TOPIC 15: ANTITRUST AND INTELLECTUAL PROPERTY RIGHTS

Topic 15| Part 2 9 January 2014Date

ANTITRUST ECONOMICS 2013David S. EvansUniversity of Chicago, Global Economics Group

Elisa MariscalCIDE, Global Economics Group

2Overview

Part 1

Overview of IP Rights

Economics of Intellectual

Property

Tension Between Antitrust and IP

Protection

Licensing of IP

Part 2

Economics of Contracting

Refusal to Supply IP Rights

FRAND, SEPS, and SSOs

Pay for Delay

3Current Issues in Antitrust and Intellectual Property

Refusal to Supply IP Rights

• IP rights holder refuses to make IP available at any price

• Microsoft “Interoperability” decision in EU

FRAND Commitments to SSOs

• Holder of standard essential patents (SEPs) requires “high” royalty

• Google Motorola Mobility commitments with FTC on not seeking injunctions to enforce SEPs

Pay for Delay Settlements

• Branded and generic pharma settle patent litigation by branded paying generic to delay entry

• US Supreme Court decision in Actavis

All of these cases involve a bilateral contract negotiation. Antitrust issues result from problems with that negotiation. Failure to reach deal in the case of refusal to supply and injunctions for SEPs. Nature of deal for pharma patent settlements.

4 Bargaining and Contracts

5Bilateral Negotiation with Buyers and Seller

Common for businesses to enter into contract negotiations with each other. Considerable portion of B2B exchanges are based on contracts, some simple, some very complex.

6Deals Happen Between Threat Points

Most the buyer is willing to pay

Least the seller is willing to take

Deal can take place between these “threat

points”

7Bargaining Power

• Availability of substitutes.• Buyer power.• Lack of sunk costs and

precommitments.• Repeat purchases.

For buyer:

• Alternative customers for excludable goods.

• Credible threat to withhold product.• Any lock-ins of customer.

For seller:

8Other Determinants of Bargaining Outcome

• Whether the buyer knows other sales prices or the seller’s true minimum

• Whether the seller knows the buyer’s willingness to pay and the demand faced by buyer

Information asymmetries

• Some buyers or sellers are better at negotiating deals

Negotiating ability

• Buyers and sellers have more of an incentive to reach “fair” outcome if there are repeated interactions

• Also, know more about threat points in repeated games

Repeated games

9Deals Don’t Necessarily Happen

Most the buyer is willing to pay

Least the seller is willing to take

Seller won’t take as little as the buyer is willing to offer. No

deal possible!

This situation is important for some of the antitrust debates because the claim is seller is “refusing to supply” in effect or charging an “unfair price”.

10Contracts are Multifaceted

Price Quality

Service Length

Some business contracts are very complicated, deal with many dimensions involving exchange of value, and address contingencies including breach of contract.

11Contracts, Bargaining, and the Antitrust of IP

Refusal to supply: refusal for leverage, or buyer isn’t willing to pay the seller’s minimum price?

FRAND: Licensor isn’t offering FRAND or buyer would like a better deal?

Reverse payments: contract to settle litigation in the face of uncertainty or contract to create and share monopoly profits?

12 Refusal to Supply Intellectual Property

13Classic Refusal to Supply Cases

European Commission decision on Microsoft (Interoperability) (2004) and European General Court judgment (2008).

Referral of IMS Health Case to European Court (2004)

European Commission decision on Magill’s access to television listings of RTE, ITP, and BBC (1988) and European Court of Justice judgment (1995)

Note, following Trinko, refusal to supply essentially per se lawful in US.

14Key Economic Issues

Does owner of IP have incentive and ability to leverage IP to secure additional monopoly profit? Raises standard vertical issues including whether Chicago single monopoly profit theorem holds and whether benefit of additional profit outweighs cost of lost revenue.

Does refusal result in the exclusion of competition necessary to make refusal profitable?

Are there efficiency benefits, including dynamic ones, from refusal such as prevention of free-riding and eliminating double marginalization? How should incentives to innovate be accounted for?

Questions: (1) Could a dominant firm refuse on grounds that the price buyer is willing to pay isn’t enough to offset its loss of revenues in downstream market in which it also competes? (2) How do we account for the incentives that “monopoly profits” play in inducing innovation in the first place?

15Economics of Refusal to Supply Pre-Microsoft

Not objectively justified

Prevents the emergence of a new product

Refusal excludes all competition in secondary market

Property indispensable to compete

Refusal per se lawful, but for “exceptional circumstances”

Microsoft European General Court judgment adopted easier test for Commission to meet. Must show “risk of elimination of competition” and impedes technological development which is short of prevention of new product. Court considers balancing incentives to innovate from providing access versus reduced incentives from forced sharing.

16Economics of “New Products”:

Q

P

MC

Value of New Product (increases from zero to this value (minus perhaps value of products it has displaced)

DemandReflects policy judgment not to interfere with property rights and incentives of firms to invest and innovate except in extreme cases including—in particular—creation of new product. Limits interventions to ones where dynamic benefits of compulsory licensing outweigh dynamic costs of compulsory licensing.

17 FRANDS, SSOs, and SEPs

18A Guide to the Alphabet Soup of Patents

SSO: Standard Setting Organization is usually a non-profit association of companies and other entities that devise technical standards.

SEP: Standard Essential Patent is a patent that claims an invention that must be used to comply with a technical standard generally enunciated by an SSO. There could be hundreds, maybe thousands, of these for a standard.

FRAND: SSOs often require that members agree to disclose patents on technologies to be included in a standard and agree to license those patents on “fair, reasonable, and non-discriminatory terms”. Some SSOs do not include the word “fair” in which case there are RAND obligations. Note that FRAND agreement requires that members license patent and therefore forbid an outright refusal to supply.

19Standard Setting Organizations in Action

“ETSI's purpose is to produce and perform the maintenance of the technical standards and other deliverables which are required by its members (Article 2 of the ETSI Statutes - see ETSI Directives). Like most standards organizations, much of this work is carried out in committees and working groups composed of technical experts from the Institute's member companies and organizations. These committees are often referred to as 'Technical Bodies' (TB), and typically meet between two and six times a year, in the ETSI premises or elsewhere. They also rely heavily on electronic communications to help progress the work, especially in-between meetings.” “When an ESSENTIAL IPR relating to a particular STANDARD or TECHNICAL SPECIFICATION is brought to the attention of ETSI, the Director-General of ETSI shall immediately request the owner to give within three months an irrevocable undertaking in writing that it is prepared to grant irrevocable licences on fair, reasonable and non-discriminatory (“FRAND”) terms and conditions under such IPR…”

“With some 33,000 granted patents, Ericsson is the largest holder of standard-essential patents for mobile communication. Our unrivalled patent portfolio covers 2G, 3G and 4G technologies, and we are a net receiver of licensing royalties with more than 100 patent-licensing agreements in place.”

20FRAND Disputes

Potential licensee approaches FRAND holder to secure license which it needs to rely on for standard technology.

What if the two parties can’t reach an agreement on the FRAND royalty rate?

The potential licensee may choose to go without a license and let the patent holder sue. In a patent dispute the court may find the patent isn’t valid or set a royalty less than what the patent holder wanted.

The patent holder may seek an injunction which if provided would prevent the licensee from using the technology unless it can find a work around.

21Patent Hold Up

Patent “hold up”: having gotten its patent incorporated into the technology the patent holder (remember this might be one of hundreds of patents) can prevent firms from participating in the technology and therefore various markets by refusing to license except on very high terms. Could do this for “exploitative” reasons or for “exclusionary” reasons.

Reverse patent hold up: patent holder can’t prevent potential licensee from using the patent except by hiring lawyers and pursuing a court challenge which can be expensive and with uncertain outcomes. And then the potential licensee could also try to pursue antitrust action which raises further risks.

Question: Technologies involve hundreds of SEPs and industries can involve multiple standards. Yet there are only a small number of patent disputes relative to the total possible and, while one could argue that innovation could be faster, many SEP-heavy industries seem to be growing quickly. But maybe the handful of disputes are very serious.

22Incremental Value Proposition

Does the SEP holder get to charge more because the patent has been included in a standard? No, that would give every SEP holder the ability to gain up to full return from the standard by blocking anyone from using it.

“Incremental value” of a given SEP is the difference in royalty rate that SEP could command over the next best alternative technology for a standard. That is how much SSO would have agreed to in a hypothetical negotiation.

Broad consensus among economists and courts on incremental value being the right approach conceptually.

23FRAND Disputes—Breach of Contract Approach

SEP holder often has a contract with SEO that requires commitment to license at FRAND.

Patent dispute with licensee is essentially a contract dispute where the parties can’t reach agreement on terms required under the contract.

Microsoft v. Motorola Mobility (Judge Robart) analyzed FRAND as a hypothetical negotiation. Follows US “Georgia Pacific Factors” which is used in patent infringement cases to determine reasonable royalty rate. Consistent with economic bargaining model.

24Sometimes Parties Just Don’t Agree

25FRAND Determination Under Contract Theory

Most the buyer is willing to pay

Least the seller is willing to take

Finder of fact tries to determine royalty rate that

willing buyer and seller would negotiate

Key factors include (1) comparable patent negotiations (same patent, other parties); different but similar patents; (2) (incremental) value of patent; (3) bargaining power.

26Antitrust Theories Concerning FRAND and SEPs

“Unfair/Excessive” Pricing (“Exploitative Abuse”): for jurisdictions that have unfair pricing as part of antitrust law. Theory is that SEP confers dominant position and patent holder is trying to charge excessive price (see Huawei v. InterDigital, China)

Refusal to supply: patent holder is asking for such a high price that it is in effect a refusal to supply. Standard essential facility argument.

Exclusionary abuse (1): patent holder is charging high price to exclude potential licensee from a downstream market (margin squeeze argument).

Exclusionary abuse (2): by filing for injunction patent holder is engaging in unfair competition that results in high prices.

27Tests Under Antitrust or Contract Theories

Assessment under antitrust theories require assessment of “FRAND” price to determine whether the patent holder is exceeding FRAND.

Shapiro et al. recommend using “incremental value”. But requires finder of fact to assess incremental value relative to other alternatives.

Schmalensee et al. recommend using “hypothetical negotiation” since this fills into contract and is operational under traditional patent approaches.

Robarts decision in Microsoft v. Motorola rejects incremental value approach in favor of hypothetical negotiation largely for reasons of it being a practical approach.

28 Pay for Delay

29Reverse Payment Settle aka Pay-for-Delay

Company A (patent holder) sues Company B (potential infringer) for patent infringement.

“Typical settlement”: B agrees to pay A and/or B agrees to pay royalty.

“Reverse payment settlement”: A agrees to pay B and B agrees to “pay for delay” of competitive entry.Cases so far have involved A being branded pharmaceutical suing generic pharmaceutical B. But in principle could be other industries. US Hatch-Waxman law allows generic to challenge branded pharmaceutical and in return get 6 months of generic monopoly if successful. First generic that sues gets first entry slot.

In US pay for delay therefore results in not only B being delayed but all generics being delayed since B is first in line.

30Settlement Economics Factors (Simple Model)

P= probability of winning patent litigation for A

T=remaining patent lifetime in years

M=monopoly profits in years for A

D=duopoly profits in years for A

C=A’s cost of litigating patent

R=reverse payment

E=Entry date for B

Reverse payment settlement involves choosing R and E

EM+(T-E)D>(PM+(1-P)D)T-C

Patentee settles with R payment and E entry date if certain monopoly profits during delayed entry minus reverse payments exceed expected value of monopoly profits minus litigation costs.

31Settlement Terms and Consumer Welfare

Simple Shapiro (2003) Model

Patentee settles with R payment and E entry date if certain monopoly profits during delayed entry minus reverse payments exceed expected value of monopoly profits minus litigation costs. EM+(T-E)D>(PM+(1-P)D)T-C

Consumers are worse off if they get on average more monopoly under settlement than they would under litigation which happens if the expected duration of the patent (PT) from litigation (assuming instantaneous result in litigation) is less than the delay (E) negotiated under the settlement.

Shapiro rule is that the reverse payment settlement is anticompetitive if reverse payment (R) is greater than the avoided cost of litigation. Otherwise patentee is paying for delay that harms consumers.

In complex settlements R is based on net value received by potential entrant for delay after deducing any value conveyed to patentee.

32Supreme Court Actavis Decision

Solvay agreed to pay generic companies between $10 million and over $100 million not to enter until a future date (but before patent expiration). FTC challenged. Lower courts affirmed that reverse patent settlements were within patent scope.

FTC sought to rule finding reverse payment settlements “presumptively illegal” (parties could rebut presumption).

Supreme Court decided rule of reason finding that there may be legitimate justifications for settlement but might also be method to secure and divide monopoly profits.

Likely validity of patent is one issue in assessing whether reverse payment is anticompetitive or not.

How should rule of reason be structured? How does risk of antitrust liability affect decision to enter into procompetitive reverse payment settlements?.

33Next Class Topic 16

Part 1

Antitrust Economics of Telecommunications

Part 2

Antitrust Economics of Payments