A cost‐based approach for calculating royalties for standard‐essential patents (SEPs)

• Date: 01 November 2018
• Author: Christoph Ann,Gunther Friedl
• DOI: http://doi.org/10.1111/jwip.12104
• Published date: 01 November 2018

DOI: 10.1111/jwip.12104

ORIGINAL ARTICLE

A cost-based approach for calculating royalties

for standard-essential patents (SEPs)

Gunther Friedl

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Christoph Ann

Technical University of Munich, TUM

School of Management, Arcisstr, Munich,

Germany

Correspondence

Christoph Ann, Technical University of

Munich, TUM School of Management, Chair

of Corporate Intellectual and Property Law,

Arcisstr. 21, 80333 Munich, Germany.

Email: christoph.ann@tum.de

We propose and discuss a novel approach for calculating

FRAND royalties based upon average total cost per patent

plus a reasonable return for the patent holder. Our approach

relies upon principles common in regulated industries such

as telecommunication networks. Compared to existing

approaches that use net sales or fractions thereof as the

basis for royalty calculation, our approach has the advantage

of arriving at an estimate for FRAND royalties without the

need to rely upon comparable licensing transactions. Thus,

our approach helps to more accurately define royalty ranges

that are FRAND compliant.

KEYWORDS

FRAND, patents, royalties, standard-essential

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INTRODUCTION

For many industries, standards are critically important. For network industries such as the telecommunications

industry, this has always held true, because the core of its business has always been putting a variety of end users into

contact with other end users. This has always required uniform standards designed to ensure network technologies'

compatibility as well as devices' ability to communicate with networks' base stations in ways that, as a simple example,

will save battery life. In order to ensure their system's operability, equipment manufacturers, and network operators

alike need to ensure that the standards are being met; to the benefit of end users, which are their customers. For the

foreseeable future, a significant increase in the relevance of standards can be predicted, because Industry 4.0 will

largely increase the degree to which industrial processes will depend upon the exchange of information not only

between people, but also between toolkits, that is, between components that used to be called “hardware.”The same

holds true for autonomous driving, data compression, or 3D printing. In all of these sectors, we will see a significant

increase of communication, which, among other things, will require standardized (as well as safe!) communication

protocols. The result of all of this will be more standardization at large.

© 2018 The Authors. The Journal of World Intellectual Property © 2018 John Wiley & Sons Ltd

J World Intellect Prop. 2018;21:369–384. wileyonlinelibrary.com/journal/jwip

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Tasked with the development and creation of standards are standard-setting organizations (SSOs). In the field of

telecommunication, the leading European SSO is the European Telecommunications Standards Institute (ETSI). It sets

standards with the help of different stakeholders that participate in the process. The task of all SSOs always is to

identify and make the most suitable technologies form the standard.

It goes without saying that the most suitable technol ogies often are patented. T hen, the underlying paten ts

become standard essential. T hat can be a problem, because these pa tents now do not just control acces s to a

certain technology, but rather to a standard. Access to the standar d is important to ensure both use and

acceptance of the standard. Other than ordinary patents (that often do n ot even earn their granting cost), standa rd

essential patents (SEPs) contr ol access to a certain market. In order for a standard to be accepted, the prob lem of

access to the standard on the one hand, and of ensuring an a dequate return for the pate nt holder on the other

hand needs to be solved; also because most likely—and alway s the case in telecommunications standards—many

different patent holders wi ll be affected.

In order to ensure both, use and acceptance of the standard on the one hand, and an adequate return (ETSI

Intellectual Property Rights Policy, 2014) on invest for the patent holders on the other, licensing terms need to meet

FRAND-criteria; this acronym standing for “Fair, Reasonable And Non-Discriminatory.”These criteria are designed to

identify licensing conditions that are appropriate, because they prevent patent holders from exploiting the market

control that their patents having become standard-existential is giving them beyond the technology control that

patents are meant to provide. And doing so opportunistically, either by denying use of their patent altogether (and

thus blocking standard access) or for using that increased leverage in order to charge excessive royalties (Layne-

Farrar, Padilla, & Schmalensee, 2007). As a tool to remedy both, the FRAND requirement for licensing fees nowadays

is commonly accepted and applied by all relevant competition authorities including the EU Commission (Official

Journal of the European Union, 2011).

Despite all agreement on the existence of a FRAND requirement in general, this does not solve what one might

call a hundred million dollar question: the issue of how to calculate the amount of licensing fees that in a specific case

will satisfy the FRAND requirement. As often, it is at this monetary result where the real problems lie. And this article is

an attempt to provide a reasonable basis for the calculation of FRAND licensing fees.

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CRITERIA AND BASIS FOR CALCULATING FRAND LICENSING TERMS

This part discusses criteria for substantiating the three FRAND terms based on US court decisions and literature. It

also discusses potential bases for calculating FRAND royalties that have been proposed by academia and that have

been used in practical cases.

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Criteria for assessing the fulfilment of FRAND licensing terms

The existing literature cites and discusses different criteria for substantiating the three FRAND terms (For an overview

see, Layne-Farrar, 2010; Sidak, 2013. For an economic interpretation see Carlton & Shampine, 2013). The terms “fair”

and “reasonable”are often regarded together, mostly because SSOs in the United States often refer to RAND instead

of FRAND terms, that is, they do not consider the criterion of “fair”specifically (Geradin & Rato, 2007).

In the United States, when assessing whether royalties are “reasonable,”courts mostly use a fifteen

factor test that was created in 1970 as a benchmark in the patent infringement case of Georgia-Pacific Corp. v.

Plywood United States Corp. The tests consists of 15 factors that a court (or a jury!) may use I order to

determine a royalty rate that the parties would have been likely to agree upon in a setting of “hypothetical

negotiations”and that thus can be considered to be “reasonable.”Basically, the Georgia-Pacific test can be

boiled down to three elements: (i) importance of the patented invention for the product and market demand;

(ii) royalties paid for these or similar inventions in the industry; and (iii) expert assessments of patent value

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