China has become the center of manufacturing for the world and the world's second largest exporter, especially for electronics. Accounting for more than a third of China’s total exports, 1 the United States has been and will continue to be a critical market for Chinese exporting companies. As many exported products must comply with applicable industry standards that may be covered by patents, Chinese exporting companies face the challenge of dealing with patent pools offering licenses to use the standards. Therefore, patents on standards and the associated patent pools have become a hotly debated topic in China.
This article will introduce the concept of a patent pool and its impact on third-party manufacturers, as well as provide suggestions to Chinese exporting companies for dealing with patent pools.
A patent pool is “an agreement between two or more patent owners to license one or more of their patents to one another or to third parties.” 2 Alternatively, a pool is “the aggregation of intellectual property rights which are the subject of cross-licensing, whether they are transferred directly by patentee to licensee or through some medium.” 3
Over the last one hundred and fifty years, patent pools have played an important role in shaping both the industry and the law in the United States. 4 Patent pools originated for two reasons. First, they help avoid competing technology owners suing each other endlessly in order to exclude each other from the particular technology area. This was the reason behind one of the first patent pools, which was established in 1856 by various sewing machine manufacturers. Second, pooling has become an imperative because many technologies involve multiple patents with different owners and no one can adopt such a technology without an efficient means for obtaining all the necessary licenses under the various patents. One example of such a patent pool is DVD6C Licensing Group that covers a technology on DVD discs, players, drives, recorders, and decoders. 5 The pooling effectively gathered its nine members, i.e., the patent owners, to jointly license the technology to third-party manufacturers.
There are two basic types of patent pools—an open pool and a closed pool. The closed pool consists of several patent owners, one of whom is designated to license the pooled patents on behalf of all of them to third parties. Philips Corporation was the licensing agent for a pool that included Philips’s patents directed to the recordable CD standard. A closed pool does not add new patent owners to the pool.
An open pool invites additional patent owners to join the pool if their patents meet established criteria, for example, that the patents are essential to the relevant technical standard. Open patent pools are usually outsourced to professional management companies, such as a joint venture, set up specifically to administer the patent pool. For example, Sisvel manages the patent pools for RFID and MPEG, and MPEG-LA manages the patent pools for MPEG-2, MPEG-4, ATSC, and others. These management companies handle the maintenance of the patent pool, add new patent owners who meet the criteria, coordinate among the patent owners, and negotiate license fees with third-party licensees.
Regardless of the type of pool—open or closed—the pool exists to grant licenses under the pooled patents to third parties. This is particularly true where the pooled patents cover an adopted standard because many of the patent owners participated in adopting the standard and are obligated to grant licenses on fair, reasonable, and nondiscriminatory (FRAND) terms. Historically, patent pools that did not exist to grant licenses to all applicants were challenged as anticompetitive. 6
A third-party licensee may be, for example, a manufacturer who wants to make and sell products that use technologies covered by the patents in the pool. For instance, a Chinese DVD player manufacturer who wants or needs to comply with the DVD6C standard will need a license from the DVD6C Licensing Group in order to use the patented technologies.
Patent pools provide several competitive benefits to third parties, including integrating complementary technologies, reducing transaction costs, clearing blocking positions, and avoiding costly infringement litigation. In particular, patent pools allow interested third parties “one-stop shopping,” i.e., to gather all the necessary patents to practice a certain technology in one place, rather than obtaining licenses from each patent owner individually. 7
Despite of these known benefits, patent pools are sometimes viewed as a hindrance by third parties, especially in the export manufacturing industry, where domestic companies are not members of the patent pool and cannot enter the foreign market without first paying royalties to the patent owners. Where a patent pool controls all essential patents directed to a standard that has been adopted internationally, manufacturing third parties have no choice but take a license and pay royalties at the asking prices. Because a patent pool may be the only source for the necessary license rights and the patent pool often cannot negotiate lower royalties because of the FRAND requirement to treat all similarly situated licensees the same, manufacturers frequently consider patent pools as obstacles to business. This is particularly the case where the manufacturer is the lowest cost producer but must pay the same royalties as a higher cost competitor in another country. 8
Because Chinese manufacturers see little benefit from paying patent pools for access to foreign markets, the patent pools are sometimes seen as the manifestation of oversea patent control in China. The well-known “DVD wars” in 2002 placed the Chinese DVD player makers at the center of a dispute when Philips alleged that Chinese DVD player manufacturers unjustifiably won market share by avoiding payment of patent royalties. Similarly, in 2007, another dispute arose in the television industry against the size of the royalties to the MPEG-2 patent pools. Digital pay-television set-top boxes were mostly made in southern China, and in order to include the MPEG-2 digital video compression technology in the set-up box to comply with digital broadcasts standards, Chinese manufactures, such as Konka, had to pay MPEG-LA a loyalty of $2.50 for each system. 9
Therefore, patent pool is indeed a “double-edged sword” to a third-party manufacturer. On one hand, it enables the third-party to acquire the technologies without significant negotiation costs dealing with individual patent owners. On the other hand, when the third-party has no choice but to implement the patented technology, it may have little negotiation power over the royalty due to the lack of alternatives. All third party manufacturers, not just those in China, face the same dilemma. It may have a greater impact on the Chinese low-cost manufacturers because the FRAND required royalty can be a more significant part of the product cost than would be true of other manufacturers.
In view of the potential impact of patent pools, Chinese exporting manufacturers should consider short-term and long-term strategies to deal with these pools proactively.
While negotiating with a patent pool, it is important to bear in mind that research and development costs and lost profits of patent-owning pool members need to be recouped, so the question is not if a royalty should be paid at all, but what royalty may be reasonable and fair. It is also important to remember that many pools are constrained by FRAND requirements. This means that they cannot grant more favorable terms to one third party without discriminating against other similarly situated licensees.
The last point is an opportunity. Under FRAND principles, all licensees in the same situation must be given the same terms. Chinese companies can seek to be in a different situation from licensees in other countries. For example, Chinese companies in the same industry may want to form an industrial alliance and negotiate collectively. If carefully formed, such a collective of competitors would not violate competition laws but would present the patent pool with a different licensing opportunity. If the patent pool managers can reduce their costs of dealing with individual licensees by negotiating with a single entity representing multiple licensees, the patent pool can justify offering a lower royalty than offered to single licensees.
Sometimes, an even more effective negotiation strategy may be to work within the patent system to build an IP portfolio either to resist or to gain entry to a patent pool. One success story was written by the Chinese television makers, including the largest television maker, TCL, and others such as Haier and Xoceco. In 2007, a company named Shenzhen Zhongcai Union Technological Co. Ltd. was founded to develop new technology, to research and identify for inclusion existing patents, and to negotiate royalty reductions with about 170 patent holders of the ATSC TV standard, including Sony, Thomson, and Tri-Vision. Zhongcai compiled a pool of 500 digital television patents owned by Chinese companies that might be relevant, and analyzed domestic and international IP resources for China’s television industry. These activities effectively improved the television makers’ positions within the standard and their negotiation power against the relevant patent pools.
As part of negotiating for reduced royalties, Chinese companies may also consider challenging a patent pool on the grounds of invalidity or anti-trust violation.
Royalties are calculated based on the collective values of all the patents included in a patent pool. For example, under the MPEG LA patent pool, all essential patents are equal in value no matter the cost of the research and development required for their actualization. Therefore, if a patent within the patent pool is found to be invalid, royalties should be reduced to exclude the economic value of that invalid patent. Chinese DVD manufacturers had successfully urged Philips, one member of the DVD4C patent pool, to remove an invalid Chinese patent, after winning a reexamination proceeding at the Chinese Patent Office.
Antitrust and equivalent laws, such as the Sherman Act in the United States, may also impact patent pools. Antitrust policy generally regards patent pools as justifiable monopoly practices because the positives outweigh the negatives. However, under certain circumstances, antitrust laws may not be tolerant of patent pools that produce anti-competitive effects. If a U.S. patent pool insists that licensees accept a package of patents, including patents not essential to the standard, such action may be an antitrust violation or fall under the patent misuse doctrine. However, a recent ruling issued by the U.S. Court of Appeals for the Federal Circuit, in a suit involving six patents licensed as a package by Philips, sends a signal that the courts have become increasingly tolerant of patent licensing practices that were previously viewed with suspicion. That decision held that it is okay to include non-essential patents in the licensed package if it did not cost the licensee any more than it would cost for the essential patents.
As Chinese say, you can dominate only if you strike first and otherwise, you will have to prepare to be dominated. As explained above, an important interaction with patent pools is the issue of standard setting. Governments and industries get together to set standards, particularly in the electronics sector. These efforts are often driven by key players whose primary interest may be to ensure that their own technology dominates. Therefore, a long-term strategy to be considered by Chinese companies is to race with foreign competitors on research and development, in order to set the next standards in their respective industries. By owning the core patents essential to the standards, Chinese companies can participate in the pool and share the royalty profits created by the patent pool, instead of paying royalties as third parties.
Such initiatives have already started in the Chinese video and telecommunication industries. An alternative standard for compression, decoding, processing, and representation of digital audio-video, known as AVS, has been created to compete with MPEG. The consortium currently comprises over 170 Chinese and multinational companies, all of which use the standard and license the patent pool. More recently, China’s State Administration of Radio, Film and Television called for the establishment of a China Mobile Multimedia Broadcasting (CMBB) industry alliance for the purpose of constructing patent pools and managing licensing policy. The technology covers the infrastructure to deliver digital video broadcast from both satellites and terrestrial sources to handheld devices.
Creating a competing standard to provide leverage in negotiations with a patent pool essential to an existing standard is necessarily a short term strategy and may not be cost effective. In the electronics industry, products, technologies and even standards quickly become obsolete. Creating a competing standard not only increases the costs of all products which now may have to meet two standards, but also detracts from the effort to develop the new technology that will replace the existing standard. In the long run, as patent pools are created with real technological and market values, rather than as a reaction to existing pools, Chinese companies will find their way to becoming industry leaders in the global market. Accordingly, Chinese companies could gain much more active positions in dealing with patent pools, once they transit from a third-party to a consortium participant.
As Chinese exporting companies become more competitive in high-tech industries, they will likely need to deal with various patent pools that cover the technologies used in their products. Patent pools reduce a third-party’s R&D costs for the technology and negotiation costs for licensing the technology, but they may also cause the third-party manufacturer to lose a cost advantage if the royalties paid to the patent pool are set too high. To gain a stronger bargaining position when dealing with patent pools, Chinese companies may negotiate as a group formed with industry competitors, look for possible legal grounds for attacking the pools, and actively develop their own standards and patent pools.
2 David Serafino, Survey of Patent Pools Demonstrates Variety of Purposes and Management Structures at 2, KEI Research Note 2007:6 (June 2007).
3 See Joel I. Klein, An Address to the American Intellectual Property Law Association, On the Subject of Cross-Licensing and Antitrust Law (May 1997).
4 See Steven C. Carlson, Note, Patent Pools and the Antitrust Dilemma, 16 YALE J. ON REG. 359, 373 (1999).
5 DVD6C Licensing Agency web site, SAMSUNG Joins DVD6C In Licensing DVD Patents, News, November 21, 2006.
6 See, for example, United Shoe Machinery (1899); Standard Oil Cracking Pool (1911); Glass Containers Association (1919); Radio Corporation of America (1932).
7 Jeanne Clark, Joe Piccolo, Brian Stanton, and Karin Tyson, Patent Pools: A Solution to the Problem of Access in Biotechnology Patents? United States Patent and Trademark Office (December 2000).
8 According to Nicholas Redfearn, Patent Pools in China, Intellectual Asset Management (September 2009), in certain cases patent royalties can form a large part of the total unit cost. For example, a Chinese DVD player maker may be charged $15 to $20 in royalties to make a DVD player.
9 Mike Clendenin, Chinese Set-top Box Makers, MPEG LA Face Off Over Patent Fees, EE Times (March 12, 2007).
10 In the U.S., for example, competitors threatened with infringement of the same patent can join in common defense agreements, allowing them to exchange defense information, hire common counsel and share the costs of defense. To avoid violation of competition laws, each competitor must be free to settle with the patent owner without notice to or permission of the other members.
11 Chinese TV Makers Team Up To Challenge U.S. Patent Charge, People’s Daily (April 25, 2007). http://english.peopledaily.com.cn/200704/25/eng20070425_369696.html.
12 See Dana J. Parker, Standard Deviations: Everyone Into the (Patent) Pool! (Sept. 1998).
13 Ying Zhan and Xuezhong Zhu, Intellectual Property Right Abuses in the Patent Licensing of Technology Standards from Developed Countries to Developing Countries: A Study of Some Typical Cases from China, The Journal of World Intellectual Property, vol. 10, issue 3-4, pp. 187 - 200 (August 2007).
14 A Chinese company injured by such an action could offensively assert an antitrust violation in a U.S. court, but patent misuse is only a defense in the event the patent pool asserts the patents against the company.
15 U.S. Philips Corp. v. International Trade Commission, 424 F.3d 1179 (Fed. Cir. 2005).
16 Tiejun Huang, Wen Gao, and Cliff Reader, A New Approach for Developing Open Standards with a More Reasonable Patent Licensing Policy, http://www.avs.org.cn/reference/HuangLSSB-confirmed-final.pdf.
17 Mike Clendenin, China’s mobile-TV spec similar to Europe’s, EETimes (December 18, 2007).
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