Standard Essential Patents: How SEP Licensees Can Reach a Fair Deal

Introduction

With the imminent 5G era around the corner, many businesses must be prepared to face licensors who will come knocking on your door and asking for patent royalties. Unlike the LTE era where most of the patented technology is applied in the telecommunications industry, 5G technology will expand into other industries and sectors such as agriculture, connected vehicles, logistics, retail, and much more. This indicates that more businesses will become potential licensees for patented technology, especially those covered by standard essential patents (SEPs)

As a potential SEP licensee, are you fully prepared to open the door yet?

In this article, we will go over the main challenges SEP licensees face in SEP licensing negotiations and examine how licensees can protect their interests when negotiating for an agreement that is fair, reasonable, and non-discriminatory (FRAND). This will include the key issues that need to be addressed in negotiations, how to calculate patent royalty rates, and possible solutions for alleviating the challenges.

Note: The numbers and screenshots in this article were taken on July 9, 2021, unless specified otherwise.

Table of contents

• The main challenges SEP licensees face
• Determining royalty rates
• Negotiating for a fair deal
• Summary

The main challenges SEP licensees face

If your business or client is using technology protected by a SEP, licensing from the SEP holder may be inevitable. But, more often than not, many SEP licensees don’t have any way of knowing if the patent royalties that the SEP holder is asking for are fair or not.

Some of the main challenges that SEP licensees face include:

• Establishing the necessity for licensing
  For instance, if a SEP holder asserts royalties for SEPs covering technology for a base station but is trying to get a patent royalty from user equipment (e.g., smartphones or vehicles). Another example would be if a licensor is asking for royalties for SEPs deployed in China and Japan, but your products are manufactured and sold only in Brazil.
• Asymmetrical and dynamic information
  Licensees that are unfamiliar with the details and workings of SEPs are vulnerable to the often intimidating requests from SEP holders due to asymmetrical information that both parties have access to or know of. Also, since patent data is dynamic, with information such as legal and assignee statuses changing from time to time, constant monitoring of such data becomes uneconomical.
• Identifying essentiality
  Over-declaration is an issue that arises from SEP holders’ need to conform to disclosure policies and the underlying intention of getting a larger share from the pie. Thus, determining the essentiality of SEPs has become an important issue that needs to be examined carefully by the potential licensee before entering into a licensing agreement. Is the SEP asserted by the licensor truly essential?
• Determining a FRAND royalty rate
  Finding other SEP licensing information to reference is difficult. Almost all licensing information is confidential and there is no “pricing list” one can simply look at to get an overall price range of reasonable royalty rate. Some litigation verdicts stipulate a FRAND royalty rate, but many of these cases settle before a decision is made, leaving the final royalty rate number obscure from the public.
• Substantial costs
  Licensing negotiations are costly, perhaps not as costly as litigation, but if your business does not have a dedicated IP legal team, you may have to seek external legal counsel. Apart from legal costs, other basic costs will arise during negotiations, such as travel and accommodation expenses.This is because licensing negotiations are often lengthy and arduous often spanning from several months to over several years. Licensees must be prepared to evaluate whether to suck up the costs that arise when negotiating a FRAND-ly royalty rate or accept whatever rate the SEP holder throws out.

As 5G technology has a grander application scope in the future, we may see more companies new to the SEP world becoming underdogs in negotiations with non-practicing entities (NPEs) and telecom giants who are already well experienced in SEP licensing battles.

Determining royalty rates

Before proceeding, please note that most of the licensing practices mentioned in this article are from pre-5G (such as 2G, 3G, LTE) SEP licensing negotiations and agreements due to its market maturity in comparison with 5G technology.

Without further ado, let us look at how to determine patent royalty rates, especially FRAND rates in SEP licensing negotiations.

1. Start off on the right foot — getting the basis of the negotiation right

First, before talking about the money, potential licensees must make sure the basis of the negotiation is sound. What this means is that you will need to make sure your products or systems are within the same scope as the technologies covered by the SEPs in the potential licensor’s portfolio.

Licensing negotiations will almost always include a technical discussion, where both parties sit down and discuss whether the SEPs cover the technology used in a potential licensee’s product or system. The SEP-holder usually presents a claim chart that maps the SEPs’ claims to relevant technical standards/specifications to prove essentiality. As a SEP portfolio may contain many patents, most of the time, only the critical patents will have an accompanying claim chart.

In licensing negotiations for LTE technology, there is less dispute over this basis since most of the technical standards are already used or in use.

2. Starting on the same page with the basic terms

Now, we can start talking about money. The terms for discussing royalties are mainly based on two base terms — the unit base and price base.

• Unit base
  Before discussing the rate, first, both parties need to agree upon the unit for calculating royalties rates, whether it may be of a single product or device, such as a handset or device.In the telecom industry and for LTE technology, a single end product or device is often the basic unit of calculations. We will also be referring to this basis in the following content. However, for 5G technology, we may see different bases in the future due to its possible applications in other industries.
• Price Base
  Another base term to be determined is the price base. The Average Selling Price (ASP) of a unit is most commonly seen in both negotiations and litigation. ASP is more often used, not just because the numbers are easier to obtain, but also because there are data providers such as IDC that can provide such data.On the other hand, we have the Net Selling Price (NSP). Although theoretically, NSP may be fairer, it is more difficult to estimate and calculate.The main takeaway is that both parties should need to specify and define clearly which rate will be used in the agreement. Sometimes, in negotiations, the specific number is not needed as price negotiations often include discount factors such as refunds that will also be included in the agreement.

3. Calculating royalty rates

Now, let’s get down to the math. How do we calculate patent royalty rates?

Approaches

A bit more theory before getting our calculators out. There are two commonly used approaches for determining FRAND royalty rates for SEPs — the comparable license approach and the top-down approach.

• Comparable license approach
  The comparable license approach (sometimes also referred to as the bottom-up approach)  requires finding similarly situated companies and information regarding SEP licensing for comparison. Then the royalty rates are then calculated by unpacking the terms of the agreements found.
• Top-down approach
  The top-down approach uses a simple equation: multiplying the aggregate royalty rate with the contribution percentage of a company’s number of SEPs. Simply put, the aggregate royalty rate is the pie, and the proportion of a company’s SEPs determines the slice of the pie they get.

The Equation

Let’s get our calculators out now. Using the top-down approach, let us calculate a royalty rate for the top ten LTE SEP-holding companies. The common method is to use the number of active SEPs in a licensor’s portfolio as the numerator and the global total as the denominator. The basic formula using simple patent family count is:

Notice how we use “active” SEPs in our equations. This is because only active patents are enforceable.

Using an aggregate royalty rate of 10% for LTE SEP licensing as an example, let us calculate the royalty rates for the top 10 LTE SEP holding companies.

First, we need to find out how many SEP families there are for LTE. Using SEP OmniLytics, we can see that there are currently 23,286 active simple LTE SEP families. For simplicity’s sake, let us leave out other factors such as essentiality and regional coverage and assume all of the active SEP families are of equal value.

Next, let us look at the number of active LTE self-declared SEP families each of the top 10 companies hold.

With these numbers, we can calculate the proportional share for the current top 10 holders. Using the previous assumption of a 10% aggregate royalty rate, we can use this proportion to calculate the patent royalty rate for each of the top 10 companies (Table 1).

We can also look at the pie like this:

This example illustrates the basic method of calculating a SEP licensing royalty rate. Other factors will need to be considered in the equation. For instance, if we factor in the SEPs for a certain standard, the equation would be like this:

If we add the regional factor in, the equation may become something like this…

Or like this…

Although these equations look simple and fairly straightforward, the real practice is not. Many other factors can be included in the equation. Licensing negotiations often require economics, financial, technical, IP, and legal experts to explain the deductions and the logic behind the calculations.

Each factor mentioned in the equations above can also be a ground for disagreement between the licensors and licensees, further dragging out the negotiation process. Just determining the proportional share can often lead to a major dispute between the licensors and licensees.

Regardless of the difficulties and challenges in using this equation, this method has been and is still widely used by many courts in different countries.

Negotiating for a fair deal

Now let’s see how potential licensees can negotiate for a FRAND license. Basically, licensors want a larger slice of the pie and potential licensees want a smaller one.

So, with this in mind, the primary goal for SEP licensees is to reach a fair trade, or FRAND license, by trying to lower the proportion the licensor exerts. Apart from ensuring the licensor includes only active SEPs in their proposal, here are a few points for potential licensees:

Lay out all of the factors and terms

When negotiating a license agreement, all factors regarding the licensor’s SEP portfolio should be listed and considered. The factors that will affect the scope of the SEP portfolio discussed during negotiations include but are not limited to, legal status, remaining life, ownership status, jurisdictions, technical specifications, working groups, multiple declarations, and essentiality.

An example would be the technical discussion we mentioned earlier where the two parties discuss the standards that can be mapped to the SEP or product. This would be a good time to determine the scope of the standards that will be considered in calculating patent royalty rates.

Which of the three 3GPP working groups will be the main focus? Are there certain technical specifications that need to be included? Such as TS 38 213 (NR; Physical layer procedures for control) which is currently the most popular with 19,877 active SEPs.

Propose a regional license

As a licensee, you can also counter an offer by examining the global coverage of the licensor’s SEPs and your business’s manufacturing and marketing regions to see if you can negotiate for a regional rate instead of a global rate. If your business only operates in certain countries or regions, it may not be reasonable to pay a global rate. To illustrate, let us use OPPO’s 5G SEP portfolio as a very simple example.

Assuming that your company’s Pro-speedz Smartphones (which use 5G technology) are manufactured in Vietnam and sold in mainly Japan and Korea. To keep things simple, we will omit other factors such as standards and remaining life. Today, OPPO has approached you with this 5G SEP portfolio:

We can also see the global status of 5G SEPs under the same criteria:

Now that we have the numerator and denominator, we can calculate the basic royalty rate for OPPO. Using SEP families, OPPO will have a SEP share of 1,088/26,185 = 4.16%. This share can then be used to calculate the “global licensing rate,” which is often seen in LTE licensing negotiations as it simplifies calculations and makes negotiation more efficient.

However, if we examine the global coverage of OPPO’s 5G SEPs, we can see that OPPO has no SEPs in Vietnam, and only four 5G active SEP families can be found in South Korea.  In Japan, we can find 574 5G SEP families with at least 122  active members.

By mapping your product’s location of manufacturing and sales, we find that only the OPPO’s SEPs deployed in Japan can be significantly asserted. If we only consider the SEPs deployed in Japan, this changes OPPO’s share to 122/9,267 = 1.32% (9,267 is the total number of active 5G SEPs in Japan), which is much lower than the 4.16% we calculated earlier. Although it may be difficult to use this as the final rate reached in a licensing agreement, the reasoning and numbers will be a good way to start the next round of negotiations.

In the upcoming 5G era, regional rates may become ever more prominent with the deployment of 5G technology becoming ever more region-specific, in instances of smart cities or like the 5G RuralFirst project for 5G farming.

Challenge the essentiality and quality of the SEPs

Traditionally speaking, the SEP holder usually presents a claim chart for the SEP’s they are exerting to prove essentiality. If a SEP-holder has 200 SEPs in their portfolio, it would be difficult for them to provide 200 such claim charts.

However, if the parties involved can produce an impartial claim chart that does not solely rely on interpretation, the increased level of transparency can alleviate some of the effort needed to challenge or defend the essentiality and quality of the SEPs-at-issue.

The Essentiality Rankings and the automated claim chart (as seen below) can allow SEP implementers to challenge the essentiality status of the patents in a potential licensor’s portfolio and SEP owners to validate their stance.

We would like to note that, it would still be necessary for the licensee to further scrutinize the SEPs, regardless of an existing claim chart or not.

Summary

By now, you may have also discovered that reaching a FRAND license relies on both parties having symmetrical information. However, potential licensees will find it more difficult to obtain transparent and quality data.

That said, having a third-party SEP database, such as SEP OmniLytics, can help build trust between all stakeholders involved. Data on SEP numbers, deployment status, legal status, technological specification distribution can all be found in SEP OmniLytics. Coupled with Patentcloud’s other apps such as Due Diligence, users can examine not just the SEP landscape, but also the quality and value of the SEPs-at-issue. Licensees prepared and equipped with the right knowledge, data, and tools will find negotiating SEP licenses as a normal activity in the IP world, instead of an attack from licensors.

For further reading on how to use Patentcloud’s SEP OmniLytics and Due Diligence to examine a SEP portfolio, check out our article on LG Electronic’s diamond SEP Portfolio.

Click the button below for more analytics and insights on the global and regional SEP landscapes!

We would also like to note that there is no one-click solution or easy way to negotiate for a FRAND license. Any possible solution or proposal can only alleviate some of the time and resources needed during negotiations. Potential licensees should not consider skimping on costs for legal and technical counsel.

The tips proposed here are just some of the many factors and terms discussed in licensing negotiations and are beginning grounds for determining the royalty rate. Many other issues and terms discussed will include the payment method, cross-licensing terms, instances of patent reassignment, licensing period, and many many more. We advise potential licensees to consult with IP professionals with experience in monetizing SEPs when facing SEP licensing agreements.

This article was written with the help of Samuel Tong, Senior Consultant of MiiC’s & Partners.

The numbers and images in this article were updated in September 2021.