1 ROYALTY STACKING

Royalty stacking refers to situations in which a single product potentially infringes on

many patents, and thus may bear multiple royalty burdens. The term 'royalty stacking'
reflects the fact that, from the perspective of the firm making the product in question, all of
the different claims for royalties must be added or 'stacked' together to determine the
total royalty burden borne by the product if the firm is to sell that product free of patent
litigation. Royalty stacking occurs when multiple patents affect a single product and thus
involve multiple licenses.
The literature has shown that three conditions are necessary:
Innovation must be cumulative, so that the patents are complementary.
There must be many patents for a given product.
The many patents must be held by numerous, distinct rights holders. If one of those
conditions were not satisfied, the magnitude of the royalty stacking problem would be
minimal or, even if potentially significant it could be resolved through a limited number of
bilateral negotiations.
1.1 Royalty packing
Royalty packing occurs when there is a requirement to bundle one technology with other
technologies. Such a requirement could be imposed by the licensor, but also could be
imposed by best practices within an industry or by a health ministry. For example, a vaccine
could be required to be administered simultaneously with one or more different vaccines that
are proprietary to one or more different companies in order to reduce the cost of
administration. In this situation, the royalties imposed on each of the proprietary products
that are administered will be packed together. Royalty packing may result in the aggregate
cost of the several packed products being too high.

1.2 Techniques to Manage Royalty Stacking and Packing

A licensee may seek to impose a ceiling for royalties in any agreements it makes with
licensors. For example, the licensee might establish a ceiling of 6% for combined royalties
on product sales. In turn, if the stacked royalties exceeded 6%, each of the licensors would
be agreeing to have the royalties they are to be paid reduced on a pro rata basis, so that the
total royalties due to the licensors would be 6%. In this situation, the licensee may be
motivated to add more technologies to its product or process because its total royalties per
unit are capped. To the contrary, the licensor may dispute the need to add the additional
technologies to the product and may be frustrated if its own share decreases much below
the expected return. In many situations, licensors take the position that their technology is
the most important and that their share of the royalties should not be depleted pro rata.
These types of competing interests require the parties to have a good understanding of how
and when reductions would apply when the agreement is made and good communications
between the parties when new technologies are incorporated into a product that would affect
the licensors expected royalty stream. Also, there may be a need to differentiate some types
of royalties from others. For example, some licensors may be willing to agree to a pro rata

reduction in royalties when other proprietary technologies are used in the product to be
commercialized. But the licensors may not be willing to agree to a reduction due to reach
through licenses resulting from the licensees use of proprietary research tools.

1.3 Other Matters

Not every arrangement requires revenues in the form of a royalty stream. For example, a
lump-sum payment for use of a research tool may be an appropriate way to disseminate and
exploit a patented technology. Some technologies may best be collected in patent
pools which allow for free use of the technologies or use of the technologies at fixed prices.
A patent pool can make the licensed technology more widely available for use in different
markets (for example, different products could incorporate the technology), and, further,
access to a number of other different but related technologies that would be useful to a
university or nonprofit organization might be available within the patent pool. Such
arrangements may allow research and development using a variety of proprietary
technologies without the need to negotiate licenses.

1.4 Managing Royalty Stacking

A licensee may seek to impose a ceiling for royalties in any agreements it makes with
licensors.
A licensor may seek to impose a floor below which its share of the royalties may not be
reduced.
In addition, the licensor may only agree to a reduction to the floor if a license from a third
party with a dominant patent position to the licensor is required to effectively use the
licensors technology (that is, a licensor may not agree to a reduction if additional
technologies are desired by the licensee to make a better product, but not needed to use the
invention
It is not unusual to have both a ceiling on stacked royalties, and a hard floor below which
royalty rates will not fall, in the same license. The hard floor may also need to take into
account other deductions from royalty payments that are allowed by the license. For
example, a deduction of patent costs may be allowed, but will be limited in any year by the
hard floor in royalty payments.
Licensees and licensors also might agree to have variable royalties which,
Eg, Depends on the importance of the technology in relation to the creation of the product.

Eg, The more important the role a proprietary technology plays in a product, the
higher the royalties, and vice versa.

Packing issues may be handled by requiring that the royalty be calculated based on the
sale prices of the product if sold alone, or the sale price of the combination or collection
product if the proprietary product is sold as a combination or collection.

1.5 Other matters Relating to royalty stacking

Not all business arrangement requires revenues in the form of a royalty stream. For
example, paying for a research tool in lump sum is a suitable way to spread around widely
And to make available a patented technology. Some technologies may be best collected
in patent pools which allow for free use of the technologies or use of the technologies at
fixed prices. A licensed technology can be more widely available in use in different markets
for a patent pool.
(for example different products could incorporate the
technology), and, further, access to a number of other different but related technologies
might be available within the patent pool that would be useful to a university or nonprofit
organization. Such arrangements may allow research and series of changes using a
number of collection of different things of proprietary technologies without the need to
negotiate licenses.

2 Royalty Demands for the Components Within Modern Smartphones

Competition in the smartphone industry is fierce, and for smartphone suppliers, achieving
profitability is highly challenging. Indeed, few suppliers are meeting the basic goal of selling
devices for more than the costs incurred in supplying them.
The data collected in this article are relevant not only to better understanding the dynamics
of the smartphone market but also to the ongoing development of the law and business
principles for determining a reasonable royalty under the patent laws and/or under
commitments to license on fair, reasonable, and non-discriminatory (FRAND) or
reasonable and non-discriminatory (RAND) terms.
The data show that royalty stacking is not purely a theoretical concern. In reality, setting
aside off-sets such as payments made in the form of cross-licenses and patent exhaustion
arising from licensed sales by component suppliers, we estimate potential patent royalties in
excess of $120 on a hypothetical $400 smartphonewhich is almost equal to the cost of
devices components. Thus, the smartphone royalty stack across standardized and nonstandardized technology is significant, and those costs may be undermining industry
profitabilityand, in turn, diminishing incentives to invest and compete.
To the extent possible, we have attempted to express the royalty demands addressed in this
article in dollar figures. To do so, we have based our analysis on a hypothetical smartphone
selling for $400. (Note that this is not the carrier-subsidized price to consumers but the full
price that carriers would pay to the smartphone supplier.) High-end, advanced smartphones
sell for $600 or more, but according to a recent estimate, the average price of a smartphone
fell to $375 from $450 at the beginning of 2012 We assume that all major technology
categories would be included in a $400 phone. Similarly, where a royalty is expressed in a

form requiring an annual sales volume assumption to determine a per-product rate, we have
assumed annual smartphone sales of 30 million units. That sales levels would make the
hypothetical smartphone supplier a successful player in the market, but is still far below what
market leaders sell.8 For some technologies, we have a considerable body of data regarding
public license demands. When license royalty data are not available for a particular
component or technology, we have provided information drawn from damages disputes in
relevant litigations. To put in context the royalty demands, we note the costs of the relevant
physical components. Depicted below are the estimated costsaccording to Nomura
Securities, which in turn relied on Gartner dataof the components in a smartphone on a
component-by-component basis.9 According to this set of estimates, the sum of the
components shown is approximately $120 to $150:

Figure 2.1
Patent holding in components of a mobile phone
These component costs are relevant not only for painting a more complete picture of the
total costs for a smartphone but also for providing useful context for the royalty demands
discussed below. We find, for example, that announced royalty demands for LTE cellular
functionality approach $60 for a $400 smartphone but the average cost of the baseband
processor that implements cellular functionality is as little as $10 to $13. The disparity
between patent royalty demands and component prices is an issue that courts will
increasingly confront as they apply the Federal Circuits apportionment jurisprudence, which
requires that damages be based on (at most) the smallest salable patent-practicing unit.

2.1 Cross Licenses and Pass-Through Rights

We represent royalty costs purely in monetary terms. We have not tried unsuccesfully to
account for a smartphone suppliers existing possibilities to reduce its cash payments for
royalties through crosslicenses and pass-through or exhaustion of patent rights. A
smartphone supplier could pay for patent rights through non-monetary payments in the
form of a cross-license to its own patents. Entering such cross-licenses would reduce the
cash the smartphone supplier would have to spend on licensing. For companies with a
strong patent portfolio, this could expel cash payments altogether for certain licenses. But

granting non-monetary patent rights is still a form of compensation and, presumably, a

licensor would demand equal compensation no matter the form in which it is received. The
smartphone suppliers royalty burden might be further reduced because of patent rights that
cohabit with components it purchasessuch as the baseband processor that provides
cellular capability of serving a purpose. The component supplier is likely to have contracted
for rights to at least some patents relevant to the component it is selling; such patents are
then exhausted through authorized sales of the components. 11 The patent rights are thus
passed through to the component customers. In the 2012 Apple v. Samsung trial in the
Northern District of California, for example, Apple over came on a patent exhaustion danger
against Samsungs two openly avowed essential cellular patents, because a cross license
between Intel and Samsung meant that Samsungs patent rights were exhausted through
Intels authorized sales to Apple of baseband processors in a substantial manner embodying
those patents.

3 LIMITATIONS
Most licensing agreements are communicated in confidence because patent holders and
licensees alike have a keen interest in keeping that information out of the public view.
Royalty information could provide a powerful superiority mastery to third parties in following
in time negotiations with the parties to the license.
4 CONCLUSION
License agreements should clearly define when and how the licensor will be paid a
royalty. An important part of any agreement is to clearly define the product, so that both
parties can understand the basis on which royalties are due. Further, to avoid any
arguments or assertion on royalty payments, the agreement should also clearly define when
royalties are not due.
Royalty stacking should be provided with a secured reputation and understood by those
involved with managing
IP in the health and agriculture fields, particularly when biotechnology products, services
and research tools are involved. Providing agreements that allow commercialization of a
product that embodies the proprietary technology of many different companies, and for
which royalty payments are due to each of those companies, requires acknowledgment by
the
parties of the role each technology performs if royalty ceilings, floors, or other
mechanisms to address stacking are to be taken up as ones own. Finally, alternatives to use
of lump sum payments and patent including the royalty bearing arrangements should be
considered.

5 REFERENCES
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M. S. Mireles, An Examination of Patents, Licensing, Research Tools, and the Tragedy of the
Anticommons in Biotechnology Innovations, 38 U. Mich. J.L. Reform 141 (2004).
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L.J. 1077
(2003).
V. Clark, Pitfalls in Drafting Royalty Provisions in Patent Licences, Bio-Science L.R. (2004),
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http://pharmalicensing.com/articles/disp/1087832097_40d70021d738c.
G. Sutton & E. Ewing, Government Alliances with Biotechs Introduce Royalty Stacking
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KEITH JONES, Executive Director, Washington State University Research Foundation, 1615
NE
Eastgate Blvd., Pullman, WA 99164-1802, U.S.A, jonesk@wsu.edu
MICHAEL EWHITHAM, Whitham, Curtis, Christofferson & Cook P.C., 11491 Sunset Hills
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Suite 340, Reston, Virginia 20190, U.S.A., Mike@WCC-IP.com
PHILANAHANDLER,Whitham, Curtis, Christofferson & Cook P.C., 11491 Sunset Hills Road,
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