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POLICYFORUM

Technological standards are ubiqui-

tous, whether they allow consumers to

communicate seamlessly across wire-

less networks or manufacturers to procure

goods across complex global supply chains.

These standardsshaped by standard-setting

organizations (SSOs) and participating engi-

neers, academics, lawyers, and executives

in turn shape how new technologies evolve,

specifying rules for how standard-compliant

products must work and interact with other

components. This standardization process is

under tremendous stress. Many disputes roil-

ing courts and administrative bodies around

the worldsuch as those involving Apple,

Google, Microsoft, and Samsungconcerncommitments made during the standardiza-

tion process and the ways that firms have

sought to game the system. We explore why

the system is breaking down and propose a

way in which standard setting could be rede-

signed to address these problems.

Standardization assures users that they

will not be stuck with an orphan technology

largely incompatible with other systems and

used by few others. Instead, users will benefit

from network externalities, where the tech-

nologys value depends on the number of oth-

ers using the technology. This boosts demandfor new technology, which provides research-

ers with incentives to innovate.

Standard-setting organizations play three

roles in this process. First, engineers iden-

tify alternative avenues to solve a given tech-

nological challenge. Second, in cases where

there are conflicting technologies where none

is evidently superior, the SSO will frequently

coordinate on one approach. This winnowing

down of alternatives is important because it

greatly simplifies the choices of manufactur-

ers and consumers.

Finally, because stakes are high for firms

participating in the standardization process,SSOs seek to regulate the behavior of mem-

bers. Particular concerns are ensuring that

firms disclose relevant patents, so as to pro-

vide adequate information to other parties in

the standard-setting process, and agree not to

price licenses to their patents too aggressively,

so as to enable broader

adoption of the technol-

ogy. But SSOs are limited in

this regulatory role, because

technology owners can seek

another SSO if rules are too

onerous.

The intellectual property

(IP) embodied in standards

has two essential charac-

teristics, which can lead to

unfortunate outcomes. First,

in many cases, new tech-

nologies tend to be covered

by a wide array of patents

issued to the different firmsthat contribute components

to the technology. In this

patent thicket, if each pat-

ent owner sets the revenue-

maximizing price for its pat-

ent licenses without considering the fact that

other patent owners benefit from wider diffu-

sion, the resulting price is likely to be far too

high. Economists term this royalty stack-

ing.

Second, in many cases, there are multiple

routes to solving a given technological prob-

lem. Each one of these may be equally viable,but often an SSO will choose only one avenue.

After the decision is made, however, any pat-

ent needed to practice the standard becomes

a standard-essential patent (SEP), and the

patent owner can ask for a high royalty even

when other patents could have offered compa-

rable value, had the technology been morphed

differently. SSOs must therefore regulate

licensing of the patents chosen to be part of

the standard. SSOs typically eschew any dis-

cussion of price before the establishment of

the standard. This reluctance largely reflects

fear of antitrust authorities: Any price discus-

sions might lead to charges of collusive andanticompetitive behavior, as the SSO could

blackmail patentees to accept low prices in

exchange for inclusion into the standard.

To restrain firms from taking advan-

tage of the essentiality of their patents that

was acquired only from being included in a

standard, SSOs commonly require firms to

commit in advance to license their patents

on fair, reasonable, and nondiscriminatory

(FRAND) terms. But FRAND commitments

are ambiguous; what exactly is fair and rea-

sonable? This is determi

not by the SSO itself, bu

a court years after the st

dard is established. Perc

tions of patent value can

fer widely when one lo

before or after the dispu

Ambiguities associated w

FRAND commitments h

resulted in dozens of exp

sive litigations (1, 2).

Even in the absence o

legal dispute, the FRAN

requirement has not wor

well. Consider the

uncommon case where pticipants in an SSO est

lish a patent pool to join

license key patents cove

by the standard. Many po

simply divide royalties

proportion to the number of patents that e

firm has contributed to the pool. Such

rules may reflect that patents initially

ferent in their importance are made equa

essential by standardization. The process t

over-rewards minor innovations at the expe

of major ones. In these settings, selection

patents for the standard (and pool) canhighly contentious. SSOs may include eit

too many or too few patents in the standar

Structured Price Commitments

We propose an alternative approach, wh

we term structured price commitments.

suggest that SSOs follow this sequence:

1. During a discovery phase, part

explore which technology combinations

technically viable (as is done now by SSO

This engineering phase makes no refere

to prices at which patents would be licens

2. Before the standard is finalized (a

unlike todays practice), there is a receduring which firms commit to a price

at which they will grant nondiscriminat

licenses to their patents. Firms make co

mitments to the maximum price (and m

restrictive terms) that they would cha

before the patent is included in the standa

3. Participants choose the standard, w

out discussing prices, as is currently done

4. Finally, some or all of the participa

may form a patent pool after the standar

set, again following todays practice.

A Better Route to Tech Standards

INTELLECTUAL PROPERTY

Josh Lerner1* and Jean Tirole2

Prestandard price commitments, as well as

government intervention, may help patent

licensing and standard setting.

1Harvard Business School, Boston, MA 02163, USA. 2Tou-

louse School of Economics and Institute for Advanced Studyin Toulouse, 31000 Toulouse, France. *Author for corre-

spondence. josh@hbs.edu

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POLICYFORU

Our theoretical analysis (3) looks at conse-

quences of this modified standard-setting pro-

cess. Initially, it might be thought that this pro-

cess, too, might lead to a variety of opportu-

nistic behaviors. For instance, a patent-holder

might set a high price cap in order to achieve

a stronger bargaining stance when it comes todividing profits from the eventual patent pool

formed around the standard. Such behavior

might lead to excessively high licensing rates

and too little technology adoption. Despite

the possibility of such gaming, our analy-

sis shows that structured price commitments

achieve the desired competitive bench-

mark, with license prices the same as would

prevail if there were no network externali-

ties and, thus, no need for a standard, which

would free users to adopt whatever mixture of

technology they wished. This provides a rea-

sonable balance between incentives for tech-nology innovation and diffusion.

How can price caps selected before stan-

dard-setting work? Intuitively, when patents

are fairly interchangeable with each other

before selection of the standard, the require-

ment to commit to a cap forces patent own-

ers to choose a lower price than they would

afterwards, so as to get their patent included

in the standard. Otherwise, the SSO would

choose a more affordable option. And when

patents are complementary rather than inter-

changeable, setting ones price away from its

competitive level leads to a loss of profit: For

instance, if a patent owner opts for a low pricecap, other owners will be less willing to give

him or her a large share of the proceeds of any

patent pool that may form.

Such commitments lower the amount that

ultimately will need to be paid to license the

key patents to implement the standard, and

also better match the rewards to innovations

(royalties) with their contributions.

We do not suggest abandoning FRAND.

SSOs may make mistakes, and important

patents may escape attention at the time the

standard is promulgated. However vague and

limited, FRAND still imposes some ex post

constraints on licensing terms. Thus, we view

structured price commitments as a comple-

ment, not a substitute, to FRAND.

Can Regulation Work?The idea that patent owners might commit

to prices before standard-setting is not new;

both academics and policy-makers [e.g., (4)]

have mentioned that possibility. Furthermore,

this policy has been tested by some SSOs (see

text box). Yet there has been little adoption by

SSOs in general.

One issue is that economists had no

framework for thinking about price commit-

ments. There was no way to predict, even at a

theoretical level, what would happen if such

commitments were mandated. The theoreti-

cal analysis comforts us about the normativeimpact of commitments (should we expect

a good outcome from this new institution?).

But thus far, it does not explain why SSOs

which, rightly or wrongly, tried them, failed

to appeal to IP owners and set a new stan-

dard for the standard-setting process.

Consistent with historical examples, our

model highlights that patent owners prefer

to go to an SSO that does not constrain their

freedom to license patents as they see fit.

Competition between SSOs, which we term

forum shopping, allows IP owners to find

more complacent SSOs that do not put such

pressure on their prices. Owners of equallyimportant, standard-relevant patents will

always opt for a lenient (commitment-free)

SSO. Only in specific circumstances will pat-

ent owners be attracted by such requirements,

e.g., when owners of clearly essential patents

fear that an SSO will include a number of

more minor patents, with whose owners they

will have to share the pie equally.

The corollary is that without a govern-

ment mandate and/or purchasing prefer-

ences, SSOs are unlikely to opt for the right

answer and demand price commitments

Nevertheless, the suggestion that price com

mitments be mandated has problems: I

could be infeasible or, if feasible, the regula

tion might do more harm than good.

Concerning feasibility, the rule can be

implemented where public procuremen

is sizable, such as telecommunications. I

would suffice to require suppliers to con

form to compliant standards enacted

by SSOs requir ing price commitments

Furthermore, antitrust authorities and courts

already involved in regulating standard

setting through reviews and litigation, could

favor compliant standards and discourage

noncompliant ones.

As for unintended consequences of reg

ulation, the requirement is simply to com

mit to a price cap. If practice does not work

according to theory (only experimentation

can tell), the hazard is that IP owners will se

too high a cap. But it cannot be worse than

the current policy, which is formally an infinite price cap. The combination of a cap with

FRAND cannot be worse than only FRAND

So this is rather low-risk.

In recent years, antitrust authoritie

have wakened to the importance of stan

dardization and the way in which firms can

manipulate this process (5). Now, the chal

lenge is to create rules that will ensure tha

standards can effectively promote transla

tion of scientific and technological insight

into new products and economic growth

Requiring price commitments is theoreti

cally appealing, rather risk-free, and worthexperimenting with.

References and Notes 1. Lemley and Shapiro (2) suggest that these disputes be

settled via arbitration, making adjudication more expedi

ent, better informed, and overall more consistent. 2. M. A. Lemley, C. Shapiro, Berkeley Technol. Law J.28,

1135 (2013). 3. J. Lerner, J. Tirole, Standard-essential patents (Work-

ing paper no. 19664, National Bureau of EconomicResearch, Cambridge, MA, 2013).

4. D. P. Majoras, Recognizing the procompetitive potentia

of royalty discussions in standard setting, Standardiza-tion and the Law, Stanford University, 23 September

2005; www.ftc.gov/sites/default/files/documents/public_statements/recognizing-procompetitive-potentia

royalty-discussions-standard-setting/050923stanford.pdf.

5. National Academy of Sciences,Patent Challenges for

Standard-Setting in the Global Economy: Lessons From

Information and Communications Technology(National

Academy Press, Washington, DC, 2013). 6. T.O. Barnett, Business Review Letter: VITA, Antitrust

Division, U.S. Department of Justice, 30 October 2006. 7. J. L. Contreras,Jurimetrics53, 163 (2013).

Acknowledgment:J.T. is a member of Industrial EconomicsInstitute, which receives funds from Microsoft, Orange, andQualcomm.

The international trade association VITA, which develops standards that govern modular embeddedcomputer systems in such products as advanced avionics devices and complex medical instruments,became frustrated when owners of patents that were essential to implementing one of their new standardsdemanded a higher royalty rate than anticipated after being deemed standard-essential. As a result, VITAproposed a new policy, which the U.S. Department of Justices Antitrust Division approved in October2006 (6). VITA demanded that members declare the highest royalty rates and most restrictive terms underwhich they would license these patents for implementation of the given standard. In response to thiscontroversial policy, Motorola launched a campaign to decertify VITA as an SSO recognized by the

American National Standards Institute, an effort that ultimately proved unsuccessful. Although VITA endedup moving forward with its standardization process, it was not a spectacular success (7). Similarly, theInstitute of Electrical and Electronics Engineers and the European Telecommunications Standards Instituteencountered stiff resistance and, in the end, had to make price commitments optional. Even if pricecommitment requirements lead to a good outcome, we cannot expect SSOs to mandate them bythemselves or expect patent holders to cooperate with standard bodies that mandate such commitments.

10.1126/science.124643PHOTOCREDIT:HARLANDQUARRINGTON/WIKIMEDIACOMMONS

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