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Our world faces challenges more intricate and abstract today than at any previous point in history. As these challenges grow ever more tangled and complex, governments and businesses strive to create innovative technological solutions.
Unfortunately, creativity is not a matter of will. And the need for solutions is not itself sufficient to bring them about. Innovation demands the proper conditions — a balanced mix of flexibility and stability, spontaneity and forethought, risk and return. Increasingly, these conditions are under threat from the very institutions that have come to rely most heavily on the technologies they produce. The patent system and the standards system — two vital contributors to U.S. economic growth and consumer prosperity, that have together kindled a generation of unparalleled technological advancement — are being wrongly targeted by regulators, academics, and special interests as impediments to future progress.
A movement has taken hold in the United States and elsewhere to reduce the benefits of patent protection and to limit royalties available to technology inventors who contribute their innovations to industry standards.1 This movement has gained traction in courts, universities and boardrooms based on the mistaken belief that inventor protections increase the cost of standards-based consumer technologies. In fact, the opposite is true,2 and public policies aimed at weakening the patent and standards systems risk stalling the pace of technological advancement.
It is far from granted that technological progress will continue at recent rates. The social, regulatory, and financial headwinds faced by inventors intensify every year. Absent the legal and economic conditions required to continually foster innovation, there is no reason to believe technological progress will continue at any particular pace, and serious cause for concern that the promises of the fourth industrial revolution will go unfulfilled.
Take the extraordinary potential of 5G wireless systems — steadily moving from the abstract promise of “next-generation” technology to concrete and widespread use — to connect drivers with roads and other vehicles around them, to connect patients with medical practitioners, and to digitize industries across a vast spectrum of commercial endeavors. Shared industry standards are necessary to make these communications instantaneous, reliable and secure, but their future is threatened by an economic and regulatory system that increasingly favors technology implementers to the detriment of technology creators.3 Companies like Ericsson and Nokia,4 leading innovators of 5G technology, have seen their licensing revenues and profits fall dramatically in recent years, due in large part to nonpayments from implementers and various government enforcement actions.5
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The future of innovation — of smart, interoperable, and interconnected products — demands a sustainable system of investment, which in turn requires reliable facilitators of capital. Patents and standards are two proven accelerators of industry, and yet each faces growing pressure from regulators and technology implementers. If society is to benefit from a future of economic growth fueled by technological innovation, careful attention is required at the delicate interface between the patent and standards systems. An objective and informed balancing of the true costs and incentives of innovation, coupled with an appreciation for the exceptional opportunities for collaboration and growth made possible by patents and standards, is necessary to ensure that the inventors we have come to rely on have the resources they need to continue delivering on their potential.
Despite the truly profound societal interest in preserving incentives for technological investment, popular discussion of patent rights and standards is limited. This is because consumers are generally unaware of the process of value creation in high technology industries. Device manufacturers are customer-facing, so their contributions are readily recognized. But the inventors who enable device-level innovation through their contributions to underlying technologies go unseen, and their contributions unappreciated. Indeed, consumers often mistakenly attribute the technological achievements of modern devices to the device makers, when much of the credit should go to the inventors who create the foundational technologies from which the devices are built.
Consider the modern smartphone. The brilliant display, high-resolution camera, and full-motion video capability are all attributable not to the device manufacturers, but their upstream suppliers. And these tangible features are, themselves, useless without the profound innovations in cellular communications and processors required to run them — innovations generated by earlier inventors.
The underappreciation of upstream innovation becomes apparent where innovation is brought to market through industry standards. Once products that implement a given standard are put on the market, the only way inventors can receive compensation for the use of their inventions included in the standard — and, therefore, the only way inventors can realize a return on their substantial investments of time and money — is through the receipt of royalty payments. In contributing a technology to a given standard, and thus foregoing patent exclusivity, innovators surrender every other viable revenue opportunity. Unlike companies competing on nonstandardized products, innovators in standards-based industries cannot recoup research and development (R&D) expenses by simply raising the prices of the finished products they sell. This is because standards-based innovators, such as InterDigital and LG, sell in price competition with standards-implementing manufacturers, such as Apple and Samsung, who place comparatively fewer resources at risk to create the standards their products implement. These competitors have a dramatically lower cost basis and do not need to make up for time and money spent innovating. Yet they are able to enjoy and exploit the underlying product improvements resulting from the work of the inventors who created and contributed the standardized technologies.
The problem inventors face in recouping their investment costs is compounded by the fact that, in order for technologies to be included in a standard in the first instance, inventors must both disclose the technologies to industry groups and commit to license them on reasonable and nondiscriminatory terms to anyone manufacturing devices practicing the new standard. Such disclosures and commitments necessarily occur years before any product embodying the new standard will reach the market, meaning that new technologies are available for implementers’ use well in advance of making royalty payments on them. During that period, manufacturers and consumers forget the importance, desirability, and value of the standardized technologies and discount associated patents and compensation accordingly, while economic, judicial, administrative, social, and competitive pressures force inventors to accept royalty rates that are unfair. The current remuneration paradigm thus involves a fragile “give now, get paid much less, much later” dynamic with respect to intellectual property. And as royalties are the only means of compensation for inventors, this dynamic can render inventors unable to access the capital they need to continue inventing, stalling the cycle of innovation.
Leadership in Innovation Requires Incentivizing Innovation-Based Standards
“Innovation-based standards,” such as Wi-Fi, Bluetooth, and 4G LTE, are standards that incorporate truly inventive technological advancements, enabling implementers to build products that do more than simply follow convention. These standards represent technologies unequivocally superior to those previously available. The natural desire of device manufacturers to acquire these technologies at their lowest possible cost is at odds with the sound public policy of incentivizing investments in innovation and the contribution of innovations to standards. It pits a short-term gambit by implementers of standardized technologies to pay less than the value they receive against the inevitable long-term consequence of inventors of standardized technologies disappearing in the face of poor returns on their sizable investments in innovation.
Implementers who would restrict the ability of innovators in standards-reliant industries to recover reasonable royalties are building profitable businesses on a technological foundation to which they made no contribution. For instance, the best empirical research to date6 suggests that royalties on the sales of most mobile phones on the market today are around 3% or 4% — pennies on the R&D dollar. What certain implementers seem to be pushing for are completely royalty-free licenses. They are, in effect, standing on the shoulders of giants while striking them at the knees. And such “short-term win, long-term lose” scenarios rarely make for good public policy.
Companies that make massive investments in R&D to generate the modern wonders of the digital world, then willingly share their hard-won successes through standards for the benefit of all industry participants and consumers, offer prime value in what is perhaps mankind’s most constructive and nuanced form of commercial activity. These innovators should be celebrated, encouraged, and rewarded. They cannot be expected to sacrifice their innovations in return for vanishing economic opportunity. Resolute leadership in championing innovation-based standards requires the careful crafting and honoring of incentives that recognize the critical role, and yet perilous position, of innovators. Leadership in this context means resisting the efforts of standards-implementing manufacturers to take without paying, supporting policies that enable innovators to receive fair compensation for their contributions, and attaching significant consequences for those who fail to pay for the standards-based innovation from which they seek to benefit.
With innovation-based standards bringing unprecedented value to our economy, U.S. policy makers must recognize what makes these standards so valuable: voluntary contributions of technology by innovators who invested much in the creation of that technology. To pursue policies aimed at rewarding and encouraging these innovators is to add impetus to the highest order of human enterprise.
1.See generally, M.K. Ohlhausen, “Patent rights in a climate of intellectual property rights skepticism,” Harvard Journal of Law & Technology 30, no. 1 (Fall 2016), 1-51; A.F. Abbott, “Key patent reforms needed to spur U.S. Innovation,” Heritage Foundation (2017), www.heritage.org; A.F. Abbott, “US government antitrust intervention in standard-setting activities and the competitive process,” Vanderbilt Journal of Entertainment & Technology Law 18, no. 2 (Winter 2016), 225-246, www.jetlaw.org; J. Farrell, J. Hayes, C. Shapiro, and T. Sullivan, “Standard setting, patents and hold-up”, Antitrust Law Journal 74, no. 3 (2007), 603-670; and A. Armstrong, J. Mueller, and T. Syrett,” The smartphone royalty stack: surveying royalty demands for the components within modern smartphones” [Working Paper] (2014), https://ssrn.com/abstract=2443848.
2.See, e.g., E. Elhauge, “Do patent holdup and royalty stacking lead to systematically excessive royalties?,” Journal of Competition Law & Economics 4, no. 3 (September 2008), 535-570; D. F. Spulber, “Standard setting organizations and standard essential patents: Voting and markets,” Northwestern Law & Economics Research Paper No. 16-21 (2016); J.M. Barnett, “Has the academy led patent law astray?,” University of Southern California Legal Studies Research Papers Series No. 17-4 (2017); A. Galetovic, S.H. Haber, and L. Zaretzki, “Is there an anti-commons tragedy in the smartphone industry?,” Hoover Institute Working Paper Series No. 17005 (2017); K. Mallinson, “Don’t fix what isn’t broken: The extraordinary record of innovation and success in the cellular industry under existing licensing practices,” George Mason Law Review 23 no. 4 (2016), 967-1006.
3.See, e.g., U.S. Chamber of Commerce, “International Competition Policy Expert Group report and recommendations 31,” ICPEG Report (2017), www.uschamber.com; and M.K. Ohlhausen, “Remarks before the American Bar Association’s 32nd Annual Intellectual Property Law Conference, Arlington, Virginia (2017),” available at www.ftc.gov.
4.Identification of specific company examples throughout is not meant as criticism of the companies identified, or of their business strategies, nor is it meant to suggest any absolutes.
5.See J. Ellis, “Top licensors Ericsson, Microsoft, and Nokia all see drop in year-on-year patent revenues,” Feb. 9, 2017, www.iam-market.com; “Fourth Quarter and Full-Year Report 2016,” Jan. 26, 2017, www.ericsson.com; and “Nokia Corp. Report for Q4 2016 and Full Year 2016,” Feb. 2, 2017, https://www.nokia.com.
6.A. Galetovic, S.H. Haber, and L. Zaretzki, “A New Dataset on Mobile Phone Patent License Royalties,” Hoover Institute Working Paper Series No. 16011 (2016); and J.G. Sidak, “What Aggregate Royalty Do Manufacturers of Mobile Phones Pay to License Standard-Essential Patents?” 1 Criterion Journal on Innovation 701 (2016).