power.

On the other side of the debate are those, like the Antitrust Division of the Department of Justice and still other amici, who decry the District Court's decision³ as an inappropriate extension of the antitrust laws into a non-antitrust arena and applaud the Ninth Circuit's decision as drawing reasonable boundaries around the application of antitrust laws.

What complicates the assessment of the decision in Qualcomm is the context in which the behavior at issue occurs. The patent overhang and, in particular, the standard-setting and essential-patent context make the analysis different—and arguably more challenging—than a typical analysis of pricing or licensing behavior in a vertical setting.

However, while arguably more challenging, the fundamental elements of the analysis are largely the same as for any other antitrust analysis. The analysis necessarily includes an assessment of the extent of the market power held by the target firm, whether the market power flows from an effort to monopolize the market, the impact of the behavior on competition, and other familiar questions.

I. WHAT IS MARKET POWER?

Our discussion begins with market power.⁴ It is axiomatic among antitrust practitioners on the economic and legal sides that an assessment of the extent of the market power enjoyed by the relevant entities is central to an antitrust analysis. Unfortunately, there is often confusion about what market power means, and what it does not. To economists, market power is a non-pejorative term that simply means that a firm can influence the amount of goods (or services) it sells by altering the price of the product or service.⁵ Noting that a firm has some degree of market power is not, by itself, a negative statement because any time a firm faces a downward sloping demand curve, i.e., a situation in which a price increase leads to a reduction in quantity demanded and vice versa, that firm has some market power. Since most goods are sold in markets in which firm demand curves slope downward, most sellers, therefore, have at least some market power. From an antitrust perspective, the issue is whether a firm has so much market power—call it "monopoly power"—that the firm has the ability to sustain prices above and output below competitive levels.⁶ Thus, a key question in an antitrust analysis is whether a firm (or collection of firms) has sufficient market power to rise to the level of "monopoly power."

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From an economic perspective, market power manifests itself in the ability to set price above marginal cost—that is, the cost incurred to produce an additional unit of a good (or service). In a perfectly competitive market, where a seller cannot influence the quantity they sell by adjusting the selling price, the sales price is equal to marginal cost. In that situation, the demand curve faced by the seller is horizontal, and not downward sloping, and the profit-maximizing price will be equal to marginal cost.⁷ Accordingly, if a firm's price is above its marginal cost, it is not operating in a perfectly competitive market.⁸ The firm's demand curve will slope downward and, hence, it has market power.⁹

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In practice, of course, markets generally are not perfectly competitive. Economic evidence and antitrust tradition acknowledge this. For this reason, there is generally no expectation that prices will be set to be equal to marginal cost and, thus, the mere fact of a deviation of price from marginal cost is not cause for antitrust concern. Typically, it is only deviations of price from marginal cost that are substantial and persistent that are issues for antitrust analysis. Thus, from an antitrust perspective, it is a reasonable shorthand to be concerned with "market power" that results in the ability to set and sustain price substantially above marginal cost, i.e., monopoly power. As stated by an Assistant Attorney General for Antitrust:

Antitrust enforcers are not in the business of price control. We protect competitive process, not a particular result, and particularly not a specific price. In fact, if a monopoly is lawfully obtained, whether derived from IP rights or otherwise, we do not even object to setting a monopoly price.¹⁰

This is a crucial point: it is when monopoly power is obtained or maintained unlawfully that monopoly prices are a matter for antitrust inquiry. If that monopoly power is obtained or maintained through the exercise of superior business skill or acumen, for example, or through effective and thoughtful innovation that results in a competitively superior product, the resulting exercise of market power—even monopoly power—is not an issue of antitrust concern. This point is especially critical to remember in the context of lawful monopolies, e.g., a monopoly over a patented technology.¹¹ This is where the analysis of Qualcomm begins.

II. THE RELATIONSHIP BETWEEN PATENTS AND MARKET POWER

Patents present a challenging situation in economics and antitrust precisely because a patent confers on the patent owner a legal monopoly on the technology taught in the patent. That means that no entity is allowed to practice that technology without a license from the patent owner. However, it is also the case that such a legal monopoly does not necessarily allow the patent owner to exercise market power, much less monopoly power, either with respect to the patent (e.g., licensing) or products using the patented technology (i.e., with respect to pricing, output, and other terms and conditions of sale). The patent monopoly and the ability to exercise monopoly power with respect to the patent are often mistakenly viewed as different sides of the same coin, but they are not. To understand why this is so, consider how a patent owner may exercise a degree of market power above and beyond what they could do, absent the patent.¹²

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Patents confer market power to the extent that they allow the patent holders to set prices at a higher level, that is, farther above marginal cost, than would otherwise be the case, absent the patent.¹³ The patent system allows this so that the patent owner has the opportunity to recover the cost of innovation and earn a return on that innovation investment. Indeed, it is precisely the prospect of being able to exercise some greater degree of market power that is the incentive to the innovator that produces the innovation.¹⁴ In this sense, it is by design that patents are intended to create the opportunity for firms to enjoy greater market power and earn higher profits than would be the case, absent the patent.

As a practical matter, the economic value of a patent is no greater than the amount of money people are willing to pay for the advantage conferred by the patented technology over the next-best alternative. This is true in the product marketplace, where the seller of a product with a patented feature (1) can set prices above competitors' prices to the extent that the market (i.e., consumers/users) perceives an advantage attributable to the patented feature that it is willing to pay for and (2) is constrained in setting that premium by the size of that perceived advantage. In other words, where a patent allows a product to incorporate features, performance attributes or some other meaningful differentiator that consumers value, consumers will pay "more" for that product. However, the amount of "more" will depend on how much better or advantageous those features are. Where the differences are small or large, the "patent price premium" will be correspondingly small or large, all else equal.

The same situation holds in the marketplace for technology, where the price or "royalty" a patent holder can reasonably obtain in exchange for a license to the patented technology is constrained by the benefits the patented technology confers on a potential licensee who incorporates that technology into their product(s). In other words, a patent holder seeking to license their technology will, all else equal, receive a higher royalty the greater the advantage to the licensee from being able to utilize the patent relative to the next-best alternative. For patent practitioners, this is a familiar line of reasoning; indeed, the assessment of the appropriate "reasonable royalty" in a patent damages setting accounts for the relative advantage of the patent versus alternative technologies (among other things).¹⁵

The value of a patent also depends on the institutional setting in which the patent is used and licensed. One example is when patents are considered essential to the standards set by a standard-setting organization ("SSO"). An SSO is an organization whose principal role is to develop, coordinate, and promulgate technical standards to facilitate the operation of firms producing products covered by the standard. The practical effect of standards set by an SSO is to create uniformity with respect to things like terminology, specifications, and so forth. One example of products subject to standards is medical devices that work the same way and display information in the same way, regardless of manufacturer.

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Compliance with and incorporation of standards into manufactured products typically requires access to patented technology. When there are patents that are considered essential to being able to comply with the standard, patent owners can agree to designate their patents as "standard-essential." Standard-essential patents ("SEPs") are patents...