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Archived updates for Thursday, September 29, 2005

FTC Chairman Addresses Patentee "Hold-Up" of Standards-Setting Organizations

In a speech entitled "Recognizing The Procompetitive Potential Of Royalty Discussions In Standard Setting" (to Stanford University on September 23, 2005), U.S. Federal Trade Commission Chairman Deborah Platt Majoras provided her perspectives on standard setting and competition:

. . . While standard setting potentially provides tremendous benefits for consumers, it also potentially presents competitive issues that cannot be ignored. The most dangerous of these, of course, is the potential that a standard-setting effort will be used as a mechanism for competitors to fix prices, allocate markets, or boycott a competing firm or technology. Fortunately, we have not seen frequent instances of naked collusion in the standard-setting context. Still, SSOs should continue to take precautions to avoid facilitating collusion or other anticompetitive agreements.

What has become more common, though, is the potential for an intellectual property rights owner to "hold up" other members of a standard-setting organization after a standard has been set. If, at the start of the process, any one of a number of competing formats could win the standards battle, then no single format will command more than a competitive price. But standardization can change that dynamic. After the standard is chosen, industry participants likely will start designing, testing, and producing goods that conform to the standard – that is, after all, the whole idea of engaging in standard setting.

Early in the standardization process, industry members might easily be able to abandon one technology in favor of another. But once the level of resources committed to the standard rises and the costs of switching to a new technology
mount, industry members may find themselves locked into using the chosen
technology. In that case, competition for the standard ends (at least for a time, until, for example, the next generation of technology supplants it). In other words, before lock in – or "ex ante" – technologies compete to be the standard, and no patent-holder can demand more than a competitive royalty rate. After lock in – or "ex post" – the owner of the chosen technology may have the power to charge users supra-competitive royalty rates -- rates that may ultimately be passed on to consumers in the form of higher prices.

. . . [S]ome experienced members of SSOs and commentators have suggested that owners of patented technology should be permitted to state their intended royalty rates ex ante, that is, before the standard is set. Indeed, as some have suggested, if owners stated their royalty rates upfront, then price could become part of the competition among technologies for incorporation into the standard. Others have proposed that permitting SSO members to go further and engage in joint ex ante royalty discussions (perhaps even auctions) would also mitigate the hold-up problem.9 Such discussions would allow SSO members to collectively discuss – before lock in ("ex ante") – a royalty rate (or at least a maximum rate) for incorporated technology.

Both of these proposals, however, have raised concerns that agreed rates are exercises in collective price-fixing and therefore run afoul of the antitrust laws’ per se ban on price fixing. Consequently, some SSOs and their participants have hesitated to allow unilateral announcements of royalty rates by, let alone ex ante joint royalty discussions with, firms that own the technology being considered for incorporation into the standard, settling instead for rules that demand RAND terms for members.

While the antitrust concerns are understandable, they may have unduly prevented announcements of pricing intentions or royalty discussions that may, in fact, provide procompetitive benefits. First, a patent holder’s voluntary and unilateral disclosure of its maximum royalty rate, like most unilateral conduct, is highly unlikely to require antitrust scrutiny. Unilateral announcement of a price is, by definition, not a collective act subject to per se condemnation or even review under Section 1 of the Sherman Act, and it is hard to see how announcing one’s price before sale (without more) could amount to exclusionary conduct under Section 2.

Second, joint ex ante royalty discussions that are reasonably necessary to avoid hold up do not warrant per se condemnation. Rather, they merit the balancing undertaken in a rule of reason review. We would apply the rule of reason to joint ex ante royalty discussions because, quite simply, they can be a sensible way of preventing hold up, which can itself be anticompetitive. Put another way, transparency on price can increase competition among rival technologies striving for incorporation into the standard at issue. They may allow the "buyers" (the potential licensees in the standard-setting group) to get a competitive price from the "sellers" (the rival patentees vying to be incorporated into the standard that the group is adopting) before lock in ends the competition for the standard and potentially confers market power on the holder of the chosen technology. (Indeed, a few SSOs do this already: SSOs that require members to license incorporated technology to each other royalty-free have already, in effect, collectively negotiated a royalty arrangement.)

If joint ex ante royalty discussions succeed in staving off hold up, we can generally expect lower royalty rates to lead to lower marginal costs for the standardized product and lower consumer prices. By mitigating hold up, joint ex ante royalty discussions might also make possible the more timely and efficient development of standards. A reduction in ex ante uncertainty on royalty rates may "reduce the extent to which litigation is needed to resolve issues relating to patent and standards." Joint ex ante royalty discussions also could prevent delays in the implementation of the standard resulting from ex post litigation (or threats of it), which may involve "inefficient allocation of resources intended for innovation."

In a rule-of-reason analysis, of course, these possible procompetitive benefits are weighed against the risk of anticompetitive harms. In particular, some have raised concerns that the SSO members could use joint ex ante royalty discussions to force patent holders to offer royalty rates below the competitive level. The fear is that innovators may then reduce new investments in their research and development efforts.

While theoretically possible, this risk is unlikely to be a frequent practical concern. If the SSO members jointly lack buying power, they would not be able to impose a lower-thancompetitive rate. Further, SSO members may have incentives to temper their instinct to drive royalty rates too low. Manufacturing members of the SSO may recognize that patent holders (particularly non-manufacturing patent holders) who fear that the group will demand anticompetitively low royalty rates may choose not to join the SSO in the first place. If they do not join, then it will be harder for the
members to know about the patent holders’ potentially relevant intellectual
property before setting a standard – exposing the group to a greater risk of
demands for high royalty rates from a non-member in the end. Moreover, concerns
about collective buyer power may be minimal when the patent holders are
themselves manufacturers. Such patent holders may be willing to license their
technology for very little – perhaps even for free – in exchange for gaining the
first-mover advantage in manufacturing the standardized product.

It may also be appropriate to consider whether joint ex ante royalty discussions are reasonably necessary to mitigate hold up. In such an analysis, we likely would consider whether an uncoordinated series of bilateral negotiations between patentees and individual would-be licensees would be equally capable of mitigating hold up, or whether bilateral negotiations actually frustrate the necessary collective evaluation of which technology alternative is preferable, taking into consideration both the merits of the technologies and their prices.

Joint ex ante royalty discussions, of course, can offer an opportunity for SSO members to reach side price-fixing agreements that are per se illegal. If in conducting joint ex ante royalty discussions, manufacturing rivals cross over the line from discussing the price of technology they will "buy," if they choose a particular standard and start discussing – and fixing – the price of the products they sell, summary condemnation is almost certainly warranted. In fact, joint ex ante royalty discussions might make such collusion cheaper: the costs of gathering together and
deciding on a common plan could be spread over plans associated with both buying and selling.

Concerns about legitimate royalty discussions bleeding into such dangerous territory may dissuade some groups from conducting them in the first place. But those risks are not cause for declaring the entire enterprise per se illegal, especially since some standards developers may already have extensive experience managing this risk.

Of course, even absent antitrust concerns, SSO members may refrain from such discussions for business reasons alone. Some members of the standard-setting community apparently believe that joint ex ante royalty discussions are time-consuming, costly, and unproductive. Discussions may prove too complex, involving important non-price terms and heterogeneous royalty rates. Moreover, SSO members may feel that productive joint ex ante royalty discussions demand the skills of especially talented business people who understand the complicated legal, engineering, and business matters at issue.

Indeed, at the FTC/DOJ Hearings on Competition and Intellectual Property Law, one panelist testified that his large company simply does not have enough of such people to attend "the 300 different standards consortia or standards bodies" in which his company participates. Joint ex ante royalty discussions may prove costly in another way: some SSOs and their members want to concentrate on the difficult job of choosing the technically best standard, and deem cost considerations to be a distraction.

Thus, by pointing out the potential for joint ex ante royalty discussions to mitigate or eliminate the hold-up problem, I do not mean to suggest that such discussions in SSOs are required. I simply offer my view that conducting legitimate joint ex ante royalty discussions does not warrant per se condemnation.

Antitrust concerns should never be taken lightly; neither, however, should the benefits that the setting of standards can bring to consumers. Fortunately, our ntitrust laws and enforcement program are flexible enough to permit procompetitive standard-setting activity. I appreciate the opportunity to discuss these important issues with you today. Thank you.

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