Industry perspective: considering the consumer in SEP/FRAND negotiations

In SEP/FRAND licensing discussions and industry forums the dialogue often revolves around the intricate balance between SEP holders and implementers, with a primary focus on the innovation sharing and compensation between them. The general idea is that the innovation cycle starts with SEP holders investing in R&D and sharing new technology with SEP implementers, and concludes when SEP holders are awarded reasonable compensation that allows them to further invest in research. Throughout this cycle, SEPs serve as the medium. 

While this process incentivises more innovation, stressing the importance of the innovation cycle alone may limit the focus of SEP holders and implementers to just a portion of the wider ecosystem – which could lead to unnecessary friction. It could even encourage both sides to engage in a confrontational zero-sum game, hindering them from cultivating and expanding the ecosystem together.

To cultivate a more inclusive approach it is key to step back and acknowledge all of the diverse stakeholders – which extend beyond innovators and implementers. Consumers, legislators and policymakers are all crucial components of a sustainable ecosystem, with consumers particularly vital. While the industry celebrates technological advancements and patent portfolios, it is essential to keep sight of whom these innovations should ultimately serve.

An overview of the IP ecosystem 

Consumers deserve equal importance in all business models, as it is they who ultimately appreciate the value of innovation – usually in the form of products – and pay for it. This payment is what enables implementers to expand the scale of implementation and allows innovators to recoup compensation from their initial investment for further innovation investment. With consumers included, an IP ecosystem can truly take shape.

Figure 1. IP Ecosystem Overview

A sustainable and prosperous IP ecosystem not only benefits innovators and implementers but also prioritises consumer satisfaction. This cycle begins with innovation, is followed by implementers' efforts to bring the product or service to market, and culminates in consumers paying to experience the value of the innovation. A portion of this sum goes to the innovators in the form of royalties, which allows them to continue creating. This fosters a continuous cycle of innovation and consumer satisfaction; any disruption to this cycle jeopardises the interests of all stakeholders, so it is crucial to maintain its integrity. 

This process functions smoothly so long as consumers appreciate the value of innovation and are willing – and can afford – to pay for the improvements that it brings to products or services. In an ideal world, consumers choose to pay for products or services based on their personal perception of its value. Only by receiving such a payment can implementers and innovators respectively sustain production and further innovation. In this sense, these parties should work together to maximise consumer satisfaction and diligently maintain the IP ecosystem. 

Further, examining the ecosystem through the lens of consumer perspective can shed light on what affects its sustainability and how innovators and implementers should behave in order to maintain and expand it. Therefore, several non-exclusive perspectives should be considered in SEP licensing.

Consumers’ willingness to pay

Consumer preferences and economic factors are constantly evolving and these significantly impact willingness to pay for new technologies. For example, although the proportion of 5G smartphones has increased slowly over past few years, the whole mobile phone market in general is heavily saturated. The introduction of 5G phones has not prevented the global mobile phone market from dropping since 2019.

Figure 2 highlights the number of global smartphone shipments, which has been dropping since 2019. This trend aligns with the fact that consumers have a relatively low willingness to pay for upgrades and instead are prolonging the upgrade cycle. There are several reasons behind this, including: 

• macroeconomic downturns due to the pandemic;
• regional conflicts; and 
• geopolitical tensions. 

Additionally, the rollout of 5G networks has not been as aggressive as originally planned. Even in countries with extensive 5G-network deployment, a lack of compelling 5G applications has resulted in many consumers being reluctant to upgrade from 4G smartphones as the 4G data speed is sufficient for most, if not all, daily needs. According to GSMA’s “The Mobile Economy 2023” report, 5G adoption will only reach 17% in 2024.

Figure 2. Global smartphone shipments (million units)

In some sense, willingness to pay for a technology – or part of it – is closely linked to the pricing of products or services. 

Hypothetical case study

In a hypothetical situation, a shelf lock can only be unlocked 1,000 times before wearing out – but users generally want a lock that is capable of unlocking 1 million times before it needs replacing. Manufacturer A invents a lock that can unlock 10 million times, while Manufacturer B invents a lock capable of unlocking 1 billion times. When it comes to pricing the product, it would be unwise for Manufacturer B to price its lock higher than that of Manufacturer A. If users are unwilling to pay for the extra millions of unlocks, the advancement of the Manufacturer B’s lock has no benefits over that of its competitor. 

The same economic tenet applies to the pricing of royalty rates.

In the context of 5G, consumers' willingness to pay should be considered when deciding the royalty rate, as this is a direct indication of the value that consumers perceive in the technology for smartphones. For example, in the Chongqing Intermediate People’s Court’s decision in Oppo v Nokia, the court decided on a 5G royalty rate range of 4.341% to 5.273%. To reach this conclusion, the court accepted an economic model that factored in consumers’ willingness to pay for 5G smartphones.

There are more than 60,000 declared 5G patent families in total and the number continues growing – significantly more than those in the 4G standard – which is partially due to the issue of over-declaration. Another crucial reason is that the 5G standard comprises technologies in vertical areas, such as the IoT. There are also plenty of optional features that are subject to implementation by implementers. If a vertical-area technology or an optional feature is not used by consumers, it is unreasonable to ask them to pay for it. Therefore, innovators and implementers should ensure that royalty rates do not factor in vertical-area technology or unused optional features – otherwise, consumers will end up paying for an extra portion of the royalty that they should not reasonably pay.

Removing unnecessary costs for consumers

The overall royalty that is paid by implementers and borne by consumers varies proportionally with the number of innovations in certain products or services. For example, with smartphones embodying more and more innovations proactively or passively, the total royalty can be significant.

Nothing illustrates this better than the video codec space. Before the standardisation of HEVC technology, implementers (ie, smartphone manufacturers and online video-streaming service providers) primarily used its predecessor, AVC technology. By paying for smartphones, consumers compensated innovators for AVC technology as it is frequently used in these products. 

However, as innovators for HEVC technology had differing opinions on royalty rates, the HEVC licensing landscape fragmented. Three patent pools were formed, with several individual innovator companies unattached to any of them, and the total royalty stack for HEVC became significantly high after adding these all up. The fragmented landscape severely impeded HEVC technology deployment on the market and led to investments in alternative and competing codec technologies.

Today, it turns out that AVC is still the primary codec, while several other competitive codecs and successive codecs (eg, VP9, AV1, HEVC and VVC) coexist. This poses a heavy financial burden not only to video-streaming service providers, but also to smartphone manufacturers, as smartphones need to be able to support almost all of these video codec technologies. Despite consumers’ low-to-no usage rate of some video codec technologies during a smartphone’s lifespan, manufacturers still need to pay for – and consumers bear the cost of – royalties for all of them. Had HEVC innovators followed suit with AVC technology, there should have primarily been one video codec, with consumers paying only for the one video codec technology that they use frequently.

Representing consumer voices

When striking a balance between hold-up and hold-out behaviours, delicacy is required to prevent either from damaging the ecosystem. Hold-out behaviour from implementers drains the incentives and financial capability to foster further innovation. Similarly, patent hold-up from innovators spells trouble for innovation, resulting in a triple-loss scenario. First, implementers might refrain from integrating innovations into products or services due to exorbitant royalty rates, which would lead to a competitive disadvantage or even a financial deficit. Second and third, as a consequence of delisting such innovations from products or services, consumers miss out on the benefits that these creations offer and innovators fail to recoup reasonable compensation for their initial investment. As a result, they lack funds for future innovation. For this reason, innovators and implementers must collaborate to maintain a sustainable IP ecosystem.

Pursuing supra-FRAND rates is deemed unfair to licensees, a point that has been highlighted in recent cases. In Lenovo v Interdigital, Justice Mellor commented: "Overall, however, I am driven to the conclusion that by consistently seeking supra-FRAND rates, InterDigital did not act as a willing licensor." Similarly, in Optis v Apple, Justice Marcus Smith stated: "No implementer could stay in business paying Optis’ rates." 

This practice is also unfair to consumers. Innovators should refrain from seeking supra-FRAND rates and acting opportunistically. Implementers should resist supra-FRAND rates responsibly, rather than adding to consumers' burden. They should also consider affordability from a consumer perspective – especially in developing countries – and reserve reasonable financial incentives for innovations in product pricing. Implementers should offer fair returns to innovators that have made genuine innovations and proposed reasonable royalty rates in order to enable further creations to become a reality.

This practice is unfair to innovators that pursue reasonable compensation for their innovation as well. In a thicket of many open standards, a single innovator cannot possess all inventions for a new technology. The act of one or more innovators pursuing supra-FRAND rates may impede the adoption and expansion of the new technology in the market, and adversely affect innovators, who pursue reasonable compensation.

A consumer's ability to pay

Financial capacity plays a pivotal role in shaping the IP ecosystem. Economic development levels (eg, resident income) are usually taken into account during the product pricing process. Similarly, discounts on royalty rates are offered for developing countries, and these are often found in licensing programmes with public royalty rates. These have been considered and accepted in court decisions worldwide as well. For example, in Unwired Planet v Huawei, Judge Birss noted, "[t]he comparable licenses show that rates are often lower in China than for the rest of the world. The relative factor varies. I find that a FRAND license would use a factor of 50%", while in TCL v Ericsson, Judge Selna provided a final FRAND rate with a differentiation between US and rest-of-the-world rates. Patent pools (eg, the VIA AAC pool) have Region 1 and Region 2 rate setups to accommodate this. As consumers in developing countries are price sensitive, these discounts serve to proliferate technology in underserved markets and reach people who would otherwise not have the opportunity to own a smartphone and access an abundance of information. 

Under this umbrella, key open questions seen in many FRAND negotiations are also relevant to consumers, such as: 

• whether percentage rates versus dollar amount rates for a product should be considered; or
• whether the FRAND rate should be considered relevant to the profit margin of the products.

Geographical perspective: consumer location versus patent coverage

Patent laws are national in scope. It is common knowledge that if an invention does not enjoy patent protection in a jurisdiction, consumers in that country do not need to pay for it. For patent portfolios with decent global coverage, a fair global rate is justifiable. However, when the opposite is true, SEP licensing should take consumers' geographical location and patent coverage into account. 

In Unwired planet v Huawei, Judge Birss presented "a table setting out the numbers of declared SEPs held by Unwired Planet around the world", and then stated, "[b]earing in mind that table, a FRAND approach would be to set MM countries for a given standard as those with more than a certain number of declared SEPs for that standard". Depending on the portfolio, the details of how this factor is more conveniently taken into account can vary. In a way, this also provides stronger legal standing for licensors as well.

Key takeaways: empowering consumer voices

In navigating the complexities of SEP/FRAND licensing, it is imperative to elevate consumer voices (either directly or indirectly) alongside expert opinions and legal considerations. Consumers are not merely passive recipients of innovation – they are active participants, whose preferences and demands shape the trajectory of technological advancement. They are the revenue origin for innovative technology, the ultimate users of innovative technology and the ones that both innovators and implementers should work together to serve. By amplifying consumer perspectives within licensing discussions, stakeholders can foster a more inclusive, sustainable, prosperous and consumer-involved IP ecosystem.