31 Pages Posted: 28 Jun 2007
Date Written: June 2007
In the last two decades, the reliance upon licensing strategies as a source of revenue for intellectual property (IP) rights holders has seen a dramatic increase. Put simply, in return for an adequate remuneration (typically a royalty, but there may be other forms of consideration), innovators (licensors) grant to other firms (licensees) the right to use their proprietary technology to manufacture products for sale in downstream markets. IP licensing strategies are not only pursued by organizations without manufacturing capabilities (e.g., university research centres). IP holders active in downstream product markets (hereafter, vertically-integrated firms) may be licensing their technologies to reap additional profits from their research and development (R&D) expenditures, but also to obtain access to other firms' technologies through cross-licensing agreements.
Licensing agreements typically benefit licensors and licensees. The licensee gains access to new technologies, which it will use to improve its manufacturing operations or embed in its products to increase their functionalities. The licensor accrues revenues from his initial R&D expenditures that can be invested in the development of new technologies, which will in turn lead to additional revenues, hence creating a virtuous circle of innovation. Licensing agreements are generally heavily negotiated between licensors and licensees, which in the vast majority of the cases reach mutually satisfactory agreements.
Yet, tensions may arise between licensors and licensees over the terms of their IP licensing deals. The diverging incentives of licensors (eager to obtain a fair level of compensation for the investments made in developing their IP) and licensees (eager to minimize the cost of acquiring proprietary technologies) may generate disputes over royalty levels and other forms of consideration. Such disputes are particularly likely to arise when licensing agreements have the potential to be worth hundreds of millions of Euros and small variations in terms and conditions can be financially significant for both parties. Potential licensees may also insist on obtaining a license on terms that are identical, or at least equivalent, to those obtained by licensees with which they compete. Licensors may, however, resist such requests insofar as differing licensing terms are justified by the particular circumstances of each specific agreement.
Additional tensions may arise when the IP in question is essential to a standard. Some have argued that once a proprietary technology has become part of a standard, its owners will be able to extract royalties in excess of those they could have charged before the adoption of such standard (the so-called hold up theory). Although, as will be seen, this theory has clear limitations it has contributed to the belief that royalty rates charged by IP holders are too high. Another claim that has been made is that in circumstances where a standard comprises essential IP held by numerous patent holders, the aggregation of the rates charged by such holders (even if individually reasonable) may lead to a royalty burden of a level such that the standard will be too costly to implement (the so-called royalty stacking theory). The proponents of such theories argue that some form of control should be placed on the royalties that can be charged by essential patent holders.
While differences of views between licensors and licensees are generally ironed out through negotiations, there will be situations where licensees may be tempted to rely on competition rules to seek redress against what they perceive as unfair licensing terms. Against this background, this paper explores the extent to which Article 82(a) and 82(c) of the EC Treaty, which respectively prohibit as abusive for dominant firms from directly or indirectly imposing unfair purchase or selling prices or other unfair trading conditions to their customers, and to applying dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage, can be relied on by licensees unhappy with the deals they have obtained from licensors. These issues are particularly important at a time where economic growth is increasingly dependent on innovation.
This paper is divided in five parts. Part II discusses the specific challenges raised by market definition and the assessment of dominance in high-technology markets with a specific focus on technology licensing. Part III discusses the application of Article 82(a) EC to licensing agreements. It explains the significant conceptual and practical difficulties of applying this provision of the Treaty in the field of technology licensing and argues that competition authorities should refrain from seeking to control prices or rates in dynamic industries. Part IV explores the issue of price/rate discrimination in IP licensing agreements. It argues that while non-vertically integrated licensors have no incentives to discriminate against their licensees, vertically-integrated firms have strong incentives to offer more favourable licensing terms to their downstream operations that to other downstream firms with which they compete. The case is made that the enforcement of Article 82 EC in this field should therefore focus on preventing vertically-integrated firms from raising their downstream rivals' costs through discriminatory licensing fees. Part V contains a short conclusion.
Keywords: patents, licensing, price discrimination, exploitation, abuse of dominant position, royalties, EC law, competition, royalty-stacking, hold-up
JEL Classification: D2, K00, K11, K21, L12, L40
Suggested Citation: Suggested Citation
By Mark Lemley