SEPs Cut Both Ways

I just read a news story about how Chinese tech companies are threatening Europe by registering so many patents. Turns out it's in the context of “open standards” and is actually Chinese companies copying what European multinationals have done for years with patents embedded in standards. That Sword of Damocles cuts both ways.

The handles of three gigantic sword statues seen against a blue sky

I still meet people who think that implementing an “open standard” is something anyone can do freely. But it's unfortunately not so – the word “open” in standards is not used the same way as “open” in software. This difference exists for a reason, resisting even clarification by the European Interoperability Framework (EIF) v1 where pro-patent lobbyists managed to get the clarification removed in the subsequent version. Even if you can get the specification without having to pay a significant sum for the privilege, chances are a standard from a body like ETSI will have a high aggregate patent royalty associated with any implementation.

Why? For years, cartel-like behaviour by technology companies has used patents they have embedded in formal standards to control the markets they monetise. They do this not just legally but with the encouragement of market authorities, who regard it as a reasonable compromise despite the obviously anti-competitive nature of the practice (which they freely admit). So they describe as “open” any standard created under a standards-body process that is theoretically equally open to all, which thus circumvents the anti-trust rules.

Once embedded in the specification, “standard-essential patents” (SEPs) must then be licensed in order to implement technologies the companies include in core standards for mobile phones, media playback, consumer device functions and more. The terms are almost always based on per-unit royalties. This has proved extremely profitable, allowing companies to continue to harvest revenues from markets they may have been unable to monetise fairly via superior products. They are supposed to license on “Fair, Reasonable and Non-Discriminatory” (FRAND) terms, but recent research shows securing licenses can be extremely difficult, if not impossible. The European Commission is now legislating to partially address that in the upcoming SEP Directive, which is also perhaps motivated by a desire to address the use of the same system by China.

But in some ways the royalties are the least issue. By creating SEPs, the corporations also gain market control, again in a way that amazingly does not break any anti-trust laws. The presence of SEPs ensures that all newcomers who are attempting to enter or disrupt a market are forced into NDA-secret negotiations with their incumbent competitors to get licenses. Controlling who can compete is just as valuable to the incumbents.

It is not unknown for incumbents to use the covert control point of terms negotiation to disrupt market access by offering unreasonable terms regardless of commitments to FRAND licensing. This raises the barrier to entry in their markets and keeps costs — and thus consumer prices — high, while the market controllers are able to privately cross-license to each other to keep their own costs controlled and their margins high. The power asymmetry is also a valuable asset; courts start out assuming the supplicant is evading their responsibilities and may well intervene for the plaintiff while the case is running. Even without these extremes, it's common for patent owners to drag their feet to disadvantage licensees.

But what if vendors in China behaved in a similar cartel-like manner and then gained control of a critical mass of SEPs needed to implement critical technologies? What if they also used their patents to block foreign companies from the Chinese market and to tax their products when they are finally allowed? Seemingly with little sense of irony, representatives of the incumbents interviewed by the Financial Times complained of just those scenarios starting to appear because of the single-minded intensity of patenting activities by Chinese companies.

There's no doubt this is a threat to the livelihood of the incumbent companies. But perhaps the problem is not China but the practice of tolerating patents in standards itself? The lesson here is to carefully consider the privileges you exploit, lest others do the same. Live by the SEP, die by the SEP.

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