In recent years, U.S. government policymakers have recounted various alleged market deficiencies associated with patent licensing practices, as part of a call for patent policy “reforms” – with the “reforms” likely to have the effect of weakening patent rights. In particular, antitrust enforcers have expressed concerns that: (1) the holder of a patent covering the technology needed to implement some aspect of a technical standard (a “standard-essential patent,” or SEP) could “hold up” producers that utilize the standard by demanding anticompetitively high royalty payments; (2) the accumulation of royalties for multiple complementary patent licenses needed to make a product exceeds the bundled monopoly rate that would be charged if all patents were under common control (“royalty stacking”); (3) an overlapping set of patent rights requiring that producers seeking to commercialize a new technology obtain licenses from multiple patentees deters innovation (“patent thickets”); and (4) the dispersed ownership of complementary patented inventions results in “excess” property rights, the underuse of resources, and economic inefficiency (“the tragedy of the anticommons”). (See, for example, Federal Trade Commission and U.S. Justice Department reports on antitrust and intellectual property policy, here, here, and here).
Although some commentators have expressed skepticism about the actual real world incidence of these scenarios, relatively little attention has been paid to the underlying economic assumptions that give rise to the “excessive royalty” problem that is portrayed. Very recently, however, Professor Daniel F. Spulber of Northwestern University circulated a paper that questions those assumptions. The paper points out that claims of economic harm due to excessive royalty charges critically rest on the assumption that individual patent owners choose royalties using posted prices, thereby generating total royalties that are above the monopoly level that would be charged for all complementary patents if they were owned in common. In other words, it is assumed that interdependencies among complements are ignored, with individual patent monopoly prices being separately charged – the “Cournot complements” problem.
In reality, however, Professor Spulber explains that patent licensing usually involves bargaining rather than posted prices, because such licensing involves long-term contractual relationships between patentees and producers, rather than immediate exchange. Significantly, the paper shows that bargaining procedures reflecting long-term relationships maximize the joint profits of inventors (patentees) and producers, with licensing royalties being less than (as opposed to more than under posted prices) bundled monopoly royalties. In short, bargaining over long-term patent licensing contracts yields an efficient market outcome, in marked contrast to the inefficient outcome posited by those who (wrongly) assume patent licensing under posted prices. In other words, real world patent holders (as opposed to the inward-looking, non-cooperative, posted-price patentees of government legend) tend to engage in highly fruitful licensing negotiations that yield socially efficient outcomes. This finding neatly explains why examples of economically-debilitating patent thickets, royalty stacks, hold-ups, and patent anti-commons, like unicorns (or perhaps, to be fair, black swans), are amazingly hard to spot in the real world. It also explains why the business sector that should in theory be most prone to such “excessive patent” problems, the telecommunications industry (which involves many different patentees and producers, and tens of thousands of patents), has been (and remains) a leader in economic growth and innovation. (See also here, for an article explaining that smartphone innovation has soared because of the large number of patents.)
Professor Spulber’s concluding section highlights the policy implications of his research:
The efficiency of the bargaining outcome differs from the outcome of the Cournot posted prices model. Understanding the role of bargaining helps address a host of public policy concerns, including SEP holdup, royalty stacking, patent thickets, the tragedy of the anticommons, and justification for patent pools. The efficiency of the bargaining outcome suggests the need for antitrust forbearance toward industries that combine multiple inventions, including SEPs.
Professor Spulber’s reference to “antitrust forbearance” is noteworthy. As I have previously pointed out (see, for example, here,here, and here), in recent years U.S. antitrust enforcers have taken positions that tend to favor the weakening of patent rights. Those positions are justified by the “patent policy problems” that Professor Spulber’s paper debunks, as well as an emphasis on low quality “probabilistic patents” (see, for example, here) that ignores a growing body of literature (both theoretical and empirical) on the economic benefits of a strong patent system (see, for example, here and here).
In sum, Professor Spulber’s impressive study is one more piece of compelling evidence that the federal government’s implicitly “anti-patent” positions are misguided. The government should reject those positions and restore its previous policy of respect for robust patent rights – a policy that promotes American innovation and economic growth.
While Professor Spulber’s long paper is well worth a careful read, keyitalicized excerpts from his debunking of prominent “excessive patent” stories are set forth below.
Standard Setting Organizations (SSOs) are voluntary organizations that establish and disseminate technology standards for industries. Patent owners may declare that their patents are essential to manufacturing products that conform to the standard. Many critics of SSOs suggest that inclusion of SEPs in technology standards allows patent owners to charge much higher royalties than if the SEPs were not included in the standard. SEPs are said to cause a form of “holdup” if producers using the patented technology would incur high costs of switching to alternative technologies. . . . [Academic] discussions of the effects of SEPs [summarized by the author] depend on patent owners choosing royalties using posted prices, generating total royalties above the bundled monopoly level. When IP owners and producers engage in bargaining, the present analysis suggests that total royalties will be less than the bundled monopoly level. Efficiencies in choosing licensing royalties should mitigate concerns about the effects of SEPs on total royalties when patent licensing involves bargaining. The present analysis further suggests bargaining should reduce or eliminate concerns about SEP “holdup”. Efficiencies in choosing patent licensing royalties also should help mitigate concerns about whether or not SSOs choose efficient technology standards.
“Royalty stacking” refers to the situation in which total royalties are excessive in comparison to some benchmark, typically the bundled monopoly rate. . . . The present analysis shows that the perceived royalty stacking problem is due to the posted prices assumption in Cournot’s model. . . . The present analysis shows that royalty stacking need not occur with different market institutions, notably bargaining between IP owners and producers. In particular, with non-cooperative licensing offers and negotiation of royalty rates between IP owners and producers, total royalties will be less than the royalties chosen by a bundled monopoly IP owner. The result that total royalties are less than the bundled monopoly benchmark holds even if there are many patented inventions. Total royalties are less than the benchmark with innovative complements and substitutes.
The patent thickets view considers patents as deterrents to innovation. This view differs substantially from the view that patents function as property rights that stimulate innovation. . . . The bargaining analysis presented here suggests that multiple patents should not be viewed as deterring innovation. Multiple inventors can coordinate with producers through market transactions. This means that by making licensing offers to producers and negotiating patent royalties, inventors and producers can achieve efficient outcomes. There is no need for government regulation to restrict the total number of patents. Arbitrarily limiting the total number of patents by various regulatory mechanisms would likely discourage invention and innovation.
Tragedy of the Anticommons
The “Tragedy of the Anticommons” describes the situation in which dispersed ownership of complementary inventions results in underuse of resources[.] . . . . The present analysis shows that patents need not create excess property rights when there is bargaining between IP owners and producers. Bargaining results in a total output that maximizes the joint returns of inventors and producers. Social welfare and final output are greater with bargaining than in Cournot’s posted prices model. This contradicts the “Tragedy of the Anticommons” result and shows that there need not be underutilization of resources due to high royalties.
This piece first appeared in Truth on the Market.