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  • Marta Beckwith

The FUD of Licensing Downstream

If you have been keeping up with my posts, you would know that I have recently focused on issues related to SEP licensing in the IoT space.  I am, of course, not the only one interested in the potential impact of SEP licensing on this really important and burgeoning area of technology.  There have been a lot of articles and posts related to SEPs, licensing and IoT.  I thought it would be worthwhile, from time to time, to summarize some of the more thought-provoking ones. 


I recently read an article focused on SEPs and the IoT space published in Science Direct: Licensing standard-essential patents in the IoT – A value chain perspective on the markets for technology - ScienceDirect by Joachim Henkel at the TUM School of Management, Technical University of Munich (the "Article"). The Article discusses the market inefficiencies that arise when a downstream user is targeted for SEP licensing.   In this context, a downstream user means an entity that “implements” the standard into its products at only the most basic level, e.g. an entity that is not involved in development of the standard and merely buys component parts, made by other companies, that implement the standard for use in their own products.[1]  Most IoT device makers fall within this definition and the article focuses on issues related to that space.


Many studies of market efficiencies in licensing presume there is transfer of knowledge that comes from patent licensing.  A patent specification is, after all, supposed to contain sufficient information to teach a person of ordinary skill in the art how to make and use the invention.[2] The Article calls this “integrated” licensing, i.e. licensing in which there is a transfer of knowledge that comes from licensing, reviewing and implementing the patent.  Integrated licensing is done upstream at the step of the value chain in which the patented invention is translated into a working format.


The Article distinguishes this “integrated” licensing from what it calls “bifurcated” licensing, i.e. licensing that is done at a stage of the value chain in which true implementation of the patented invention does not occur.  Licensees in bifurcated licensing situations gain no benefits from the disclosure contained in the patent because they are not the ones translating that disclosure into a functional product.


The Article points out that the main reason why cellular and WiFi SEP licensing have historically been somewhat integrated is because the primary downstream licensors have been “telecommunications and electronics firms, relatively homogeneous, few in number, typically large, and many of them such as Huawei, Samsung, and LG are important SEP holders.” In other words, because historically SEP licensees for telecommunications standards have also been SEP holders and participants in standard development, they are knowledgeable about the technology underlying the standard.  So, even if they do not gain their knowledge from a patent, they are able to gain knowledge about the technologies used in the standard from their participation in the development of the standard. 


In contrast, the “IoT scenario is starkly different . . . IoT device makers are numerous and often small and medium-sized enterprises (SMEs) or startups. Based in diverse industries, they are typically unfamiliar with the inner workings of communication technologies.” Because of impact of SEP licensing on these types of businesses, commentators have recently begun to reassess the level at which SEP licensing should take place – asking the question of whether it makes market sense to license at the device maker level (or at least at the “passive” device maker level). 


The Article evaluates this issue based on a number of interviews with SMEs with a focus on European IoT device makers.  According to the Article, the interviewees also include a few established implementers, a small mobile phone manufacturer, a module maker and five SEP licensors.

 

The Article groups the reactions of the interviewees into various first order, second order and aggregate dimension categories.  These categories include “small firms afraid to speak up”, “Uncertainty,” and lack of technical and patent knowledge and about the process of SEP licensing and about the overall SEP burden and concerns about whether companies can continue to operate in the face of such doubt.  In another words, for these licensees, the way SEP licensing is done engenders FUD (fear, uncertainty and doubt).  In an oddly fitting way, here’s how Wikipedia defines FUD: FUD “is a manipulative propaganda tactic used in sales, marketing, public relations, politics, polling, and cults.”[3] 


For all of those commentators that say there is no or minimal impact on SMEs from SEP licensing, you need only read some of the comments from SMEs contained in the Article to understand that there are significant impacts on SMEs from SEP licensing, even beyond the FUD it causes.  A number of the SMEs interviewed pointed out the very real impact SEP licensing demands have on them. 


Licensing demands require SMEs to expend resources they do not have to make sense of the alleged SEPs, the technology used in the standard and the license offer.  It requires them to pay money they do not have and for which they had no idea they needed to budget (or how much) when they developed and started selling their product.  And the demands are so high compared to the margin they are getting for their products that some have contemplated shutting down entirely or at least transitioning away from the impacted standard.  This type of licensing does not help meet the goal of promoting innovation and entrepreneurship by downstream device makers.


In that regard, let’s step into the real world for a moment.  At the present time, I, like you, am using tens, probably hundreds of standards.  I have an access point and secure VPN router that all implement WiFi as does my laptop and the wireless printer on which I printed out the Article.  My TV implements various TV standards, as well as WiFi and Bluetooth.  I am using the Internet on my various devices, and thus a multitude of IETF standards.  My two phones each have cellular connectivity, WiFi, and Bluetooth.  A number of my devices implement 802.3 (the Ethernet standard), any number of H. and other audio and video standards— and those are only the ones I can think of off the top of my head.  I know there are others.[4]   


Now imagine if the SEP licensors decided to license all the way downstream to you and me.  They rarely do so because it is transactionally difficult and not cost-effective, but there are few legal impediments to doing it.  Imagine how you would feel if you were contacted by an entity that gave you a list of hundreds of patents and said you owed them what amounted to 10% of what you paid for each of those devices.  How would you figure out whether that was true? Now, imagine that another one contacts you and then another. 


Imagine how you would feel if, when you went into a store to buy a device, the shopkeeper told you that they had no idea how much the device would ultimately cost you.  Imagine if the shopkeeper said pay me this much now, and in the future you will have to pay an unknown amount of money to an unknown number of other people at some unknown future time.  And by the way, the total amount you end up paying might be more than what I am asking you to pay me right now to purchase the device. Because you use the device to sell your homemade items on Etsy, your use of the device is worth more than the device. Because of that, you will ultimately have to pay some percentage (but don't ask me how much) of your Etsy revenue to those other people. 


That would likely not seem reasonable to you, but that is what is happening to SMEs in the IoT space.  They are often only one step up from you and me.  Yes, they make money from selling products, but they only implement the standards through their purchase and use of products made by other companies.  They reasonably expect that if an implementing device costs $15, that is the total amount they have to pay to use both the device and the standard it implements.  You expect it, I expect it and — quite reasonably — so do they.  If these expectations are not met, then we (and they) are much less likely to buy and use devices that implement that standard.


So, back to the Article.  The Article makes essentially this same point but from an economic perspective.  The article concludes:


Compared to upstream licensing, I find that device-level licensing creates higher transaction costs within the dyad of licensee and licensor, magnified by a larger number of licensees. For startups and SMEs, these challenges are compounded by resource constraints and pressure from licensors and stakeholders. The increased transaction costs of downstream licensing reduce MFT efficiency. 


Innovation and entrepreneurship in the IoT will probably be negatively affected by device-level SEP licensing once firms become aware of the risks and uncertainties to which the implementation of communication modules exposes them . . . . the potential to acquire fully licensed IoT components should accelerate the innovation process by making the costs of such components and the associated licenses predictable, creating legal certainty, and allowing the implementation of IoT technology at low transaction costs.


The Article is well worth a read for these insights, but also for the quotes it contains from the various IoT device makers.  The comments are really eye-opening.


[1]          I called these type of companies “Passive Implementers” and “Non-Participating Device Makers” in my post explaining the various levels of standards development, implementation and use: The Cellular Multiverse (sepessentials.com).

[2]          Although for many telecommunications and networking SEPs this is not actually the case.  Most such SEPs are implemented in semiconductor chips and nearly uniformly the patents do not include any details about how to implement the patented technology into such chips.  Other researchers have demonstrated that this also is often not true in the chemical and life sciences: Who reads patents? | Nature Biotechnology.

 

 

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