Intellectual Property and Compatibility Standards: A Primer
First Monday

Intellectual Property and Compatibility Standards: A Primer by Tim Simcoe



Contents

Introduction
Intellectual Property in Industry Standards
The Hold–Up Problem and SSO IPR Policies

 


 

Introduction

Voluntary standard setting organizations (SSOs), such as those certified by the American National Standards Institute (ANSI), are an important venue for achieving compatibility and inter–operability in information technology markets. These groups provide a forum where industry participants perform collaborative research and discuss the merits of alternative technologies. The goal is to identify the best available solution for a given problem. Ultimately, SSOs choose a particular technology and issue a formal endorsement. This certification is meant to signal the end of deliberations and promote industry–wide investments in the new standard [1].

A widely recognized problem for SSOs is the treatment of intellectual property rights. When an SSO promulgates a standard that turns out to utilize proprietary technology, it can leave the market in a precarious position and possibly damage the SSOs’ reputation. Consequently, most SSOs require participants to disclose patents during the standard–setting process, and many will only endorse a standard if patent holders commit to license their intellectual property (IP) on “reasonable and non–discriminatory” or RAND terms.

This first half of this paper documents a large increase in the amount of intellectual property disclosed to SSOs over the last twenty years. We discuss several possible explanations for this trend, including changes in patent policy; an increase in standards production; the outcome of specific court cases; and, changes in the technology development process.

The second half of the paper argues that RAND licensing commitments are not a workable solution to SSOs’ intellectual property problems. The problem with RAND is that it is very difficult to define (let alone measure or adjudicate) “reasonable” prices [2]. The cost of this uncertainty is potentially very large. Beyond the obvious costs and delays associated with litigation, IP holders may hesitate to embed their technology in a voluntary standard, and vendors may hesitate to implement such a standard when costs are unclear and litigation likely. We conclude by describing two possible alternatives to the policy of requiring RAND licensing commitments.

 

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Intellectual Property in Industry Standards

The voluntary standard setting process dates back to at least the late 1800’s and the rise of modern network industries (e.g. electricity, rail transport and telecommunications). Formal standards developing organizations, such as the International Telecommunications Union (ITU) and the Institute for Electrical and Electronics Engineers (IEEE), were created to provide a forum for industry–wide coordination on technical issues that might affect all industry participants. Many of these groups adopted intellectual property policies that compel members to disclose patents if they might cover essential elements of a proposed standard.

Between 1980 and 2004 there was a dramatic increase in the amount of intellectual property disclosed to standard setting bodies. This is illustrated in Figure 1, which is based on disclosure data from nine SSOs [3]. This trend reflects an increase in disclosure at established SSOs (e.g. IEEE and ITU) and the rise of new forums, such as the Internet Engineering Task Force (IETF) and World Wide Web Consortium (W3C).

 

Figure 1: Total IPR Disclosures
 
Figure 1: Total IPR Disclosures.

 

Figure 1 is based on Simcoe (2006), which examines a number of standard measures of the importance of disclosed patents. The data reveal that patents disclosed to SSOs contain 6.7 more claims than an average patent from the same technology class, are 22 percent more likely to be part of a “family” of international patents, and are 7 to 10 times more likely to be litigated.

What’s Going On?

There are several plausible explanations for the large increase in IPR disclosure at SSOs. Broadly speaking, these explanations include the increase in patenting, an increase in the demand for new standards (largely caused by the Internet), changes in the legal environment, and changes in the industrial organization of new technology development. The remainder of this section briefly discusses these four factors.

Perhaps the most obvious explanation for the increase in IPR disclosure is that it is driven by the “patent explosion” that has occurred in the United States [4]. However, the size and timing of the change in IPR disclosures suggests that this is not the only explanation. Figure 2 compares the IPR disclosure rate to the five, ten, and seventeen year stock of U.S. patents (normalizing this ratio to one in 1983 for comparison). It shows that IPR disclosures are growing significantly faster than the patent–stock. Comparing disclosures to the number of patent grants reveals a similar pattern.

 

Figure 2: Disclosures Normalized by U.S. Patent-stock
 
Figure 2: Disclosures Normalized by U.S. Patent–stock.

 

Of course, the impact of increased patenting is amplified by any increase in the number of standards produced. The Internet has clearly led to an increase in standards production, primarily because it is a general purpose technology that provides a platform for delivering a host of different applications, each requiring their own protocols and specifications.

Case law and public policy have also had an impact on the amount of IPR disclosed in the standard–setting process. The two most important cases were the FTC’s antitrust actions against Dell and Rambus, and a great deal has been written about each of them. The central message of both cases is that firms that fail to disclose their intellectual property, or worse attempt to manipulate the disclosure process, may forfeit their property rights.

On the policy side, there has been a resurgence of patent pools following the 1995 publication of the DOJ/FTC “Antitrust Guidelines for the Licensing of Intellectual Property” [5]. These guidelines encouraged collaborative licensing arrangements — subject to antitrust review — to help solve the “thicket” problem that emerges when a group of essential patents is widely distributed among firms in an industry [6]. Patent pools provide a mechanism for generating revenue from standards–related IPR. Moreover, this mechanism allows small firms to capture value from their patents without having to enter cross–licenses negotiations with much larger customers and/or rivals. Patent pools therefore create incentives for small firms to disclose more in order to ensure they don’t lose the opportunity to use their IPR.

A final explanation for the increase in IPR disclosure at SSOs is that there has been a profound shift in the new technology development process. In the days of incumbent telephone monopolists and large integrated hardware/software vendors, the companies who developed new technologies also commercialized them. Cooperation in standards development was easy for these firms since there were only a few of them, they were relatively symmetric, and competition occurred downstream from standard–setting/product–development — primarily in sales and delivery.

Today, things are different. There are many more small entrepreneurial firms that specialize in technology development. Most of these companies commercialize their inventions via the technology input market (i.e., licensing) or the market for corporate control (i.e., buyouts). These smaller and more specialized firms continue to benefit from the creation of standards that open up new markets. However, they often have a much stronger interest in whether their own technology becomes part of the industry standard. Unlike their large vertically integrated counterparts, these firms cannot capture any of the value created by a standard through participation in the downstream product and service markets. As a result, the business model of these firms is more likely to rely heavily on IPR.

All of these explanations for the increase in IPR disclosure are plausible. Unfortunately, it is not possible to test their relative importance with the data at hand. While this places some limits on what we can claim to know about the increase in IPR disclosure, it also brings us to a larger and more important question: are the IPR policies of established SSOs well suited to handle the increasing volume of disclosures?

 

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The Hold–Up Problem and SSO IPR Policies

Why do SSOs require their members to disclose patents and potentially license them on “reasonable” terms? The answer lies in what economists call the “hold–up” problem [7].

Imagine that a group of firms must choose one of two technologies to adopt as the industry standard. The technologies are perfect substitutes (i.e. prospective users are indifferent between them). Once a standard is chosen, firms will invest a great deal of time and money in designing new products and services based on that technology. Switching back would be expensive. The hold–up problem occurs when a standard is chosen, investments are made, and the winning technology turns out to be patented. At that point, a patent holder can charge royalties up to the switching costs (and perhaps even more) before firms will reconsider their decision on standards. Thus, a patent that is worthless prior to standardization — given the existence of a perfect substitute — may become quite valuable if an endorsement by an SSO leads to substantial technology–specific investments [8].

If SSOs or their members are forward–looking, why don’t they anticipate the hold–up problem and work to prevent it? One natural solution would be to negotiate royalty payments with any prospective licensors ex ante — before technology–specific investments make potential substitutes less attractive. In fact, SSOs have taken a number of steps in this direction. Most SSOs require their members to disclose any patents they believe might be essential to implement a standard and to license these patents on “reasonable and non–discriminatory” or RAND terms [9].

Ironically, the problem with RAND is that it is not a standard. The concept of “reasonable” pricing has no clear meaning: Is RAND a commitment not to seek an injunction against the use of a technology? Is it a commitment to accept a certain percentage of the final good’s price, or a commitment that all patents incorporated in the product will split a certain percentage? How should a RAND price be set? In some cases, it seems that IP holders make RAND pricing commitments with the belief that the commitment is so vague and ill–defined that it is in fact vacuous [10]. While the meaning of RAND is currently the subject of litigation, it is hard to imagine this will yield a definitive answer [11].

As for individual firms, there are several reasons why they often fail to conduct a comprehensive patent search before implementing a new standard. In information technology markets, the existence of “patent thickets” (large numbers of independently held patents with overlapping claims) can make the transactions costs of securing independent licenses prohibitive. Moreover, firms may hesitate to sign licenses when there is substantial uncertainty over a patent’s validity. This uncertainty is amplified by long lags in the PTO review process, and the fact that some applications are filed during or after SSO deliberations. Finally, there is probably some inertia. Many large “systems” vendors are simply accustomed to implementing new standards, secure in the knowledge that they have already signed comprehensive cross–licensing arrangements with the other major industry players.

While a few SSOs have adopted a policy of royalty–free licensing, most have been hesitant to move beyond RAND. The reason seems to be that since SSOs explicitly consider competing technologies, price setting by SSO participants raises the specter of antitrust law. RAND commitments can be viewed as an attempt to provide some assurance that ex post prices will be “reasonable” while maintaining a strict prohibition on any discussion of the actual pricing.

It is not clear whether SSOs’ antitrust fears are justified. In particular, there is gathering support to have SSOs negotiate licensing fees simultaneously with determining a standard (Lemley, 2007; Majoras, 2005). Although the FTC and DOJ may be supportive of SSO rate setting, there would no doubt be private antitrust suits in this context. And while the issue could be resolved by the U.S. Supreme Court or through legislation, this would likely take considerable time. Given SSOs reluctance to allow explicit ex ante negotiation, and firms’ inability or unwillingness to negotiate independent licenses, the dominant policy has become vague RAND promises followed by ex post dispute resolution.

We conclude by describing two potential alternatives to RAND pricing commitments. The first focuses on creating the conditions for ex ante pricing commitments within the standard setting process. The U.S. Department of Justice recently issued a Business Review Letter that endorsed a policy proposed by VITA, an SSO that promotes the VMEbus computer architecture [12]. This policy requires IP holders to commit to a “price cap” (i.e. a maximum royalty rate and most restrictive set of licensing terms) which can be amended downwards, but prohibits any actual negotiations. Other SSOs appear to be seriously considering variations on this type of ex ante IPR policy (Updegrove, 2006).

For SSOs that remain concerned about the threat of public or private antitrust actions, Rysman and Simcoe (2007) describe an alternative policy that mimics the underlying patent system by rewarding inventors with monopoly rights for a limited time. Under a NAAST (Non–Assertion After Specified Time) policy, a firm would give up the right to assert its patent after a period of time specified by the SSO. Until that time, the IP holder would be free to license the patent at whatever rates it could collect. They argue that NAAST pricing does not imply substantial delays in standards implementation. Rather, IP holders will have an incentive to license their technology quickly with the threat of a non–assertion period growing closer. If vendors are willing to pay to be among the first producers in a market, then patent owners will obtain reasonable returns on their investment in a short period of time. Finally, NAAST has the great benefit of being straightforward to adjudicate.

There is no reason to expect a reversal of the trend identified in the first half of this paper. Indeed, new applications of the Internet continue to drive the demand for standardization at the same time as many high–tech industires are increasingly characterized by fierce technology–based competition. If anything, the commercial stakes of the standard–setting process are likely to increase. In this environment, RAND pricing commitments are an increasingly unworkable policy. In the coming years, we expect to see SSOs experimenting with a wide variety of policies — such as royalty–free licensing, NAAST and ex ante negotiation. Hopefully, they will converge on a new “standard” for SSO IPR policy that strikes an appropriate balance between providing incentives to innovate and encouraging investment in new technology by mitigating hold–up concerns. End of article

 

About the author

Tim Simcoe is Assistant Professor of Strategic Management in the Joseph L. Rotman School of Management at University of Toronto.
E–mail: timothy [dot] simcoe [at] rotman [dot] utoronto [dot] ca

 

Notes

1. Rysman and Simcoe (2005) provide some evidence that these endorsements have an impact on the value of the underlying technology.

2. While the meaning of RAND is currently the subject of litigation, it is hard to imagine this will yield a definitive answer — Nokia Inc. vs. Qualcomm Inc. Civ. A. No. 2330–N (Delaware).

3. The SSOs are the American National Standards Institute (ANSI), ATM Forum, Alliance for Telecommunications Industry Solutions (ATIS), European Telecommunications Standards Institute (ETSI), Institute for Electrical and Electronics Engineers (IEEE), Internet Engineering Task Force (IETF), International Telecommunications Union (ITU), Open Mobile Alliance (OMA), and the Telecommunications Industry Association (TIA).

4. See, for example, M.A. Lemley, “Rational Ignorance at the Patent Office,” Northwestern University Law Review, volume 95, number 4 (2001), pp. 1495–1532; A.B. Jaffe and J. Lerner. Innovation and Its Discontents: How Our Broken Patent System Is Endangering Innovation and Progress, and What to Do About It. (Princeton, N.J.: Princeton University Press, 2004).

5. U.S. Department of Justice and Federal Trade Commission, “Antitrust Guidelines for the Licensing of Intellectual Property,” at http://www.usdoj.gov/atr/public/guidelines/0558.htm.

6. The creation of the MPEG–2 and DVD patent pools showed that firms could create joint–licenses without violating antitrust law.

7. See Farrell, et al. (2004) for a detailed discussion of the hold–up problem in this context.

8. Of course, this argument depends critically on the assumption that the patent is valid and enforceable. However, under current patent law, the threat of injunction provides even “weak” patent owners with a very large stick in the bargaining process.

9. Lemley (2002) provides a summary of the IP policies adopted by a number of SSOs.

10. Broadcom Corp. vs. Qualcomm Inc. Civ. A No. 05–3350 (MLC) (D.N.J), Memorandum in Support of Defendant’s Motion to Dismiss (filed 12 December 2005).

11. Nokia Inc. vs. Qualcomm Inc. Civ. A. No. 2330–N (Delaware).

12. The letter is available at http://www.usdoj.gov/atr/public/busreview/219380.htm, accessed 20 January 2007.

 

References

Joseph Farrell, Jay Pil Choi,, Aaron S. Edlin, Shane Greenstein, Bronwyn H. Hall and Garth Saloner, 2004. “Brief Amicus Curiae of Economics Professors and Scholars in the Matter of Rambus, Inc.,” U.S. Federal Trade Commission Docket, number 9302, at http://www.ftc.gov/os/adjpro/d9302/040415scholarsamicusbrief.pdf, accessed 7 June 2007.

Adam Jaffe and Josh Lerner, 2004. Innovation and Its Discontents: How Our Broken Patent System Is Endangering Innovation and Progress, and What to Do About It. Princeton, N.J.: Princeton University Press.

Mark A. Lemley, 2007. “Ten Things to Do About Patent Holdup of Standards (and One Not to),” Boston College Law Review, volume 48, pp. 149–168.

Mark A. Lemley, 2002. “Intellectual Property Rights and Standard Setting Organizations,” California Law Review, volume 90, pp. 1889–1981. http://dx.doi.org/10.2307/3481437

Mark A. Lemley, 2001. “Rational Ignorance at the Patent Office,” Northwestern University Law Review, volume 95, number 4, pp. 1495–1532.

Deborah Majoras, 2005. “Recognizing the Procompetitive Potential of Royalty Discussions in Standard Setting,” speech prepared for Standardization and the Law: Developing the Golden Mean for Global Trade, conference at Stanford University, 23 September 2005, at http://www.ftc.gov/speeches/majoras/050923stanford.pdf, accessed 7 June 2007.

Marc Rysman and Tim Simcoe, 2007. A NAASTy Alternative to RAND Pricing Commitments. Rotman Working Papers, University of Toronto, at http://www.rotman.utoronto.ca/timothy.simcoe/papers/NAAST.pdf, accessed 7 June 2007.

Marc Rysman and Tim Simcoe, 2005. “Patents and the Performance of Voluntary Standard Setting Organizations,” NET Institute Working Paper, number 05–22, at http://www.netinst.org/Rysman2005.pdf, accessed 7 June 2007.

Tim Simcoe, 2006. “Explaining the Increase in Intellectual Property Disclosure,” In: Sheri Bolin (editor). The Standards Edge: Golden Mean. Ann Arbor, Mich.: Bolin Communications.

Andrew Updegrove, 2006. “The Great Ex Ante Debate,” Consortium Standards Bulletin, volume 5, number 6, at http://www.consortiuminfo.org/bulletins/jun06.php, accessed 26 March 2007.

 


 

Contents Index

Copyright ©2007, First Monday.

Copyright ©2007, Tim Simcoe.

Intellectual Property and Compatibility Standards: A Primer by Tim Simcoe
First Monday, volume 12, number 6 (June 2007),
URL: http://firstmonday.org/issues/issue12_6/simcoe/index.html





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