SSPPU and Component Licensing: Assessing the Impact and Neutrality of Multiplication in Royalty Negotiations

1. Smallest salable patent practicing unit (SSPPU) and component licensing: Why $1 is not $1? Axel Gautier & Nicolas Petit Liège Université

2. Introduction • Courts use SSPPU and EMV in patent damages litigation • Provides base for assessing ex post the appropriate royalty revenue for technologies protected by patents in case of litigation • Policy question: extend SSPPU and component licensing in ex anteroyalty negotiations? • SSPPU+ • What would be the impact of this move? • Topic of this paper • Focus on royalty negotiations

3. Related literature • Comparison between ad-valorem and per unit royalties • Llobet and Padilla(2016) • Llobet, Layne Farrar and Padilla (2014) • Kamien and Tauman (1986) • Impact of SSPPU • Teece (2015) • Putnam and William (2016) • Starck (2015)

4. Why $1 is not $1 ? Judge Behavioral economist Mathematician

5. The neutrality of multiplication • Consider the following example • Handset with retail value $1,000 • Firm A has a patented technology included in the handset • Value of the technology = $50 (supposed to be known) • but common knowledge is an issue • Embedded in a chipset, produced at cost = $10 • EMV • Firm A will set a licensing rate of max 5% giving a payment of 0.05 x $1,000 =$50 • SSPPU • The licensing rate should be made by reference to smallest component, the chipset • Licensing fee of max 500% giving a payment of 5 x $10= $50

6. The neutrality of multiplication • For a mathematician $1 = $1 Royalty revenue = royalty base x royalty rate • A change in the royalty base can be compensated by a inversely proportional change in the royalty rate

7. Behavioral economics • Behavioral economics: decisions are based on heuristics • Anchoring effect • Agents make estimates by starting from an initial value and then make adjustments • Adjustments are systematically insufficient • Estimate biased to the initial value • ‘The anchor’ • Strongest heuristic in behavioral economy

8. Behavioral economics • Example (ctd’) • The reference is the end market value ($1,000) • Valuation estimate is likely to be high • The reference is the component value ($10) • Valuation estimate is likely to be low • For both the buyer and the seller

9. SEP bargaining (based on Sidak, 2013) Royalty payment • The bargaining range is the difference between the WTB and the WTS • The bargaining range is non-empty if WTB > WTS Licensee WTB =Surplus Bargaining range SEP holder WTS

10. SEP bargaining Royalty payment Buyer’s surplus Licensee WTB =Surplus Bargaining range Seller’s surplus Royalty point SEP holder WTS • Bargaining range = Surplus

11. Anchoring effect: application to SEP bargaining Licensee WTB $60 =Surplus Bargaining range $50 Royalty point Licensee WTB Seller WTS $40 =Surplus Bargaining range $30 Royalty point Seller WTS $20 SSPPU EMV Apportionment method

12. Anchoring effect • The anchoring effect is likely to change the royalty point in negotiation • But not : • The total surplus • The sharing of the surplus • Surplus of the parties remain constant • In addition: • Cognitive skills decrease the anchoring effects • Anchoring effects can be –partially– corrected in business negotiations

13. Judges and courts • Negotiation takes place in the shadow of litigation • Behavioral economics in courts • 500% is ‘high’, 5% is ‘low’ (unit effect) • 500% is digits-away from industry practice • Courts do not believe in the neutrality of multiplication • Cornell vs HP : jury agreed on a royalty rate (0.8%) then the judge proceeds to determine the SSPPU • Changed the definition from CPU Brick to processor without changing the royalty basis.

14. Judges and courts • Antitrust constraints • Excessive pricing (EU, China, Korea) • Prices which exceeds cost by 100% of value are unfair • Essential facilities rules • Obligation to license • Likely to monitor licensing terms and conditions • FRAND • Reference to « commercial practices in the field » which is a concern if the courts do not believe in the neutrality of multiplication

15. Price cap & revenue cap • Three-digit royalty rates will be considered to be problematic by judicial authorities • De facto price-cap on the royalty rate (r<rmax) • The combination of • A price cap on the nominal royalty • Component licensing • Leads to an implicit revenue cap on licensing Rmax = rmax x Component value

16. Consequences for SEP bargaining Royalty payment • With a revenue cap, the bargaining range and the surplus no longer coincide • Transfer of surplus to implementers • Unlike the anchoring effect, it goes in one direction Licensee WTB Surplus License point Revenue cap Rmax Bargaining range SEP holder WTS

17. Consequences for SEP bargaining • Technologies embodied in low cost components are more constrained than those embodied in high cost components • Redistribution between SEP owners • Impossibility of trade • If Rmax < WTS • Even if trade is profitable Rmax < WTS < WTB • Incentives to invest, to participate in a standard, to vertically integrate,…

18. Uniform pricing accross industries • What is the value of the 5G technology?

19. Uniform pricing accross industries • Different values accross industries • Different royalty revenues • Might be impossible if the revenue cap applies • Revenue cap = uniform pricing accross industries • Revenue is disconnected from value ! • Concern in General Purpose Technologies (GPT)?

20. Conclusions • SSPPU+ • Price cap on nominal royalty rate • Which combined with component licensing creates a revenue cap • Uniform pricing across industries • Consequences • Redistribution issues • Incentives to invest • Market structure • Will SSPPU+ become a standard?

21. Comments welcome Paper available on SSRN https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2954592