1. 11/29/2018
Class 15 Network Industries, Spring, Platforms: Patents & Standard Setting
Randal C. Picker
James Parker Hall Distinguished Service Professor of Law
The Law School
The University of Chicago
Copyright © Randal C. Picker. All Rights Reserved.

2. What issues are posed by standard setting?
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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?
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3. Too much competition? Formats
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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)
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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
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5. Winner Take All Markets: Simple Version
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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?
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6. Winner Take All Markets: Simple Version
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Winner Take All Markets: Simple Version
Answer
499 in sector 1, 1 in sector 2
GNP is 499 * * 1 = 5990
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7. Winner Take All Markets: Simple Version
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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 * *1 + 99*0 = 5000
Same GNP as if we did not have WTA sector: the value of that sector is fully dissipated
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8. WTA Markets: Version II
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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
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9. WTA Markets: Version II
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WTA Markets: Version II
What outcome do we want?
Answer
Again, allocate 499 to ST, 1 to WTA, for social welfare of 5990
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10. WTA Markets: Version II
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WTA Markets: Version II
What outcome will we get?
Equilibrium condition given by:
Solution:
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11. WTA Markets: Version II
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WTA Markets: Version II
Numbers
g =1 gives N = 100, as before
g = gives N = 9
g = gives N = 1, the social optimum
Note this version assumes WTA losers do not share in spillover; could do version in which they did
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12. WTA Markets: Version II
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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
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13. Consequences/Implications
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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?
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14. Consequences/Implications
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Consequences/Implications
Solutions?
Weaken property rights to solve the problem?
Allow collectivization ala DVD standard setting and patent pool to minimize competition?
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15. Too little competition?
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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?
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16. Pathologies in standard setting?
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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.
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17. Pathologies in standard setting?
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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.
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18. 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.
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19. The Process Works Values: B0 = 5, A0 = 1, BN = 2, AN= 3 Player No. 1
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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 =
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
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20. The Process Fails: Excess Inertia
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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 =
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
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21. The Process Fails: Excess Momentum
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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 =
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
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22. Technology Competition and Monopoly
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Technology Competition and Monopoly
1st Stage
2nd Stage I II
Possible Technologies
SSO
III IV
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23. Is This a Market Power Problem? No
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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))
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24. Is This a Market Power Problem? No
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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
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25. Is This a Market Power Problem? No
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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
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26. Is This a Market Power Problem? No
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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
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27. Is This a Market Power Problem? No
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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
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28. Is This a Market Power Problem? No
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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
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29. 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:
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30. 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;
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31. 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.
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32. 11/29/2018
Article 101 [81]
2. Any agreements or decisions prohibited pursuant to this Article shall be automatically void.
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33. 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,
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34. 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;
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35. 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.
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36. Standaris(z)ation in the EU
The EU Guidelines on Horizontal Co-Operation Agreements
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37. EU Horizontal Co-Operation Guidelines
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38. 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)
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39. Standardization Tools
Key Features
Equal access to necessary intellectual property rights (IPR)
FRAND commitments ( )
No exclusivity terms (fn 118)
No unnecessary technical blocks on connectivity (fn 122)
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40. EU Guidelines: Open Process Rules
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41. EU Guidelines: FRAND Commitments
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42. EU Guidelines: FRAND Commitments
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43. EU Guidelines: FRAND and Cost-Based Royalty Setting
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44. EU Guidelines: Example 3 (SSO Design)
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45. EU Guidelines: Example 3 (SSO Design)
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46. EU Guidelines: Example 5 (Green Washing Machines)
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47. EU Guidelines: Example 5 (Green Washing Machines)
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48. EU Guidelines: Example 5 (Green Washing Machines)
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49. 11/29/2018
Function for Example
Value under the old standard is given by the function
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50. 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.
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