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

Abstract

The royalty stacking hypothesis is based on the Cournot-complement model. It states that the royalties individually set by each standard essential patent holder (SEP holder) may add up to prohibitively high levels. We develop an equilibrium model with general log-concave constant-pass-through demand, downstream oligopoly and endogenous entry into manufacturing. Each SEP holder independently sets a linear royalty to maximize her individual profit. The model shows that roughly 10 SEP holders suffice to significantly reduce equilibrium output; with 100 SEP holders output nearly collapses. As the number of SEP holders increases (i) the equilibrium price rises; (ii) quantity falls (iii) individual SEP holders royalties and margins fall; and (iv) downstream manufacturing concentrates.We look for evidence of royalty stacking in the world mobile wireless industry. The number of SEP holders for the widely deployed 2G, 3G, and 4G wireless cellular standards protractedly grew from 2 in 1994 to 130 in 2013. We find no evidence of royalty stacking. Between 1994 and 2013: (i) the number of devices sold each year rose 62 times or 20:1% per year on average; (ii) controlling for technological generation, the real average selling price of a device fell between 11:4% and 24:8% per year (iii) the introductory average selling price of successive generations fell over time; (iv) neither the average gross margin of SEP holders nor of non-SEP holders shows any trend; (v) the number of device manufacturers grew from one to 43; (vi) since 2001, concentration fell and the number of equivalent manufacturers rose from six to nine.