Licensors must understand that what is FRAND in US and EU may not be in China, says Xiaomi IP strategy chief

This time seven years ago, Xiaomi did not exist; now it is one of the five biggest mobile businesses in the world. As it seeks to grow its business in both China and beyond, that presents the company with a series of major IP challenges. As part of its programme to meet these, last week it signed a deal with Via Licensing that will give it the right to use the assets that form Via’s Advanced Audio Coding patent pool in its products worldwide. Like a similar deal done with Lenovo just before Christmas, Xiaomi’s agreement with Via was tailored to reflect what both parties understand to be the unique dynamics facing Chinese businesses operating in the mobile space.

Speaking exclusively to IAM, the company’s vice-president of IP strategy, Paul Lin, explained what these are and why they mean that licensors have to think creatively about the way in which they engage with licensees based in China.     

Why is FRAND such an important issue to Xiaomi and other Chinese companies?

Paul Lin (PL) - Xiaomi is a young company that has grown so quickly that it has become a global player in just a few years. Many other Chinese companies have been through similar growth bursts. However, growing a sizable, high-quality IP portfolio takes much longer - typically 10 years or more. Therefore, Xiaomi and many other Chinese companies face significant gaps in the scale of their businesses and their IP portfolios. In order to gain sufficient design freedom, they will need to license many technologies, but without much benefit from cross-licences to reduce the net amounts paid to licensors (this is one of the reasons why Xiaomi has been rapidly building up its patent portfolio through aggressive investment in R&D and patent acquisition). As a result, the potential costs to secure various patent licenses could well exceed affordability.

Xiaomi’s hardware business has razor thin margins (again, like many other Chinese companies), which leaves a very small buffer to absorb patent royalty costs. Hence, Xiaomi must be careful in taking necessary licences at reasonable royalty rates while building a sustainable business. What’s more, Xiaomi faces fierce competition from both global and domestic companies. If we take licences at higher rates than our competitors, or they avoid paying royalties altogether, then we could put ourselves in such an uncompetitive position that we cannot grow a sustainable business.

In light of those considerations and constraints, Xiaomi (and other Chinese companies) would prefer to take licences on FRAND terms. The benefit of a FRAND licence is that, presumably, (1) everyone pays (fair from a competition perspective), (2) it is affordable to businesses (reasonable), and (3) the same royalty rate and other terms apply to everyone (non-discriminatory). True FRAND licensing practice would address the major concerns that Chinese business leaders have – (1) I pay but others don’t pay (2) I pay a higher rate than others (3) the rate is too expensive to afford.   

You have said in the past that over-reliance on the Court of Justice of the European Union's Huawei v ZTE decision is a mistake - what are some of the guiding principles that are more important in China?

PL – What I meant by “overreliance” is that some licensors take what is an EU ruling literally and think that it is the “Bible” for FRAND licensing around the world, including China. But each country has its own rules and regulations that are set based on their own market situations and realities. Political, economic, and social factors (even cultural customs) have a major impact on how these rules are set. I’m not an antitrust lawyer nor a regulator in China, so I can speak only based on my own experiences about how FRAND licensing could be done pragmatically here. A few practices I’d like to share and I believe they are helpful:

• Try to understand the licensee’s business model. Where do they sell most of their products? What is the competition landscape? What is the value-add of their products (software or hardware)? Where do they source their components? Where do they manufacture their products? At what cost basis they operate?

• Based on your understanding of the licensee’s business model, develop your own analysis of the licensee’s needs and identify what its challenges are, then have an open conversation with them to understand their perspectives.

• Understand your own portfolio (from a licensor’s perspective). What is your portfolio geography coverage? Do you have sufficient patents to cover the regions where your licensee is generating most of its sales?

• Many licensors have tried to charge Chinese companies with royalty rates that are applicable to the US or EU, where their portfolios have good coverage, even though they might have far fewer patents in China. Their argument is that our worldwide rate is a blended rate. That argument might work for companies selling globally with sales across many countries, but it fails completely to resonate with Chinese companies that sell most of their products in China because there are simply not enough patent assets in the licensors’ local portfolio to justify such rates.

• Develop a royalty rate that reflects the reality of the licensor’s portfolio and also addresses the licensee’s needs. Qualcomm’s settlement with NDRC is a good reference case for the points I just mentioned above. Our recently agreed deal with Via Licensing does the same thing. We engaged in open and constructive discussions with Via, which led to a licence deal that met both parties’ needs.

Some licensors are going to balk at the idea that Chinese companies ought to get a discount relative to others. How would you respond to this?

PL – I think “the idea that Chinese companies ought to get a discount relative to others” is often misinterpreted. What that really means is that the licensor needs to take into consideration a market’s unique dynamics and develop a licensing programme that can be accepted in that marketplace accordingly.

This is not a China-unique situation. In a simplistic way, licensing patents is like selling products. Companies study different markets and come up with different pricing for each market – the same cars sell at different prices in the US, in Germany, in China and in many other countries, for example. That’s been done commonly across all industries for as long as I can remember and it’s a generally accepted concept. So why is it so hard to understand when it comes to patent licensing?

The interesting thing is that, even to date, Chinese patents still sell at a significant discount to US or EU patents (although the value of Chinese patents has been rising in recent years), but very few people have rejected that idea. Many of your readers can give better reasons than me to explain such phenomena. So you got into a situation where a licensor who does both licensing and selling patents wants the same royalty rate for Chinese and US/EU goods but would charge a higher valuation (selling price) for US/EU patents. Why so? Is that a logical and reasonable practice?

I fully anticipate the day will come when Chinese patents are valued the same as US/EU patents, and the China market will be as mature as the US/EU markets in terms of IP protection as well as other business related concerns. At that point, you will naturally see that royalty rate discrepancy starts to disappear. But this day has not yet arrived in my opinion. But, of course, this is a complicated issue and we could write an essay on it if there were time.

How do you see FRAND-related issues playing out in China over the coming years? Will the country follow developments elsewhere or can we expect a different perspective?

PL – I think most of those kind of things will be equalised across the world in the long run. The heart of FRAND-related issues from the licensees’ perspective is really fair competition (remember “cost” is one major part of competition). No government will see their domestic companies being unfairly forced into less competitive positions without doing anything about it. That’s why there are regulators.

As previously stated, regulators often take into account their own country’s unique dynamics to develop appropriate rules. For China, whether from a totality point of view or from a specific industry point of view, you should appreciate that many elements are still in a developing stage compared to the US or EU - whether that be technologies or IP enforcement or other concerns.

I cannot predict how FRAND-related issue will shape out in the near term, but what you can bet is that there will be more changes coming, whether from regulators or based on landmark legal cases. Developments in other countries or regions could be references for China; but, again, China has its own unique dynamics to consider.  

So, should we expect Chinese competition authorities to take a closer interest in FRAND and SEP-related issues?

PL – I cannot speak for the Chinese government. However, as Chinese antitrust authority and other regulatory bodies get more sophisticated with regards to handing FRAND and SEP-related issues, naturally one would expect that more clear guidance or even more regulations will be developed in China to encourage fair competition and discourage discriminatory behaviours.

Do you have any specific advice for a NPE seeking to license patents on FRAND terms in China? Are there different or additional steps they need to take to get licence deals concluded?

PL – Unfortunately, this is a question on which I will stay silent: not that I’m against or have any bias towards NPEs. The NPE as a business entity, or business model for that matter, shouldn’t be discriminated against; for example, most universities are NPEs. Licensing patents for the purpose of driving technology adoption and seeking appropriate return for inventors is a legitimate business. As long as the licences are done based on FRAND principals, I don’t view them differently whether the licensors are product companies or NPEs. 

Aside from patent assignments, what are some other value-added things a licensor can offer a Chinese company to get a deal done?

PL – Transferring patent assets is certainly one of the ways that is welcomed by some Chinese companies. But I wouldn’t expect that to work for every deal. Each company has its own needs and challenges.

As I have already stated, a smart thing for a licensor to do is to have an open engagement with Chinese companies and try to find win-win solutions or at least a solution that addresses some of licensee’s major concerns. It pays to have someone on the licensor’s team who really understands the China market and the industries the licensee operates in.

It’s hard to generalise the value-added things as each deal has its own unique dynamics; but to name a few: technology collaboration, business side of collaboration and joint-R&D development are all good ideas, though they do not always work in practice. I’ve always viewed patent licensing as an opportunity for business collaboration and partnership development. What really makes the difference are the people doing the negotiation. If one or both sides takes a purely assertion-based approach, very seldom will a good deal come out of it.