In its 1853 decision in Seymour v. McCormick, the Supreme Court established that reasonable royalty patent damages ought to be limited to the patented component’s contribution to the whole product. After 159 years and many damages theories that were “better entitled to the epithet of ‘speculative,’ ‘imaginary,’ or ‘fanciful’ than that of ‘actual,’” we are arguably at a point of inflection. Courts are closely scrutinizing reasonable royalty patent damages claims. Recent Federal Circuit decisions have banned the so-called “25 percent rule,” limited the circumstances in which the entire market value rule can be applied and rejected the use of royalty rates taken from licenses that do not involve technology comparable to that at issue.
A point of inflection or a return to basics?
There is a well-developed body of economics relating to the factors that determine the price of intellectual property in reasonable royalty cases. Yet, the guidance in Seymour and other landmark cases, such as Grain Processing Corp. v. American Maize-Products Co., Panduit Corp. v. Stahlin Bros. Fibre Works, Inc., and Georgia-Pacific Corp. v United States Plywood Corp., have been repeatedly ignored. The basic economic principle is that:
The reasonable royalty award should reflect the incremental value of the patented technology to the licensee (defendant) and the incremental cost to the licensor (plaintiff) compared to the next best alternative.
In keeping with this fundamental principle, how should patent damages experts approach estimating reasonable royalties?
Apportionment done right
In general, the value of one input—the intellectual property at issue—in a product that contains many inputs, e.g., patented and unpatented components, is the incremental value of that component. Experts, however, have used many arbitrary methods to try to “apportion” a value that is unrelated to the incremental contribution of the patented technology at issue. Experts have attempted to “apportion” by asserting that the value of one patent in a portfolio of N patents is one divided by N, or that the value of a portfolio of three blocking patents to a given technology is worth three times the value of a single blocking patent. Even the “25 percent rule” is a method of apportioning profits to derive a royalty rate. Other examples abound, and a common theme is that such “apportionment” methods are completely divorced from the incremental value of the patented component.
How does one isolate the value of intellectual property? The answer depends on the facts of the case. In some cases, licenses of the technology at issue or similar technologies provide the market’s valuation. In other cases where there are no data on royalty rates for comparable technologies, one approach is to analyze market data on prices, quantities and features. An expert may be able use benchmarks and compare prices and/or sales of an infringing product with prices and/or sales of products without the infringing feature. When data availability is not a constraint, hedonic pricing, a technique to statistically relate price to different features, can be used.
Similarly, if appropriate data are available, the economic expert can calculate substitution elasticities and estimate how substitutable the infringing feature is compared to the next-best alternative on the supply and/or demand side. Consumer surveys also can be used to determine the use of an infringing product or the reasons why customers purchased a given product. In some situations, a carefully designed consumer survey can simulate the marketplace to determine customers’ willingness to pay for a feature covered by the patented technology.
Reading the tea leaves
Notwithstanding several important decisions in the past few years, areas of uncertainty remain in the world of patent damages. Damages experts, attorneys and their clients will continue to look to the Federal Circuit for clarity. Meanwhile, what is not in doubt is an increasing demand from the courts for market-based evidence. Accordingly, the use of economists and marketing experts is likely to grow in importance to accurately estimate the incremental value of features that are covered by the patented invention. This is a welcome return to basic principles.
The views expressed in this article are solely those of the author, who is responsible for the content, and do not necessarily represent the views of Cornerstone Research.