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85 Tex. L. Rev. 1991 (2006-2007)
Patent Holdup and Royalty Stacking

handle is hein.journals/tlr85 and id is 2007 raw text is: Patent Holdup and Royalty Stacking* Mark A. Lemley** & Carl Shapiro*** We study several interconnected problems that arise under the current U.S. patent system when a patent covers one component or feature of a complex product. This situation is common in the information technology sector of the economy. Our analysis applies to cases involving reasonable royalties but not lost profits. First, we show using bargaining theory that the threat to obtain a permanent injunction greatly enhances the patent holder's negotiating power, leading to royalty rates that exceed a natural benchmark range based on the value of the patented technology and the strength of the patent. Such royalty overcharges are especially great for weak patents covering a minor feature of a product with a sizeable price/cost margin, including products sold by firms that themselves have made substantial research and development investments. These royalty overcharges do not disappear even if the allegedly infringing firm is fully aware of the patent when it initially designs its product. However, the holdup problems caused by the threat of injunctions are reduced if courts regularly grant stays to permanent injunctions to give defendants time to redesign their products to avoid infringement when this is possible. Second, we show how holdup problems are magnified in the presence of royalty stacking, i.e., when multiple patents read on a single product. Third, using third-generation cellular telephones and Wi-Fi as leading examples, we illustrate that royalty stacking can become a very serious problem, especially in the standard-setting context where hundreds or even thousands of patents can read on a single product standard. Fourth, we discuss the use of reasonable royalties to award damages in patent infringement cases. We report empirical results regarding the measurement of reasonable royalties by the courts and identify various practical problems that tend to lead courts to overestimate reasonable royalties in the presence of royalty stacking. Finally, we make suggestions for patent reform based on our theoretical and empiricalfindings. * © 2007 Mark A. Lemley & Carl Shapiro. We are grateful to Apple Computer, Cisco Systems, Intel, Micron Technology, Microsoft, and SAP for funding the research reported in this Article. We emphasize that our conclusions are our own, not theirs. We thank Ashish Arora, Chris Cotropia, Peter Detkin, Sandra Draibye, Charles Eskridge, Joseph Farrell, John Flynn, John Golden, Rose Hagan, Tim Holbrook, John Hayes, Paul Krieger, Amy Landers, Matt Lynde, David McGowan, Alan Morrison, Craig Nard, Arti Rai, Michael Samardzija, David Simon, Mallun Yen, and participants at workshops at Stanford Law School, the University of Texas School of Law, and the University of California at Berkeley for comments on a previous draft. We are also grateful to Jackie Chou for research assistance and data collection. ** William H. Neukom Professor, Stanford Law School; Of Counsel, Keker & Van Nest LLP, San Francisco, California. *** Transamerica Professor, Haas School of Business, University of California at Berkeley; Senior Consultant, CRA International.

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