[GuestPost] Opinion: Skirting FRAND requirements under the guise of promoting innovation and efficiency (Part II)

But a review of litigations where SEPs are asserted against end-product suppliers demonstrates that negotiating with component suppliers would not decrease efficiency. To the contrary—licensing component suppliers would increase efficiency as they are frequently key to evaluating the merits of SEP assertions because they created the components on which the infringement allegations center. As the examples below demonstrate, end-product suppliers often lack knowledge about how standardized technology is incorporated into their products through components and thus it falls to the component suppliers to provide critical technical information necessary to evaluate issues such as infringement:

• In Saint Lawrence Communications LLC v. Motorola Mobility LLC, the court denied a motion to enhance damages for willfulness because, among other factors, “the accused products were alleged to infringe because of chips made by Qualcomm, which are used industry-wide, rather than technology created by Motorola. Indeed, Motorola did not even have access to the infringing source code contained on the Qualcomm chips, which militates against a finding that Motorola deliberately copied SLC’s technology.” 5

• In Core Wireless Licensing S.A.R.L. v. LG Electronics, Inc, the court observed in a case where Core Wireless asserted cellular SEPs obtained from Nokia that “[i]t is undisputed that the baseband chips referenced in Core’s infringement contentions are Qualcomm baseband chips. Accordingly, this case turns in large measure on the function of the Qualcomm baseband chips. Indeed, Core has stated that it ‘expects to rely on Qualcomm source code for most, if not all, of the thirteen standard-essential patents asserted against LG.’ 6

• When InterDigital asserted SEPs claimed essential to the LTE standard against ZTE, one of InterDigital’s experts described his task to the jury as follows: “I was asked to look at how the ZTE LTE phones process a certain message called a PDCCH message. I found that in the ZTE phones this processing was done by a Qualcomm chip. So I looked at the hardware and software source code for this Qualcomm chip.”7

• In GPNE Corp. v. Apple, Inc., GPNE alleged Apple infringed patents that it claimed were essential to the GPRS, EDGE, and/or LTE cellular standards. GPNE conceded, however, that the relevant functionality was entirely within the baseband processors Apple purchases: “Neither party contests that the patent’s contribution to the art is a signaling technique performed by the baseband processor.” 8  GPNE’s technical expert conceded that “each of the GPRS and LTE signals identified in [his] report are processed by the . . . base band processors in Apple products” and offered the same infringement theory for various accused Apple products because they all contained the same baseband processor chipsets.9  GPNE further confirmed that “the baseband processor … enables the cellular functionality in Apple’s products.” 10  Indeed, the court held “as a matter of law that in this case, the baseband processor is the proper smallest salable patent-practicing unit” for the purpose of determining a royalty.11

• Moreover, in motions to transfer, the location of chip suppliers has received heavy weight because of the importance of chipsets to infringement analysis. 12

Similarly, in litigation where cellular network equipment has been accused of infringing SEPs, providers of network equipment have played a similar role. When Huawei asserted claimed cellular SEPs against T-Mobile, both Ericsson and Nokia argued that they should be allowed to intervene in the case because T-Mobile is a customer. Nokia contended that its intervention would “streamline and simplify” the litigation because Nokia had “[t]he technical know-how.”13  Nokia elaborated that it “also possesses a broad and deep understanding of its own technology. Accordingly, it is the most important source of information about its products and keeper of potentially key, relevant documents and the sole keeper of its source code. It would be unfair to force T-Mobile to litigate the issues that [Nokia] best understands.”14  Similarly, Ericsson argued that “documents and other tangible evidence, including source code and product specifications, likely reside with Ericsson. The technical know-how and testimony for this equipment also likely resides with Ericsson.” Echoing Nokia, Ericsson also contended that “[i]t would be unfair to force T-Mobile to litigate the issues that Ericsson best understands.” 15

As the above examples demonstrate, component suppliers bring specialized knowledge to litigation that uniquely positions them to provide information relevant to whether SEPs are infringed. They would bring the same unique insights to SEP negotiations as the parties that designed the components that provide standardized functionality. Component suppliers are also best positioned to understand whether SEPs are used and the value of any such usage, how much of the component the accused functionality represents, and what alternatives technologies are viable. In the case of cellular baseband chips, the limited number of suppliers means that they could potentially decrease the number of negotiations by obtaining licenses that would protect their customers under principles of patent exhaustion.

As discussed in Part 1 and above, SEP owners in the past acknowledged (and at times advocated) that a FRAND commitment requires licensing component suppliers, invested in their SEP portfolios with that understanding, and utilized the technical expertise, documents, and testimony of component suppliers in litigation. Despite all this, some SEP owners today argue against licensing to component suppliers.

The real reason for these SEP owners’ current arguments is clear: licensing at the end product level drives up royalties. In fact, as Judge Koh highlighted in her 2019 Qualcomm opinion, SEP owners have admitted as much. Judge Koh quoted the following statements made by Qualcomm employees to the IRS:

“But [] having to choose between one or the other then you’re right, obviously the handset is humongously more … lucrative for a bunch of – a bunch of reasons.” 17

“Yeah, but if I would average royalty on all the handsets that we collect royalties on – I don’t remember what it is anymore, I used to know the number – but if – if it were ten dollars, for example, you couldn’t charge a ten-dollar royalty on a chipset that cost five dollars, or six dollars, or seven dollars.”18

That this preference for using the end device is likely to pay off in inflated royalties is further supported by studies demonstrating that “anchoring” demands to a larger royalty base inflates royalties, especially for patented features included in complex, multi-component products. When judges and jury members are exposed to revenues of a finished product—which is easy to understand—it acts as an “anchor” value from which further calculations are made. This often causes judges and jury members to find large royalties are reasonable because they are a small percentage of a large base. 19

Therefore, while SEP holders claim that licensing at the end device level promotes efficiency, the opposite is true. Determining royalties based on end devices results in outsized royalties that are not apportioned to the value of SEPs. As the Federal Circuit has explained, apportionment is critical to ensure that a reasonable royalty “does not overreach and encompass components not covered by the patent.”20  The danger of such royalties is that they undermine the incentives for innovation by misallocating rewards. SEP holders receive windfalls and are incentivized to overinvest in SEPs, while the non-standardized innovation in the end devices that is being taxed by SEPs suffers. Accordingly, royalties based on the price of a device are only allowed in the rare circumstance that “the demand for the entire product is attributable to the patented feature.”21 Such is rarely, if ever, the case when valuing a patent that reads on a complex, multi-component device that incorporates many other patented and non-patented features. “[T]he smallest salable unit approach was intended to produce a royalty base much more closely tied to the claimed invention than the entire market value of the accused products.” 22  Licensing at the component level addresses these concerns by putting the focus on the smallest salable unit that practices the standardized technology. Doing so ensures that SEP holders are compensated for the value of their SEPs and product suppliers are not disincentivized from bringing innovative products to market by paying outsized royalties that tax innovations that are separate and apart from the standard.

Overall, the evidence described above and in Part 1 demonstrates that discrimination by certain SEP owners against licensing component suppliers allows them to maximize their licensing returns by targeting more expensive products. SEP licensors’ arguments that licensing at the OEM level is consistent with their FRAND commitments and is necessary for innovation are unavailing. Historically, a FRAND commitment has included licensing at the component level, innovation for future standards does not depend on maximizing SEP licensing revenue, and it would be more—not less—efficient to license at the component level. Moreover, licensing at the component level aligns with the most appropriate methodology for valuing SEPs that claim features of complex, multi-component products.