11/29/2018 Class 15 Network Industries, Spring, 2014 Platforms: Patents & Standard Setting Randal C. Picker James Parker Hall Distinguished Service Professor of Law The Law School The University of Chicago 773.702.0864/r-picker@uchicago.edu Copyright © 2000-14 Randal C. Picker. All Rights Reserved.

What issues are posed by standard setting? 11/29/2018 What issues are posed by standard setting? Can there be too much competition? Can there be too little competition? Are there pathologies in standard setting? November 29, 2018

Too much competition? Formats 11/29/2018 Too much competition? Formats Computer makers wanted to avoid multiple DVD formats ala VCR Beta and VHS formats The first letter suggests that there were a number of possible formats for high-density disks (DIVX, MMDF and ASMO, for example) November 29, 2018

11/29/2018 Too much competition? What are the harms of too much competition? What does that mean? Winner Take All example suggests that too many firms may seek to set standards November 29, 2018

Winner Take All Markets: Simple Version 11/29/2018 Winner Take All Markets: Simple Version Two Sector Economy 500 individuals One sector: everyone earns $10 Second sector: one person will earn $1000, everyone else will earn nothing, probability of winning is just 1/N What outcome do we want? November 29, 2018

Winner Take All Markets: Simple Version 11/29/2018 Winner Take All Markets: Simple Version Answer 499 in sector 1, 1 in sector 2 GNP is 499 * 10 + 100* 1 = 5990 November 29, 2018

Winner Take All Markets: Simple Version 11/29/2018 Winner Take All Markets: Simple Version What outcome will we get? Answer Individuals enter sector 2 until expected return is $10. 100 individuals in sector 2, 400 in sector 1 GNP is 400 * 10 + 1000*1 + 99*0 = 5000 Same GNP as if we did not have WTA sector: the value of that sector is fully dissipated November 29, 2018

WTA Markets: Version II 11/29/2018 WTA Markets: Version II Empirical Claim Creators do not capture all of the social benefits of their discoveries Spillover from the WTA Sector to the Sure-Thing Sector The winner in the WTA sector only gets 1000g, where g is [0,1] The balance, (1-g)1000, spills over into the other sector November 29, 2018

WTA Markets: Version II 11/29/2018 WTA Markets: Version II What outcome do we want? Answer Again, allocate 499 to ST, 1 to WTA, for social welfare of 5990 November 29, 2018

WTA Markets: Version II 11/29/2018 WTA Markets: Version II What outcome will we get? Equilibrium condition given by: Solution: November 29, 2018

WTA Markets: Version II 11/29/2018 WTA Markets: Version II Numbers g =1 gives N = 100, as before g = 0.10645 gives N = 9 g = 0.012 gives N = 1, the social optimum Note this version assumes WTA losers do not share in spillover; could do version in which they did November 29, 2018

WTA Markets: Version II 11/29/2018 WTA Markets: Version II Bottom Line Spillovers can mitigate concern over tragedy of the commons style over-competition Indeed, if spillovers are too high, we could have too few pursuing the WTA sector Essentially empirical question on conflicting incentives November 29, 2018

Consequences/Implications 11/29/2018 Consequences/Implications Match to Standards Setting Think of standard setting problem as one in which only a few standards (K =1, 2 or 3?) will survive? Does this suggest that too many firms will try to be standards setters, given the returns, than is optimal? November 29, 2018

Consequences/Implications 11/29/2018 Consequences/Implications Solutions? Weaken property rights to solve the problem? Allow collectivization ala DVD standard setting and patent pool to minimize competition? November 29, 2018

Too little competition? 11/29/2018 Too little competition? Collusion If we permit firms to establish standards collectively, won’t they collude? Won’t this result in lower output and higher prices, the classic harms of monopoly? How should we evaluate whether a particular deal is collusive? November 29, 2018

Pathologies in standard setting? 11/29/2018 Pathologies in standard setting? Basic Idea of Network Externalities The more individuals using the product, the more valuable it is to each user. The telephone is the classic example; a single-phone network is of no use. November 29, 2018

Pathologies in standard setting? 11/29/2018 Pathologies in standard setting? Collective Adoption Defects At least in theory, adoption of products with network externalities can be frustrated through collective action problems. Excess inertia: an old standard should be displaced, but isn’t. Excess momentum: an old standard should be maintained, but is not. November 29, 2018

11/29/2018 Example The common set up is that we have Z0 = 5 individuals on the old standard, with sequential entry by two new players. New players can choose the old standard or the new standard. November 29, 2018

The Process Works Values: B0 = 5, A0 = 1, BN = 2, AN= 3 Player No. 1 11/29/2018 The Process Works Values: B0 = 5, A0 = 1, BN = 2, AN= 3 New Old (94, 19, 9) (90, 18, 0) (85, 0, 9) (80, 10, 10) Player No. 1 Player No. 2 Payoffs: (Existing Players, Player 1, Player 2) 1 3 2 SW = 122 108 94 100 At node 1, P1 selects Old as 19 > 10 At node 3, P2 selects New as 10 > 9 At node 2, P2 selects Old as 9 > 0 November 29, 2018

The Process Fails: Excess Inertia 11/29/2018 The Process Fails: Excess Inertia B0 = 5, A0 = 0.2, BN = 2, AN= 3 New Old (57, 11, 6) (56, 11, 0) (56, 0, 6) (55, 10, 10) Player No. 1 Player No. 2 Payoffs: (Existing Players, Player 1, Player 2) 1 3 2 SW = 74 67 62 75 At node 1, P1 selects Old as 11 > 10 At node 3, P2 selects New as 10 > 6 At node 2, P2 selects Old as 6 > 0 November 29, 2018

The Process Fails: Excess Momentum 11/29/2018 The Process Fails: Excess Momentum Values: B0 = 5, A0 = 1, BN = 4, AN= 3 New Old (93, 19, 10) (90, 18, 0) (85, 0, 9) (80, 20, 20) Player No. 1 Player No. 2 Payoffs: (Existing Players, Player 1, Player 2) 1 2 3 SW = 122 108 94 120 At node 1, P1 selects New as 20 > 19 At node 2, P2 selects Old as 10 > 0 At node 3, P2 selects New as 20 > 9 November 29, 2018

Technology Competition and Monopoly 11/29/2018 Technology Competition and Monopoly 1st Stage 2nd Stage I II Possible Technologies SSO III IV November 29, 2018

Is This a Market Power Problem? No 11/29/2018 Is This a Market Power Problem? No 1st Stage 2nd Stage I II Possible Technologies SSO Purpose of patents is to propertize inventions and create power to exclude (remedy is a different point (see eBay)) November 29, 2018

Is This a Market Power Problem? No 11/29/2018 Is This a Market Power Problem? No 1st Stage 2nd Stage I II Possible Technologies SSO Market power rules (antitrust and network industries type regulation) should respect legitimately obtained property rights, including those that give rise to market power November 29, 2018

Is This a Market Power Problem? No 11/29/2018 Is This a Market Power Problem? No 1st Stage 2nd Stage I II Possible Technologies SSO Exercise of market power here through patent shouldn’t give rise to market power regulation November 29, 2018

Is This a Market Power Problem? No 11/29/2018 Is This a Market Power Problem? No 1st Stage 2nd Stage III IV Possible Technologies SSO Should expect first-stage competition to limit harms of ex-post monopoly created through selection November 29, 2018

Is This a Market Power Problem? No 11/29/2018 Is This a Market Power Problem? No 1st Stage 2nd Stage III IV Possible Technologies SSO That goes to competing away second-stage monopoly profits November 29, 2018

Is This a Market Power Problem? No 11/29/2018 Is This a Market Power Problem? No 1st Stage 2nd Stage III IV Possible Technologies SSO Also should expect mechanism to control second-stage price setting to avoid deadweight losses November 29, 2018

11/29/2018 Article 101 [81] 1. The following shall be prohibited as incompatible with the common market: all agreements between undertakings, decisions by associations of undertakings and concerted practices which may affect trade between Member States and which have as their object or effect the prevention, restriction or distortion of competition within the common market, and in particular those which: November 29, 2018

11/29/2018 Article 101 [81] (a) directly or indirectly fix purchase or selling prices or any other trading conditions; (b) limit or control production, markets, technical development, or investment; (c) share markets or sources of supply; November 29, 2018

11/29/2018 Article 101 [81] (d) apply dissimilar conditions to equivalent transactions with other trading parties, thereby placing them at a competitive disadvantage; (e) make the conclusion of contracts subject to acceptance by the other parties of supplementary obligations which, by their nature or according to commercial usage, have no connection with the subject of such contracts. November 29, 2018

11/29/2018 Article 101 [81] 2. Any agreements or decisions prohibited pursuant to this Article shall be automatically void. November 29, 2018

11/29/2018 Article 101 [81] 3. The provisions of paragraph 1 may, however, be declared inapplicable in the case of: any agreement or category of agreements between undertakings; any decision or category of decisions by associations of undertakings; any concerted practice or category of concerted practices, November 29, 2018

11/29/2018 Article 101 [81] which contributes to improving the production or distribution of goods or to promoting technical or economic progress, while allowing consumers a fair share of the resulting benefit, and which does not: (a) impose on the undertakings concerned restrictions which are not indispensable to the attainment of these objectives; November 29, 2018

11/29/2018 Article 101 [81] (b) afford such undertakings the possibility of eliminating competition in respect of a substantial part of the products in question. November 29, 2018

Standaris(z)ation in the EU The EU Guidelines on Horizontal Co-Operation Agreements http://eur-lex.europa.eu/legal-content/EN/TXT/?qid=1398873019133&uri=CELEX:52011XC0114(04) November 29, 2018

EU Horizontal Co-Operation Guidelines November 29, 2018

Standardization Tools Key Features Openness? Who can participate in the process for defining the standard? (280, 295) What are the voting rules? (281) Transparency (280) November 29, 2018

Standardization Tools Key Features Equal access to necessary intellectual property rights (IPR) FRAND commitments (287-290) No exclusivity terms (fn 118) No unnecessary technical blocks on connectivity (fn 122) November 29, 2018

EU Guidelines: Open Process Rules November 29, 2018

EU Guidelines: FRAND Commitments November 29, 2018

EU Guidelines: FRAND Commitments November 29, 2018

EU Guidelines: FRAND and Cost-Based Royalty Setting November 29, 2018

EU Guidelines: Example 3 (SSO Design) November 29, 2018

EU Guidelines: Example 3 (SSO Design) November 29, 2018

EU Guidelines: Example 5 (Green Washing Machines) November 29, 2018

EU Guidelines: Example 5 (Green Washing Machines) November 29, 2018

EU Guidelines: Example 5 (Green Washing Machines) November 29, 2018

11/29/2018 Function for Example Value under the old standard is given by the function November 29, 2018

11/29/2018 Function for Example Value under the new standard is given by the function In both cases, the As and the Bs are parameter values that will change. November 29, 2018