Prof. Doug Lichtman, UCLA School of Law
December 15, 2011
In Germany last week, Apple suffered a potentially significant setback when a German patent court rejected Apple’s “RAND licensing defense” and instead took a step toward allowing Motorola to ban the sale of certain, allegedly infringing, Apple products. The loss has not attracted significant attention, in part because there are still appeals ahead, and in part because the RAND issue is an admittedly esoteric one. That said, in my view, questions relating to the proper reading of the RAND commitment are going to be some of the most important questions affecting technology markets in the next five years; so I want to use the fight in Germany as an opportunity to publicly sketch some introductory thoughts about RAND and its implications.
Let’s start at square one: what is the RAND commitment?
Prior to adopting a technical standard, standard-setting organizations typically endeavor either to make sure that the standard does not infringe any patent rights or to clear the necessary permissions. The task is a difficult one. The protocol that governs how information is stored on DVD-R media, for example, is known to implicate at least 342 different patents. The encoding, decoding, and transmission protocols relevant to just one type of cellular telephony touch well over 1,000. And RFID technology – those electronic tags that Wal-Mart and the Department of Defense hope will someday transform inventory management – is at this point rumored to labor under the weight of over 4,000 issued patents in the United States alone.
Those large numbers are problematic because it takes substantial time and money to evaluate a patent. To do the job right, consensus would have to be achieved as to whether the patent is valid, whether it covers a truly essential aspect of the standard at issue, and exactly how much the patent contributes as compared to next-best alternatives. Worse, all of that would need to be done in a context where patent holders have strong incentives to exaggerate; where information about pending patent applications is understandably hard to come by; and where there will often rage an independently contentious debate over non-patent issues like the specifics of what should and should not be included in the standard.
Thus enters the RAND commitment. Instead of undertaking the difficult task of evaluating asserted patents, most standard-setting organizations simply keep a running list of patents that have been asserted to be relevant by one or another patent-holding participant. Those participants are then required to agree that, ultimately, they will make available to the public, on “reasonable and nondiscriminatory terms,” any truly essential patent. The need for careful patent analysis is thereby diminished. If a given patent turns out to be irrelevant, no one will need a license for its use anyway. But if a given patent turns out to be essential, at least the relevant patent holder has promised to license at a reasonable and nondiscriminatory rate.
Hidden in that simple solution, of course, is enormous complexity. Is the RAND commitment a license, such that firms can go ahead and implement the technology subject only to a later obligation to negotiate the price? Is it a promise to license, which would mean that implementing firms in fact have no right to use the patented technology until they cut a specific deal? And what happens if, as seems enormously likely, an essential patent holder ultimately thinks one price is reasonable whereas the implementing firms think a much lower number is appropriate? Is that dispute a contract dispute, litigated using traditional contract-damages measures, or a patent dispute, meaning that the patent system’s damages regime controls the process?
These are the very sorts of issues in play right now in Germany. Apple and Motorola agree that many of Motorola’s patents are subject to the RAND commitment, but they disagree about what that means in terms of the potential for court-ordered remedies like damages and injunctions. In particular, how should the court think about Apple’s liability for its past use of the patented technologies? Should Apple be allowed to pay a reasonable royalty today, even though it arguably should have paid that royalty years ago? Or should those backward-looking damages be allowed to be unreasonable, in essence to punish Apple for not paying RAND rates from the get-go?
I do not want to answer all this in full here. I will instead come back in my next column and say more about how I think courts should understand these specific puzzles. For now, however, I want to set the stage by thinking about RAND from a purely business perspective. That is, for the moment I want to put aside patent, contract, and antitrust damages, and I want to focus instead on the business question of why firms might prefer the ambiguous RAND commitment over a more conventional, explicit pricing term. The answer is not immediately obvious. After all, in most business settings, buyers very much want to know the prices associated with competing options so that they can ultimately make tradeoffs between price and quality. Yet, in standard-setting, that norm has been largely abandoned. Why?
One reason is that intricate negotiations over patent validity and patent value would take an enormous amount of time. To work through a process where dozens of companies would debate the merits and worth of hundreds of patents would take years. Worse, were consensus not achieved, litigation would run yet more time off the clock, with substantial time lost first at the district court and then on appeal. One charm of the RAND commitment for participants and the public alike, then, is that RAND allows technological implementation to move forward while the parties in parallel work out legal and financial details.
A second and related reason that firms opt for the RAND commitment is that standard-setting is a process run by engineers, not lawyers. A technology firm like Microsoft or Dolby can easily be involved in dozens of standard-setting processes at the same time. To send to each of those bodies not only the obviously necessary engineers but also an army of lawyers, business executives, and pricing specialists would be enormously expensive. The RAND commitment thus simplifies the conversation, allowing the engineers alone to run the show until the technical details are fully selected and documented.
A third reason that firms choose RAND is that many new technologies flop. Digital Audio Tape (DAT) technology for a time looked like it was going to be so important that Congress passed a set of laws specifically regulating its sale and use. Oops. Similarly, from 2002 through 2008, the HD-DVD standard was backed by industry heavyweights including Toshiba, Sanyo, and NEC. Today, HD-DVD technology, too, is just a footnote in history. Thank goodness, then, that EMI, Sony BMG, Universal Music Group, Warner Music, Sony, Toshiba, Sanyo, NEC, Paramount, Hewlett Packard, Microsoft, Apple, and their peers did not each invest a fortune vetting those patent situations. They would have negotiated detailed terms for a group of patents that turned out to have little actual commercial value.
A fourth reason that firms opt for RAND – and this is in essence a more general version of reason three – is that RAND allows implementing firms to wait for additional information before they commit to a specific royalty structure. When Al Gore invented the Internet, no one really understood the impact those protocols would have on commerce, culture, and communication. Much the same, when the now-familiar 2G wireless standard was first promulgated, even that technology’s strongest proponents could not have foreseen the degree to which cell phone usage would permeate both work and play. Financial arrangements will often be more efficient in the long run if their details can be negotiated after the negotiating parties more fully understand how the technology at issue is going to be used and by whom. The RAND commitment delays pricing negotiations and thereby allows at least some of that information to be included in the ultimate royalty negotiation.
None of this is meant to imply that a RAND-like approach was inevitable, or even that RAND is clearly the right way to go. My points about delay, failure, and the desirable absence of lawyers are all general arguments that could apply with comparable force in other settings. Businesses are routinely forced to delay the launch of products and services while they lawyer up their relationships and negotiate elaborate deals. And yes, many of those complicated deals ultimately prove worthless because consumers reject the resultant offering. Just the same, in many settings, delay would allow beneficial information to come to light – for instance, information about consumer preferences and the pace of market adoption. But businesses all the time enter into contracts anyway, allocating risk without knowing exactly what will happen next and sometimes making their various obligations contingent on future events. So, while these are all real problems to be sure, RAND is neither the only nor a necessary way to overcome them.
Moreover, RAND has some real drawbacks. Consider, for instance, the fact that the RAND commitment separates the negotiation over the details of a technology from the negotiation over its cost. At my house, that would be an obvious and unacceptable blunder. I can only imagine what my wife would say were I to choose an expensive piece of home electronic equipment – say, a new flat-screen television – without having an estimate of what that hardware and its accessories would ultimately cost. Yet sophisticated companies like Nokia, Ericsson, Nortel, Sony, InterDigital, Texas Instruments, Alcatel, DirecTV, and NEC did exactly that when they hammered out the details of the recently launched Long Term Evolution (LTE) telecommunications standard. They made hundreds of nuanced choices about how LTE-compliant devices will decode, encode, and transmit data, but they did so without any real understanding of what the various options would cost in terms of patent fees. That sort of economic blindness is par for the course in the standard-setting process. But it is still jarring, and it still represents a real downside to the RAND approach.
RAND has another significant drawback as well: It forces courts to take a more active role when it comes to pricing patents. Judges and juries are unlikely to be very good at valuing patented inventions. This would be true in even a simple case where a single patent was at play; but it is all the more true in the context of standard-setting, where the value of any one patent has to be judged in light of hundreds or even thousands of other necessary patent rights. An explicit pricing regime would address this difficulty: Standard-setting participants would negotiate each patent’s appropriate price, and courts would be asked only to enforce the agreed-upon deals. The RAND commitment, by contrast, puts courts center-stage. If the parties cannot agree as to what “reasonable” means, a judge or jury will ultimately have to wade through the evidence and pick a number. Moreover, even if the parties in the end agree on what “reasonable” means, their agreement will unavoidably have been influenced by what each party expected a court would do if agreement had not been reached. RAND, then, takes a task that courts perform poorly and makes that task a central driver in the ultimate economic interaction.
All that said, however, the RAND commitment is, as of this writing, widely used in settings where a large number of patents are plausibly implicated by a given technological standard. It might be a good idea. It might be a terrible one. But RAND is today pervasive, and so the questions facing that court in Germany are questions that will inevitably repeat in other high-stakes fights. Thus, next time, I want to think about how the business reality behind RAND ought to influence judicial interpretation of it.