Erik Hovenkamp

The Viability of Antitrust Price Squeeze Claims

A price squeeze occurs when a vertically integrated firm squeezes a rivals margins between a high wholesale price for an essential input sold to the rival, and a low output price to consumers for whom the two firms compete. Price squeezes have been a recognized but controversial antitrust violation for two-thirds of a century. We examine the law and economics of the price squeeze, beginning with Judge Hands famous discussion in the Alcoa case in 1945. While Alcoa has been widely portrayed as creating a fairness or fair profit test for unlawful price squeezes, Judge Hand actually adopted a cost-based test, although a somewhat different one than most courts and scholars would adopt today. We conclude that strictly cost-based predatory pricing tests such as the one the Supreme Court developed in its 1993 Brooke Group decision are not appropriate to the concerns being raised in a price squeeze. We also consider several efficiency explanations, the importance of joint costs, situations in which the dominant firm uses a squeeze to appropriate the fixed cost portion of the rivals investment, as well as those where the shared input is a fixed rather than variable cost for the rival. Ultimately, we find little room for antitrust liability except in one circumstance: where a squeeze is used to restrain the rivals vertical integration into the monopolized market.

Predatory Patent Litigation: How Patent Assertion Entities Use Reputation to Monetize Bad Patents

Despite their expertise in patent law, the most litigious patent assertion entities (PAEs) frequently file dubious infringement claims on which they are ostensibly very unlikely to turn a profit. Thus one might conjecture that these PAEs are mistaken to follow through on their litigation threats when their chances of coming out ahead are so scant. To the contrary, this paper demonstrates that this is in fact a calculated strategy of predatory patent litigation: by following through on its threats of seemingly irrational litigation, the PAE develops a litigious reputation that convinces other producers that these threats are credible, leading them to accept licensing offers they would ordinarily rebuff. This allows the PAE to garner substantial licensing revenues using low quality patents that would otherwise be difficult or impossible to monetize. This paper develops a stylized dynamic model of patent assertion and reputation building by a PAE with low quality patents. The model has a unique equilibrium that involves predatory patent litigation, and in which the PAE intermittently forfeits and rebuilds its litigious reputation over time. Predatory patent litigation generates substantial social costs, and creates a perverse incentive for patent applicants to seek coverage of technologies so obvious or non-novel that they are likely to be widely unintentionally infringed by unsuspecting producers. Importantly, fee shifting will not solve the problem. Rather, it will lead predatory PAEs to focus their ire on small, vulnerable targets, such as technology startups, for whom litigation may be crippling even if attorney’s fees are ultimately recouped. Potential defendants could better deter predatory PAEs by entering a litigation cost-sharing agreement in which members jointly pay one another’s litigation costs and litigate all meritless claims to judgment. If properly limited in scope, such an arrangement is lawful and will not materially undermine meritorious infringement actions.

Anticompetitive Patent Injunctions

The current approach for determining when courts should award injunctions in patent disputes involves a myopic focus on the hardships an injunction might impose on the litigants and the public. This article demonstrates, however, that courts sometimes could rely instead on a consideration far more relevant to the patent systems goal of promoting innovation: the extent to which the right to exclude was actually a necessary quid pro quo for the plaintiffs decision to bring its products to market. We illustrate the value of this approach with a critique of a recent Federal Circuit decision, Trebro Mfg. Inc. v. FireFly Equipment, LLC, which held that injunctive relief may be appropriate when a defendant infringes a patent that the plaintiff-competitor does not practice, and against which it lacked any legal protection when it entered the relevant downstream market. These circumstances — which are increasingly common in industries with rich markets for secondhand patents, result in the formation of what we refer to as a “diagonally integrated” nonpracticing entity (NPE) — a producer who owns a patent it does not practice, and who competes with downstream rivals who use (or would like to use) the patented technology. We develop a simple model showing that if such a firm acquired the unpracticed patent after entering the relevant product market, an injunction poses a threat to competition and consumer welfare that is not offset by any plausible benefit to innovation. Further, diagonally integrated NPEs have a perverse incentive to exclude or substantially limit all use of the patented technology, making them more likely to seek excessive licensing fees and aggressively seek injunctive relief than are conventional, “unintegrated” NPEs. This effort to foreclose all use of a technology is novel in the patent literature, but the spirit of this tactic is well known in antitrust: a dominant firm acquires patents that it has no intent to use simply in order to deny the technology to rivals, thus perpetuating its dominant position. The model’s implications also extend to a range of topics at the core of contemporary patent policy debates, including patent privateering, FRAND-encumbered patents, and preemptive patenting. It also suggests that in considering appropriate remedies the court should weigh competition concerns more seriously, particularly when there is little or no tradeoff with innovation concerns.

Antitrust Law and Patent Settlement Design

For competing firms, a patent settlement provides a rare opportunity to write an agreement that forestalls competition without transparently violating the antitrust laws. Problematically, such agreements are highly profitable for reasons that have nothing to do with resolving a patent dispute. Thus, even if the firms think the patent is very likely invalid or noninfringed, they prefer to restrain competition to monopoly and share in the proceeds. In response, antitrust has recently come to focus on how the settlement’s competitive effects compare to the expected result of foregone patent litigation, which seemingly requires some assessment of the likelihood that the patentee would have prevailed. But this “case-within-a-case” approach leads to major complications in practice. Indeed, outside of one well-known settlement format—so-called “pay-for-delay” agreements—how to administer this burgeoning antitrust standard remains an open question. nApplying recent work in economics, this article argues that antitrust law should reframe its settlement analysis to focus entirely on the nature of the settlement agreement—the particular way it restrains competition or otherwise redistributes profits between the firms. That is because the settlement’s design is ultimately what determines how private bargaining outcomes will compare to the firms’ litigation expectations. Under this approach, the antitrust question can be addressed without inquiring into the likelihood that any particular patent is valid and infringed, making it much more administrable. Instead, the focus is on how the settlement design affects private bargaining generally. This disentangles the relevant antitrust violation from the extent of the resulting harm, and can be applied to all kinds of settlement agreements. Finally, this approach is broadly consistent with the Supreme Court’s recent Actavis decision. All of this points to a clear prescription for antitrust reform: evaluate the agreement, not the patent.

Antitrust Policy for Two-Sided Markets

As technology and interconnectivity have continued to flourish, so too has an important and complex form of enterprise: the platform. Services like Uber, Google Search, Hulu, and American Express cater to distinct but deeply-interdependent “sides” of customers that derive value or revenues from one another, such as the patients and care providers on a health insurance network, or the advertisers and consumers on a social media platform. A hallmark of “two-sided markets”—those in which platforms compete—is the need to get both sides on board. The platform cannot operate successfully without a critical mass of users on both sides, which is often challenging. Platform economics has important implications for antitrust policy, as the interdependence between sides adds new complexity to the evaluation of competitive effects. It becomes critical to discern whether a platform-defendant’s conduct is plausibly necessary to get both sides on board. Until recently, courts had dealt with platform commerce only on an ad hoc basis, without articulating any general principles for evaluating restraints within two-sided markets. But the Supreme Court is poised to bring platform competition to antitrust’s frontier, as its impending decision in American Express is likely to influence how core aspects of antitrust law and procedure are to be applied within two-sided markets moving forward. Against this backdrop, this article provides a broad analysis of antitrust in two-sided markets. It begins with a discussion of the distinctive features of platform commerce, explaining how they sometimes clash with established intuition and methods in antitrust. The bulk of the paper addresses a wide range of different antitrust concerns that might emerge from platform conduct, with emphasis on discerning when the market’s two-sidedness might plausibly justify the practice in question (and when it probably doesn’t). The balance of the paper then addresses the issues in American Express—both the market definition and burden shifting questions before the Supreme Court, and the substance of the original antitrust claim.

Tying, Exclusivity, and Standard-Essential Patents

When a technological standard is adopted, implementers must pay to license all “standard-essential” patents (SEPs)—those covering core features of the standard—although the particular price terms usually cannot negotiated beforehand. To allay implementers’ fear of being “held up,” SEP owners usually make commitments to offer licenses on “fair, reasonable, and nondiscriminatory” (FRAND) terms. Among other things, this acts as a contractual price control for SEP licenses—albeit an imprecise one that is subject to judicial interpretation. nAside from licenses, an SEP holder may further supply an important “collateral input”—one that is not subject to the FRAND pledge, but which implementers nevertheless require in order to market a viable product. For example, this might be a physical component of the final product. The SEP holder might tie its SEP rights to the collateral input. It might also engage exclusive dealing or related practices, such as a “loyalty discounting” arrangement that imposes larger royalties on implementers who buy the input from competing providers. Importantly, FRAND’s operation as a price control significantly alters the economic analysis: here the primary impetus for tying may be to circumvent the price control by shifting the desired overcharge to the tied good—a concern that does not arise when a seller has complete autonomy over its pricing (as is usually the case). The natural result may be to foreclose competitors’ input sales. nSuch restraints have received little attention in the FRAND literature, but they are an emerging concern for innovation and competition policy. They have recently been attacked in two high-profile complaints filed against Qualcomm—one by the Federal Trade Commission, and the other by Apple. Against this backdrop, this article provides a legal and economic evaluation of tying and exclusive dealing arrangements in FRAND licensing. Such practices may act to undermine the FRAND price control, potentially violating the SEP holder’s commitment. The case for antitrust intervention is harder to make, but in principle the arrangement could act to exclude actual or potential competition in the collateral input market, bringing it within antitrust’s reach. I conclude by offering several policy recommendations for how courts and standard setting organizations might address these tying and exclusivity arrangements.

Proportional Restraints and the Patent System

Competitors embroiled in a patent dispute always prefer to preserve and share monopoly profits, even if the patent is likely invalid. Antitrust has come to embrace a policy that requires horizontal settlements to be proportional in the sense that their anticompetitive effects are commensurate with the expected result of counterfactual patent litigation, which might have excluded the patentees rival(s). But the standard presents serious practical complications, due to the uncertainty about counterfactual litigation, and as yet it has only been successfully applied to one type of settlement. We show that one can evaluate proportionality by focusing entirely on the nature of the firms agreement, as this determines what the firms can agree on in relation to their expectations about litigation. We exploit this to propose a new enforcement approach that avoids the implementation problems with the current regime. n nThis is a previous draft. The updated version is available at: https://papers.ssrn.com/abstract=3670815

Competition, Inalienability, and the Economic Analysis of Patent Law

Most influential economic theories about private disputes, including the Coase theorem, assume that there are no legal restraints on alienability. However, the parties to a patent dispute are often competing firms, and their private dealings may thus be constrained by the antitrust laws. Antitrust prohibits private transactions that allocate commercial rights in ways that unreasonably subvert competition between the parties. This creates an asymmetry between (1) the allocations of rights that the parties can effect through contract; and (2) those a court can effect through its judgment. For example, antitrust may condemn a “reverse payment” settlement in which a monopolist-patentee pays an accused infringer to stay off the market for several years. But if the dispute were litigated to judgment, a court could produce the same exclusionary outcome by issuing an injunction. The result is ultimately that, in contrast to familiar Coasean logic, a court’s delimitation of patent rights can influence the final allocation of such rights, even if the parties can bargain. Further, the parties may (rationally) litigate to judgment even if they have common expectations about litigation, and even if they are perfectly capable of entering into a lawful settlement ex ante.Antitrust limits on alienability may thus critically alter the nature of a private dispute, distinguishing it from the more conventional property conflicts studied in classical law and economics. Aside from altering the parties’ incentives and behavior, it changes the appropriate normative policies toward settlement and litigation. The parties may be settling not simply to avoid litigation costs, but rather to avoid a procompetitive judgment they cannot lawfully bargain around (e.g. patent invalidation), or to obtain a judicial stamp on what would otherwise be an unenforceable contract. As such, when a proposed settlement concerns rights that are not entirely alienable, the court should carefully review its terms to ensure they do not defy the relevant inalienability rule. Unfortunately, the patent courts have missed this important point (although it has been recognized implicitly in some other areas of law). They continue to treat patent suits as ordinary private conflicts over fully-alienable rights, approving virtually all settlement proposals as a matter of course. I explain the benefits of reviewing patent settlements in certain cases, and I offer a detailed account of how such review ought to operate in practice.

Patent Pools and Related Technology Sharing

A patent pool is an arrangement under which patent holders in a common technology commit their patents to a single holder, who then licenses them out to the original patentees and perhaps also to outsiders. The payoffs include both revenue earned as a licensor, and technology acquired by pool members as licensees. Public effects can also be significant. For example, technology sharing of complementary patents can improve product quality and variety. In some information technology markets pools can prevent patents from becoming a costly obstacle to innovation by clearing channels of technology transfer. By contrast, a pools aggregate output reduction or price fixing in a product market can produce cartel profits. A traditional justification for patent pools is that they facilitate improved products by uniting complements Sharing of complementary patents means that licensees can then employ all the patents in their product, rather than creating silos in which each manufacturer incorporates only its own patented features. Pools created for this purpose can reduce problems of royalty stacking and holdup, as well as problems involving blocking patents. A more robust explanation for pooling in many markets comes out of the economics of transaction costs, which emphasizes the role of limited information and the costs of obtaining it, as well as uncertainty in bargaining and sharing. Pooling is an efficient solution to problems of technology development and transfer when determining patents validity or identifying their boundaries is costly. In this sense, patent pools function much as traditional common pool resources. An individual patent’s boundaries distinguish its protected technological embodiments from noninfringing technology. But when multiple patents are aggregated what really matters are the outer boundaries that separate the portfolio as a whole from outside patents or the public domain. So long as the relevant rights are somewhere in the portfolio, the parties do not need to delineate the boundaries of individual patents in order to strike a deal. While most patent pools are socially beneficial, certain practices or structures can pose competitive problems. The biggest antitrust risk from pooling is collusion, and its threat depends on two things. First is the market structure and the power of the pool within its market. Second is the nature of pricing and exclusivity arrangements within the pool. Pool exclusivity can take several forms. First, it can refer to the contract that each licensor has with the pool, asking whether that licensor is free to license to others outside of the pool. Second it can refer to the pool’s willingness as licensee to accept an offered technology from an outsider for inclusion in the pool. Third it can refer to the pools willingness as licensor to license to outsider manufacturers. Fourth, it can refer to field-of-use or other restrictions given to licensees from the pool. A large but inconclusive literature considers the relationship between pooling and innovation. Conclusions are sensitive to assumptions about patent strength and quality, about the relationship among the patents in a pool and the strength of alternatives outside the pool, about the impact on innovation of insiders vs. outsiders to the pool, and finally, about the strategic responses of participants. Most of the literature concludes that most pools increase innovation rates. A pool should increase the demand for innovation of complements to the pool. First of all, access to the existing technology by pool members should be guaranteed and cheaper. To the extent the pool reduces licensing costs and eliminates royalty stacking the cost of further improvements should decline. When innovation is cumulative the development of new technology may require the licensing of existing technology with multiple patent holders. Pooling can reduce these costs and thus facilitate cumulative innovation.

How Patent Damages Skew Licensing Markets

If a litigated patent has previously been licensed to a third party, the courts generally adopt the terms of the prior agreement as the best measure of damages. However, while administratively convenient, this “licensing-based damages” standard creates problematic incentives and undermines the efficient commercialization of patented inventions. It rests on the trivialized (and generally false) presumption that a patent license is like a commodity, with the patentee charging a common price to all comers. As a consequence, patentees distort their future recovery prospects – and by extension the outcomes of future licensing negotiations – whenever they license their patents, whether or not today’s agreement will be a good proxy for tomorrow’s dealings or disputes. Knowing this, patentees are discouraged from licensing at anything less than a high royalty rate, even if they could reach many additional mutually-beneficial agreements on more modest terms. The result is that patent holders rationally cut off the bottom segment of the licensing market, creating substantial deadweight loss. This injures not only patentees, but also prospective licensees and their consumers. The standard creates additional problems by encouraging secrecy and “gamesmanship” in patent licensing. We propose that the licensing-based damages standard be abandoned, and that damages should generally be awarded ad hoc. This does not mean that private parties should ignore comparable licenses in their private dealings; it simply means that courts should not use them as a measure of damages. That this necessitates some speculation does not suggest it is the less desirable approach, for it is better that damages be somewhat random than systematically harmful. Further, while the licensing-based damages standard is clearly easy to apply, there is little reason to believe it is accurate in a typical case. As such, its apparent lack of randomness does not suggest that it is producing good results.