Approaches To Pricing Standard Essential Patents

April 27, 2023
- Standard Essential Patents (SEP)

Standard essential patents (SEP) claim an invention that must be used to conform to an accepted technical standard in the industry. These standards are generally created by companies that are part of Standard Setting Organizations or SSOs. The company holding a SEP is obligated to comply with FRAND terms (Fair, Reasonable, and Non-discriminatory) when licensing SEPs to other businesses that seek to implement the standard.

Evaluating SEP Royalty Rates

While a SEP holder is obligated to offer licensing under FRAND terms, there are no definitive guidelines monitoring the process. Since the patent holders are under no compulsion to license the product, their say on the matter is final. The royalty rates, if the SEP holder chooses to license the product, vary based on conditions. The IP portfolio, parties involved, expected sales, and cross-licensing prospects are some factors that determine the royalty rates.

Top-Down and Bottom-Up Methods

There are two common methods employed to evaluate a fair royalty rate that would be agreeable to both parties:

The top-down approach assesses the standard’s aggregate value, which is then apportioned by the value attributable to the implemented standard. It thus works by evaluating the collective value of a standard, as opposed to calculating the value of individual patents. Once a royalty percentage is determined, it is then allocated to the SEP owner based on the proportional contributions of that SEP to the standard.
In mathematical terms, the numerical ratio used to determine the share of the SEP holder is the number of SEP holder’s SEPs covering the standard divided by the total number of SEPs covering the standard. So, if a standard contributes 20% of a product’s value, a patent owner controlling 40% of all SEPs to that standard would be allocated 2% of the value of each such product.

The bottom-up approach assesses the value of individual SEPs independent of other essential patents. This assessment generally follows the modified Georgia-Pacific factors set forth by Judge Robart in Microsoft v Motorola:
- Using comparable licenses to determine the FRAND licensing rates
- Value of the patented technology apart from the standard
- The overall contribution of the patent to the standard
- Contribution of the patented technology to the product without taking into account the value of the standard.

This approach is applicable only when a comparable license is available that may be used as a reference. This reference license must also be technologically and economically comparable for the method to be valid.

Bottom-Up vs Top-Down Approach

Both approaches have their share of laurels and criticisms. Some of the pros and cons of each are:

The Bottom-Up approach is seen as instrumental in preventing the accumulation of monopolistic powers in the hands of the SEP holders and encouraging a competitive market. It thus helps mitigate patent hold-ups and royalty stacking. But this approach suffers from some serious flaws. It is often difficult to determine comparable licenses, as each company strives to make distinctive products with both legacy and new features. For the licenses to be truly comparable, the conditions like bargaining powers of the parties, terms, and conditions of the comparable license, etc., must be considered. It is also difficult to separate the value of a technology and the value of the standard in which it operates.
The top-down methodology has enjoyed popularity in SEP royalty calculation. Since the total aggregate royalty is explicitly determined, the top-down method averts the royalty stacking problem. This approach was used for calculating the FRAND royalty rate in TCL v. Ericsson but was later reversed by the Federal Circuit. While this approach may yield consistent results, it is subject to the inputs being accurate. That is where the foremost problem arises. There is no way for researchers to accurately determine the aggregate, one-way royalty rates for all SEPs reading on any given standard since this information is mostly confidential. Similarly, there can be variations in the royalty base and total number of actual essential SEPs.

Conclusion

As litigation in determining the FRAND rates increases, there is a need for standardization. Both the existing approaches have their advantages and disadvantages. The solution perhaps could lie in combining the two to create a hybrid model that could correct the current flaws and reveal a more mutually acceptable resolution for licensing issues.

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