Innovation Policy: The Balance Between Standards and Patent Regulation

By Georg C. F. Greve, president, Free Software Foundation Europe

[Editor’s Note: The Standing Committee on the Law of the Patents (SCP) of the World Intellectual Property Organisation (WIPO) is expected to discuss the regulatory aspects of patents in the field of standardisation during its session in March 2009. This inside view takes a look at the policy issues in this field from the perspective of a software professional.]

Interconnectivity, commoditisation and increased reuse and recombination are key trends within the maturing information and communication technologies (ICT) industry that drive innovation and development. As the United Nations Conference on Trade and Development (UNCTAD) Information Economy Report 2007-2008 highlights, the ICT sector is a main driver for innovative and economic benefit, with the impact on ICT-enabled sectors potentially outweighing that of the ICT sector itself. Harnessing this potential depends on a variety of factors, including open innovation models, such as free software.

Interoperability is another key factor with significant economic impact in which two areas of regulation overlap: Standardisation and patents. This paper provides an analysis of the interaction of patents and standards, including a public benefit consideration to maximise innovation, development and economic growth.

The initial paper was prompted by a workshop of the European Commission’s Directorate General (DG) Enterprise and Industry in Brussels on 19 November 2008, titled “IPR in ICT standardisation.” It has been revised February 2009 for the upcoming meeting of the Standing Committee on the Law of the Patents (SCP) of the World Intellectual Property Organization (WIPO).

Both patents and standardisation are areas of regulation based on public benefit considerations. Succinctly put, a patent is a monopoly granted for a limited time by the government on behalf of its citizens to promote disclosure of breakthroughs that will in turn enable future innovation.

The term monopoly rightly carries negative connotations. A monopoly stifles innovation and increases price due to the absence of competition. On these grounds a monopoly is generally understood to be to the detriment of economy and society. It is not illegal to obtain a monopoly, but society has a legitimate interest in limiting abuse of the power that a monopoly confers, and seeks to achieve this through antitrust law.

The monopoly right created by a patent brings with it all side effects of a monopoly. It is among the strongest regulations of the market, and regulators need to be aware of both its costs and benefits.

Patents in Standardisation

Like patents, standards are closely related to disclosure. The root of the word standard appears to go back to heraldry, where it refers to a symbol that is used to make a rallying point visible in battle.

Modern use of the term keeps that meaning of publicly visible point of reference, although it has been transferred to other areas. So among other things it is understood as “something established by authority, custom, or general consent as a model or example” or also “a structure built for or serving as a base or support” (from the Merriam-Webster online dictionary).

In ICTs, a standard has both the above meanings. According to the British Standards Institution (BSI), a standard is “an agreed, repeatable way of doing something. It is a published document that contains a technical specification or other precise criteria designed to be used consistently as a rule, guideline, or definition. […] Any standard is a collective work. Committees of manufacturers, users, research organisations, government departments and consumers work together to draw up standards that evolve to meet the demands of society and technology. […]”

The function of standards is to establish common ground, to define the language that allows interoperability, and consequently innovation and competition. If all participants in an ICT market adhere to the same standards and make an effort to guarantee interoperability, not only can customers choose freely between various products and services, they can also exchange information with one another without problems.

The value of standardisation in an area is determined by the strength of the networking effects. ICTs are characterised by extraordinarily strong networking effects. Absence or failure of standardisation makes monopolisation almost certain. Users of one product or service will only be able to interoperate with users of the same product or service. Over time, one solution would attain such a large user base that other users are de facto left with the choice to join this group, or be unable to communicate fully with the majority of users. This effect could be made even more potent by bundling software with a predominant hardware platform.

The benefit of standards to society arises from increased competition through freedom of choice. The purpose of standards is intrinsically anti-monopolistic.

The second function of standards is to allow innovation upon the state of the art.

Since derivation from a standard automatically breaks it, standardisation and innovation of the standard conflict where changes are not done in consensus between implementers, resulting in an updated version of the standard available to all.

Due to its global, consensus-driven nature, innovation in standards tends to be comparatively slow. It also raises issues of barriers to entry into the standardisation process, in which large companies are consequently overrepresented in comparison to small and medium enterprises (SMEs), which usually tend to be a driver for innovation.

The true innovative potential of standards arises not from innovation in the standard, but rather innovation on the basis of pre-existing standards. This form of innovation is equally available to all parties and tends to be much faster, dynamic, and potentially disruptive. If the innovation was made by just one party, the result will be a temporary monopoly. But given a certain maturity, the innovation is then likely to be formalised into a standard again, forming the base for the next innovation to be built on top.

While the first path allows primarily for slow, small improvements, the second path allows for full participation of the economic majority and is much better suited for groundbreaking ideas and arguably the more important to protect for society.

Conflict: Fundamentally Opposed Instruments

Karsten Meinhold, chairman of the European Telecommunications Standards Institute (ETSI) IPR Special Committee, pointed to the fundamentally different goals of patents and standards during the workshop when he summarised that, “IPRs and standards serve different purposes: IPRs are destined for private, exclusive use, standards are intended for public, collective use.”

Both based on public benefit, patents and standards are in fact fundamentally opposed instruments. Upholding one deprives the other of its function. Or, as Tomoko Miyamoto, senior counsellor of the Patent Law Section in WIPO said in her presentation: Patent thickets and patent hold-ups may arise from certain forms of legitimate exploitation of the exclusive rights conferred by patents.

In other words: Conferring these exclusive rights is the intended function of the patent system, and legitimate usage of these rights brings about consequences of patent thickets and patent hold-ups. Allowing patents on standards consequently is an intentional act to grant monopolies on standards to certain parties that includes the right to block implementation by other parties. [Note: the preceding two paragraphs were updated 6 May 2009]

A very similar conflict exists for copyright, which also establishes a time-limited monopoly. Copyright on standards could also render standards ineffective, which is why it is common practice for participants in standardisation processes to assign their copyright to the standardisation body in order to free the standard for general use.

No such general practice exists for patents, although multiple ways exist in which the standardisation community has sought to mitigate the effect of patents on standards.

Ex-Ante Disclosure

One of these mechanisms is called “ex-ante disclosure.” The parties working on a standard use this mechanism to commit to licensing terms while the standard is still being drafted. If these terms are not acceptable to the other parties working on the standard, the technology that is covered by the patent is not included in the standard.

Acceptability of terms is unfortunately highly subjective. A large corporation with a big patent portfolio and existing cross-licensing agreement with the holder of the relevant patents might consider adding one more patent to the agreement a minor inconvenience. The same situation looks substantially different from the perspective of a small or medium enterprise that typically has at most a small patent portfolio and has to be concerned about extortionate licensing.

With SMEs strongly under-represented in standardisation, ex-ante disclosure is likely to bring more satisfactory results to large corporations with large patent portfolios that compete in the same area. The economic majority generally has no say about the acceptability of the terms.

Another issue raised by ex-ante disclosure is enforcement, as Suzanne Michel, assistant director, Office of Policy and Coordination of the US Federal Trade Commission (FTC) pointed out in her presentation. The FTC had found that Rambus Incorporated had joined and attended standardisation meetings of the Joint Electron Device Engineering Council (JEDEC) in order to modify their patent applications to cover technology that was under discussion for inclusion in future standards. In the opinion of the FTC, this behaviour was deceptive, violated JEDEC’s disclosure policy, and illegally gave Rambus monopoly power.

The DC Circuit Court disagreed with the interpretation of the FTC in their April 2008 decision. According to Michel, the court said that avoiding so-called “reasonable and non-discriminatory” (RAND) licensing terms does not constitute abuse, and that there is no proof that JEDEC would have avoided technologies if it had known that Rambus was planning to use its patents to the fullest extent allowed by law. The court also expressed reluctance to make patents unenforceable based on vague disclosure policies.

From a public benefit perspective, this outcome was devastating. From a legal perspective it appears undoubtedly correct, as recently confirmed by the Supreme Court. Establishing time-limited monopolies is the purpose and function of patent law. The role of courts does not extend to the undoing of laws and most legislators have not given the public interest conflict between patents and standards consideration.

JEDEC has meanwhile updated its disclosure policy, which may help to avoid similar issues in the future. Considering the value that patent law has in relation to standardisation for many courts, only a future court case can demonstrate whether the issue has been resolved in a way that holds up to formal legal review.

(F)RAND

Only a minority of standardisation bodies currently require ex-ante disclosure. Instead the majority of bodies appear to rely on purely voluntary disclosure and the assurance that patent holders involved in the process will provide so-called RAND or FRAND (“Fair, Reasonable and Non Discriminatory”) terms to competitors.

For lack of a binding or commonly accepted definition of what is reasonable, these licensing terms are left to subjective interpretation at the time a competitor requests a licence. The licensing practices found in the market are therefore vastly different, and determined by a variety of factors, including, but not limited to, the stake in a certain market, the dependency upon competitors, the business model and the culture of the company.

(F)RAND terms generally amount to a vague assurance to licence upon request. Such an assurance does not constitute a perpetual licence on the patent and will in particular not bind future holders of relevant patents, which can be sold or acquired as part of a business restructuring or acquisition. Future patent holders are therefore not only likely to have a different subjective interpretation of what is reasonable, they are also not obliged to remain reasonable. Like patent holders that have not participated in the standardisation process itself, all legal and intended patent exploitation options, including patent hold-ups on all existing implementations of a standard, are available to them.

This insecurity and the subjective perception of what is reasonable has resulted in RAND terms often being perceived as arbitrary, especially among players with legal departments that cannot stand up to large multinational corporation.

During the workshop it was Charles Schulz of Ars Aperta who articulated this frustration among SMEs as RAND referring to “RANDom licensing at the sight of competitors.” In his presentation, Schulz also pointed out that (F)RAND terms are discriminating against free software. Even RAND terms linked to zero royalties, the so-called RF-on-RAND (“Royalty Free on RAND”), RAND-RF (“RAND Royalty Free”) or RAND-Z (“RAND with Zero royalties”) can exhibit the same problems if they do not permit sublicensing, for instance.

Free software (aka Open Source, FOSS or FLOSS) is a software model defined by a high level of user control over the software in combination with far-reaching freedoms to inspect the source code, to study and innovate upon the software. In particular, it is based on the principle that every living person and every legal entity can be a user, developer, distributor, or any combination of the above. Only conditions which permit this to take place are acceptable to free software, which was estimated to reach 32 percent of all IT services and 4 percent of European GDP by 2010 and highlighted as a critical driver of economic development by the UN Conference on Trade and Development (UNCTAD) in its Information Economy Report 2007-2008.

In her presentation, Amy Marasco, general manager for standards strategy at Microsoft, emphasised that business models based on all software models, proprietary or free software, are legitimate. Free software has already permeated the industry, fostering innovation and competition. According to the aforementioned UNCTAD report, the innovative, competitive and economic development impact of free software on ICT-enabled sectors is likely even larger than that on the ICT industry itself.

Non-discrimination against a software model that permeates the industry with so many benefits to innovation, competition and economic growth needs to be taken as a common and necessary criterion of what constitutes (F)RAND. Current practice falls short of this minimum criterion, and likely several others.

Harm from Exclusion?

If patents are part of a standard, only an implementation that is covered by the patents proves effective against monopolisation. Having to circumvent patents will generally break standards compliance and harm the public benefit that is the driving force behind standardisation.

So patents in standards have the potential to make full interoperability impossible for legitimate businesses in some markets. As the aforementioned BSI points out: “Standards are designed for voluntary use and do not impose any regulations. However, laws and regulations may refer to certain standards and make compliance with them compulsory.”

Once a technology has been standardised, certain choices are no longer made on innovative or technological quality. Even where a better solution exists that would have the additional value of not violating a potential patent on the standard, an implementer would choose to follow the technologically inferior standard in order to have full access to the market. Such a case reverts the initial idea of patenting: The technology becomes valuable because it is patented, it is not patented because it is valuable.

This is particularly harmful due to the structuring effects of public procurement, which not only accounts for approximately 30-40 percent of the IT market in many countries, it also establishes the technological reference for local business.

Insufficient patent conditions in combination with special recognition for organisations such as the International Standards Organisation (ISO) in public procurement create a situation in which through standards-based procurement some patent holders effectively control participation in certain tenders by public bodies. This distortion of competition is detrimental to the public benefit. It also results in higher pricing for public bodies, and thus higher taxes.

Remedies for this situation would have to address the way in which governments grant procurement preferences to standards, the way in which patents are handled in standards, the patent system itself, or a combination of all of the above.

Attempted Remedies

During the workshop, it was Rigo Wenning, legal counsel and patent policy team contact of the W3C/ERCIM, who highlighted that good patent research costs around €100,000 EUR per case. This is a prohibitively expensive for most SMEs, and substantial even to very large companies. Injunctions against a product or claims for damages easily exceed that cost.

In his presentation of IBM’s “SoftIP” concept, one of the potential alleviating approaches, Roger Burt, senior counsel of IBM Europe, introduces the issues with a quote from a BSA et al amicus brief in eBay v MercExchange:

“Technology products typically consist of hundreds or thousands of patented components. It therefore is impossible for technology companies to investigate all of the patents, and pending patent applications that may be relevant to a new invention (product), notwithstanding their best efforts to do so. When, as frequently occurs, the claim of infringement is not made until after the new product is released or the industry standard has been adopted, designing around the claim is no longer a realistic option. Because an injunction will issue automatically upon a finding of infringement – even if the claim relates to an insignificant part of the product – the target of the claim is forced to pay an extortionate settlement in order to preserve its business.”

Another approach to keep cost within the range of what can be borne by large multinational enterprises was introduced by Tim Frain, director of IPR regulatory affairs at Nokia, in his presentation about “FRAND Best Practice.” Frain advocates a system based on “Aggregated Reasonable Terms” & “Proportionality” (ART+P), in which every patent holder should voluntarily commit ex-ante that the aggregate licensing cost for all patents will be reasonable.

Both approaches are attempts to curb the legitimate use of monopolies granted by patents through voluntary buy-in from other parties which pledge not to exercise their full rights under the patent system. In order to avoid conflicts with antitrust law, the ART+P approach has to carefully avoid forming a cartel, reducing its effectiveness. Furthermore, both approaches suffer from similar systematic weaknesses that the (F)RAND approach demonstrates, most importantly discrimination against part of the industry.

But even when ART+P can, for instance, limit royalties of the mobile communication stack to 10 percent, the total accumulated royalties of smart phones can still reach 50 percent. For some devices, eg, notebooks with built-in UMTS technology, or embedded devices with typical profit margins much lower than 10 percent, these royalties would have significant impact on the perspective of innovators.

When an innovative company with a new product and all the associated risk faces a situation in which the total monopoly rent for patent fees is higher than the sum of production cost and profit margins, the company would usually reconsider to enter into competition with a large multinational that does not have to bear the patent fees due to cross-licensing agreements.

Public Benefit Analysis

Patents and standards both are forms of regulation for the public benefit, and there is good indication that standardisation suffers from over-regulation. In particular, the patent system exhibits friction with a part of the IT industry that is a main contributor to innovation, economic development and the commoditisation of software for the benefit of all sectors of economy that are ICT enabled.

Patents have a long history, with strong anecdotal evidence to their beneficial effect in the past. That beneficial effect arises in part from disclosure, for which patents have no meaningful effect in software. Simultaneously, the cost of each patent to society is higher in areas with continuous incremental evolution and commonly occurring co-development, such as software.

The publications of Professor Raymond Kurzweil indicate another reason why the assumptions on which the patent system was built may be undergoing transformation. Kurzweil discovered an exponential pattern in innovation, reaching back all the way to single-cell organisms. His postulation that exponential growth of the speed of innovation is a universal principle provided the basis for several predictions, several of which have turned out to be largely accurate so far.

The cost of a patent to society is proportional to its duration. Applying the principle of exponential growth of the speed of innovation to patents with constant duration results in an exponential growth of the cost of a patent for society, while its return on investment to society has largely remained constant. In areas where co-development is common, the benefit is slightly declining, even.

This provides a scientific explanation for the growing debates about the patent system: Costs have been rising exponentially for society since the initial patent bargain was struck. While initially a patent helped to build a market that would then become subject to competition for the public benefit, increased dynamics in some areas have led to a situation where patents do not expire during the entire life-cycle of a market segment.

Decreasing the duration of patents in accordance to the increase in speed in innovation would be one potential remedy to keep the cost of patents constant. Another potential remedy would be to adjust the patent system according to the benefits they bring in certain fields, eg, whether they provide meaningful disclosure.

Where standards and patents overlap there is perhaps surprisingly large consensus that the cost of patents is too high in standardisation, and that solutions need to be found. Controversy focuses primarily on the issue of whether attempted alleviation schemes such as (F)RAND, ART+P or “SoftIP” are sufficient, or whether more needs to be done.

An Baisheng, deputy director of the Division of Technical Regulations, Department for WTO Affairs of the Chinese Ministry of Commerce, highlighted in his presentation at the workshop how it is essential to “Strike the Right Balance between Public and Private Interests in IPR in ICT Standardization”. As demonstrated above, public and private interests are arguably out of balance at the moment for most standardisation bodies, and the combination of standards and patents has led to over-regulation that discriminates specifically against SMEs and a large part of the IT industry.

Potential Remedies

There are several potential remedies that can be implemented following the principle of least invasive change in order to not disrupt the patent system altogether.

1. Interoperability trumps patent

In the software patent debate within the European Union over the past decade, a strong consensus emerged among SMEs and big businesses representatives from companies employing various software models, such as IBM or Sun Microsystems, that patents which limit or prevent interoperability should be rendered unenforceable.

Although implementing this remedy would require substantial debate, it has the potential to resolve the issues caused by over-regulation for all existing and future standards. Considering the extraordinary networking effects in the IT market and the enabling role it has for economic development overall, the benefits resulting from securing interoperability in this way likely justify the cost of implementation.

2. Update policy in SSOs

The Common Patent Policy of ITU-T, ITU-R, ISO and IEC states the principle that “a patent embodied fully or partly in a Recommendation | Deliverable must be accessible to everybody without undue constraints.” As demonstrated, current application of (F)RAND falls short of that principle.

A minimal remedy could define binding criteria for (F)RAND, including for instance a perpetual obligation to license upon request. A more far-reaching remedy could follow the precedence set by common copyright policies in Standards Setting Organisations (SSOs) where copyright is transferred to protect resulting standards from future copyright claims.

3. Update governmental procurement guidelines

In order to harness the shaping effects of public procurement for the promotion of interoperability, governments and intergovernmental organisations should update their procurement guidelines to procure only products and solutions based upon standards that do not discriminate against any part of industry. This will require review of blanket approval for certain standard-setting organisations, and only a limited approval for organisations that have not updated their patent policies appropriately by the time of the review.

Author Disclaimer: This paper was written from the perspective of an expert in the field of software. The conclusions may apply in their entirety, partially, or not at all to areas other than software.

Georg Greve is a self-taught software developer with several years of experience on the job, and traditionally trained Physicist. Experienced writer with over a hundred published articles in English and German. Eight years of experience in the coordination of a multi-national organisation. Over seven years of experience in international policy at the United Nations, European Commission and in various countries, with focus on Information Technology related policy. Several years of experience coordinating interdisciplinary, international activities, often involving multiple organisations. Experienced speaker with speeches and keynotes at conferences and training seminars addressing a wide variety of audiences, including UNCTAD, the WorldBank and various training institutes. Strong background and interest in interdisciplinary policy issues involving technology, law and society.