Royalty Stacking and Standard Essential Patents: Theory and Evidence from the World Mobile Wireless Industry

IP² Working Paper No. 15012
by Alexander Galetovic and Kirti Gupta

Original Date: May 1, 2015

ABSTRACT:

The royalty stacking hypothesis states that each standard essential patent (SEP) holder will charge excessive royalties to downstream manufacturers. Royalty stacking creates a Cournot-complement problem, hurts innovation and raises prices paid by consumers. With an equilibrium royalty stacking model with entry we also .nd that, as the number of SEP holders increases and becomes large: (i) downstream sales fall; (ii) downstream concentration increases; (iii) each SEP holder prices less aggressively and her margin falls; (iv) the equilibrium aggregate royalty rate increases almost dollar by dollar if manufacturing unit costs fall in one dollar or quality improvements increase consumers.willingness to pay in one dollar; (v) eventually, the downstream industry may be priced out of existence.

We look for evidence of royalty stacking in the world mobile wireless industry, where the number of SEP holders protractedly grew from 2 in 1994 to 130 in 2013. Contrary to the predictions of royalty stacking theory, between 1994 and 2013: (i) the (non-quality adjusted) average selling price of a device fell 8;1% per year on average; (ii) the number of devices sold
each year rose 62 times or 20,1% per year on average; (iii) the number of device manufacturers grew from one in 1994 to 43 in 2013; (iv) since 2001 concentration fell and the number of equivalent manufacturers rose from six to nine; (v) the average gross margin of SEP holders no trend, neither increasing nor decreasing.

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ABSTRACT: Royalty Stacking and Standard Essential Patents: Theory and Evidence from the World Mobile Wireless Industry