Antitrust & Competition Policy Blog

Editor: D. Daniel Sokol
University of Florida
Levin College of Law

Wednesday, November 6, 2019

SEP Royalties: What Theory of Value and Distribution Should Courts Apply

Alexander Galetovic, Universidad Adolfo Ibáñez; Stanford University - The Hoover Institution on War, Revolution and Peace; University of Padua - CRIEP and Stephen Haber, Stanford University - Hoover Institution and Political Science theorize about SEP Royalties: What Theory of Value and Distribution Should Courts Apply.

ABSTRACT: Courts are often required to determine the royalty to which the owner of a FRAND-encumbered standard essential patent (SEP) is entitled. We argue that in adjudicating the value of SEPs, courts should do what they do in pricing other assets or the flows of income they produce: rely on information from the market about the value of comparable assets or their rental rates. In short, they should inquire about the observed royalty base and rate charged in the market by a SEP licensor to a different licensee, and make adjustments to account for differences in circumstance, such as the timing of the license.

The practical logic for doing so is straightforward: a royalty is simply the rental price of an asset created by investments in R&D. It is no different from other assets that courts value by inquiring about their market price, such as real estate, inventories, art collections, music catalogs, or personal business assets. The conceptual logic is also straightforward: the comparable method is based on price theory, the basic building block of microeconomics, which explains where value comes from and how it is distributed among factors of production, including intellectual property.

We argue that courts should not employ the “bottom up” and the “top down” techniques of royalty apportionment. Both are based on the theory of patent holdup and royalty stacking, which assumes that any observed royalty is the result of “excessive royalties” wrought by the additional monopoly power conferred by standardization through patent holdup and royalty stacking. This theory has been shown to be logically inconsistent and logically incomplete, and its predictions have been rejected by systematic empirical tests. Bottom up techniques cannot actually be operationalized. Top down techniques were invented in order to address this limitation, but employing them requires a court to reject the implications of price theory.

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