Patent royalties in the IoT industry:

An economics perspective
Prof. Dr. Joachim Henkel

Conference Component-Level SEP Licensing

Brussels 12 November 2019

Prof. Dr. Joachim Henkel | Patent royalties in the IoT industry | Brussels, 12 Nov 2019 1
Patent licensing in the IoT: What is different?
Diversity of applications and needs
• E.g., production robots vs. weather sensor

Less of a need for global compatibility

• Local, insular solutions partly viable (e.g., network within one factory)

 Diversity of technological solutions

 Closer collaboration of technology providers – vendors and operators – with device makers
needed

High technological uncertainty

• New use cases coming up regularly
• Opportunities for startups

Prof. Dr. Joachim Henkel | Patent royalties in the IoT industry | Brussels, 12 Nov 2019 2
 Agenda

1 Specificities of patent licensing in the IoT

2 The amount of FRAND royalties

3 Component or product level licensing

4 Conclusion

Prof. Dr. Joachim Henkel | Patent royalties in the IoT industry | Brussels, 12 Nov 2019 3
FRAND royalties
Basis for determination of FRAND: EC Guidelines for Applicability of Article 101, § 289:

Fees should “bear a reasonable relationship to the economic value of the IPR […]”

“it may be possible to compare the licensing fees charged by the company in question for
the relevant patents in a competitive environment before the industry has been locked into
the standard (ex ante) with those charged after the industry has been locked in (ex post).”

Prof. Dr. Joachim Henkel | Patent royalties in the IoT industry | Brussels, 12 Nov 2019 4
Not proportional to device price
IoT solutions are integrated in devices that are not mainly communication devices.
• Value contribution of IoT capability to expensive device may be very small.

Reference to device price invites excessive royalty demands:

• Weaker negotiation position of device maker (small relative increase in cost).
• Courts may find royal rates of 0.001% for patent portfolio “small enough.”

 Device price not a basis for determination of FRAND royalties.

 If licensing on device level, need to analyze specific value contribution.

Prof. Dr. Joachim Henkel | Patent royalties in the IoT industry | Brussels, 12 Nov 2019 5
Not related to stage in value chain
The economic value of a technology embodied in a device is realized by the end user
(consumer or firm).

In this sense, a component does not have differing values on different stages of the value
chain.

 Given the component’s final use, the amount of FRAND royalties should be independent
of where they are charged.

Prof. Dr. Joachim Henkel | Patent royalties in the IoT industry | Brussels, 12 Nov 2019 6
Not the incremental value
Argument: “A licensee’s maximum willingness-to-pay for a technology (including its patents)
is that technology’s incremental value to the product.”

Correct only in simple cases.

Incorrect if several technologies are complementary to each other.

• E.g., the incremental value of the battery to a smartphone is close to 100%
since without a battery a smartphone is hardly usable.
• However, a buyer’s maximum willingness-to-pay for the battery is much lower than the
price of the smartphone.

 To determine a technology’s value contribution one needs to consider overall device value,
all components, and their interaction in creating use value.

Prof. Dr. Joachim Henkel | Patent royalties in the IoT industry | Brussels, 12 Nov 2019 7
Royalty stacking, hold-up
For IoT as for other communication technologies, royalty stacking and hold-up are issues.

Royalty stacking due to often large number of licensors:

• Patent pools
• Individual practicing patent owners
• Privateers
• Other Patent Assertion Entities

 Negative externalities
 Result: Slowed-down adoption; excessive license demands (Cournot 1838)

Hold-up: Royalty demands often only after standard adopted & adopters have switching cost.

 In determination of FRAND royalties, consider (hypoth.) ex-ante situation with competition.

 Positive example: MPEG LA; declared royalties right after standard establishment.
Prof. Dr. Joachim Henkel | Patent royalties in the IoT industry | Brussels, 12 Nov 2019 8
Price discrimination
Value contribution of a communication component for a given standard varies between
products  Case for price discrimination.

Possible on device level, component level, or intermediate stages.

Limited by requirement of “fair and reasonable” royalties in case of FRAND licensing.

Device level:
• Potentially more accurate.
• But: high complexity due to diversity of devices; correctly accounting for value
contribution difficult or impossible.

Component level:
• Higher value contribution of the standard often reflected in components of higher
quality and higher price.
• Better quality of component directly linked to higher value from patented technology.
• Much simpler due to small number of component vendors.
Prof. Dr. Joachim Henkel | Patent royalties in the IoT industry | Brussels, 12 Nov 2019 9
Price discrimination on component level
Techrankup.com (2 Nov 2019):
48 different smart phone processors
with differing performance

Differing prices good basis for

price discrimination of SEP licenses.

Capture standard-related ……
differences between devices rather ……
than those stemming from screen,
camera, marketing differences.

Prof. Dr. Joachim Henkel | Patent royalties in the IoT industry | Brussels, 12 Nov 2019 10
 Agenda

1 Specificities of patent licensing in the IoT

2 The amount of FRAND royalties

3 Component or product level licensing

4 Conclusion

Prof. Dr. Joachim Henkel | Patent royalties in the IoT industry | Brussels, 12 Nov 2019 11
Licenses on all stages of value chain
Actors on all stages of the value chain have the right to a FRAND license (cf. Kühnen, 2019).

Who pays?
• In principle, overall royalties could be split between stages. BUT:
• Highly intransparent; temptation to charge higher amount in total.
• Multiplies transaction cost for contracting, monitoring, paying.
 Single-stage royalty charging only sensible solution.

How do other stages obtain a (free) license?

• Individual licenses. But: even for free licenses high transaction cost.
• General commitment (covenant not to sue/enforce). Problematic:
• How to define who is to pay and who receives a free license? What if e.g. a product can be
a final product but can also be integrated into other products?
• Legal certainty? Covenants not to sue typically highly specific to situation at hand.
• Component-level licensing: Simple solution; license comes with component.
 Component-level licensing best way to ensure all actors are licensed.

Prof. Dr. Joachim Henkel | Patent royalties in the IoT industry | Brussels, 12 Nov 2019 12
Transaction cost: Wi-Fi devices at Amazon
Search for “Wifi” on Amazon.de yields “over 70,000 results” in 30 departments

Prof. Dr. Joachim Henkel | Patent royalties in the IoT industry | Brussels, 12 Nov 2019 13
Transaction cost: Wi-Fi chipset manufacturers
1. Broadcom
2. Qualcomm Atheros
3. MediaTek
4. Marvell
5. Intel
6. Realtek
7. STMicroelectronics
8. NXP
9. Texas Instruments

Source: Global Wi Fi Chipsets Market Report 2019, Garner Insights

Prof. Dr. Joachim Henkel | Patent royalties in the IoT industry | Brussels, 12 Nov 2019 14
Transaction cost
For communication technologies, typically:
• Few component manufacturers; competent in technology.
• Huge number of device makers; typically unable to evaluate royalty demands.

For consistent licensing at device level:

• Huge transaction cost: Identification, negotiation, contracting, monitoring.
• E.g.: With 1000 device makers, 20 patent holders: 20,000 licenses.
• Difficult for small firms  entry barriers.

 Ensuring that all makers of IoT devices are consistently licensed (“ND” in FRAND)
is impossible with device-level licensing.
 On component level, small number of licensors makes consistent licensing of all actors on
all stages of the value chain possible.

Note: Question addressed by Padilla & Wong-Ervin (2017, The Antitrust Bulletin).
They do not consider larger number of device makers, however.
Prof. Dr. Joachim Henkel | Patent royalties in the IoT industry | Brussels, 12 Nov 2019 15
Arbitrage
Possibility of arbitrage complicates device-level licensing further.
• E.g., smartphone with screen mirroring in the car.

For a device that can be used stand-alone or integrated into a larger product:
• Where to license?
• How to trace the final use?

 Again, if consistent licensing is the goal, component-level licensing is preferable.

Prof. Dr. Joachim Henkel | Patent royalties in the IoT industry | Brussels, 12 Nov 2019 16
Competition intensity
Intensity of competition affects prices – both in component and in device industry.

Needs to be taken into account in determining royalties.

Fixed per-unit royalties increase variable cost, so would not be competed away.

Prof. Dr. Joachim Henkel | Patent royalties in the IoT industry | Brussels, 12 Nov 2019 17
 Agenda

1 Specificities of patent licensing in the IoT

2 The amount of FRAND royalties

3 Component or product level licensing

4 Conclusion

Prof. Dr. Joachim Henkel | Patent royalties in the IoT industry | Brussels, 12 Nov 2019 18
Conclusions
Amount of FRAND royalties
• Value contribution to device (not incremental contribution – complementarities)
• Not proportional to device price, not related to stage in value chain
• Price discrimination limited by “FR” requirement
• Associated with quality and thus price of component

Component- vs. device-level licensing

• Device-level licensing
• Royalty determination potentially more accurate
• However, need to account correctly for all value contributions to the device;
difficult to impossible to implement consistently
• Component-level licensing
• Royalties directly tied to implementation quality of patented technology
• Much lower transaction cost
• Also startups and small-volume device makers are licensed
• Actors on all stages of value chain are licensed consistently
Merci
Prof. Dr. Joachim Henkel | Patent royalties in the IoT industry | Brussels, 12 Nov 2019 19