How Antitrust Law Can Make FRAND Commitments More Effective.

Author:Melamed, A. Douglas
Position:Fair, reasonable, and non-discriminatory - Symposium: Unlocking Antitrust Enforcement
 
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INTRODUCTION

Compatibility standards comprise a critical part of the information and communications technology sector. From Wi-Fi and 4G cell phone standards to the ubiquitous JPEG and MPEG file formats, many of the benefits generated by the recent and dramatic advances in information technology would have been difficult or impossible to achieve without compatibility standards.

For the past twenty years, antitrust enforcement related to standard setting has focused largely on the interpretation and implementation of the commitments made by patent holders as part of the standard-setting process to license their Standard-Essential Patents (SEPs) on Fair, Reasonable and Non-Discriminatory (FRAND) terms. The Department of Justice (DOJ) and the Federal Trade Commission (FTC) devoted an entire chapter to this topic in their 2007 report on antitrust enforcement and intellectual property rights. (1) The debate over FRAND commitments has continued undiminished in the ten years since the publication of that report.

With respect to SEPs, the most significant and immediate commercial and antitrust concern centers on the SEP owners' command of substantial market power once the standard in question becomes widely adopted. Put simply: without some checks, SEP owners could opportunistically engage in patent holdup, talcing advantage of the fact that the firms and users adopting the standard become individually and collectively locked in to the standard over time. Of course, it is precisely this danger of ex post opportunism that motivates market participants and standard-setting organizations (SSOs) to require participants in the standard-setting process to make FRAND commitments in the first place.

By its nature, standard setting involves collaboration among competitors and thus raises core antitrust issues. In this Feature, we argue that existing antitrust laws have an important role to play in ensuring that SSO rules are effective to prevent ex post opportunism. In Part I, we set forth the pertinent background regarding standard setting and the competitive process. In Part II, we explain why effective FRAND rules are needed to prevent exploitation by SEP holders of market power created by the standard-setting process, and we refute arguments that SEP-holder market power and holdup are not a serious problem. In Part III, we explain the important role that antitrust law can play in preventing and remedying anticompetitive violations of FRAND commitments and in ensuring that SSOs adopt effective FRAND rules. We explain in particular a heretofore overlooked reason why SSOs and their members can violate Section 1 of the Sherman Act (2) if the SSO fails to adopt and enforce rules that are effective to prevent SEP owners from exploiting the ex post monopoly power created by the standard. This Section 1 liability facing SSO participants and SSOs works alongside liability under Section 2 of the Sherman Act for unilateral conduct by SEP owners. (3)

  1. STANDARD SETTING AND THE COMPETITIVE PROCESS

    The fundamental economics in the information technology sector, driven by network effects, implies that there is enormous value associated with establishing compatibility standards. Popular standards include the mobile broadband standards used in cell phones, which are established by the 3rd Generation Partnership Project (3GPP), and the Wi-Fi technology for wireless local area networks, which is enabled by the 802.11 standard established by the Institute of Electrical and Electronics Engineers (IEEE). (4)

    There are many SSOs, and their rules and procedures differ considerably. In addition to IEEE, leading SSOs include the International Organization for Standardization (ISO), the International Telecommunication Union (ITU), the European Telecommunications Standards Institute (ETSI), the Internet Engineering Task Force (IETF), and the World Wide Web Consortium (W3C). (5) SSOs generally establish standards by holding a series of committee meetings among industry participants. These meetings culminate in a vote on a technical specification that describes what features or attributes a product must have in order to comply with the standard. Most SSOs are open to all industry participants and seek to operate on a consensus basis, applying certain voting rules. SSOs do not normally engage in patent licensing, nor do they specify how patent royalties will be divided up among patent holders. They leave that to their members, which in some cases form patent pools to address these issues. (6)

    SSOs adopt specific policies relating to intellectual property rights (IPRs). (7) These IPR policies are generally intended to enable the SEP holders to obtain reasonable royalties for licensing their patents, while prohibiting them from charging excessive royalties after other industry participants have committed to the standard. At that point, firms committed to implementing the standard--which we call "implementers"--would find it very costly to avoid using the patented technology. For this purpose, most SSOs require SEP owners to license their SEPs on FRAND terms. (8)

    FRAND policies are especially necessary because negotiations between SEP holders and implementers generally take place only after the implementers have used and infringed the technologies claimed by the SEPs. Standards involving information and communications technology can involve hundreds or even thousands of SEPs, many with uncertain boundaries for infringement. In addition, a time lag exists between patent application and patent issuance. For these and other reasons, it is impractical for implementers to enter into negotiations for patent licenses with all SEP owners prior to the establishment of a standard and to their implementation of it. (9)

    The fact that patent negotiations generally do not take place until after implementers have used and infringed the technologies has several critical implications. First, at the time of negotiation, implementers are locked into the standard and the technologies claimed by the SEPs--that is, the cost to switch to an alternative technology or standard at that point--ex post--is much greater than it was ex ante, before the patented technology was first included in the standard. Ex post, the patent holder is no longer competing to have its technology included in the standard, nor is it competing to have implementers of the standard use its technology. Instead, because the patent holder owns an asset that is essential to the standard, implementers have no choice but to use the patented technology. If the standard is commercially successful, implemented are willing to pay a much larger royalty for use of the patented technology than they would have paid ex ante, when the SEP holder faced competition from other technologies. In these circumstances, the SEP holder can be said to have obtained monopoly power in the market in which the patented technology is licensed for use in implementing the standard. (10)

    Second, because of lock-in and the implementer's ongoing infringement, the potential for litigation looms large in licensing negotiations. In effect, the parties are negotiating about how to settle an infringement suit, and that negotiation is heavily influenced by their predictions as to what the court will do if they cannot agree. This situation is not unique to SEPs; it arises frequently when firms are faced with patent infringement claims for products they have independently developed or technologies they have inadvertently infringed. Patent law addresses such instances by specifying that patent holders are entitled to "reasonable royalties," defined as the royalties that the parties would have negotiated prior to the infringement and thus prior to lock-in. (11) Those hypothetical ex ante royalties reflect the market value of the patent license. Notwithstanding the law's embrace of this principle, however, as a practical matter, patent holders are generally able to recover more than the ex ante value of the patent when litigation occurs after the implementers are locked in. Further, negotiations in the shadow of litigation after lock-in tend to result in royalties in excess of the ex ante or market value of the patented technology. (12)

    Third, the shadow of litigation is particularly problematic in the communications and technology sector, in which products typically include hundreds or thousands of patented technologies. A court-ordered injunction involving such products would deprive the implementer of not only the value of the technology covered by the patent-in-suit, but also the value of the entire product. (13) Implementers that are forced to bear the risk of an injunction are thus induced to agree to royalties greater than those that would be appropriate if only the value of the patented technology were at stake. Those royalties systematically provide SEP holders with excessive compensation in comparison with the benchmark of ex ante royalties.

    These implications of lock-in and ex post dealings are well-understood: they represent an example of the general concept of lock-in and opportunism developed by Oliver Williamson. (14) The Federal Circuit has also recognized the market distortions caused by the inclusion of patented technologies in public standards and the resulting danger of patent holdup involving SEPs. (15)

    For these and other reasons, the SEP holder has ex post monopoly power that, if left unchecked, would enable it to obtain royalties far in excess of the royalties that it could earn in a competitive market. (16) To address this common problem and limit ex post opportunism by SEP holders, SSOs typically require participants that own SEPs to make certain FRAND commitments. In particular, by requiring a commitment to license on "fair and reasonable" terms, the FRAND requirement aims to prevent, or at least reduce, the extent of monopoly pricing by SEP holders. And by requiring a commitment to license on...

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