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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