A Review Of ‘Standard Essential Patents Within Global Networks – An Emerging Economies Perspective’ By Dieter Ernst 06/03/2017 by Guest contributor for Intellectual Property Watch Leave a Comment Share this:Click to share on Twitter (Opens in new window)Click to share on LinkedIn (Opens in new window)Click to share on Facebook (Opens in new window)Click to email this to a friend (Opens in new window)Click to print (Opens in new window) The views expressed in this article are solely those of the authors and are not associated with Intellectual Property Watch. IP-Watch expressly disclaims and refuses any responsibility or liability for the content, style or form of any posts made to this forum, which remain solely the responsibility of their authors. By Roya Ghafele, OxFirst Dieter Ernst’s study[i] is one of the few, if not the only one, to thoroughly examine the role, function and effects of Standard Essential Patents from a developing country’s perspective. As such, the study is a refreshing read, given that the discourse on Standard Essential Patents and the FRAND (fair reasonable and non-discriminatory) regime is pretty much driven from a developed country’s point of view. The FRAND Regime Lacks Transparency, says Ernst Dieter Ernst claims in this study that the FRAND regime remains shackled with transaction costs and that the licensing of SEPs is prone to a host of different market failures associated with information asymmetries, market power and free riding as well as externalities (both positive and negative). Roya Ghafele He substantiates his critiques of the FRAND regime by pointing to key findings in the literature. For example, the number of SEP holders for 3G and 4G standards grew from 2 in 1994 to 130 in 2013 and the number of SEPs rose from a fewer than 150 in 1994 to more than 150 000 in 2013.[ii] While these Standard Essential Patents have generated their owners major revenue streams, this has not come without a price, as the famous ‘patent wars’ in the telecom space illustrate. Part of the problem is that it is very costly to verify if and to what extent these SEPs are actually standard essential. In that respect he criticises Standard Setting Organizations for not introducing mechanisms that would prevent the over declaration of SEPs. Further challenges relate to lack of clarity of what FRAND actually means and the tendency to file ‘just in time patents’, which leaves Standard Setting Organizations little time to verify the quality of the SEPs at stake. Lack of transparency also translates into ambiguity as to how high a licensing rate will actually be. This in turn can lead to an unpredictable cost increase for the licensee, meaning that the licensee may find it difficult to adequately price its products or service offerings. Ernst cites in that respect studies from the European Commission underlining the argument[iii] and draws a parallel to developing countries arguing that these issues, which are already challenging in a developed country context are even more challenging in a developing country context. Shedding Light on the Developing Country Perspective Ernst introduces here the notion of ‘global production and innovation networks’ or GPNs. In an increasingly internationalized economy, production as well as R&D is global in character. The linear production chain has been replaced by a network of small and large firms, universities and public research organizations, which reside in both developed and developing countries. GPNs are in and of themselves a major organizational innovation that would in principle allow innovators in developing countries to interact with developed countries at equal eye sight. Yet, so he shows, developing countries remain even in such networks at the lower end of the production chain; higher tier suppliers outsource to lower tier suppliers in developing countries. Hence, they likely find themselves rather on the receiving end. Furthermore, in developing countries, so the argument goes, an incomplete FRAND regime remains embedded in an overall malfunctioning institutional structure. Developing countries are often wrongly characterized as struggling above all with basic infrastructure. What they often struggle most with is the establishment of a functioning legal architecture guaranteeing the working of commercial transactions. This hampers growth in developing countries. Markets can only function if the underlying legal system allows them to do so. At the very least one needs to be sure that what one owns today, one will also own tomorrow. De Soto for example observes that developing countries remain poor in spite of a wealth of natural resources because of a lack of respect for property rights. The inadequate guarantee of private property prevents the development of prospering markets.[iv] Translated to markets for intellectual property, a fairly abstract concept in and by itself, this suggests that IP can only assume its role as governance structure for the knowledge-based economy, if the rule of law has meaning. This is not to say that developing countries are lawless societies. However, often the laws that bind markets together remain at an informal level and are expressed through tacit agreements or a cultural code. Worse, at many instances there can be quite a gap between what the law states (in theory) and what the de facto practice in a country is (in reality). With such cleavages it is difficult to establish an abstract legal concept like IP as a source of wealth generation, as also underlined by this study. Ernst observes that China for example is heavily filing for patents, however that it extracts fairly little economic value from it. ‘In 2011, 64% of Chinese companies received less than 500 000 yuan (77 400 USD) of royalties from patent transfer or licensing; 76.6% paid royalties in this bracket. In both cases, most companies fell within the below 50 000 yuan bracket. Apparently, high patent implementation rate does not mean high market value and profitability.’[v] (at p.18, quoting a SIPO study) So, mix the formula of a poorly defined FRAND regime with the already difficult business climate that prevails in developing countries and you get, according to Ernst, not the much-aspired ‘gains from trade,’ but an innovation regime that makes it rather difficult for firms in developing countries to cope. So, What Can Be Done About That? Obviously, the overarching dilemma associated with aligning a legal practice (a legal habitus if you like) with an officially sanctioned legal code extends beyond the FRAND regime. Yet, this does not mean that one can address the FRAND regime outside that context. As yet another judiciary framework its success in developing countries will rely heavily on how it melds into the legal culture of the country. Laws that are foreign exposed with no ties to the local habitus are probably not going to work particularly well. The FRAND regime forms no exception to that. While this aspect remains undiscussed in Ernst’s paper, he contends that there are some practical steps one can take to overcome the dilemma. In that respect he cites the updated IEEE patent policy and recommends it as a means to improve the governance structure of SEPs, in both developing and developed countries alike. He sees the IEEE patent policy as an important step towards overcoming SEP-related market imperfections and calls for further research in that respect. Takeaway Ernst’s study is an interesting read, as it reminds us of the particular challenges associated with establishing the FRAND regime in developing countries. It also puts the flagship success of developing country firms like Huawei into perspective, by reminding us that it is probably the laudable exception to the norm. That being said, the paper remains obliged to a certain perspective on the FRAND debate; ignoring for example that not every SME is an implementer, be it in the developing or developed world. Yet, I take his point for the need for further transparency. Markets for IP remain opaque, licensing transactions are undertaken under Non-Disclosure Agreements and the further up-take of markets for IP remains as much hampered by a lack of adequate price discovery as by the lack of adequate structures to that would allow to accelerate the licensing process. This for sure, serves neither SEPs owners nor implementers, be they in developing or developed countries. Roya Ghafele is the Director of OxFirst, an IP law and economics consultancy. She specializes on assessing the economic impact of IP policy and IP strategy. Prior to launching OxFirst she was an Assistant Professor in IP Law with Edinburgh University and a Lecturer in Political Economy with Oxford University. Email: firstname.lastname@example.org for comments. [i] Ernst, Dieter, Standard-Essential Patents within Global Networks – An Emerging Economies Perspective (December 2, 2016). Available at SSRN: https://ssrn.com/abstract=2873198 [ii] Ibid at p. 4 [iii] ECSIP Consortium, 2014. Patents and Standards. A modern framework for IPR-based standardization, a study prepared for the European Commission, DG Enterprise and Industry, Ref. Ares (2014) 91 7720-25/03/2014. See also European Commission 2015, Public Consultation on Patents and Standards – A modern Framework for Standardisation Involving IPR. Summary Report. Brussels, 27 October: 12 pages. [iv] Soto, H. de. 2000. The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else. Basic Books. New York [v] WIPO 2014. CDIP/13/INF/8, 13th session Geneva, May 19-23 2014 Summary of the study on Patents’ role in business strategies: research on Chinese companies’ patenting motives, patent implementation ad patent industrialization, prepared by the IP Development and Research Center, State Intellectual Property Office (SIPO), Beijing, the People’s Republic of China, p.1. Share this:Click to share on Twitter (Opens in new window)Click to share on LinkedIn (Opens in new window)Click to share on Facebook (Opens in new window)Click to email this to a friend (Opens in new window)Click to print (Opens in new window) Related Guest contributor may be reached at email@example.com."A Review Of ‘Standard Essential Patents Within Global Networks – An Emerging Economies Perspective’ By Dieter Ernst" by Intellectual Property Watch is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License.