Wednesday, November 14, 2012

Surface argument is more of the same from Google's Motorola on patent royalties

Yesterday was the first day of the Microsoft v. Motorola Mobility FRAND rate-setting trial in the Western District of Washington. I did a post on the relevance of the underlying issue to startups.

While I can't attend this one physically, I have been following this case closely ever since it started two years ago and there are great online resources to find out about developments in Seattle. I have set up a public Twitter list named MicrosoftMotoFRANDtrial, replicating the tweets from several reporters who reported from the courtroom. Here are links to several media reports on the first day (in alphabetical order):

The most interesting testimony tidbits that I saw on Twitter relate to Motorola's participation in the negotiations that led to the formation of the MPEG LA AVC/H.264 pool. Motorola didn't ultimately participate in the pool, but according to testimony presented yesterday, it was actually arguing in favor of low per-unit rates and a royalty cap that is even lower than the one MPEG LA ultimately adopted. A witness also said that Motorola didn't argue at that stage that its patents were more valuable, relative to their number, than the average of all other patents contributed to the pool. But at this point, the now wholly-owned Google subsidiary does claim that its patents are more valuable than the patents in the pool. I have seen this argument in court filings and I heard it in open court in Mannheim, Germany, in February.

Unless Motorola's own witnesses can provide some really good reasons for this change of mind, its earlier position on the appropriate H.264 royalty rate will strongly undermine the positions it takes today.

I'm actually not surprised that Motorola took an innovation- and consumer-friendly position years ago. There may be cases in which contributors to standards engage in long-term ambush strategies, starting with violations of their disclosure obligations and other attempts to manipulate the standard-setting process. But it appears that in most cases companies are constructive participants in the process -- not necessarily saints though -- and just change their approach later, either because patent monetization becomes a higher priority to them (typically after their operating business shrinks) or because they have a major infringement problem and hope that standard-essential patents give them leverage for cross-license agreements that allow them to get away with their infringement of non-standard-essential patents. In a recent post I said that "I'm inclined to believe that Samsung used to be a good citizen of the standard-setting universe until it got sued by Apple and decided to cling to its SEPs as a strategic weapon, in an act of desperation because it lacks powerful non-standard-essential patents of the kind that would give it leverage against Apple."

Unlike Samsung, which apparently played a defensive role in connection with SEPs until the dispute with Apple began, Motorola has previously been somewhat aggressive in SEP assertions (such as against Research In Motion). Still, it may have been much more reasonable when the MPEG LA pool was being formed -- or (which I don't know and won't be able to find out) it may have had bad intentions from the beginning, participating in those talks in bad faith in order to bring down prices and ultimately deciding to monetize its H.264 SEPs on its own in a rent-seeking effort. Whatever Motorola's motivation may have been, the discrepancy between the positions it took then and the ones it takes now reflects unfavorably on it in this FRAND contract litigation. It will have some explaining to do.

Reporters noted yesterday that the next-generation Xbox gaming console, codenamed Durango, and the Surface tablet were mentioned. That's mostly because Google (Motorola) tries to argue that new and upcoming devices complicate the FRAND rate-setting process. It suggests that over time it will be entitled to higher royalties because of changes to Microsoft's product offerings. Here's a very telling passage from its trial brief:

"Microsoft's new Surface tablet will use only 802.11, instead of cellular or wired connections, to connect to the internet. [...] Without 802.11 capability, the Surface tablet would be unable to compete in the market, because consumers can readily select tablet devices other than the Surface that have 802.11 capability."

The first sentence states an undeniable truth, though I don't know if cellular versions of the Surface tablet will at some point become available. The second sentence mirrors Motorola's hold-up logic: you need to implement the standard so you must pay a lot for anybody's patents declared essential to the standard. The less of a choice you have, the higher the price will be. But that's not the way to calculate a FRAND royalty. I'll just quote Judge Posner on this:

"There is another decisive objection to Motorola's damages claim. The proper method of computing a FRAND royalty starts with what the cost to the licensee would have been of obtaining, just before the patented invention was declared essential to compliance with the industry standard, a license for the function performed by the patent. That cost would be a measure of the value of the patent qua patent. But once a patent becomes essential to a standard, the patentee's bargaining power surges because a prospective licensee has no alternative to licensing the patent; he is at the patentee's mercy. The purpose of the FRAND requirements, the validity of which Motorola doesn't question, is to confine the patentee's royalty demand to the value conferred by the patent itself as distinct from the additional value--the hold-up value--conferred by the patent's being designated as standard-essential. Broadcom Corp. v. Qualcomm Inc., 501 F.3d 297, 313–14 (3d Cir. 2007); Daniel G. Swanson & William J. Baumol, 'Reasonable and Nondiscriminatory (RAND) Royalties, Standards Selection, and Control of Market Power,' 73 Antitrust L.J. 1, 7–11 (2005). Motorola has provided no evidence for calculating a reasonable royalty that would be consistent with this point."

Motorola didn't create wireless networking as a whole. It would be possible to build fully functional wireless networks without infringing on its IEEE 802.11 declared-essential patents -- there are alternatives to all of the techniques covered by those patents, but after the industry at large agreed to make IEEE 802.11 the WiFi standard, those alternatives, no matter how good they are in a technical sense, wouldn't allow users to connect with existing WiFi infrastructure.

There's another reason for which I doubt that Motorola will get much mileage out of the Surface argument. The other big issue -- besides hold-up value -- is apportionment. It doesn't really matter that Microsoft now sells WiFi-capable tablets. Even if Microsoft surprisingly started to build airplanes or Mars rovers with built-in WiFi capability, this foray into new strategic business areas wouldn't have any bearing on the value of all IEEE 802.11 SEPs it licenses, or on the relative value of Motorola's patents compared to other IEEE 802.11 SEPs. The Surface features a greater diversity of functionality than the Xbox gaming console (which is also a multifunctional home entertainment system but not a multi-purpose computer like the Surface). That's why its price is higher than that of the Xbox. But the price differential is unrelated to the contributions of IEEE 802.11 to the product, and to Motorola's contributions to IEEE 802.11.

Motorola basically argues that without WiFi, the Surface can't connect to the Internet, but that doesn't make Motorola a key enabler of the multiplicity of functionalities the Surface has on board.

It's really difficult to see what Motorola hopes to achieve by repeating, in different ways, shapes and forms, the same hold-up arguments. At least in the United States it doesn't appear to be a winning strategy. Maybe its strategy will become clearer as the trial unfolds.

The trial is scheduled to run until November 21, 2012, the day before the Thanksgiving holiday, and a FRAND rate-setting decision is apparently not expected before late December at the earliest, and more likely, in early 2013. And my guess is that Google (which micromanages Motorola's patent lawsuits) won't like the result, which is unlikely to be anywhere near the 2.25% royalty rate it demands, and will appeal -- unless the parties can reach an agreement in the meantime, which probably depends mostly on Google's willingness to accept that the FRAND value of Motorola's SEPs is entirely detached from the $12.5 billion it paid to acquire the company.

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