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May 2, 2009

Reasonable Royalty

35 U.S.C. §284 awards damages "in no event less than a reasonable royalty for the use made of the invention by the infringer." Reasonable royalty is thus the lowest award possible for patent infringement, and in no way bounds what infringement should cost. §284 also allows award of enhanced damages, regardless of willfulness: "[T]he court may increase the damages up to three times the amount found or assessed." Herein, a gander at the damages floor: reasonable royalty.

A basic formula for damages based upon reasonable royalty:

Damages ($) = Royalty Base ($) x Royalty Rate (%)

where the royalty base relates to the revenue of infringing products, and royalty rate is a reasonable royalty rate.

With some exception, damages begins with infringement. So, nominally, royalty base for damages is the duration of infringement, bounded by patent expiration. §286 limits damages duration to six years prior to filing a complaint. And §287, the marking statute, requires a manufacturer to mark products embodying a machine or composition patent claim, else, without such constructive notice, the damages clock only begins ticking with notice, such as "filing of an action for infringement." Non-manufacturing patent holders are thus exempt from §287, and method claims don't apply either.

The 1970 Supreme Court decision in Georgia-Pacific v. United States Plywood laid down what has become the case law bible for assessing damages, listing 15 factors for consideration in assessing damages. With regard to reasonable royalty, the following factors stand out:

8. The established profitability of the product made under the patent; its commercial success; and its current popularity.

9. The utility and advantages of the patent property over the old modes or devices, if any, that had been used for working out similar results.

10. The nature of the patented invention; the character of the commercial embodiment of it as owned and produced by the licensor; and the benefits to those who have used the invention.

11. The extent to which the infringer has made use of the invention; and any evidence probative of the value of that use.

12. The portion of the profit or of the selling price that may be customary in the particular business or in comparable businesses to allow for the use of the invention or analogous inventions.

13. The portion of the realizable profit that should be credited to the invention as distinguished from nonpatented elements, the manufacturing process, business risks, or significant features or improvements added by the infringer.

15. The amount that a licensor (such as the patentee) and a licensee (such as the infringer) would have agreed upon (at the time the infringer began) if both had been reasonably and voluntarily trying to reach an agreement; that is, the amount which a prudent licensee - who desired, as a business proposition, to obtain a license to manufacture and sell a particular article embodying the patented invention - would have been willing to pay as a royalty and yet be able to make a reasonable profit and which amount would have been acceptable by a prudent patentee who was willing to grant a license.

The thrust of these guidelines is an assessment of what infringement is worth to the infringer.

The last GP factor (15) goes to a hypothetical negotiation: what would the infringer have been willing to pay, and the patent holder willing to accept? Such a hypothetical negotiation is purely speculative. As amply evidenced by innumerable litigations, large corporation are particularly apt to treat patent litigation as a roll of the dice, unwilling to consider licensing until the dice dots make a showing. But that factor is considering the most telling, as it posits an objective viewpoint, one well suited for an adjudicator (a judge).

Georgia-Pacific represents an apportionment of product profit, with the patent holder, under reasonable royalty, entitled only to that portion attributable to infringement. In other words, GP aimed at figuring infringing feature value.

There is then the issue of whether the patent holder is entitled to all of the infringing feature value. With that in mind, royalty rate may be figured as:

Royalty Rate (%) = Infringing Feature Value (%) x Value Split (%)

Where the infringing feature value is an assessment of what the patent is commercially worth to the infringer, and value split is the relative split in infringer profit from adopting the patent technology.

An economic theoretician1 might posit value split as follows:

The normal profit is the economic return on the investment in developing, producing and marketing the product, while the monopoly profit is the economic return resulting from the patent itself.

After paying the royalty, each licensee earns only its normal profit, and all of the monopoly profit is paid to the patent holder in royalty payments. Thus, in a competitive licensing market the patent holder is able to license its invention without giving up any of its monopoly profit.

With few potential licensors in the market, the royalty is likely to be bargained and not established unilaterally by the patent holder at the level which extracts all of the patent profit from the licensees.

1 Richard S. Toikka, "Patent Licensing Under Competitive and Non-Competitive Conditions," Journal of the Patent and Trademark Office Society, 2000.

Fine and dandy. Determine market competitiveness, then slice off monopoly profit for the patent holder accordingly. Tell it to the judge. Hence the problem with academic prescriptions that are at best tangential to reality, and provide no substantive guideline for sussing something out.

More practically, under a hypothetical negotiation scenario, an infringer would not have adopted a patent technology if unable to profit it from it to some extent, even if that meant staying competitive: in other words, to avoid loss by not infringing. What that means is that value split may reasonably something less than 100% to the patent holder.

By that logic, an infringer is entitled to profit from infringement. One rationale is that the infringing adopter took risk in commercializing its product(s), and so entitled to profit somewhat, even from infringement.

In 1959, patent consultant Robert Goldscheider advised his client, Philco, who had an ongoing patent licensing campaign, that Philco's licensees assumed the major risk of commercializing their products. Goldscheider surmised that risk at 75%, leaving 25% as value split to the patent holder. The Georgia-Pacific factors make no mention of the risk concept embraced by Goldscheider.

But folks cotton to simple rules, and so this arbitrary division stuck, all the while being a lightning rod of controversy. Goldscheider himself recognizes the 25% rule as just a starting point. "Unfortunately, its application is not nearly as simple as it initially appears." Greed feeling free to roam, Goldscheider has noted that patent holders think of it as the "25% to 33% rule," while potential licensees view it as "15% to 25% rule."

The revenue base that Goldscheider preferred was pretax profits, which is not a notably clean number to ascertain. Most companies sell multiple products, and typically not all infringe a particular patent assertion. There is no governmental accounting requirement for companies, nor necessarily an easy way, to apportion expenses on a per product basis, and so derive a tidy profit number for an infringing product. Further, much accounting shenanigan potential lies between product revenue and corporate profit. Sales revenue is however a readily available number, and, considering that the simple Goldscheider 25% rule for value split creams off most of infringing feature value to the infringer, sales revenue may be considered appropriate in its simplicity, just as the 25% rule is convenient in its simplicity.

Tradition weighs in on royalty rate to some extent, as evidenced by GP factor 12. A few organizations, including the Licensing Executives Society (LES) and the Association of University Technology Managers (AUTM), publish royalty rates by industry. But as patents are by definition unique, it smacks of insensibility to slap a standardized number on infringing feature value, particularly when specific factor analysis is much more appropriate and doable.

Some finer points to consider in determining infringing feature value, and which correspond to Georgia-Pacific factors:

1. Is the infringing feature advertised? Is so, it is an admission of considerable value to the infringer.

2. How has the infringing feature been perceived by the consumer? Some patents provide a manufacturer with a perceived positive value, to which a consumer may be neutral or even anathema. Copy protection for software is an example. Mixed perception complicates infringing feature value assessment. Unabashed applause argues for a high infringing feature value.

3. Does infringement provide a tangible competitive edge? This may be more easily viewed from the inverse perspective: how much more poorly would an infringer fare without the infringing feature?

4. Does infringement esteem the infringer? A subtle form of convoyed sales: is the infringing product, and hence its maker, perceived as more state-of-the-art?

Posted by Patent Hawk at May 2, 2009 3:27 PM | Damages


Of your text -- The 1970 Supreme Court decision in Georgia-Pacific v. United States Plywood laid down what has become the case law bible for assessing damages, listing 15 factors for consideration in assessing damages--, note that the 1970 decision is a district court decision [ 318 F. Supp. 1116 (S.D.N.Y. 1970)]. The amount of the award was reduced on appeal, and the Supreme Court declined to hear the appeal from the Second Circuit. [ 92 S.Ct. 105 ]

Merely as an observation, Mark Lemley, in his prepared testimony before Congress on March 10, 2009, did not mention the Georgia-Pacific case.

Posted by: Lawrence B. Ebert at May 3, 2009 9:11 AM

Thanks Lawrence. The entry has been corrected.

Posted by: Patent Hawk at May 3, 2009 2:47 PM