Searching for FRAND in FRAND valuations – Part 2 / 3

Continuing from my previous post, this post analyses the Innovatio IP Ventures decision.  In the Innovatio case, Judge Holderman modifies some of the concepts in Judge Robart’s decision in Motorola.  Hence, the modifications and reasoning thereof are highlighted separately in this post. Both the Motorola, and Innovatio decisions form the basis of my next post in the series.  Long post follows.

Innovatio IP Ventures: In September 2013, in the third case involving determination of FRAND royalties, Judge Holderman, in n re Innovatio IP Ventures, MDL 2303, Case No. 11 C 9308 N.D. Ill. , Eastern Division, Sep. 27, 2013 provided for the second time, a framework for calculating the value of SEPs on FRAND terms.

In this case, Innovatio had sued a large number of wireless internet service providers like coffee shops, hotels, restaurants, supermarkets, large retailers, transportation companies, and other commercial users.  In turn, various Manufacturers (Cisco, Motorola, SonicWall, Netgear, and HP) of the WiFi equipment used by wireless internet providers filed declaratory judgment actions against Innovatio seeking the reliefs that Innovatio’s patents are:  not infringed by the Manufacturers products; and invalid.

All the parties (service providers), Manufacturers, Innovatio and the Court agreed that the best course toward resolving dispute would be to evaluate the potential damages available to Innovatio if the service providers, and Manufacturers are found to infringe Innovatio’s patents.

Innovatio proposed a royalty determination methodology that included a functionality factor, and based on the functionality factor a royalty range from $3.39 – $ 36.90 depending on the end product using the wireless functionality.  However Judge Holderman, like Judge Robart, used the WiFi chip as a royalty base, instead of the end product as proposed by Innovatio.  Judge Holderman determined the FRAND royalty rate to be 9.56 cents per WiFi chip.

Judge Holderman’s FRAND framework:  Modified Judge Robart’s FRAND framework

I.  Judge Holderman’s FRAND determination framework was based on the one by Judge Robart and considered the same factors as were done by Judge Robart.  The factors were: (i) the importance of the patent portfolio to the standard, considering both the proportion of all patents essential to the standard that are in the portfolio, and also the technical contribution of the patent portfolio as a whole to the standard; (ii) the importance of the patent portfolio as a whole to the alleged infringer’s accused products given standard; (iii) examining other licenses for comparable patents to determine a RAND rate to license the patent portfolio, using its conclusions about the importance of the portfolio to the standard and to the alleged infringer’s products to determine whether a given license or set of licenses is comparable.

Application of the Georgia Pacific Factors:

Judge Holderman then modified these factors as follows: (i) Instead of finding a F/RAND range, because of the requirements of the case, a F/RAND rate was determined; (ii) Instead of determining whether the alleged SEPs were in fact essential to the standard, and then parties hypothetically reducing the value of the SEPs, determining that ALL of Innovatio’s patents were standard essential.  Consequently, deciding the issue whether to adjust the license rate for patents whose essentiality was questionable prior to the court’s adjudication as not adjusting the F/RAND rate in light of pre-litigation uncertainty about the essentiality of a given patent; and (iii) determining the appropriate royalty base to be the Wi-Fi chip – this step effectively merges steps one and two of Judge Robart’s methodology. Hence Judge Holderman’s analysis did not have a separate section evaluating the importance of Innovatio’s patents to the accused products, but instead merged that analysis into the inquiry about the importance of Innovatio’s patents to the 802.11 standard.

Judge Holderman also considered the following factors as being relevant to a F/RAND analysis:

(i)  Avoiding Patent Hold-Up:  Patent hold-up occurs when the holder of a SEP demands excess royalties after standard implementers are already locked into using the standard.  Patent hold-up is a substantial problem that F/RAND is designed to prevent.  A judicially determined F/RAND rate, to the extent possible, must reflect only the value of the underlying technology and not the hold-up value of standardization.

(ii) Avoiding Royalty Stacking:  Royalty stacking concerns arise because most standards implicate hundreds, if not thousands of patents, and the cumulative royalty payments to all SEP holders may quickly become excessive and discourage adoption of the standard.  Accordingly, Judge Holderman considered the impact of possible royalty stacking and determined a rate that addressed the risk of royalty stacking by considering the aggregate royalties that would apply if other SEP holders made similar royalty demands of the implementer.

Additionally, Judge Holderman also considered that it was not appropriate to determine the value of the non-asserted SEPs based merely on numbers.  If a patent holder owns ten out of a hundred patents essential to a given standard, it does not automatically mean that it contributes 10% of the value of the standard.

(iii)  Incentivizing Inventors to Participate in Standard-Setting Process:  a RAND rate must be set high enough to ensure that innovators in the future have an appropriate incentive to invest in future developments and to contribute their inventions to the standard-setting process.

II.   Determining an Appropriate Royalty Base:  Like Judge Robart, Judge Holderman also considered the WiFi chip as a royalty base and outlined the reasoning as:

The argument over the appropriate royalty base to calculate patent damages is not unique to the RAND context, but is instead common to non-RAND patent cases. The overall goal of patent damages is to “award the claimant damages adequate to compensate for the infringement, but in no event less than a reasonable royalty for the use made of the invention by the infringer.” 35 U.S.C. § 284. The Federal Circuit has explained that “[w]here small elements of multicomponent products are accused of infringement, calculating a royalty on the entire product carries a considerable risk that the patentee will be improperly compensated for non-infringing components of that product.” Accordingly, the court must calculate royalties “not on the entire product, but instead on the smallest salable patent practicing unit.

Innovatio’s reasoning: Innovatio contended the royalty should be calculated as a percentage of the selling price of end-products with wireless functionality, including laptops, tablet computers, printers, access points, and the like.  This step is followed by discounting the final selling price of end-products by a “Wi-Fi feature factor,” which supposedly took into account the value of the end product that is attributable to the 802.11 functionality. Eg. A laptop has a WiFi feature factor of 10%, an access point has a feature factor of 95%.  After multiplying the feature factor by the price the Manufacturers charge for the end-products, then multiplying the result by a 6% benchmark royalty rate.  This method results in royalties on average of approximately $3.39 per access point, $4.72 per laptop, up to $16.17 per tablet, and up to $36.90 per inventory tracking device (such as a bar code scanners).

Innovatio asserted that its apportionment proceeded in two steps, first by apportioning the value of the end-products down to 802.11 through the application of the “Wi-Fi feature factor” and second, by applying the benchmark royalty of 6% based on licenses of comparable portfolios of 802.11 SEPs and patents essential to other comparable standards.

However, Innovatio did not provide the court with legally sound and factually credible method to apportion the price of the accused end-products to the value of only Innovatio’s patented features.  The court therefore had no choice but to look to the Manufacturers’ proposed method of calculating a RAND royalty based on the price of a Wi-Fi chip.

Manufacturer’s Reasoning: The Manufacturers, contend that the royalty be calculated as a percentage of the price the Manufacturers paid for each wireless chip, a small silicon device about the size of a dime that is inserted during manufacturing into an electronics device, such as a laptop computer or wireless access point, to provide the device with 802.11 wireless functionality. Each of the accused end-products in this case includes at least one Wi-Fi chip.

The Manufacturers, unlike Innovatio, presented evidence that all of the features of the 802.11 standard are “implemented” on the Wi-Fi chip, which includes both hardware and software to run the 802.11 features of any device in which it is inserted.  Innovatio’s expert also agreed that the Wi-Fi functionality is implemented on one or more Wi-Fi chips.

Additionally, the Manufacturers also noted the Federal Circuit’s endorsement in LaserDynamics of a phrase from an earlier decision suggesting that the proper royalty base is “the smallest saleable infringing unit with close relation to the claimed invention.”

Because Innovatio’s patents did not invent access points, radios, or antennas, but instead only a method for using those devices, the instructions for which are contained on the Wi-Fi chip, the Manufacturers concluded that the smallest saleable patent-practicing unit is the Wi-Fi chip.

Application of Georgia Pacific factors

(i) The Importance of lnnovatio’s Patents to the 802.11 Standard:

Innovatio’s entire portfolio was divided into separate classes based on technology / features and each category was found to be of moderate, or moderate to high importance to the entire WiFi (802.11) standard.

(ii) Comparable Licenses:

Innovatio’s proposed comparable licenses: (a) The court rejected the proferred rate in Motorola Mobility (MMI) MMI-VTech license.  Judge Robart had also rejected the MMI-VTech License as a comparable license as the rate in the agreement was determined only as a part of a package deal involving the larger cordless phone patent. There was prior litigation between VTech and MMI, and the 802.11 and H.264 patents were a trivial part of the overall deal, and were thus unreliable indicators of appropriate 802.11 and H.264 royalty rates.  (b) The court also rejected Symbol Licenses with Proxim and Terabeam @ 6%: Innovatio contended that the royalty rate of 6% is an appropriate comparable for determining a RAND rate for its patents. The Symbol licenses were not comparable as both adopted under the duress of litigation.  (c) Symbol / LXE License:  This one was also rejected as Innovatio did not present any evidence indicating how many patents Symbol owned at the time, or how valuable Symbol’s 802.11standard-essential patents were compared to other patents in its portfolio.  (d) Qualcomm / Netgear License:  This one was also rejected as not being a comparable license because of the sheer size of Qualcomm’s portfolio–Qualcomm had about 33000 patents.  Hence the rate in the Qualcomm agreement would not be appropriate for an agreement including only twenty-three patents.  Also the Qualcomm license involved the 802.16 and 802.20 standards, rather than the 802.11 standard.

The Manufacturers’ Proposed Comparable Licenses: (i) The Via Licensing Patent Pool: The Court rejected the Via licensing pool model as a comparable rate like Judge Robart had done.  The Via pool charges a license fee of between $0.05 and $0.55 per unit, depending on the volume of units purchased.   The court identified various problems with using the Via rate: success of the pool – Via pool had only five licensors, thirty-five patents, and eleven licensees.  Via pool also did not include high value patents and had limited utility for determining a RAND rate.

2. Non-RAND Comparable Licenses

The Court rejected one “Bottom Up” Approach as provided by the Manufacturers.  In this approach, the cost of implementing reasonable alternatives to the lnnovatio patents that could have been adopted into the standard was determined, and dividing that cost by the total number of infringing units to determine the maximum per unit royalty Innovatio’ s patents would have merited in the 1997 hypothetical negotiation.

This approach was rejected as there are no alternatives to the Innovatio patents that would provide all of the functionality of Innovatio’s patents with respect to the 802.11 standard. Such an “incremental value” approach was also rejected by Judge Robart on the ground that an accurate analysis is too complicated for courts to perform.  The method was also rejected because did not account for the royalty that the alternatives to Innovatio’s patents might be able to charge.

TOP DOWN APPROACH: The Court endorsed the top down approach, and slightly modified the model as provided by the Manufacturers to determine a F/RAND rate.  The Court listed several advantages of the Top Down Approach:

I.  By taking the profit margin on the sale of a chip for a chip manufacturer as the maximum potential royalty, it accounts for both the principle of non-discrimination and royalty stacking concerns in F/RAND licensing. The profit of the chip manufacturer on the chip was found to be appropriate because a F/RAND licensor cannot discriminate between licensees on the basis of their position in the market.

II.  The approach apportions the value of Innovatio’s patented features without relying on information about other licenses that may or may not be comparable to accomplish the apportionment.

III.        The approach provides a quantifiable and analytical rigor to the F/RAND analysis as it requires verifiable data points, such as the number of 802.11SEP, the average price of a chip, and the average profit of a chip manufacturer, as inputs. Hence there is some objectivity to the approach and it allowed the court to base its F/RAND rate on objective considerations and sound hypotheses, rather than on mere speculation.

IV.  The approach does not apportion to the value of lnnovatio’s patented features based solely on the numerical proportionality of Innovatio’s patents to all 802.11 SEPs.  The approach provides a means by which the court can account for its conclusion that Innovatio’s patents are of moderate to moderate-high importance to the standard, and therefore more important than the average 802.11 SEP, without sacrificing quantitative rigor and objective verifiability.

Methodology

Determining the price of a Wi-Fi chip:  “ABI Research Report” – The Report calculated or projected the average selling price of a Wi-Fi chip in each year from 2000 to 2015, and also provided figures for the number of units sold in each year.  The prices varied from a high of $37 in 2000, when 5.4 million Wi-Fi chips were sold, to a projected low of $2.54 in 2015, when over 2.015 billion chips would be sold.  The Manufacturer’s suggested taking a weighted average for all chips sold from 2000 to 2013 but the Court rejected the same as the parties to a hypothetical negotiation in 1997 would not consider a weighted average leading to a depressed chip price. The Court simply averaged the price of a chip resulting in an average price of $14.85. 

Chipmaker’s Profit Margin on a Wi-Fi Chip: There was evidence from Broadcom, Marvell, another chip manufacturer, leading to the conclusion that the profit margin on a Wi-Fi chip is between 9.4% and 14.4%. The Court used 12.1% as the profit margin on a Wi-Fi chip.

Total Number of 802.11 Standard-Essential Patents: It was suggested by the Manufacturers expert that the court use 3000 as a reasonable estimate of the number of 802.11 SEPs to use when determining a F/RAND rate.  The Court relied on multiple reports and Innovatio’s expert did not reject the number.  However, the Court cautioned that there is no guarantee that all of those approximately 3000 potentially essential patents are in fact essential. In this case, the court conducted a detailed inquiry into the essentiality of Innovatio’s 23 patents and determined that the claims were indeed essential to the standard–hence weighting the portfolio as moderate, moderate to high importance to the standard.

Calculation: There were three variations provided by the expert for the courts consideration. In these variations, what changed was the determination that Innovatio’s patents were in the top 50% of the 3000 802.11 patents, in the top 20%, or in the top 10%.  The expert adjusted the value attributable to Innovatio’s patents in each of those cases by relying on a 1998 article finding that the top 10% of all electronics patents account for 84% of the value in all electronics patents. (Mark Schankerman, How Valuable is Patent Protection? Estimates By Technology Field, 29 RAND J. ECON. 77, 94 tbl.5 & n.12 (1998).) For example, for the top 10% hypothesis, multiplied the profit margin on a Wi-Fi chip by 84% to determine the percent of that value attributable to the top 10% of all 802.11 SEPs. The expert then multiplied that value by 23/300 (Innovatio’s patents divided by 10% of all 802.11 SEPs) to determine Innovatio’s share of the value in the top 10% of 802.11 SEPs.

The court had found that Innovatio’s patents are all of moderate to moderate-high importance to the standard, meaning that they provide significant value to the standard. Because 84% of the value in electronics patents is found in the top 10% of electronics patents, the court can conclude that any patents providing significant value are likely among the top 10% of all patents essential to the 802.11 standard.  Moreover, a large percentage of the 3000 SEPs are less valuable to the standard than Innovatio’s patents because they have not had their essentiality confirmed, further indicating that Innovatio’s patents are in the top 10%.