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Abstract

Current controversies over patent policy place standard-setting organizations (SSOs) on a collision course with antitrust law. Recent theoretical research conjectures that, in an SSO, patent owners can "hold up" patent users in the sense of demanding high royalties for a patented input after the SSO has adopted the patented technology as an industry standard and manufacturers within the SSO have incurred sunk costs to design end products that incorporate that standard.

Consistent with this conjecture, actual SSOs have recently sought no-action letters from the Antitrust Division for a variety of amendments to SSO rules that would require or request, at the time a standard is under consideration, the ex ante disclosure by the patent owner of the maximum royalty that the patent owner would charge under the regime of fair, reasonable, and nondiscriminatory licensing. This price information - which is characterized as the "cost" of the patented input - would, under at least one recent SSO rule modification, be a permissible topic for potential users of the patent to discuss when deciding whether to select it in lieu of some alternative standard. This exchange of information among horizontal competitors would occur ostensibly because the cost of the patented technology had been characterized as simply one more technical attribute of the standard to be set, albeit an important technical attribute.

The Antitrust Division and the Federal Trade Commission have jointly stated that such discussion, by prospective buyers who are competitors in the downstream market, of the price of a patented invention that might become part of an industry standard should be subject to antitrust scrutiny under the rule of reason rather than the rule of per se illegality. The rationale that the antitrust agencies offer for applying the rule of reason to such conduct is that such horizontal collaboration might avert patent holdup. The Antitrust Modernization Commission (AMC) similarly endorsed the view that rule-of-reason analysis is appropriate for ex ante discussion of royalty terms by competing buyers of patented technology. This rule-of-reason approach, however, is problematic because it conflicts with both the body of economic research on bidder collusion and with the antitrust jurisprudence on information exchange and facilitation of collusion.

Put differently, because of their concern over the possibility of patent holdup, the U.S. antitrust agencies and the AMC in effect have indicated that they may be willing in at least some circumstances to forgo enforcement actions against practices that facilitate oligopsonistic collusion by encouraging the ex ante exchange of information among competitors concerning the price to be paid for a patented input as an implicit condition of those competitors' endorsement of that particular patented technology for adoption in the industry standard. However, neither the proponents of these SSO policies nor the antitrust agencies and the AMC have offered any theoretical or empirical foundation for their implicit assumption that the expected social cost of patent holdup exceeds the expected social cost of oligopsonistic collusion.

This conclusion does not change even if one conjectures that such collusion will benefit consumers by enabling licensees to pass through royalty reductions in their pricing of the downstream product incorporating the patented technology. Proper economic evaluation of the plausibility of the passthrough conjecture will require information about the calculation of royalty payments; the demand and supply elasticities facing the licensees; and the structure of any industries further downstream between the manufacturer and the final consumer. Consequently, the magnitude of this effect will likely be a matter of empirical dispute in every case. Moreover, such a justification for tolerating horizontal price fixing finds no support in antitrust jurisprudence.

Given the analytical and factual uncertainty over whether patent holdup is a serious problem, it is foreseeable that antitrust questions of first impression will arise and affect a wide range of high-technology industries that rely on SSOs. However, there is no indication that scholars and policy makers have seriously considered whether oligopsonistic collusion in SSOs is a larger problem than patent holdup.

I. INTRODUCTION

In a standard-setting organization (SSO), or a standards development organization (SDO), owners and users of patents agree to establish standards that make possible the production of interoperable end products that use patented technologies as inputs. A notable example is the cellular telephone, for which applicable standards rely on hundreds, if not thousands, of patented inputs. An influential article by Professors Mark Lemley and Carl Shapiro conjectures that the owner of a patented input can "hold up" firms that wish to use that input to manufacture end products.1 Lemley and Shapiro describe patent holdup as occurring when the patent holder uses a court's issuance of an injunction (or merely the threat of an injunction) to block an infringer's use of the patented invention unless the infringer, who has made sunk investments in expectation of using the patented invention, pays a royalty that is, from the infringer's perspective, excessively high. Lemley and Shapiro argue that the phenomenon of patent holdup justifies changing patent law, through legislation and judicial interpretation, to limit the availability of patent injunctions. These proposals envision public collective action to address patent holdup.2

Private collective action is another way to respond to the patent-holdup conjecture. Although the Lemley-Shapiro analysis is not confined to SSOs, such organizations present the more interesting case of possible patent holdup because they are institutions that evolved explicitly for the purpose of coordinating ex ante agreements among multiple actors to harness the productive potential of complementary technologies. For example, a standard over cellular telephone technology allows communications over different networks and subscriber devices, so that those different networks and devices can interoperate. An SSO introduces the possibility that its members will privately act, through the SSO's collective decision making process, to adopt or reject a particular standard that incorporates particular technology. An implicit assumption of the nascent debate over patent holdup has been that collective action privately undertaken by SSOs to resist holdup should be permitted, if not actively encouraged. The argument is that licensees are justified in conducting ex ante joint negotiations because of the incremental market power conferred on holders of essential patents by virtue of inclusion of their patents in the standard. Stated differently, ex ante joint negotiations are supposedly a welfare-enhancing means to take advantage of competition for inclusion of a technology in a standard that ends when the SSO adopts or implements the standard. This changed role for the SSO regarding ex ante joint negotiation of royalties is significant because collaborative selection of an interoperable technology does not require oligopsonistic price setting. Price is not a technical characteristic of a technology.

Some scholars share my skepticism about the existence and empirical significance of patent holdup.3 The legal and economic literature on this subject continues to develop, and the intellectual debate over patent holdup would be unlikely to be resolved soon, if left to ripen undisturbed by the exigencies of real-world controversies. For sake of argument, I will assume, contrary to my skepticism, that patent holdup can occur, and that it causes demonstrable social harm when it does occur. The contribution of this article is not to add to the existing debate with respect to patent law but to consider an important but neglected antitrust implication of that debate. Simply put, ex ante collective action that is privately undertaken in an SSO to counteract potential patent holdup may facilitate, if not serve as an outright facade for, horizontal price fixing by oligopsonists of the patented input. It is well established in antitrust jurisprudence that the rule of per se illegality applies to competitor exchanges of contemporaneous or forward-looking information on pricing. It is not obvious why a more lenient rule should apply when competing buyers of a patented input discuss the price that they believe the patented input should fetch now or in the future. It is also not obvious why policies of antitrust prosecutorial discretion should favor licensees of patented technologies over licensors.

Consistent with the recent research on patent holdup, actual SSOs have recently sought no-action letters from the Antitrust Division of the Department of Justice for a variety of amendments to SSO rules that would require or encourage, at the time that a standard is under consideration, the ex ante disclosure by the patent owner of the maximum royalty that the patent owner would charge under an agreed-upon regime of fair, reasonable, and nondiscriminatory (FRAND) licensing. This price information would, under at least one recent SSO rule modification, be a permissible topic for potential users of the patent to discuss, although the policy created some ambiguity by also purporting to prohibit joint discussion of "specific license terms." This exchange of information among horizontal competitors would occur ostensibly because the "cost" of the patented technology-namely, its royalty rate-would be characterized as simply one more technical attribute of the standard to be set, albeit an important technical attribute.

The Antitrust Division has issued business review letters permitting the mandatory or voluntary disclosure of royalty and other licensing terms, and the Division and the Federal Trade Commission (FTC) have jointly stated that discussion among horizontal competitors who will need a license should be subject to antitrust scrutiny under the rule of reason rather than the rule of per se illegality. The rationale offered by the antitrust agencies for that legal standard is that such horizontal collaboration may be a justifiable response to the perceived problem of patent holdup. In 2007, the Antitrust Modernization Commission (AMC) similarly endorsed the view that rule-of-reason analysis is appropriate for ex ante discussion of royalty terms by competing buyers of patented technology. It bears emphasis that-unlike the conduct at issue in the FTC's enforcement actions in Rambus,4 Dell,5 and Unocal6-the holdup scenario envisioned here does not arise from the patent holder's misrepresentation or knowing, intentional failure to disclose to the SSO that the patent holder owns intellectual property rights in essential technologies.7 Rather, the assertion of patent holdup addressed here arises because the patent holder does not forbear from charging the highest royalty that it can, once its technology has been knowingly chosen by the SSO for its standard. This reasoning conflicts with the Supreme Court's reasoning in Trinko that "[t]he opportunity to charge monopoly prices-at least for a short period-is what attracts 'business acumen' in the first place . . . [and] induces risk taking that produces innovation and economic growth."

The rule-of-reason approach of the Antitrust Division, FTC, and AMC is also problematic because it conflicts with both the body of economic research on bidder collusion and with the antitrust jurisprudence on information exchange and facilitation of collusion. Put differently, because of their concern over the possibility of patent holdup, the antitrust agencies and the AMC in effect have indicated that they may be willing in at least some circumstances to forgo enforcement action against practices that facilitate oligopsonistic collusion. Those practices encourage the ex ante exchange of information among competitors concerning the price to be paid for a patented input as an implicit condition of those competitors' endorsement of that particular patented technology for adoption in the industry standard. Neither the proponents of those practices nor the antitrust agencies and the AMC, however, have offered any theoretical or empirical foundation for their implicit assumption that the expected social cost of patent holdup exceeds the expected social cost of oligopsonistic collusion. This conclusion does not change even when the enforcement agencies assert that such collusion will benefit consumers by enabling licensees to pass through royalty reductions in their pricing of the downstream product incorporating the patented technology. The magnitude of this effect is a matter of theoretical and empirical dispute. Moreover, such a justification for tolerating horizontal price fixing finds no support in antitrust jurisprudence.

Lemley and Shapiro also make a conjecture about "royalty stacking." They hypothesize that, if multiple licensors of complementary inputs each tried to hold up licensees by demanding high royalties, the downstream product could become uneconomic to produce. However, neither the antitrust agencies nor the AMC have identified royalty stacking (as opposed to patent holdup per se) as a justification for coordinated action among competing buyers in an SSO. And, in any event, the existence and severity of royalty stacking are still conjectures rather than empirically substantiated facts. Put differently, royalty stacking is, fittingly, a conjecture stacked upon another conjecture. The probability that royalty stacking will occur with respect to a given downstream product is necessarily less than or equal to the probability that patent holdup will occur with respect to an essential patent reading on the standard for that downstream product. From a lawyer's perspective, therefore, royalty stacking cannot be bootstrapped into a more plausible theory than patent holdup for justifying private collective action in restraint of trade. Consequently, both patent holdup and royalty stacking would encounter a court's considerable skepticism under existing antitrust jurisprudence. Because of the doubly speculative nature of the royalty-stacking conjecture, I focus in this article on the antitrust implications of the patent-holdup conjecture. If the patent-holdup conjecture collapses under antitrust scrutiny, then so must the royalty-stacking conjecture.9

Given the analytical and factual uncertainty over whether patent holdup is a serious problem, and given the divergence of desired interpretations of antitrust law concerning SSO self-help responses to possible patent holdup, it is foreseeable that antitrust litigation on questions of first impression will arise and affect a wide range of high-technology industries that rely on SSOs. On the heels of the September 2007 Microsoft ruling by the Court of First Instance, broadening a monopolist's duty to share its intellectual property under European competition law,10 the European Commission initiated an Article 82 antitrust case against Qualcomm on October 1, 2007, in response to complaints of other firms (including vertically integrated firms that own and sometimes license patents covering competing and complementary technology and that make or sell products using such technology) that the level of its patent royalties for WCDMA technology for cellular telephones constitutes an abuse of dominance.11 This view of European competition law, like the proposals of Lemley and Shapiro to attenuate patent rights under American law, would fundamentally alter the nature of negotiations between patent owners and patent users in SSOs. However, in neither jurisdiction is there any indication that scholars-or enforcement agencies bringing cases against patent licensors or issuing statements of an intention not to prosecute ex ante negotiations among licensees-have considered the possibility that oligopsonistic collusion in SSOs is a larger problem than patent holdup.

Part II of this article explains the Lemley-Shapiro patent-holdup conjecture. It then explains the legal and economic arguments that cast doubt on the plausibility of that conjecture.

Part III shifts the perspective to antitrust law. It critiques the reasoning by which the Antitrust Division, the FTC, and the AMC have concluded that rule-of-reason analysis should apply to collective action privately undertaken among buyers in an SSO, purportedly to prevent patent holdup. These three bodies have failed to give appropriate attention to the possibility that the risk of oligopsonistic collusion in SSOs is significant. It bears emphasis that use of the rule of reason need not be a rubber stamp for per se legality. Narrowly read, the antitrust agencies' endorsement of the rule of reason in this context may reflect nothing more than a current underweighting of the risk of and harm from oligopsonistic collusion in SSOs. It may indicate only that those agencies are not prepared to assume that such risk and harm will always outweigh any countervailing justifications. This article argues that the antitrust agencies should revise that current perspective. If, in the alternative, the statements of prosecutorial discretion from the antitrust agencies are read to support a broader conclusion on the presumptive legality of oligopsonistic collusion, they should be repudiated on the ground that they are antithetical to the purpose of antitrust law as articulated by the Supreme Court.

Part III further argues that existing antitrust jurisprudence indicates why the rule of per se illegality is the more appropriate rule to apply to negotiations among competitors in an SSO over the maximum level of royalties to be charged by a patent holder seeking adoption of its technology into the standard. The proper concern is not, as the proponents of buyer collusion evidently believe, how the exchange of information among competitors will affect the division of rents between licensors and licensees; the proper concern is whether that exchange of information will expand output, increase both allocative and dynamic efficiency, and increase consumer welfare. In the SSO context, is the objective of negotiations among competitors over licensing terms and royalties to reduce input prices through combined buyer power? Or is this coordinated action necessary to achieve some output-expanding objective that advances consumer welfare, and for which the royalty negotiations are merely an ancillary restraint of trade? If patent holdup is the only concern-if the only question is how rents will be distributed between patent licensors and patent licensees-then the negotiations among competitors over royalty rates are properly considered horizontal price fixing subject to the per se rule of illegality.

Part IV asks whether any of the preceding analysis of the patent-holdup argument requires modification if the justification offered for the SSO policies in question is the assertion by licensees that the lower licensing fees resulting from negotiations between colluding oligopsonists and owners of competing patented technologies will be passed on to consumers. This assertion is difficult to evaluate in the abstract. Proper economic evaluation of the plausibility of the assertion will require information about the calculation of royalty payments; the demand and supply elasticities facing the licensees; and the structure of any industries further downstream between the manufacturer and the final consumer, such as final-assemblers or retailers (in the computer industry) or network operators (as in wireless telephony). The complexity of those inquiries underscores why, as a matter of established antitrust jurisprudence, the passing on of cost reductions achieved solely by virtue of oligopsonistic collusion is not-and should continue not to be-a legally cognizable mitigation, justification, or excuse for horizontal price fixing.

II. THE PATENT-HOLDUP CONJECTURE

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J. Gregory Sidak is an Expert Economist in the fields of Antitrust, Telecommunications Regulation, Commercial and Investment Arbitration, and Intellectual Property Law. Prof. Sidak is the Ronald Coase Professor of Law & Economics at Tilburg University and the Chief Economic Expert at Criterion Economics in Washington, DC. The focus of his research has been regulation of network industries, antitrust policy, the Internet and electronic commerce, intellectual property, and constitutional law issues concerning economic regulation.

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