Jorge Padilla

The Antitrust Economics of Tying: A Farewell to Per Se Illegality

We describe the main features of U.S. and E.C. tying law and consider their recent evolution. We then review the economic literature on tying and summarize its main implications for the analysis of tying cases: First, recent advances in economic theory unambiguously endorse a rule-of-reason approach to tying such as that adopted by the D.C. Circuit Court of Appeals in Microsoft III. Second, there is no economic basis for a per se prohibition of tying. And third, the modified per se rule adopted by the U.S. Supreme Court in Jefferson Parish does not accurately screen pro-competitive from anticompetitive tying. Drawing on the findings of the economic models developed by the Chicago and post-Chicago Schools, we conclude by proposing a three-step test to implement rigorously a rule-of-reason analysis to tying cases.

The Optimal Scope of the Royalty Base in Patent Licensing

Legal scholars debate the merits of using the total value of the product, as opposed to the value of the component to which the technology contributes, as the base for a royalty in licensing contracts. In this paper we make use of the fact that these two royalty bases are equivalent to using ad valorem and per-unit royalties, respectively. We abstract from implementation and practicability considerations to analyze the welfare implications of the two rules. Ad valorem royalties tend to lead to lower prices, particularly in the context of successive monopolies. They benefit upstream innovators and do not necessarily hurt downstream producers. This benefit increases when there are multiple innovators contributing complementary technologies, as is typical of standard-setting organizations. Ad valorem royalties are even more desirable when enticing upstream investment is optimal. Our findings explain why most licensing contracts include royalties based on the value of the product.

Payments and Participation: The Incentives to Join Cooperative Standard Setting Efforts: Incentives to Join Cooperative Standard Setting

Formal, cooperative standard setting continues to grow in importance for the global economy. And as standards become more pervasive, the stakes rise for all participants. It is not surprising then that many standards are covered by intellectual property rights, that battles over the licensing of those rights have reached a fevered pitch in several industries, and that competition agencies around the globe are seriously weighing whether and how to intervene in the standard setting process. One suggestion for such an intervention is the imposition of a licensing cap, referred to as the incremental value rule. We evaluate this proposal and find that even in contexts where this rule is efficient from an ex�?post point of view, it induces important distortions in the decisions of firms to innovate and participate in standard setting organizations (SSO). Such a rule reduces the R&D investment that a firm makes in relevant technologies and lowers the probability that it will join the SSO. We characterize a variation of the incremental value rule for defining fair, reasonable, and nondiscriminatory that accounts for both investment and participation incentives.

Settling FRAND Disputes: Is Mandatory Arbitration a Reasonable and Non-Discriminatory Alternative?

This paper reviews the recent proposal that SSOs amend their IPR policies to require SEP owners and willing licensees to resolve disputes over licensing terms, particularly FRAND royalty rates, using mandatory, binding baseball-style (or “final offer�?) arbitration. We first consider the fundamental underlying premise of the arbitration proposal - namely, that there are systemic problems relating to FRAND-based standardization and that current disputes are not being efficiently addressed. We find that mandatory baseball arbitration is a solution in search of a problem, will not necessarily afford “better�? outcomes, and is more likely to lead to decisions that undermine the standardization process.

For Welfare's Sake? Balancing Rivalry and Efficiencies in Horizontal Mergers

There has been an extensive debate about whether the proper objective of merger control should be long run consumer welfare or long run total welfare. We review the various arguments that have been put forward to justify the use of a consumer welfare standard and find none of them convincing. However this debate risks missing the point. Maximizing long run total welfare may be a suitable objective for governments enacting merger control legislation. But the long run effects of a merger are often too complex for this to serve as a practical guide to decision making. Instead, competition authorities are usually given a target related to competition, allowing for some consideration of efficiencies. In practice this target is often interpreted as a focus on the short term effects on consumers, so that efficiencies count only to the extent that benefits are passed on. The real debate is not about the objective of merger control, but about whether this is the right target.

Assessing the Link between Standard Setting and Market Power

Some policymakers, courts, and academics have expressed concerns that when a firm’s patents are incorporated into a standard, the inclusion can create market power for the patent holders that can then be abused when the standard is commercialized. This paper offers a critical assessment of that proposition. Our analysis has two aims: first, to better understand exactly how an SSO might confer market power on included patents and second, to move closer to an empirical understanding of the market power proposition. We create a dataset of patents named to voluntary standard setting organizations, as well as the patent pools that sometimes develop around such standards, with the goal of providing some suggestive measurements of the effect standardization might have on market power. As it is extremely difficult to measure market power directly, we rely on proxies capturing a patent’s importance or value. We find that some SSOs do appear to enhance some included patents’ importance, but most do not. Moreover, the effects change over time, across standards, and across patents. Thus, we conclude that, on average, inclusion in an SSO tends to enhance a patent’s value, but for any particular patent named to a particular standard a positive effect is not inevitable. Instead, a broad range of effects is possible, some even negative but most equal to zero.

Antitrust Analysis Involving Intellectual Property and Standards: Implications from Economics

There is a significant industrial organization (IO) economics literature on the economics of innovation and intellectual property (IP) protection. As some courts and antitrust agencies have recognized, the IO economics toolkit for business arrangements (e.g., vertical restraints, tying and bundling, etc.) involving IP rights is sufficiently flexible to be applied in high-technology areas involving antitrust and IP. In this Article, the authors explain the economics of innovation and IP protection, licensing, and compulsory licensing, with specific applications to standards development and to standard-essential patents. The authors then propose first-best approaches based on the implications of the economics that courts and agencies can apply at each stage of an antitrust inquiry, from market definition and market power to the assessment of particular business practices. The authors conclude by providing a summary of the approach applied in each major antitrust jurisdiction—China, the European Union, India, Japan, Korea, and the United States.

Another Look at the Economics of the UK CMA’s Phenytoin Case

Davies and Padilla examine the UK Competition and Markets Authority’s 2016 decision to penalise Pfizer and Flynn Pharma for excessive pricing of phenytoin, an off-patent anti-epilepsy drug. The authors describe the CMA’s assessment of the gap between prices and cost and note that this same evidence is used in assessment of each of market definition, dominance and abuse. The CMA properly considered other evidence too, but this could serve as a precedent for a fragile and unreliable approach to assessing excessive pricing. The CMA found the price excessive ‘in itself’, rather than placing weight on comparator prices: a more appropriate measure of value. The authority imposed a fine uplifted by 400% for ‘deterrence’, and the authors question how realistic such deterrence objectives are, for excessive pricing provisions.

Portfolio Licensing to Makers of Downstream End-User Devices: Analyzing Refusals to License FRAND-Assured Standard-Essential Patents at the Component Level

Competition agencies around the globe are investigating whether a standard-essential patent (SEP) holder’s choice to license to the makers of downstream end-user devices, rather than to makers of the components of those devices, violates competition laws. Some authorities have already reached that conclusion. While much has been written about FRAND-assured SEPs, the literature to date focuses largely on the appropriateness of seeking and obtaining injunctive relief on such patents or on the meaning of “fair and reasonable,” and has largely ignored the “nondiscriminatory” prong of FRAND (fair, reasonable, and nondiscriminatory). This article analyzes what we observe to be the common industry practice of licensing on a portfolio basis at the end-user device level, and whether a patent holder’s refusal to license at only at the downstream end-user device level, and not at other levels of the production chain, may constitute an antitrust violation. We conclude that (1) whether the “nondiscriminatory” prong of the FRAND promise requires licensing at the component level is a fact-specific inquiry that depends upon the specific standard-development organization’s policy; (2) even if there is potential for a failure to comply with a FRAND assurance, that alone does not constitute an antitrust violation; and (3) the refusal to license at component level cannot be anticompetitive when the vertically integrated holder of one or more SEPs does not assert its patents against the makers of components but, instead, licenses its SEP portfolio to end-device manufacturers on FRAND terms.

The Inverse Cournot Effect in Royalty Negotiations with Complementary Patents

It has been commonly argued that the decision of a large number of inventors to license complementary patents necessary for the development of a product leads to excessively large royalties. This well-known Cournot-complements or royalty-stacking effect would hurt efficiency and downstream competition. In this paper we show that when we consider patent litigation and introduce heterogeneity in the portfolio of different firms these results change substantially due to what we denote the Inverse Cournot effect. We show that the lower the total royalty that a downstream producer pays, the lower the royalty that patent holders restricted by the threat of litigation of downstream producers will charge. This effect generates a moderation force in the royalty that unconstrained large patent holders will charge that may overturn some of the standard predictions in the literature. Interestingly, though, this effect can be less relevant when all patent portfolios are weak making royalty stacking more important.