With the growing geopolitical rivalry between the U.S. and China, the topic of technology leadership has come to the forefront of economic and national security concerns. How does a nation achieve or maintain technological leadership? It needs a healthy and thriving industry of invention fueled by private and public R&D investments in critical technologies.
Regulators, policymakers, and industry consortia are hard-pressed to recognize the merit and value of the inventions that establish the technological foundation of global standards such as 5G. How can this be done, not in an equal way, but an equitable way that rewards the toil and investment of inventors who research and develop the critical technologies that are the underpinnings of the future of our digital economy?
The War on Invention is a War on Innovation
Over the years, numerous dramas have played out in the courts around the world that have challenged the prevailing IP valuation and licensing methods of standard essential patents (SEPs), which have provided the technology foundation for each generation of the mobile network. Inventors have increasingly come under attack as licensees sue to dispute the basis of licensing and the royalties that they pay for the critical technologies that underpin their products and services.
More often than not, patent disputes in the mobile communications world concern the issue of FRAND (fair, reasonable, and non-discriminatory) licensing and the SEP holder’s right to seek reasonable royalties. While litigants like to conflate these topics as subjects of antitrust, the courts have clarified that FRAND licensing is a contractual matter between the inventor and the standard development organizations (SDOs) such as ETSI, TTA and the five other SDOs that are members of 3GPP. They are not matters of antitrust by nature.
The reality is the licensing of technology in the mobile communications world is a complex legal and economic policy matter. Yet, inventors suffer a constant uphill battle against the oversimplification of the topic of patent licensing in the courtrooms and by the industry media. This courtship with convenience has skewed the discourse about IP licensing in the public domain which must be corrected in order to duly consider what is fair for the inventor.
The “Top Down” Approach — Inequitable Equality
Prof. David Teece of the Hass School of Business, an authority on IP licensing and economics, has served as an expert witness in several IP licensing cases in the mobile communications industry. He cites the “Top-Down” approach as one of the common but deleterious methods for determining IP portfolio value pushed by litigants of patent licensing disputes. This methodology, as Teece states in his paper, “Patent Counting and the ‘Top-Down’ Approach,” is a “creation of litigants” that peddles three misconceptions that have muddied the waters of the valuation discussion for mobile communications IP:
- Misconception 1 – There should be a maximum aggregate royalty.
- Misconception 2 – Patents are of equal economic value.
- Misconception 3 – Royalties should be based on the “smallest saleable patent practicing unit.” (SSPPU).
Maximum cumulative royalty is a convention of the “Top-Down” approach that claims to address what is the “mythical problem of royalty stacking,” according to Teece. This angst about royalty stacking has little economic justification given that mobile communications IP are standards-based and subject to SDO terms of FRAND licensing. An implied regulatory ceiling on royalties undermines the value of SEPs given that the “Top-Down” approach is advanced by implementers who seek to minimize the royalties they need to pay for their products.
The “Top-Down” approach is further flawed in that it promotes the notion that patents are of equal economic and technological value which is simply not true. Nevertheless, the approach advocates patent counting as a “simple and consistent” mechanism to determine the apportionment of the royalty pie among multiple patent holders. Simply put, the patent holder with the most patents wins the biggest piece of the economic pie thus upsetting the economic incentive for invention in the industry.
The third common misconception promoted by the “Top-Down” approach is that technological inventions such as the 5G air interface are expressed physically in hardware and their value attributed to the smallest functional unit or SSPPU such as a modem chip in a connected car or smartphone. Fortunately for inventors, courts in the U.S. and in the EU have determined that the OEM implementer’s argument that licensing should be based on SSPPU was untenable and conflicts with prior approvals of more market-based methodologies that value patents based on comparable licenses.
The Long Tail of 5G Technology Value
In order to arrive at an equitable and accurate perspective on SEP licensing and valuation in the 5G world, we need to recognize three simple principles that have been affirmed by courts around the world in cases that have and continue to build a precedence for the mobile industry and beyond:
- Inventions are of heterogenous value.
- SEP holders can set the basis for royalties on the price of the end-device.
- Equitable valuation of patents should be based on comparable licensing or market-based approaches.
According to Teece, “patents have widely dispersed values” and quality. He further states that the “distribution of patent values is highly skewed” suggesting that most patents have very little or no value. Furthermore, only a small number of patents are of essential value to a technology standard such as 5G.
In regard to the basis of royalties, the courts have established that SEP holders are free to calculate their licensing fees based at the level of their preference including the market value of an end product. For example, the 5G air interface is realized through a complex system of user equipment (UE) and radio access network (RAN) software and hardware working in concert. Without essential 5G technologies, the smartphone does not provide the end user value and the end market value creation potential that it has today.
Finally, it is important to understand that market-based approaches to valuation are the viable and equitable ways to determine the value of SEPs. According to the Hudson Institute, the comparable license approach is the “gold standard” for benchmarking patent value that has managed to overcome the “Top-Down” approach in the courtroom.
A Healthy Invention Economy for a Competitive Innovation Economy
It is vital to incubate and nurture an industry of invention, not undermine it. Ensuring reasonable valuation of technological inventions that serve as the basis for 5G is in the national interest. Standards-based technologies such as 5G are universal and the essential inventions that form their foundation are global in scope and claim.
Undervaluing and underappreciating essential inventions for strategic technologies such as 5G can further the tech trade imbalance between the U.S. and China. This is why policymakers and regulators in the U.S. and around the world will want to support a high global standard for IPR and valuation today in order to continue nurturing a healthy invention ecosystem and secure the global value share that will sustain their technology leadership and contributions well into the future.
Leonard Lee is the founder and managing director of neXt Curve, a research advisory firm focused on Information and Communication industry and technology research. He has worked as an executive consultant and industry analyst at Gartner, IBM, PwC and EY and has advised leading companies globally on competitive strategy, product and service innovation and business transformation. Follow Leonard on LinkedIn: linkedin.com/in/leonard-lee-nextcurve
“Industry Voices” are opinion columns written by outside contributors—often industry experts or analysts—who are invited to the conversation by Fierce staff. They do not represent the opinions of Fierce.