. 1 Modeling Patent Damages: Rigorous and Defensible Calculations Roy J. Epstein, PhD American Intellectual Property Law Association Annual Meeting, Washington, D.C. October 31, 2003

. 2 Roadmap Growth of Patent Damages Statutory Guidance Reasonable Royalty and Lost Profits: Key Elements Recent Advances

. 3 Patent 6,469 (May, 1849) “A new and improved manner of combining adjustable buoyant air chambers with a steamboat…”

Lincoln Patent 2003 Patents Issued, 1836–2003

. 5 Damages and Prior Statutes 1793: At least three times the price. 1836: No more than three times actual damages. 1870: Actual damages plus defendant’s profits.

U.S.C. 284 (1952) “…damages adequate to compensate for the infringement, but in no event less than a reasonable royalty.” “Expert testimony” to aid the court.

. 7 Role of Economics in Damages Help make the injured party whole. Quantify the harm as reliably as possible. Avoid overcompensation.

8 The Reasonable Royalty

. 9 Hypothetical Negotiation Allow infringer a reasonable profit. (Georgia Pacific v. U.S. Plywood) Use only information available prior to first infringement — no hindsight. (Integra Lifesciences v. Merck KgaA)

. 10 Georgia-Pacific Factors Dominant royalty damages framework. 15 factors of varying relevance to a given case. Guidance, but not methodology.

. 11 Limitations of G-P Range of outcomes too often is too wide. No procedure to quantify factors for a bottom-line royalty. Growing dissatisfaction among practitioners.

. 12 Royalty Surveys Market based, but: –Problem of comparability. –Can yield wide range of rates with no way to choose.

. 13 The 25% and 5% “Rules” Convenient, low-tech, but: –Mutually inconsistent. –Often require extensive and subjective adjustment.

14 Lost Profits

. 15 “But-For” Causation Damages: difference between “but-for” and actual financial position of the patent holder. (Aro Mfg. v. Conv. Top Replacement) Requires “sound economic proof.” (Grain Processing v. Am. Maize Prods.)

. 16 Panduit Lost Profits Test 1) Demand for the patented product. 2) No acceptable alternatives. 3) Mfg. and marketing capability. 4) Patent holder’s profit margin. (Panduit v. Stahlin Bros. Fibre Works)

. 17 Market Share Rule Emerged to allow lost profits despite Panduit (2). (State Industries v. Mor-Flo) Infringer’s sales awarded to patent holder in proportion to market share.

. 18 Market Share Example Shares: 20% infringer, 40% patent holder, 40% non-infringing alternatives. Patent holder: credited with 50% of infringing sales.

. 19 Price Erosion Occurs when infringement lowers price received by patent holder. Stands on same ground as damages caused by lost sales. (Panduit; Crystal Semiconductor v. TriTech)

. 20 Price Erosion: Two Issues Proof of amount of price erosion. (Brooktree; Lam; 3M v. JJO) Federal Circuit: need “credible economic evidence” on decrease in sales at higher but-for price. –“Price elasticity” effect.

. 21 Damages and Unpatented Products “Entire market value” rule. Damages increasingly permitted on other sales that do not embody the infringed patent. (Rite-Hite v. Kelley; King Instruments v. Perego)

. 22 Grain Processing Defense Infringer in but-for market  No lost profits. ‘Design around’ not allowed post- infringement. –Delay in non-infringing entry eliminates defense. (Micro Chemical v. Lextron)

23 Recent Advances

. 24 Royalties: FIRRM Financial Indicative Running Royalty Model –Roy J. Epstein and Alan J. Marcus, 85 Journal of the Patent and Trademark Office Society (2003). Infringer’s next-best investment determines royalty.

. 25 SmithKline Diag. v. Helena 926 F.2d 1161 Defendant: 3% royalty. Plaintiff: 48%. Court “may reject the extreme figures proffered by the litigants as incredible.” (Federal Circuit)

. 26 FIRRM Analysis Indicates royalty from 23.7% to 36.5%. –Defendant and plaintiff royalties possible but extreme. –Clarifies assumptions needed for extreme outcomes. Court awarded 25%.

. 27 Lost Profits: PERLS Price Erosion and Lost Sales –Roy J. Epstein, 31 AIPLA Quarterly Journal (2003). Integrated analysis. Key idea: market share logic compatible with price elasticity.

. 28 Crystal Semiconductor 246 F.3d 1336 Involved audio chips used in personal computers. Crystal sought: –$35+ million price erosion; –$14 million lost sales under market share rule.

. 29 The Elasticity “No-No” Actual: Units Profit/unit Patent holder 800 $4 Infringer 200 1,000 1,000 But-for market: $1 price erosion Lost profits NOT $1,800  ignores elasticity.

. 30 PERLS Lost Profits

. 31 PERLS Elasticity Adjustment Depends on: –Infringer’s market share –Patent holder’s revenues –Patent holder’s profit margin –Amount of price erosion (in %) –Magnitude of the price elasticity

32 PERLS and Crystal $49.0 Defendant Claim $7.9 ($ Millions) Plaintiff Claim Court Award $21.8 PERLS Lost Profits Range

. 33 Damages: The Road Ahead Need for increasingly sophisticated economic analysis. Federal Circuit receptive to new analyses for “market reconstruction.” Academic research applies directly to lost profits and reasonable royalty.

. 34 Slide deck can be downloaded from To contact Roy Epstein: phone: (617)