A Broader Look at Patent Royalties and Antitrust

Abstract

It is well known in antitrust economics that competitors can rely on patent licensing with supracompetitive royalties as a surrogate for price fixing. This paper addresses a number of alternative situations in which patent royalty agreements may raise antitrust concerns, even if the royalty rate is ostensibly reasonable (implying the agreement is not transparently anticompetitive). First, a royalty may serve effectively as a vertical restraint, preventing the downstream firm from passing too much of the licensing value through to consumers, which may enhance joint profits. Second, licensing to a rival creates an "alignment effect" by giving the licensor a stake in its rival's success, thereby diminishing inter-party competition. This is the same problem that arises when a firm buys stock in a competitor. Consequently, even if the royalty rate is reasonable, the arrangement may reduce consumer welfare overall. Indeed, it creates essentially the same welfare tradeoff as horizontal merger: it engenders some procompetitive efficiencies, but it makes the market less competitive.

Additionally, offsetting (i.e. reciprocal) license payments between competitors often warrant scrutiny even if each royalty appears individually reasonable. Even under cross-licensing, offsetting payments are generally unnecessary for the parties to reach a mutually-beneficial agreement, which is the relevant antitrust question. Instead, the practical effect of offsetting royalties is to replicate a collusive agreement to restrain consumer pass-through, ensuring the firms retain more of the licensing surplus. The results shed new light on the competitive impact of patent pools, which typically create widespread royalty offset and alignment between competing members, even if patents are complementary.

Keywords: patents, intellectual property, licensing, cross-licensing, patent pool, royalty, antitrust, competition policy, vertical restraints, welfare, double marginalization, royalty stacking, collusion, price fixing, cartel, price competition

JEL Classification: O34, L40, L41, L42, D45, D40