Innovation in a maturing industry, such as electronics, is fraught with challenges. Not only are the technical problems highly demanding, often requiring the combined skills of a large team of researchers, but the market in innovation is itself highly competitive with many companies all looking for the next ground-breaking development. That leads to a proliferation of intellectual property rights - particularly patents, copyright and designs - under diverse ownership, and many of these rights may simultaneously be relevant to competing products. A good example in the last few years has been the proliferation of wireless broadband access technologies, forcing consumers to install a separate chip for each vendor they wish to use.
Further, for many companies the end product is a consumer item - a mobile phone, a music player or a home computer - which is subject to the twin scourges of continuous price pressure and rapid obsolescence. The level of investment required to produce the next market-leading product can only be justified by a level of sales which may not be achievable in competition with existing products, which will be discounted in order to maintain market share pending catching up technologically. Consumers of hi-tech electronic products and services are becoming less tolerant towards the idea that they should have to acquire multiple incompatible versions of the same product, or take all accessories from the supplier of the original part: interoperability is simply demanded as a condition of widespread market acceptance.
All of these factors point towards a natural solution: collaboration, at least as to the technical standards products ought to comply with, if not as to how the products can be designed and made. Collaboration began in the electronics industry more than two decades ago because it was necessary to make the substantial improvements in technology which would drive the market forward. Today, vendors whose products and services are competing at retail level are collaborating on a next generation of technology, or looking even further ahead. WiMAX, the new generation of wireless access based on microwave frequencies, is a case in point. A standard has already been agreed for the Korean telecoms industry, and certification testing was starting in the second half of 2005 for the USA and Europe. The end result for users will be the luxury of a single inbox for data communications in any form along with low cost voice transmission and high quality audio-visual content over the same link - and a new era of competition amongst telephony services providers both fixed and mobile.
Patent pooling and the competition regime
But even though the introduction of a new technology is made possible by it, collaboration can be, or be uncomfortably close to, prohibited, anti-competitive collusion.
Collaboration efforts generally can be carried out in a manner consistent with competition laws provided that the participants make sure that they are complying in substance and not just in form. This mistake was made by Philips in the patent pooling agreement it intended to smooth the market penetration of its VCR format against competition from Sony's alternative. The agreement recited a pro-competitive objective: to increase consumer choice by making available to consumers video cassettes using the Philips standards from a range of different manufacturers. However, consumers were not to have the benefit of a choice of format from those same manufacturers: the agreement not only prohibited the parties from making any video cassettes incompatible with the format but also from distributing such cassettes made by other manufacturers. (Interoperability benefits could have been achieved through the much less restrictive means of requiring compliance with VCR standards.) Competition between products was reduced. In addition, a party which decided to leave the pool immediately lost the benefit of the licences it had under the remaining parties' patents, but could not withdraw the licences those remaining parties had under its own. Effectively, any company which signed up would not withdraw, since to do so would mean throwing away all the investment it had made in developing compatible technology in order to start afresh with a different format. Competition between technologies was therefore suppressed.
The agreement was in effect for less than two years before indications as to the European Commission's views caused the parties to withdraw it - which did not, however, prevent the Commission from completing its investigation and ruling that the agreement had breached European competition principles. The Commission reached the same conclusion much more recently in Microsoft Internet Explorer Licensing, only clearing Microsoft's ISP standard form licence when a clause prohibiting licensee ISPs from promoting and advertising competing browser software was removed. In order to make this effective in practice, Microsoft also had to remove a clause under which failure by the ISPs to attain minimum distribution volumes or percentages for Internet Explorer browser technology would result in termination of their agreements -which had made it essential for the ISPs to focus on promoting Internet Explorer above any competing technologies.
The distinction illustrated in the Phillips VCR case between product markets and technology markets is an important one: both need to be considered before a company can be confident that its agreements are not anti-competitive. Indeed, the Commission also recognises a third arena: the market in innovation, and the impact on this must also be taken into account.
The essential distinction is between collaboration which attempts to deal with market failures so as to make the market work better, and joint efforts which attempt consciously or unconsciously to supplant market competition. When examining such arrangements, the enforcement agencies' essential objective is to determine whether the collaborative efforts will create efficiencies and promote competition or stifle competition and work to the detriment of consumers. There is a danger that patent pooling will foreclose alternative technologies (thus reducing innovation), involve fixing of royalties or licence terms as between competing licensors, and/or bundle or tie non-essential patents so as to unfairly burden licensees with the cost of paying for technology they do not need.
In stark contrast to the VCR format case, the Commission decision on the MPEG-2 Licensing Programme shows that competition principles can operate in favour of collaborative arrangements provided that these are properly formulated. The Commission concluded that an arrangement whereby certain holders of patents essential to the implementation of the MPEG-2 standard agreed to license their patents through a single, nonexclusive and non-discriminatory licensing programme allowed the quick and efficient dissemination of the MPEG-2 technology - to the benefit of consumers. The appointment of a single US undertaking to act as licensor and grant parties interested in exploiting the new technology a Patent Portfolio License giving access to all of the parties' patents through a single licence did not act to give that licensor undue market power because of the terms upon which the arrangement was made. In the DVD Patent Licensing Programme, the EC noted that each licensee must grant a licence on fair, reasonable and nondiscriminatory terms to any essential patents it holds, to all other licensees under the scheme. In MPEG-2 the EC also noted that useful but not essential patents must also be licensed on fair and reasonable terms.
The fact that patent pools and jointly agreed standards can be procompetitive does not, however, mean that they will always be accepted to be so. The Technology Transfer Block Exemption Regulation ("the Regulation") expressly excludes agreements involving more than two parties, which means that all multiparty arrangements have to be considered individually and their proand anti-competitive effects weighed in the balance. Under the current regime of competition regulation enforcement, this is not as great a disadvantage as under the former regime, when two party licences had the benefit of an automatic exemption provided that they included only terms listed in the Regulation as acceptable. The current Regulation requires even parties to two-party licensing arrangements to carry out an assessment of the economic impact of the agreement. Identical terms in two different agreements may or may not be exempt in either depending upon the market relationship between the parties: whether they are competitors or non-competitors, holding market shares exceeding a given threshold or not. Reciprocal or cross-licences between competitors concerning the same technological field or product market are treated even more strictly by the Regulation.
Despite their exclusion from the Regulation, technology pooling arrangements are discussed at some length in the accompanying Guidelines. Technology pools, as opposed to formal standards fixing, may in practice amount to a price fixing cartel. The establishment of a pool can also support an industry standard or establish a new standard, thereby reducing competition in the market for innovation by foreclosing alternative technologies from the market. Where licensors or licensees are prevented from developing or licensing alternative technologies outside the pool, this reduces the licensees' incentive to consider nonpooled substitutes for the nonessential components - reducing intertechnology competition. The upsides - creation of a 'one-stop shop' for licensing, reduction of transaction costs and setting limits on cumulative royalties (a real issue in other heavily IP protected industries such as biotechnology) - are pro-competitive. The balance between these two sets of factors depends on whether the technologies in the pool are substitutes for each other. If so, the Commission's view is that the royalties are likely to be higher than they would be in the absence of a pooling arrangement since a prospective licensee would otherwise pay for only one of the options. It may therefore be difficult to draft arrangements for licensing a pool consisting substantially of substitute technologies which is not viewed as anti-competitive. The complements/substitutes distinction equates to the essential/non-essential patents issue; essential patents will typically be complements, and nonessential patents will typically be substitutes.
If on the other hand the technologies pooled are complementary, each being required in order to manufacture a given product, the Commission's view is that the arrangement reduces transaction costs and may lead to lower royalties overall. They will therefore generally be pro-competitive in effect, especially if each of the patents concerned is essential to the manufacture of a given product - even if the participants wield significant market power. However, some kind of cumulative royalty limit may be essential: Vodafone, T-Mobile, Telefónica and other large telecoms groups in November demanded an overhaul of the way the European Telecommunications Standards Institute ("ETSI"), the body responsible for standardisation of information and communication technology in Europe deals with intellectual property. The telecoms groups warn that the body's current IPR rules leave companies exposed to "unsustainable" and "excessive" demands for royalties. They warn that the "benefits of standardisation are being eroded".
Including non-essential technologies in a pool of complementary technology may undermine the pro-competitive effect. Licensees pay a royalty a component of which is likely to be for a technology they do not need or intend to use. This clearly pushes up prices for the end product; the Commission or national competition regulator will need to assess whether there is any compensatory procompetitive effect. However, if the licensor can establish that in fact the non-essential patents made no difference to the overall royalty the anti-competitive effect may be lessened, increasing the chances that the overall balance of factors will be found pro-competitive. This argument succeeded in a recent case before the US Court of Appeals for the Federal Circuit, in which Philips were alleged to be misusing their CD patents by licensing them only as a complete package. The International Trade Commission had ruled that Philips could not enforce any of the relevant patents against importers because this licensing arrangement was an impermissible arrangement tying licences of patents which are essential to manufacture CDs according to the applicable standards to others which are not. The Appeal Court disagreed: as Philips did not force any licensee actually to use the inessential patents or put them at any economic disadvantage when considering alternatives to the non-essential patented technologies, the practice was not misuse.
Maximum flexibility in the arrangements for licensing out of the pool is also a pro-competitive factor. The ideal would be if each right in the pool could be licensed individually, at a proportion of the total royalty.
Alternatively, contributors' freedom, despite the pooling arrangement, to license their own portfolios individually, can ensure that prospective licensees can put together an alternative technology package without being forced to license the entire content of the pool - although the Commission will need to be convinced that the contributors have some real incentive to grant such licences in practice. Similarly the ability to split the pool contents into packages for different applications which may be licensed separately will limit the potential anticompetitive impact. This was the case in the 3G Patent Platform Partnership albeit that this was a standardisation agreement case; licensees were given a choice as between five alternative technology packages. Selection of the technologies for inclusion in the pool by an independent expert is also likely to increase the chances of this, since it increases genuine competition between technologies. The contributors to the pool should also be subject to royalty obligations, and any grant-back arrangements in respect of improvements to the licensed technology must be limited to those developments which are essential or at least important to the use of the pooled technology.
Of course, technologies may be substitutes in part but complements in other parts. If so, they will be treated as complements, making the pool more likely to be pro-competitive, if the result of integrating the two technologies is increased efficiency: it is likely that a potential licensee would in practice want to license both even absent the pooling arrangement. Individual licences granted over pooled technologies are in effect two party licences, and are therefore entitled to the 'safe harbour' provided by the Regulation if the appropriate market share conditions are met and no 'hardcore' restrictions - such as price fixing terms - are included. However, if the pool itself has a dominant position on the market, for instance because the pool is of technologies essential to a standard, the only basis upon which it can operate pro-competitively is to offer non-exclusive licences to all comers on a fair, reasonable and nondiscriminatory ("FRAND") basis. This should (arguably) not exclude the setting of different royalty rates for the use of the pooled technologies in different product markets, if the values added in those product markets differ.
Finally, patentees' rights to terminate the licences granted by the pool if a licensee challenges a patent's validity must be limited to a right the holder of the challenged patent to terminate the licensee's rights under that licensor's patents, in order not to stack the risk so far in favour of not challenging that the pool acts as a shield for weaker patent rights. The Commission has always been wary of the possibility that a pooling of intellectual property rights may provide a mechanism for parties to extend protection. The operation of a collecting society, which represents copyright holders collectively in licensing their works to users such as broadcasters, is in some ways analogous to the operation of a technology pool in that it provides the one-stop shop but also creates a dominance which each contributor might not individually be able to attain. In one of the earliest cases in which IPRs were in issue, concerning the German copyright collecting society GEMA, the Commission founded its decision that GEMA was abusing its dominant position on the fact that the terms of the collective licensing arrangement included not only the obligation for participants to assign to GEMA rights in works as yet unmade but also the obligation for licensees to pay royalties for works which were not protected by copyright.
Essential or inessential: who decides?
The Guidelines set out certain requirements regarding the institutional framework of the pool, in order for it to be compatible with Article 81 EC: the pool must be open to all interested parties; there must be safeguards to prevent the exchange of sensitive information; independent parties should be entrusted with dispute resolution; and independent experts should be involved in the operation of the pool, including derisions on whether relevant patents are valid and essential.
Notably absent from the guidance given in the Guidelines is any consideration of parties' conduct in settling upon the patents to be included in the pool, except for the expression of a preference for independent experts to be involved or at the least for the selection 'panel' to include representatives of all interest groups. This may change when the next revision of the Regulation and Guidelines is issued, as the Commission is becoming more concerned. The issue was brought to the fore by the Rambus/JEDEC disputes, where the US Federal Trade Commission charged Rambus, a US memory chip technology company, with violating antitrust provisions by withholding information about its patent applications from the JEDEC standard-setting group until after a standard had been agreed and then claiming royalties from chip producers such as Samsung, Toshiba and Hitachi.
In the wake of this, the Commission recently investigated the ETSI IPR Policy to assess whether companies could exploit the body's rules to pull off similar "patent ambushes", and ensure that standards are agreed according to transparent criteria. In response to the Commission's initial view that the rules did not prevent such a situation, they have been amended by strengthening the requirement for early disclosure of those IPR which are essential for the implementation of a standard.
Although each ETSI meeting is open to all ETSI members, and before any other work is carried out, participants are told of the necessity to declare any related IP, the penalty for failure to do so may only be loss of ETSI membership. This would not involve loss of access to the technologies of other participants since ETSI's requirement that participants extend licences on fair, reasonable and nondiscriminatory terms does not apply only to other ETSI members. It would, however, exclude the ambusher from participation in future standard setting discussions - leaving them potentially a licensee-only in all future related product markets. Although this does not actually prevent any company from deciding to carry out an ambush, it does substantially reduce the commercial attractiveness of such a move for companies which manufacture as well as license, if the longer term implications are weighed against the immediate short term gains to be made. However, for 'patent trolls', which hold portfolios of relevant patents for the purpose of licensing without any concomitant manufacture, this sanction is unlikely to have any real force.
Another issue arising over the ETSI arrangement is the lack of any independent policing of the patents which members declare to be essential. The system is effectively trust-based, so that any participant may declare numerous patents essential without discussion as to whether or not the standard can be implemented by technology not incorporating the inventions protected by those patents. This can be problematic since manufacturers then risk being sued for infringement if they claim that their products comply with the ETSI standards without taking a licence, despite holding the view that the patents are not genuinely necessary to meet the standard. In 2005 the English Court of Appeal permitted a case to proceed to trial in which one of the parties asked for a "declaration of non-essentiality" in order to get around this problem.10 The patentee objected to this request on the grounds that the Patents Act 1977 does not provide for any such form of relief. The Act provides at section 71 for a party to apply for a declaration that their product does not infringe another party's patents, but since the request here did not refer to any particular product or component, merely to the industry set standard, it did not fall within this section. However, the Court concluded that it had the power to make such a declaration under its inherent jurisdiction since the issue was a live, commercial one between the parties, and was evidently capable of being decided: the standard and the definition of essential were both clear, and the court would in any case have to construe the patents in the course of the dispute. The declaration could flexibly indicate which of the options permitted by the standard were covered by the patent and which were not, if that issue arose. The case was tried between November 2005 and January 2006, and judgment is currently awaited. If the declaration is ultimately granted, this may provide a new mechanism for parties affected by over-broad claims of essential patent rights.