Has the promise of patent pools dried up?

Patent pools – platforms for cooperative patent risk mitigation – have been a tremendous source of revenue for their administrators and licensors. However, they have a chequered past.

There was a time when patent pools were viewed as anti-competitive, cartel-like cooperatives that monopolised industries and controlled growth. This view started to change when it became clear that patent thickets were causing the United States to lag behind Europe in aircraft technologies during World War I. The government actually incentivised the Wright brothers and their competitors to create a pool, clearing the way for innovation in the US aircraft industry and removing dependence on foreign-produced aircraft during the war. However, more recently the increased profitability of patents pools such as MPEG LA, which has generated billions for licensors including Sony, Phillips and Samsung, has revived concerns about patent pools as potential drivers of anti-competitive behaviour.

The rise of MPEG LA in the 2000s triggered a wave of patent pool administrators, which attempted to replicate its success. However, the unique market conditions that enabled MPEG LA to prosper are gone and are unlikely to return. To complicate matters further, potential licensees are tackling new patent pool creators head on, with challenges based on potential anti-trust violations and accusations that FRAND commitments are not being honoured. With significantly lower royalty rates and legal challenges, are there still profits to be made through patent pools? Or have the days of plentiful profits gone forever?

But first, a patent pool primer

Simply put, a patent pool is a group in which multiple owners of patents essential to a technology come together and offer licences to third parties for all the patents in the pool. When a patent pool is formed, the licensors get together and determine the royalty rates and related terms for the bundled licence. While some patent pools are managed by their members, the more typical structure is for the patent holders to appoint a pool administrator or licensing agent to manage the pool on their behalf. The most common use of patent pools is to provide a one-stop shop to license patents that are essential to an industry standard.

While today’s patent pools can be seen as being both noble and profit-creating, patent pools have had to overcome the fact that they were created for exclusionary purposes. MPEG LA opened the door for modern patent pool creators by establishing ground rules that are still followed today. MPEG LA’s MPEG-2 patent pool provided access to patents essential to the MPEG-2 video and systems coding standards used in DVD players, TVs and other digital video products. MPEG-2 is now considered the gold standard for patent pools and is often used as a model.

MPEG-2 was an early standard for video compression that enabled the commercial digital delivery of video content, both over cable and on optical discs. It presented the potential to create a market for high-quality digital video. However, many companies had contributed technology to the development of the standard. The patent thicket and potential royalty stacking stood as a citadel against this burgeoning market that would ultimately generate trillions of dollars in sales. Purchasing all the necessary individual licences from essential patent holders seemed an insurmountable task, while the resulting royalty stack would have significantly slowed ubiquitous consumer adoption. Recognising the potential struggle as well as the opportunity that digital video could bring, Cable Labs, joined by Sony, Philips, Fujitsu, Panasonic, Columbia University, Mitsubishi Electric, Scientific Atlanta and General Instrument founded MPEG LA. The citadel could not hold out against the founders’ licensing prowess and dominant portfolios. They had created a new collective solution, which helped the electronics and cable industry reduce the risk of potential patent litigation as well as increase cost predictability in the highly competitive and volatile technology market (Robert P Merges and Michael Mattioli, “Measuring the Costs and Benefits of Patent Pools”, Ohio St L J 281, 283-290 (2017)).

However, patent thickets and royalty stacking were not the only obstacles. Gathering competitors together in a room to set royalty rates for a standardised technology smacked of potential antitrust violations. Indeed, historical patent pools were rife with anti-competitive abuses and inappropriate market controls.

History

The Sewing Machine Combination in the 1800s was the world’s first ever patent pool. After multiple patents from multiple inventors covering the components of the sewing machine led to significant infringement litigation and countless injunctions, the industry players sought a solution. The relevant patents were placed into a trust, where member consent was required to license them. Although critics of this patent pool saw the Sewing Machine Combination as anti-competitive, it survived subsequent attacks.

The next generation of pools was not so lucky. As the pendulum started to swing towards stricter antitrust rules, the Supreme Court held in 1912 that Standard Sanitary’s patent pool covering the process for sanitary ironware violated antitrust laws because it restricted the marketing of “seconds” and overreached in controlling the prices of products sold.

The Supreme Court also viewed patent pools that were used to vertically restrain competition through patent licences as anti-competitive. In the 1940s the Hartford-Empire pool combined patented technologies for glassware manufacturing illegally, prescribing limits on the types of products and quantities that licensees of the pool were allowed to produce. Hartford-Empire went even further, discouraging outsiders from increasing glassware manufacturing and preventing new entries into the field. This was clearly anti-competitive. Patent holders could also be viewed as anti-competitive when they decreased competition and deterred technological progress through price fixing or setting up unnecessary patent pools. The Summit Technology-VISX patent pool for eye surgery laser equipment in the 1990s, for example, was challenged by the Federal Trade Commission as a price-fixing scheme.

However, as shown by MPEG LA, patent pools can be pro-competitive. They can support competition by “integrating complementary technologies, reducing transaction costs, clearing blocking positions, and avoiding costly infringement litigation” (“DOJ-FTC Antitrust Guidelines for licensing of Intellectual Property” (2017), 5.5 Cross-Licensing and Pooling Arrangements).

The US Department of Justice (DOJ) protects against antitrust abuses in the United States. In light of the stigma around patent pools, the DOJ initially needed some convincing to reach the conclusion that MPEG LA would be pro-competitive. It took some effort, but with skilled counsel, MPEG LA convinced the DOJ that it was precisely that: in order for ground-breaking
technology to become available to consumers at attractive prices, a patent pool was required to solve the patent thicket. The proposal that MPEG LA submitted to the DOJ set out antitrust safeguards, including limiting the pool to “technically essential patents”, allowing bilateral licences with individual patent pool members, offering worldwide non-exclusive licences and not restricting licensees from using alternate technologies (Letter from Joel I Klein, DOJ, to Garrard R Beeney, Sullivan & Cromwell (26 June 1997)).

The founding intentions of MPEG LA and its MPEG-2 patent pool were noble – the founders sought to solve a real problem that was likely to block the market acceptance of high-quality digital video. However, noble intentions need not be based on charity and the MPEG-2 patent pool was successful beyond the wildest dreams of its founders. It generated billions in profits for its licensor members – a great side benefit if you happened to be one of the founders or one of the 26 patent-holding members over the course of the programme.

We will never know every licensor’s intentions but whether they were driven more by idealism or by profit, two things are certain: the innovation-stifling patent thicket was avoided and the patent-pool participants made a lot of money in the process. Even entities that originally thought they would give licensing a go on their own, such as Thompson Multimedia, ultimately joined MPEG LA, because of its tremendous success and global acceptance.

The now

The success of the MPEG-2 patent pool generated a plethora of followers in its wake. The consumer electronics industry is in large part a slave to industry-wide standards that ensure compatibility across devices and platforms. As such, most of these follower patent pools are in the consumer electronics industry, including EVS (enhanced voice services), HEVC, DASH and AVC/H.264, as well as earlier versions of ATSC. However, no patent pool to date has been able to come close to the commercial and financial success of the MPEG-2 pool.

What might explain these shortcomings? Perhaps it is as simple as disagreements between companies over appropriate licensing fees, such as royalty rates and royalty products. More broadly, it could be the general challenges of keeping up with rapidly changing standards.

HEVC pool fractures over royalties and royalty product

While HEVC was a natural progression of the previous chain of video codec pools – MPEG-2, MPEG-4 and AVC – the world had moved on since those predecessor pools. The Internet and smart devices had become ubiquitous and video was no longer primarily delivered by physical mediums such as DVD or Blu-Ray. The commercial model for video delivery had changed as well – much of it was delivered for free to the consumer, with revenues coming from ads and sponsors. The collision between the worlds of consumer electronics hardware manufacturers and internet-based software providers had foreseeable results – outright disagreement about proposed royalty rates and who and what should bear them. The fallout from these disagreements resulted in the fracturing of the HEVC patent pool into three distinct pools (see Figure 2 for an illustration of the major companies in each pool):

• MPEG LA;
• HEVC Advance; and
• Velos Media.

The emergence of multiple pools increased friction by making it difficult to navigate the HEVC licensing world and thus slowing the deployment of devices using HEVC. One cannot help but notice that a couple of the biggest software companies who played integral roles in the ultimate disagreements that fractured HEVC are now unaffiliated with any HEVC pool. It is almost as if someone threw a hand grenade into the discussion room and then walked out, closing the door behind them.

In 2014 MPEG LA launched the first of the HEVC pools with relatively low royalty rates (see Figure 3 for a rate comparison chart). HEVC Advance was formed one year later with departees from the MPEG LA group. The primary difference between HEVC Advance terms and MPEG LA’s was that the HEVC Advance licence included a content royalty rate of 0.5% of the revenue generated from HEVC video services (streaming royalties), on top of device royalties. The initial rates of HEVC Advance were widely criticised; in response, HEVC lowered its rates just five months after its launch. HEVC Advance’s insistence on streaming royalties also drew significant criticism, and in November of 2016, HEVC Advance removed this royalty as well. Had all the participants in the original MPEG LA HEVC discussions collectively concluded that streaming royalties were not practical, perhaps the split would never have happened.

Velos Media, the last HEVC pool to form, was created in March 2017 by several industry titans, including Sony, Panasonic and Qualcomm. Most recently, Blackberry joined the Velos Media pool. Unlike MPEG LA and HEVC Advance the Velos Media pool keeps its licensing terms secret, including rates and essential patents, refusing to reveal them without a non-disclosure agreement. The lack of transparency has raised some concerns, while Unified Patents has targeted Velos’s patents for validity attacks through inter partes reviews.

The wedge that ultimately caused the fracturing of the HEVC pool efforts was really just a simple question: why should content get a free ride, with hardware carrying the royalty burdens? The HEVC schism has become more than just a fight over what a reasonable royalty should be, it is also a fight over who should bear it. Will HEVC survive the convoluted royalty and patent pool situation? Or will the industry simply move on to other technology solutions, such as AV1? Only time will tell.

AOM’s AV1 Codec – royalty free? Not so fast

Patent pools or pool-like licensing programmes are not always driven by the collection of royalties. There are organisations that purport to exist simply to clear a path through or around a patent thicket. The Alliance for Open Media (AOM) was created in 2015 by Google with the goal of developing the AV1 video codec as an alternative to HEVC, while ensuring that it was royalty free in an attempt to eliminate the patent thicket altogether and put AV1 on the path to become the dominant video codec. Perhaps an altruistic pursuit, but one cannot help but notice that the progenitor of AOM also happens to own and operate the biggest video-streaming business in the world, making it the company that would be most affected by a content-streaming royalty. However, the lofty goals of the royalty-free model of AV1 are already being challenged with the emergence of a new patent pool on AV1 that will seek royalties. In March 2019 Sisvel announced that it intends to create its own patent pool covering the VP9 and AV1 standards. While it is too early to determine the effects that this pool will have on AOM and AV1, the challenge posed by this new pool could put the principle of whether royalty-free pools have any place in the market other than for open-source software to the test.

Some licensors are hedging their bets by joining multiple pools. For example, Samsung Electronics is both a licensor and licensee of HEVC Advance, a member of MPEG LA’s patent pool and – as announced in April 2019 – a member of the board of AOM. The various competing interests between the companies, and thus licensees and licensors, in addition to the wide range of royalty rates have made the current patent pool landscape extremely confusing for users to navigate.

The future

One does not need a history lesson on patent pools to intuit that licensors are financially motivated to increase licensing rates, while licensees are financially motivated to reduce them. So, expecting future patent pools to altruistically put aside business goals would be unrealistic. While in theory, the DOJ would like for pool participants to think only as licensors when meeting as a pool, participants cannot simply ignore that they may be licensees as well. As demonstrated by HEVC Advance, patent pools risk becoming unsuccessful where licensee motivations are at significant odds with licensor interests.

For patent pools to suceed, licensees and licensors must align around an overriding business goal. Better yet, that business goal should create sufficient financial incentive to compromise during the rate-setting process. Attempts by major licensees to make technology royalty free, like AOM, are likely to continue to be met by profit-driven efforts, such as the Sisvel response.

Public interest can be a shared goal between licensors and licensees, but even then a patent pool’s public interest goals may fall flat unless there is a financial incentive and a means of incentivising participants. For example, two biotech patent pools in the pipeline have utilised public-interest reasoning to incentivise the creation of a patent pool – CRISPR and BRCA. CRISPR is a genome engineering technology derived from bacteria that has significant implications in disease treatment. BRCA is an important gene in cancer screening and research. Ensuring the widest possible access for researchers and other medical experts to develop treatment for diseases motivates participants in both of these biotech patent pools. Who can fail to rally behind the idea of eradicating cancer?

However, so far, both patent pools have failed to garner interest from the majority of essential patent holders and so both patent pools continue to flounder. Although the Broad Institute of the Massachusetts Institute of Technology (MIT) along with Rockefeller University and Harvard University have recently joined the CRISPR patent pool, there is still considerable hold out by other significant essential patent holders. The CRISPR patent pool is further complicated because the main CRISPR patent holders have already entered into exclusive licence agreements with corporate sponsors and benefactors. The BRCA pool has even less traction. It is only at the point of pre-formation discussions.

It is simply not clear at this point whether the public interest in eradicating cancer will carry the day and provide sufficient motivation to potential licensors to coalesce into a patent pool or two. Pharma, in particular, is an industry that is traditionally about exclusivity in its licensing practices, rather than the need for ubiquitous adoption and compatibility that is the standard for consumer electronics. It is uncertain whether a public interest motivation without sufficient financial incentive will draw licensors away from traditional profit models based on exclusivity. Further, without a profit component it is unclear who would financially support these standardisation efforts.

Patent pools in which direct or indirect business goals for licensors and licensees align in a way that also generates mutual financial benefits are more likely to succeed. The broadening of a commercial market opportunity due to ubiquitous adoption that is driven at least in part by a resolution of patent thickets, is win-win for licensors and licensees. It may also be that a lower royalty will feed a larger market for the sale of goods, which points to the old adage: “we will make it up in volume.” Another factor that can feed the success of a patent pool is when the relevant technology is simply iterative of older technologies. There is almost always a need for backwards compatibility. If you make a phone today for 5G, it must be backwards-compatible with LTE and basic CDMA technology. Aging patent pools will continue to receive new life when their relevant base technologies progress into new iterations. Patent pools of the future that relate to standards for cutting-edge technology that is related to other technologies are apt to succeed because the market demand for backwards and forwards-facing compatibility will prolong the revenue lifecycle of innovative technologies.

Similarly, participants in patent pools for ubiquitous technologies share a common goal of reducing upfront operating risk, which leads to indirect financial benefits for licensors and licensees. Avanci, a group that was formed in 2016, is in effect a patent pool for wireless technology in specific sectors, with a focus on the Internet of Things generally, and 5G specifically. Soon consumers will expect all devices to function with 5G, and products that do not integrate 5G will not sell. 5G rollout will also prolong the revenue of patent pools around legacy technologies with which these new 5G devices must be compatible, such as 3G and LTE.

However, the threat of antitrust violations remains. Recently Continental AG sued Avanci and a number of its members for antitrust and FRAND commitment violations. It is critical that any group that forms a pool or is patent pool-like, must adhere to the guidelines set out by the DOJ. It is all about balance – does the benefit to the consumer outweigh the potential anti-competitive impact of parties getting together to set royalty rates?

Despite best efforts, if the developers of a technology set the price for its use through a pool royalty, the decision of the technology’s true value still ultimately sits with the marketplace. Is it worth paying for HEVC or is it better to utilise AV1? Will a user pay for the increased speed of 5G or is 4G enough? If the technology is good and the benefits are apparent, users – who ultimately bear the burden of any royalties – will pay.

So is it realistic for pools in industries such as biotech and pharma, where business models depend on patent exclusivity, to put aside profit motives for the public good? Without government intervention this is unlikely. Rather than advocating for altruism by asking licensees and licensors to put aside financial motives, the better solution for future patent pools will be to gather around reducing mutual sunk costs. In that case, we may very well see market competitors in the biotech industry shift towards standards that mutually lower the research costs sunk into innovation. Both licensors and licensees must come together to create an all-around beneficial situation.

A way forward

So is there still a place for patent pools in our modern innovation landscape? The answer is, as clichéd as it may sound – it depends.

MPEG LA’s MPEG-2 patent pool was tremendously successful – it facilitated cooperation among essential patent holders to create pro-innovation standards that advanced an industry; it dissolved government stigma against patent pools and assuaged antitrust concerns; and it made billions for its licensors and administrator.

At its peak, MPEG LA executed its noble intentions to incredible financial return. Today, noble intentions may have to suffice, as the market’s low tolerance for royalty constrains the profit potentials of most modern patent pools. Some collectives, such as the Open Invention Network, have embraced this shift and the idea that an open source posture of patent non-aggression is the key to robust, unfettered, profitable innovation, through the sale of products, rather than the collection of royalties. Whether this model will define the role of patent pools moving forward will hinge on the outcomes of strategic and philosophical dramas between companies such as AOM – with its royalty-free approach to patent thicket clearing – and the likes of Sisvel and Via, with their appeal to companies’ traditional financial interest in intellectual property.

What can be said for sure is that there is a continuing need for clarity of the cost of risk mitigation – clarity that patent pools can and should provide. In the right business environment, where all parties benefit from that clarity, patent pools may still be successful. But, the pool’s goals, applications, and incentives – financial and cultural – must be just right.