Repeated interaction in standard setting

• DOI: http://doi.org/10.1111/jems.12287
• Published date: 01 June 2019
• Date: 01 June 2019

Received: 2 March 2017

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Revised: 26 July 2018

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Accepted: 8 August 2018

DOI: 10.1111/jems.12287

ORIGINAL ARTICLE

Repeated interaction in standard setting

⁎

Pierre Larouche

1

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Florian Schuett

2

1

University of Montreal, Canada and

TILEC

2

Department of Economics, TILEC,

Tilburg University, The Netherlands

Correspondence

Florian Schuett, Department of

Economics, Tilburg University,

Warandelaan 2, 5037 AB Tilburg, The

Netherlands.

Email: f.schuett@uvt.nl

Funding information

Qualcomm Inc.; Mines ParisTech IP &

Markets for Technology Chair

Abstract

Standardization may allow the owners of standard‐essential patents to charge higher

royalties than would have been negotiated ex ante. In practice, however, standard‐

setting efforts are often characterized by repeated interaction and complementarities

among technologies. These features give firms that contribute technology to

standards both the ability and the incentive to avoid excessive royalties by

threatening to exclude other technology contributors from future rounds of

standardization if they charge royalties exceeding ‘fair, reasonable, and nondiscri-

minatory’(FRAND) levels. We show that such an outcome can be sustained as a

subgame‐perfect equilibrium of a repeated standard‐setting game and examine how

the decision‐making rules of standard‐setting organizations (SSOs) affect the

sustainability of FRAND royalties. Our analysis provides a novel justification for

super‐majority requirements and other rules frequently adopted by SSOs.

KEYWORDS

standardization, standard‐essential patents, FRAND royalties, royalty stacking, repeated games

JEL CLASSIFICATION

C73, L15, L24, O34

1

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INTRODUCTION

Technology standards are a pervasive feature of the information and communication technology (ICT) industries.

Standards can be welfare enhancing because they allow industry participants to coordinate on one of several potential

solutions, thereby harnessing network effects and avoiding duplication of investments. At the same time, there is a

concern that standardization may create artificial market power for the owners of intellectual property reading on the

standard. When several different technologies are able to perform the same function, competition among these

© 2018 The Authors. Journal of Cellular Physiology Published by Wiley Periodicals, Inc.

J Econ Manage Strat. 2019;28:488–509.488

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wileyonlinelibrary.com/journal/jems

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This is an open access article under the terms of the Creative Commons Attribution NonCommercial License, which permits use, distribution and reproduction in any

medium, provided the original work is properly cited and is not used for commercial purposes.

*We are grateful to Daniel Spulber (the editor), the coeditor, and three anonymous referees, whose comments have greatly improved the paper. For

useful comments and suggestions, we thank Cédric Argenton, Albert Banal‐Estanol, Jan Boone, Marc Bourreau, Jay Pil Choi, Sebastian Dengler,

Margaret Kyle, Jonathan Lee, Gaston Llanes, Noriaki Matsushima, Yann Ménière, Jeanine Miklos‐Thal, Jens Prüfer, Markus Reisinger, Pekka

Sääskilahti, Mark Schankerman, Emanuele Tarantino, Bert Willems, Nicolò Zingales, participants at the MaCCI conference (Mannheim, 2015),

EARIE (Munich, 2015), Searle Center Conference on Innovation Economics (Chicago, 2016), Conference on the Economics of ICT (Paris, 2017),

LCII‐TILEC Conference on Standard Setting (Brussels, 2017), CRESSE (Heraklion, 2017), and seminar audiences at the universities of Florence and

Tilburg. Both authors are members of the Tilburg Law and Economics Center (TILEC). For its research on competition, standardization, and

innovation, TILEC receives funding from Qualcomm Inc. Schuett gratefully acknowledges financial support from the IP & Markets for Technology

chair at Mines ParisTech. The research on which this paper is based was conducted in accordance with the rules set out in the Royal Dutch Academy

of Sciences (KNAW) Declaration of Scientific Independence. Olia Kanevskaia provided excellent research assistance. All errors are our own.

technologies can hold license fees in check. Standardization, however, often selects one particular technology to be

included in the standard. The patent on the technology then becomes standard essential, and its holder gains market

power because the standard effectively eliminates substitute technologies. This may allow the patent holder to charge

higher royalties than those that would have been negotiated ex ante, that is, before the adoption of the standard

(Dewatripont & Legros, 2013; Farrell, Hayes, Shapiro, & Sullivan, 2007; Ganglmair, Froeb, & Werden, 2012).

1

Standard‐

setting organizations (SSOs) have responded to this concern by imposing commitments to license on ‘fair, reasonable,

and nondiscriminatory’(FRAND) terms, which has been interpreted as reflecting an ex ante view (Swanson & Baumol,

2005). The vagueness of these commitments and the informational difficulties associated with their ex post enforcement

have led many observers to question whether they have much bite in restraining standard‐essential patent (SEP)

holders, however (Lerner & Tirole, 2015).

In this paper, we argue that two additional features of the standard‐setting process are important for understanding

whether SEP holders will comply with their FRAND commitments: technological complementarities and repeated

interaction. Products in high‐tech industries frequently combine several complementary technologies (Heller &

Eisenberg, 1998; Shapiro, 2001). This may lead to royalty stacking (better known to economists as the multiple‐

marginalization or Cournot‐complements problem): Because individual patent holders do not take into account the

effect of their royalties on the demand for licenses addressed to other patent holders, their royalty rates will tend to

exceed the level that would maximize joint profits. An important implication of this is that a high royalty rate on one

essential patent decreases the demand for the standard, and thus the profits of the remaining contributors.

In addition, the standard‐setting process is often characterized by repeated interaction. Many standards evolve over

time, with several generations of the standard succeeding each other, each building on the previous generation. The set of

standards for mobile communicationsisprobablythebest‐known example of this. In the 1990s, earlier mobile systems

were replaced by systems using Time Division Multiple Access (TDMA) and Code Division Multiple Access (CDMA),

like GSM and D‐AMPS.

2

In the 2000s, the sector moved to standards based on improvements of CDMA, such as UMTS and

CDMA2000.

3

At the time, it became increasingly common to refer to these standards in generational terms as 3G or third

generation.

4

A generation represents a new set of standards that is not backward compatible with the previous generation.

This generational view has now become so widespread that the current set of standards is known as 4G,

5

and work has

begun on the next generation, already christened 5G.

6

Roughly speaking, a new generation of mobile communications

standards ascends to primacy every decade. Each generation is characterized by significant technological improvement, as

translated in higher performance characteristics. 2G ushered in digital cellular technology, 3G strengthened data

communications, 4G marked the move to an Internet Protocol (IP)‐based network (where voice is merged with data

communication), and 5G is intended to support the data communications forecast with the Internet of Things.

As this brief description shows, in the ICT sector, standardization itself can no longer be seen as an ad hoc

phenomenon, but should rather be considered an institution. Once an activity or a functionality is successfully

standardized, established SSOs are expected to work continuously on maintaining and improving standards, and thus to

produce successive generations of standards over time. Next to mobile communications standards, industry players and

users are now accustomed to generations of standards regarding computing and communications equipment interfaces

(Universal Serial Bus [USB] and Bluetooth), local data communications (wireless fidelity [Wi‐Fi]), computer

components (random‐access memory [RAM]) or television. Importantly, often the same firms contribute to different

generations of the standard.

In this paper, we show that the combination of technological complementarities and repeated interaction can

restrain SEP holders in their exercise of market power. Complementarities mean that technology contributors have an

interest in keeping the royalty rates of other contributors low. Repeated interaction means that contributors are able to

discipline others that charge high royalties by excluding them from future generations of the standard. Indeed,

most SSOs are consensus building bodies whose decisions are made through some sort of voting procedure (Baron &

Spulber, 2018; Chiao, Lerner, & Tirole, 2007; Simcoe, 2012). This creates scope for participants to punish a contributor

who misbehaved by voting against the inclusion of its technologies in the next generation of the standard. Thus,

complementarities create the incentive and repeated interaction the ability for technology contributors to hold other

contributors’market power in check and ensure compliance with FRAND commitments.

We develop a stylized model of standard setting that captures the repeated nature of the process. After each generation

of the standard, thereis some probability that the standardwill evolve to another generation. In eachgeneration, there are

two perfectly complementary technologies

A

and

B

, neither of which have stand‐alone value. Technology

A

is developed

by a single firm, whereas technology

B

is developed in two competing versions by firms

B

1

and B

2

.Firm

B

1

makes the

more valuable version of the technology. Under hypothetical ex ante licensing, competition would drive the royalty rate of

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