The Internet of Things (IoT) continues to develop and expand at an ever-increasing rate—every day, another product becomes “connected” in one form or another. As the next generation of cellular standards (5G) becomes more widely deployed, licensing of 5G Standard Essential Patents (SEPs) for IoT will become increasingly important.
In addition to the complexity introduced by licensing disparate end products in the IoT space, the limited and unpredictable law of SEP licensing in the United States under Fair, Reasonable, and Non-discriminatory (FRAND) terms presents substantial uncertainty for a SEP holder in developing an appropriate strategy and protocol for licensing its patents.
In view of this, companies with 5G SEPs should proactively develop a patent licensing strategy now to confront the unique challenges presented by IoT. This article identifies some of the considerations that SEP licensors should explore in formulating an efficient and productive 5G SEP IoT licensing strategy.
Overview of Telecommunication Standards
Standard-setting organizations (SSOs) develop technical standards through a collaborative process with their members, many of which are technology companies conducting extensive (and costly) research and development. These technology companies oftentimes receive patents for inventions that result from that research and development—the very same features that are incorporated into these important technical standards.
In an effort to encourage widespread adoption of standardized technologies that use these patents, SEP holders participating in standards development contractually obligate themselves via the SSO’s policies to license their SEPs on FRAND terms.
Wireless networks and their corresponding standards have existed for nearly 40 years, with each new standard offering increased speed and efficiency, while simultaneously adding new features, such as multiplexing, digital broadcasting, and data transfer. As a result, each new standard contributes significant value to our wireless devices.
The first commercially automated cellular network (first generation or 1G) was launched in Japan in the late 1970s. The second (2G) and third (3G) generation standards were developed in the 80s and 90s, respectively, mainly by established technology companies that were direct competitors. These companies were similarly situated with one another, in both technical and consumer-centric ways, meaning that each company was both knowledgeable of its competitors and had a need and desire to cross license their patent portfolios on foreseeable and reasonable terms to provide “patent peace” and freedom to operate in this important market.
By cross licensing their respective technologies, these competitor companies were able to benefit from lower effective royalty rates—sometimes enjoying “zero-zero” cross licenses.
As the communications industry transitioned to 4G (and to a similar extent, Wi-Fi), new, non-direct competitors began using the 4G standard. For example, manufacturers began including 4G capability in everything from luxury cars to household appliances to cameras. But these devices came from a variety of very different industries with dramatically different price points and divergent sets of features. This created new licensing challenges as traditional telecommunications companies began competing with companies that were historically non-competitors as well as new technology companies and technologically adjacent companies.
Because these companies did not often have good product-patent alignment, problems resulted and cross licenses were no longer necessary and became less common.
5G SEP Licensing Challenges
These licensing challenges are expected to persist—and likely increase—as IoT use expands into more diverse products and as companies incorporate 5G technology in these products at an ever-increasing rate.
With this backdrop, disputes and litigation may increase, particularly as licensing becomes more one-sided (i.e., where a cross license is not available or acceptable, based on product-patent misalignment or the fact that the patent owner does not make its own products). Advanced planning by licensors will curtail litigation, saving the licensor time and money, and reducing risk. That time is now—the standalone version of the 5G standard was ratified in June 2018 and an SEP licensor’s delay in considering and developing its SEP licensing plan may leave it at a disadvantage as licensing 5G technology for IoT products begins in earnest and continues to expand.
With these challenges in mind, we will consider a hypothetical technology company that has a portfolio of SEP patents essential to the 5G standard and wishes to establish a licensing strategy for its SEP portfolio. Imagine that, like many companies in the 5G space, this hypothetical SEP licensor is not perfectly aligned with most of its prospective licensees. Therefore, it must understand and plan for a variety of issues that may arise during licensing discussions.
Consider How to Structure Your Opening Offer
An SEP licensor must decide how to most effectively structure its opening offer.
For example, our hypothetical licensor must decide whether to merely invite negotiations, provide a specific list of patents to be licensed, and/or propose a specific rate in advance. Each of these decisions comes with tradeoffs, especially in the IoT space. Inviting negotiations, without proposing specific patents or a rate, is attractive if a licensor wishes to negotiate privately or under an NDA, or if the licensor does not have sufficient insight into the business or product of the potential licensee (which may often be the case in the IoT space). But such an opening offer is less likely to get the attention of a licensee and may make it more difficult to advance discussions in a meaningful timeframe, especially if the licensee does not have its own patents to cross license and is faced with a higher effective royalty burden (which, again, may be the case in the IoT space).
As another example, listing specific patents is helpful in putting a party on notice for damages in litigation, but doing so may eliminate the element of surprise and invite preemptive challenges of those patents by the prospective licensee, including at the Patent Trial and Appeal Board or by a declaratory judgment action. And while disclosing a specific rate in advance may support an argument that the SEP licensor is fair and reasonable and that every similarly situated prospective licensee is receiving the same offer, the diverse nature of the products in the IoT space may result in a proposed rate being challenged for reasonableness, which could form the basis for a breach of contract claim or otherwise generate a FRAND defense.
Ultimately, an SEP licensor needs to carefully consider how any offer might affect negotiations (or litigation) and adapt its planned program accordingly.
Consider Royalty Rate Structures
One challenge for our hypothetical licensor is how to structure its desired royalty payments. Like we have seen in the context of prior standards, as traditional non-competitors become competitors in the IoT space, there necessarily will be a collision of different licensing schemes, structures, and practices. Per-unit payments may be more desirable and/or reasonable in one industry, whereas a royalty as a percentage of end-product sales may be more appropriate in other industries.
In addition to these considerations, business customs, profit margin, significance of patent pools and their pricing means, aggressiveness of companies in the field, and even projected growth or contraction of the particular industry will come into play when setting a royalty rate structure.
For example, in high-sales-price, stable industries, our hypothetical SEP licensor may prefer a percentage-based royalty for IoT products instead of a fixed fee. In contrast, our licensor might be opposed to a running royalty percentage for a licensee whose IoT products are expected to be commoditized with a decreasing price over time.
During license negotiations with such a licensee, at the very least, our hypothetical licensor might consider negotiating a higher royalty rate initially to accommodate estimated reductions in royalties over time, or a set of price tiers for which different per-unit amounts would apply. Ultimately, in the IoT space, with a wide variety of manufactures (with a correspondingly wide range of prices for their products), SEP licensors setting up an IoT licensing program should aim to balance their needs as an innovator with that of the licensee to fully maximize use of the SEPs and should craft a flexible strategy that can adapt to a diverse set of licensees.
Consider the Royalty Base
Another important consideration is how to define the royalty base.
For example, do the patents of our hypothetical 5G licensor cover only a small component of an IoT end product device (such as a chip in a connected dishwasher), or do the claims cover a product more broadly (such as a “mobile terminal”)? The answers to these questions can produce dramatically different results for a licensor as it sets up a licensing program.
And the effects reach beyond the simple royalty calculation—they also impact how a licensor determines whether two companies with IoT products are similarly situated such that they should receive the same royalty offer under the “non-discriminatory” aspect of FRAND licensing. Ultimately, these decisions will be driven by the scope of the claims being licensed, but their downstream impact cannot be ignored when licensors consider licensing in the IoT industry.
Stay Current on the Evolving Nature of FRAND Law
As SEP licensors consider their IoT licensing program, they also need to remain flexible and monitor and adapt to changing case law. Uncertainty surrounding FRAND royalty obligations and methods of calculating FRAND rates increases risk for all involved entities, and an active strategy is the optimal way for reducing potential risk.
To date, there have been only a few cases in the United States in which a FRAND rate was set, and each of the cases has utilized different techniques and produced rates. Thus, it is essential that our hypothetical SEP licensor frequently assess and possibly modify its licensing strategy in light of new developments. The following description provides a brief summary of the current law, including the uncertainty with respect to FRAND licensing.
In the first FRAND rate case, Judge Robart in Microsoft v. Motorola adopted a modified hypothetical negotiation based on a subset of the Georgia-Pacific factors, a framework for SEP license assessments. Judge Holderman in the Innovatio IP Ventures case largely adopted this framework, but the analysis differed in a few important ways. For example, Judge Holderman set only a single rate for the SEPs rather than setting a range of rates, as Judge Robart did in Microsoft. And, significantly, Judge Holderman determined the royalty base as the smallest salable unit—the Wi-Fi chip—instead of the net selling price of the accused products, as in Microsoft. In the end, the royalty rate in Innovatio was approximately three times that set in the Microsoft case for the same standard.
In Ericsson v. D-Link, the Federal Circuit reversed and remanded the jury’s FRAND determination. The Federal Circuit took issue with the jury instruction describing an unmodified Georgia-Pacific analysis. The Federal Circuit stated that “many of the Georgia-Pacific factors simply are not relevant; many are even contrary to RAND principles” and “courts must consider the facts of record when instructing the jury and should avoid rote reference to any particular damages formula.” Thus, the Federal Circuit generally endorsed the modified Georgia-Pacific approach used in Microsoft and Innovatio, but did not identify a specific set of factors that must be analyzed by a district court.
Another tension in FRAND licensing is whether to employ a “bottom-up” or “top-down” approach. Judge Selna in TCL v. Ericsson employed a “top-down” approach, in which the court or jury identifies the proportional value attributable to a particular SEP out of the aggregate royalty attributable to the standard as a whole. In contrast, other courts traditionally have employed a “bottom-up” approach, in which the value of particular SEPs is assessed in isolation by evaluating the alternatives that could have been incorporated into the standard in place of the existing patented technology. It is unclear which approach will be used in the future as well as which method will be best for a SEP licensor in particular cases.
Just recently, in FTC v. Qualcomm, Judge Koh found that Qualcomm has a duty to license its SEPs to rival modem chip manufacturers because Qualcomm “engaged in a voluntary course of dealing with its rivals” even though Qualcomm had consistently refused to license its SEPs to them. The impact of the FTC v. Qualcomm decision is not yet clear, but an obligation to license to competitors (and potentially licensees at different levels of the supply chain) could further complicate SEP licensing.
In light of these relatively few decisions and the different approaches to determine FRAND rates, establishing a FRAND licensing program, particularly in the IoT context, is a challenging process. Indeed, as courts continue to wrestle with these challenges, other decisions—and other methods of calculating and evaluating FRAND obligations—will make monitoring these cases and adapting a licensing program accordingly even more important.
In the end, flexibility and vigilance are key for any successful SEP licensor. An SEP licensor will benefit most by developing and revising a streamlined licensing plan with an aim of reducing its litigation burden, particularly as the likelihood of patent litigation increases with the continued emergence of IoT.
Steven Pepe is a partner in the intellectual property litigation practice of Ropes & Gray in New York.
Kevin J. Post is a partner in the intellectual property litigation practice of Ropes & Gray in New York.
Lance W. Shapiro is an associate in the intellectual property litigation practice of Ropes & Gray in New York.