Most of the efforts to “reform” the patent damages laws in the past few years have been designed to reduce the recovery patent owners can receive. The courts and Congress seem to believe that patentholders are engaged in a game in which they somehow trick juries into giving them much more than their patent is worth.
The present stick these reformers are using to reduce plaintiff’s damages awards is “damages allocation” and their strategy is to eviscerate what is known as the “entire market value rule.” This question boils down to one issue: how should infringement damages be awarded when a patent only covers a component of a larger product?
Many patentholders, in the press and before Congress, argue that there should be no such limits, arguing that, otherwise, the patentholder is not being properly compensated.
I believe, however, that this view is not politically viable, either in the courts or the Congress and will eventually lead to even more draconian measures being taken to reduce damage awards and the risk to technology companies.
However, the courts may have solved the allocation “problem” in a way which benefits patent owners by enabling them to receive full value for the value of the patent to each individual infringer and maximize a patentholder’s leverage in negotiations with prospective licensees.
The issue can be demonstrated by an example from the software industry.
Say you are a small software developer who has invented (and patented) a word processing program feature that enables the user to change the color of the font on a selected passage with just a keystroke, rather than laboriously highlighting the text and using the menu.
In Microsoft’s last version of Word, the company implemented this feature, along with 1200 other changes, some of which were intended to provide new functions to the user and others that, behind the scenes, made the software work more efficiently.
Assume further that the latest version of Word is held to infringe this patent and that the product sold 300 million copies with a retail price was $100.
What is the most equitable way of awarding damages in this situation that fully compensates the inventor for the value of his invention and still makes economic sense?
Clearly, the best way would be to determine the “value” of the patented feature to Microsoft and its customers. The more valuable Microsoft would have considered the feature to be to the users of Word, the more Microsoft would have paid the patentholder to be permitted to use it.
The parties could have determined the value (or the popularity) of this feature in a number of ways. They could have looked at Microsoft’s advertising and marketing literature to see if Microsoft highlighted the “color changing” feature as a way of selling its product. They could look at reviews of the product to see if the press thought that the feature was valuable or would be popular with consumers. They could commission consumer surveys to determine the importance Word customers gave to this feature and whether the presence or absence of this feature made any difference to their buying decision or to the price they would have paid to buy the product.
If including the patented feature increased Microsoft’s profits on Word by 2%, there would be a solid basis to argue that Microsoft would have paid a royalty representing half of those profits to the patentholder. Such a result would be equitable, sensible and would make complete economic sense.
Nobody does this.
This year, however the courts took a big step in solving the allocation problem in two cases – one involving Cornell University’s case against H-P and the other pitting Lucent against Microsoft.
The patent in the Cornell case claimed technology that covered an “instruction reorder buffer,” which was part of a computer processor, which , in turn, was part of a CPU module that, combined with other components, became a “CPU brick.” Sets of CPU bricks were , in turn, incorporated into a “cell board,” which was then inserted into H-P’s server.
Judge Rader, future Chief Judge of the Federal Circuit, sitting by designation, became frustrated with Cornell’s insistence that damages be based on the price of the server when Cornell made no effort to show how valuable the buffer was to H-P or its consumers or any reason why Cornell should be able to collect damages on the entire H-P product instead of the component alone. Judge Rader threw out the expert’s testimony and, on his own, based Cornell’s damages award on the “hypothetical revenues” of the processor – a speculative figure, given that the processor had never been sold alone.
Thus, Cornell’s initial $900 million damages claim was reduced to $54 million.
The Lucent v. Gateway case presented allocation issues even more severe than those in the Cornell case. The patent covered a method for entering information into fields without using a keyboard. The "date-picker" calendar tool in Microsoft Outlook was held to infringe this patent and Lucent was awarded $357 million in damages.
In striking down the award, the Federal Circuit court set a theme that provides the rationale for the entire opinion on damages – the critical importance of consumer choice and the consequent value of the patented technology to the parties to the license agreement.
Most important was Judge Michel’s discussion of the entire market value rule. Like Judge Rader in Cornell, Judge Michel took particular offense at the results-oriented testimony of Lucent’s damages expert. Initially, Lucent had taken the position that the proper royalty base for Outlook’s date-picking feature was the entire price of the computer in which it was installed -- $1000 on average – employing a royalty rate of 1%.
Once that royalty base was struck down, Lucent’s damages expert changed his focus, testifying that the proper royalty base was, instead, the market value of Outlook, but increased the royalty rate to 8%, unsurprisingly, reaching exactly the same total royalty amount he had come up with in the first place.
To Judge Michel’s obvious irritation, Lucent’s expert could not provide any economic justification for choosing the larger royalty base, the smaller royalty base or either royalty rate. He could not explain the importance of the date-picking feature to Microsoft or its customers or even its importance to the functioning of Outlook .
The court put the focus of the reasonable royalty analysis where it should be – on the actual value of the patented feature to Microsoft and its customers and how often they use that feature. As the court made clear, “the damages award ought to be correlated, in some respect, to the extent the infringing method is used by consumers.”
Judge Michel, instead, applied an economically realistic approach that could actually be employed by courts and juries. He noted that, in the real world of licensing, the parties do not lock themselves into preconceived notions of what royalty rates “ought to be” and then construct complicated scenarios to calculate hypothetical revenues for the patented feature to determine the proper royalty vase to apply this royalty rate to.
Instead, they just take the royalty base for which figures are most easily obtained and which are easiest to verify – the revenues for the “entire commercial embodiment” -- and simply adjust the royalty rate to reflect the actual value of the patented feature. As the court noted, “sophisticated parties routinely enter into license agreements that base the value of the patented inventions as a percentage of the commercial products’ sales price. There is nothing inherently wrong with using the market value of the entire product, especially when there is no established market value for the infringing component or feature, so long as the multiplier accounts for the proportion of the base represented by the infringing component or feature.”
How does this help patent owners who are trying to get a fair return from an infringer?
When attempting to license his patent every patentholder must focus on is the value of his patent to each individual licensee. He must not only “sell” the value of his patent to that target, but must develop a convincing case that, because of this particular target’s use of the patent owner’s particular technology that the licensee is particularly at risk. The patent owner must do its research and determine how the prospective licensee actually uses its technology and the extent to which consumer demand is based on this use.
In sum, every patent owner, when licensing its patent or suing an infringer, must make sure that when damages are “allocated,” those damages are allocated to the patent owner’s technology. In that way, patent holders can use the Cornell and Lucent opinions to make sure that they receive the highest possible return for their technology.