A working paper by an Intel in-house counsel and two WilmerHale lawyers, The Smartphone Royalty Stack: Surveying Royalty Demands for the Components Within Modern Smartphones, has just been published (direct link to PDF). Intel Vice President and Associate General Counsel Ann Armstrong and WilmerHale's Joseph Mueller and Timothy Syrett have made an invaluable contribution to the debate over reasonable royalties and incentives for innovation in this field.
This first-rate paper finally answers the billion-dollar question everyone with an interest in smartphone patents has been asking for some time: the total licensing cost per device. The authors have thoroughly researched the licensing environment and highlight various key facts that should give policymakers, regulators and courts pause. They note that royalty stacking, "in which the cumulative demands of patent holders across the relevant technology or the device threaten to make it economically unviable to offer the product, [...] is not merely a theoretical concern" (as, by the way, the likes of Qualcomm allege). Based on publicly-available data, these competent authors "estimate potential patent royalties in excess of $120 on a hypothetical $400 smartphone--which is almost equal to the cost of [the] device's components" (estimated to be $120 to $150 in total based on figures published by Nomura Securities in reliance on Gartner data). They conclude that "those costs may be undermining industry profitability--and, in turn, diminishing incentives to invest and compete". I also believe that smartphone-related patent licensing costs, relating to standard-essential as well as non-standard-essential patents, must come down. Policymakers, antitrust enforcers and judges -- Judge Posner certainly did his best in this regard -- will hopefully bring those fees down in the years ahead.
The paper does properly distinguish between royalty demands and actual royalty payments. Patent holders frequently have to lower their demands during the course of negotiation. Cross-licenses and "patent exhaustion arising from licensed sales by component suppliers" can also make a major difference, but the terms on which companies actually agree are usually kept confidential. Royalty demands sometimes surface in litigation.
The authors based their study entirely on public documents. They (especially the WilmerHale lawyers, who, among other things, defend Apple against Samsung's counterclaims) have obviously seen some confidential license agreements, but couldn't make use of any of that information for their working paper. They also don't speak for any particular company or firm. Apple just demanded a "reasonable royalty" of $40 per device from Samsung at the recent California trial, for five software patents. Now a paper authored in part by lawyers representing Apple against Samsung (with a defensive focus, but still) says that $120 per device for everyone's patents, -- hardware and software patents, standard-essential and non-standard-essential patents -- may be "diminishing incentives to invest and compete". This shows independent thinking and writing. I would not be surprised to see Samsung's lawyers quote certain key findings of this study in their U.S. litigations with Apple. The paper appears slightly Apple-friendly to me in the context of the design patents-related part of Apple v. Samsung, but within reason (I agree in principle with what it says about that). The study also notes that UI patents can typically be worked around, and "[a] truly distinctive and innovative user interface--as distinct from a copied or derivative design--may result in minimal or no royalty exposure".
One key characteristic of the study is that it analyzes licensing costs on a component-by-component (including software components) basis: cellular baseband chip, random access memory (different kinds), flash memory (different kinds), WiFi, Bluetooth, GPS, NFC, battery, power management, audio (different subcategories such as MP3), camera/video (non-standards-based as well as standards-based formats like JPEG and H.264), applications processor, operating system, other pre-installed software, SMS, MMS, email, W3C (royalty-free standards), UPnP (royalty-free), digital media sharing, USB, user interface, outer design (also an area in which the study notes that infringement can be easily avoided).
The study has a much broader focus than my own litigation monitoring in recent years. Its findings appear plausible to me, except that I believe the "operating system" part of the royalty stack is underestimated. No operating system patent holder ever told me what their demands or actual deal terms were, but a couple of years ago I downloaded a litigation-related document that was publicly accessible for less than a day on the ITC document system that mentioned a major operating system patent holder's royalty demands. Against that background I think the study published today is very conservative (to say the least) with respect to operating system patent licensing costs -- but this, if anything, reinforces the overall message.
This is not a policy paper per se, but it does raise and stress policy concerns, particularly about non-practicing entities (NPEs), colloquially often referred to as "patent trolls", and the growing problem of "privateering" (patent transfers from major operating companies to NPEs in order to hide behind others that will assert patents aggressively against the original patent holder's competitors). Certain patent holders' demands, tactics and positions are discussed as examples of factors that exacerbate the royalty-stacking problem. Those patent holders include Ericsson and, to a far greater extent, Nokia, a company that has sold patents to a number of NPEs in recent years and is itself increasinly turning into a patent assertion entity.
This paper is recommended reading for everyone with an interest in smartphone IP issues from a legal and/or economic point of view. It's particularly recommended reading for all those who could, through their actions and decisions, address at least parts of the problem this paper describes. I believe it will be quoted a lot in court documents and academic writings in the years ahead.
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