Jan 29, 2018 – The IP community should concentrate on the bigger issue of how IP is recognised and valued in a world of technological and economic changes
The IP landscape is in a state of flux. The US has benefited over the years from its reputation as the world’s most patent friendly jurisdiction, but this is being challenged as a result of many self- inflicted wounds.
Changes resulting from recent Supreme Court of the US decisions on patentable subject matter and further proposed patent reform legislation are having a negative impact on the effectiveness of patent protection which could ultimately stifle innovation. The US has moved from first to tenth place in terms of patent protection, tied with Hungary, according to a study by the US Chamber of Commerce.
This decline is tied to the increased amounts of innovation in high-tech products and the commoditisation of hardware. The latter is surprising, considering that, in a world of increasing tech complexity, hardware should be manufactured only by the most innovative technology companies that invest significantly in R&D, and are thus able to sell their products at premium prices. But the opposite is true and, despite the complexity of the innovation, hardware is becoming more and more commoditised.
I believe this trend has happened for a number of key reasons:
Analogue v digital
The relatively recent switch from analogue to digital is one core reason. In the “analogue world” it was easy to spot the differences between good and mediocre hardware. Think of home video reproduction. With analogue VCRs, the playback from top players was far superior to entry level products, with customers able to appreciate that difference and therefore willing to pay for quality.
In the “digital world,” DVD players have substantially eliminated the video output quality gap between different equipment, leading to customers deciding purchases on price or, at best, on brand association.
The second reason lies in the advent of cooperative innovation (standardisation) and large stacks of innovation packed in cheap microchips, which grant every manufacture access to a level of innovation unattainable to any of them independently. This has allowed large numbers of new entrants to succeed in a technology-rich market without having to invest in core innovation.
“In reality IP made standardisation possible. Without patent protection, no CEO would allow their inventors to go around the world sharing their most valuable ideas.”
This combination, helped by the digital world (where the most important aspect of a product is that it works, since the quality of the technology is guaranteed by standardisation and cheap access to innovation rich components) has lowered the barriers of entry. Which has led to the demise or shrinkage of many top “analogue-era” consumer electronics companies.
This revolution has led to a fall in technology prices. DVD players (introduced in 1997 with a retail price of a $1,000 plus) had, within six years, seen price falls of 95%. Today we don’t need DVD players, with multiple devices capable of streaming HD movies. There has been a “democratisation” of innovation, with technology affordable and available to everybody.
While credit for this “revolution” is often attributed to standardisation, in reality IP made standardisation possible. Without patent protection, no CEO would allow their inventors to go around the world sharing their most valuable ideas.
At the same time the speed of the technology price war and increasing difficulties defending and licensing patents has resulted in a spike in unauthorised IP usage and shrinking profitability for the manufacturers who carried the cost of innovation.
New nature and role of hardware
Standardisation, miniaturisation, and technology convergence have changed the nature of hardware and the Internet of Things means those changes are destined to continue to spread.
The continued packing of multiple technologies in single products is resulting in high value products displacing existing categories. The scale of this transformation is illustrated by smartphones which have become a ubiquitous product-set combining numerous technologies into one product with an IP value often far higher than the hand-set retail price. In conjunction, hardware has ceased to be “closed” products, remaining forever in the same status. Information can now flow from the hardware to the outer world and from the outer world to the hardware, which means that hardware can be upgraded with further innovation remotely.
This difference is a Copernic revolution which is shifting value away from hardware and moving it towards the revenue streams hardware generates. Technology products today have multiple income streams in addition to sale price, including direct and indirect services income, subscription fees, and data collection.
This concept was understood by operators when, 20 years ago, they started offering hand-sets for 1 cent in exchange for a long- term service contract. The phone was often worth several hundred dollars, but the subscription generated revenues to cover the cost of the handset, building and managing the infrastructure, and a good profit.
Hardware is now a gateway to countless revenue generation opportunities with a far greater value than mobile service fees.
What does this imply from an IP perspective?
The real value generated by hardware IP is becoming much higher than the sale price, and the value of a microchip is not the cost of manufacturing, but rather the value of innovation, IP, services, and data which the microchip gives access to.
As we move from a hardware society to one where value is primarily driven by content and services, we must ensure hardware innovation continues, we need to find models to place fair value on technology that facilitates access and allows technology innovators to generate profits.
FRAND AND RAND
FRAND and RAND were devised as a way to generate fair returns for innovators while giving access to standard technologies.
Last year, the High Court in London decision in a FRAND case, between Huawei and IP aggregator Unwired Planet, made headlines. The court ruled Unwired Planet was entitled to injunctive relief for Standard Essential Patents (SEPs) and the decision was seen as a key step in establishing value in SEP patents and much analysis speculated whether the UK would become a more important jurisdiction for ruling on FRAND disputes.
I think this is now likely, but the IP community should concentrate on the bigger issue of how IP is recognised and valued in a world of technological and economic change, with FRAND being just one part of this.
Traditional hardware manufacturers (and inventors of much of the IP) are no longer the companies that gain the most benefit from it. The lower entrance barriers for new players has caused a price erosion which has blocked-out most traditional manufacturers, because new entrants have benefitted from innovation created by others without making any meaningful monetary contribution to the R&D. In this situation, the retail price of the technology-enabled product is no longer relevant to determine the value of IP.
For example, the “Open Compute Project” launched in 2011 to enable delivery of the most efficient server, storage, and data centre hardware designs for scalable datacentres. The declared intention was to provide accessibility and sharing of innovation but with the, potentially unintended, consequence being an overlooking of the R&D expense incurred by hardware companies that invested in years of innovation to develop quality datacentre infrastructure.
Participation and contributions to Open Compute were royalty free between its members, which meant that many hardware companies initially resisted participating. But, after experiencing an eroding market share that drove their share price down, many hardware companies accepted that commoditisation of the low-end hardware stack was inevitable and embraced the initiative to try to maintain relevance in the market. The value created by such innovation over the years shifted to the end user of the infrastructure consumed in the cloud.
Surely a royalty bearing FRAND approach to IP protection would have been a possible option to compensate for innovation in this case, but it was not an option because companies that extract value from the new economy often view infrastructure as a simple cost of sale, and do not attribute specific value to the underlying IP.
With more companies focused on “riding the wave” and embracing the New Economy, IP is ceasing to sustain the pace of high-tech innovation and the result will inevitably be a decay of infrastructure which will materialise, years after the underinvestment occurs, with an “avalanche” of failures.
To avoid this, we need to recognise that, contrary to what many technology users argue, an open-access model to innovation is not desirable, and accept that IP value cannot just be calculated as a small fraction of the retail price of hardware, but rather valued for what the innovation enables and the value it unlocks. Even the current debate on what constitutes a fair royalty rate for SEPs in FRAND/ RAND, and in an environment where the value has shifted from the cost of hardware to the value generated by it, remains focused on the sale amount of the hardware.
This is like saying the value of a pharmaceutical treatment should be based on the cost of manufacturing the pill, or measuring the value of a book by the cost of printing.
The FRAND/RAND discussions should be seen as the starting point for a far wider debate on how we reward innovation and measure the value it brings.
Is there value for technology used in hardware?
Both consumers and companies benefit greatly from handsets packing a mind- blowing array of technologies, so it seems obvious that some return should be given to all who contributed to the underlying innovation. There is value in the technology and there should be compensation to those who created and protected it.
How should that value be calculated?
Courts and many scholars seem to think damages and royalties should be based on the production or sale price of the product, and more recently even on the cost of the smallest licensable component.
This principle, which emanates from a hardware centric economy, is no longer applicable. The calculation of the value of an invention has to be linked to the advantages offered by it not the cost of the products or a component. We need to revise our thinking. IP is about value-creation, not a physical tool or product.
Who should be paying?
The traditional approach sees IP value added to a product’s sale price, with an increase sufficient to cover royalty payments. The alternative is that royalties (ie, the cost of technology) are not supported exclusively by the hardware manufacturer, but also serviced by those making best use of the technology, and ultimately generating the largest portion of profits from the capabilities of IP.
While FRAND/RAND cases continue to raise many questions about how we set royalty fees for SEP innovations, the debate needs to shift to encompass a more fundamental point: how do we ensure fair reward for innovation to guarantee a continued cycle of innovation? New approaches that shift IP payments so they do not exclusively fall on the hardware manufacturers, but require royalty payments by the players that benefit from the value generated by IP is more in sync with the value chain.
For this solution to work the IP community needs to come together and embrace novel sharing models which require industry cooperation to succeed. It also needs IP users to be good citizens and actively participate in licensing models which can ensure there continues to be a return on investment for innovators to motivate them to continue to invent.
If we don’t reward and remunerate IP developers then everyone loses. Certainty over IP protection and wide compliance by all players is the best way to achieve this.
The article was first published on https://www.intellectualpropertymagazine.com/patent/valuing-the-hardware-innovators-128287.htm