A Broader Look at Patent Royalties and Antitrust

Posted by Social Science Research Network

A Broader Look at Patent Royalties and Antitrust Erik N. Hovenkamp (Northwestern University)

Abstract: It is well known in antitrust economics that competitors can rely on patent licensing with high royalties as a surrogate for price fixing. This paper addresses a number of alternative situations in which patent royalty agreements may raise antitrust concerns, even if the royalty rate is ostensibly reasonable. For example, a royalty charged to a competitor creates an “alignment effect” by giving the licensor a stake in its rival’s success. This is the same problem that arises when a firm buys stock in a competitor (a potential antitrust violation). By aligning the firms’ interests, this blunts competition and benefits both parties independently of the underlying exchange. Thus, for example, if a firm charges a rival $5 per unit for an invention that lowers production costs by the same $5, then even the rival-licensee strictly benefits, because its net costs are unchanged, but now the market is less competitive. More generally, the alignment effect may lead welfare to decline overall even if the royalty rate is strictly lower than the licensing value (e.g. $4), just as a merger may reduce welfare even if it produces some cost efficiencies.

Additionally, offsetting (i.e. reciprocal) license payments between competitors often warrant scrutiny even if each royalty appears individually reasonable. Even under cross-licensing, offsetting payments are never necessary for the parties to reach a mutually-beneficial agreement, which is generally the relevant antitrust question. Instead, the practical effect of offsetting royalties is to replicate a collusive agreement to restrain consumer pass-through, ensuring the firms retain more of the licensing surplus. The results shed new light on the competitive impact of patent pools, which typically create widespread royalty offset and alignment between competing members, even if patents are complementary.