Intellectual Property Protection in China and Valuation of Intellectual Property. Alan J. Cox, Ph.D. NERA San Francisco

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1 Intellectual Property Protection in China and Valuation of Intellectual Property Alan J. Cox, Ph.D. NERA San Francisco Shanghai, China December 12, 2006

2 Additional NERA Practice Areas Intellectual Property (IP) IP patents, copyright, trademark, trade secrets, trade dress Antitrust and Competition Policy Mergers, Trials (e.g., Microsoft, VISA) Securities and Finance Securities Fraud Investigations (e.g., Enron) Contract Damages 1

3 Cost of an Ineffective Patent Regime Discourages domestic investment in innovative activities Increases the cost of foreign investment in comparison with countries where IPR are protected Increased costs include: Lost sales to companies which have access to lost IPR Reduction in brand confidence Limiting personnel who have access to IP 2

4 Benefits of an Effective Patent Regime Increases the rate of economic growth through: Increased innovation Increased foreign investment Compliance with international agreements and protection of IP abroad 3

5 Importance of Appropriate Damages Calculation Appropriate damages required under international agreements Provides adequate protection for investment in research, development, design and marketing Accurate damage calculations tend to appropriately deter infringement though they may need to be supplemented with additional damage awards If there is no injunctive relief, damages may be the only relief available 4

6 Appropriate Damage Awards Required Under International Agreements Article 41 of TRIPS: WTO members are required to make available "effective action" against infringements Article 45 of TRIPS: Member countries are to provide the judicial authorities with the authority to order the infringer to pay the right holder damages adequate to compensate for the injury the right holder has suffered because of an infringement of that person's intellectual property right by an infringer who knowingly, or with reasonable grounds to know, engaged in infringing activity 5

7 Standards for Appropriate Damages 1. Damages should adequately compensate owner of the IPR for any lost incremental profits (including losses due to decrease in price) or Damages should be adequate to pay to the owner of the IPR appropriate share of the infringer s profits 2. Damages should not induce companies to overspend on due diligence 3. Should be based upon the preponderance of the evidence 4. Should be calculated using accepted procedures of finance, economics, statistics and, sometimes, accounting 5. All else equal the size of punitive damages awards should be inversely related to the probability of detection 6. Provide for pre-judgment interest 6

8 Standards for Appropriate Damages 1. Damages should adequately compensate owner of the IPR for any lost incremental profits (including losses due to decrease in price) or Damages should be adequate to pay to the owner of the IPR appropriate share of the infringer s profits 2. Damages should not induce companies to overspend on due diligence 3. Should be based upon the preponderance of the evidence 4. Should be calculated using accepted procedures of finance, economics, statistics and, sometimes, accounting 5. All else equal the size of punitive damages awards should be inversely related to the probability of detection 6. Provide for pre-judgment interest 7

9 Damages Should Adequately Compensate Owner of the IPR for Any Lost Incremental Profits In fact, most patents are worth less than $50,000 40% Distribution of the Value of Electronics-Related Patents % Percent of All Electronics- Related Patents 20% % 3 0% Under $1,000 $1,000 $10,000 $10,000 $100,000 $100,000 $1,000,000 Greater Than $1,000,000 Source: Mark Schankerman, "How Valuable Is Patent Protection? Estimates by Technology Field, Rand Journal of Economics, Spring

10 Damages Should Adequately Compensate Owner of the IPR for Any Lost Incremental Profits 60% 50% Distribution of the Value of Pharmaceutical-Related Patents 50 40% Percent of All Pharmaceutical Patents 30% 20% % % Under $1,000 $1,000 $10,000 $10,000 $100,000 $100,000 $1,000,000 Greater Than $1,000,000 9

11 Damage Awards Should Adequately Compensate Owner of the IPR for Any Lost Incremental Profits Consistent with the low value of many patents, in the US most lawsuits appear to have resulted in damages of less than $100,000 (Based on California Cases: ) Number of Cases $1 $100,000 $100,001 $1,000,000 $1,000,001 $10,000,000 $10,000,

12 Damage Awards Should Adequately Compensate Owner of the IPR for Any Lost Incremental Profits Though the average award can be very high Average Award Amount in California Patent Cases, by Industry ( ) 5 Award Size (US$Millions) Software Tech/ Comm/Elec Bio/ Medical Semiconductors Manufacturing Misc 11

13 Damage Awards Should Adequately Compensate Owner of the IPR for Any Lost Incremental Profits And some awards have been in the hundreds of millions of dollars 1,200 1,200 1, Dollars (US$MM) M v. Johnson & Johnson Stac Electronics v. Microsoft Honeywell v. Minolta Fonar v. General Electric DCS Communications v. General Instruments Proctor & Gamble v. Paragon Haworth v. Steelcase Polaroid v. Kodak Honeywell v. Litton 12

14 Patent Value and Damage Awards Patent value is highly skewed; a few patents worth a lot These are also the patents that need to be protected in order to encourage the most valuable forms of innovation Therefore, damages awards properly calculated will also be skewed, with some very large Large damages awards must be calculated correctly in order for inventors and users of technology to make decisions and act in a manner best suited for the operation of an efficient and growing economy 13

15 Compensation Under Chinese Law Article 60 under proposed revised Chinese Patent Law Compensation to be based on: 1) Lost profits to patent holder caused by infringement or 2) Profits which infringer has earned due to the infringement If it is difficult to calculate lost profits or infringer s profits, damages are to be based on royalty charged in existing licenses for the patent If there is no license, people s court may award damages of not less than RMB 5,000 and not more than RMB 1,000,000 in light of factors such as the type of the patent right, the nature of the infringing act and the circumstances (Note that there is no explicit mention of harm or damages) 14

16 Recent Significant Awards by Chinese Courts Xingbake litigation, Starbucks won $62,000 Dunhill sued a Beijing department store for selling wallets, ties, and belts bearing Dunhill s mark and won $6,200 Violation of ETS copyright of its TOEFL exam, resulted in $456,000 damage award 15

17 Standards for Appropriate Damages 1. Damages should adequately compensate owner of the IPR for any lost incremental profits (including losses due to decrease in price) or Damages should be adequate to pay to the owner of the IPR appropriate share of the infringer s profits 2. Damages should not induce companies to overspend on due diligence 3. Should be based upon the preponderance of the evidence 4. Should be calculated using accepted procedures of finance, economics, statistics and, sometimes, accounting 5. All else equal the size of punitive damages awards should be inversely related to the probability of detection 6. Provide for pre-judgment interest 16

18 Damages Should Not Induce Companies to Overspend on Due Diligence If a firm inadvertently infringes a patent of low value it should only pay the low value that it receives In the United States there are 12,542 patents in the electronic digital logic circuitry class. A complete review of patents every time a new semiconductor product is introduced will generally be economically inefficient 17

19 Other Considerations for Patent Owners in China

20 Compulsory Licensing Under Chinese Patent Law Article 49 (proposed): Where a national emergency or any extraordinary state of affairs occurs, or where the public interest so requires, the Patent Administrative department Under the State Council may grant the entity which is qualified for exploitation a compulsory license to exploit the patent. 19

21 Compulsory Licensing Under Chinese Patent Law Article 50 (proposed): If: A patent has been granted that involves important technical advance of considerable economic significance in relation to an earlier patent, and The exploitation of the later patent requires exploitation of the earlier patent, The Patent Administrative department may, upon the request of the later patentee, grant a compulsory license. Patent Administrative department may, upon the request of the earlier patentee, also grant a compulsory license to exploit the later invention or utility model 20

22 Competition and Contract Issues Proposed Anti-Monopoly Law, Article 54 (06/22/06 draft): The anti-monopoly law does not apply to enterprises that act in accordance with relevant IP laws or regulations to exercise IP rights. The law does apply to activities of enterprises that abuse IP, eliminate or restrict competition Restrictions under Chinese contract law For instance, restrictions on grant-backs 21

23 Standards for Appropriate Damages 1. Damages should adequately compensate owner of the IPR for any lost incremental profits (including losses due to decrease in price) or Damages should be adequate to pay to the owner of the IPR appropriate share of the infringer s profits 2. Damages should not induce companies to overspend on due diligence 3. Should be based upon the preponderance of the evidence 4. Should be calculated using accepted procedures of finance, economics, statistics and, sometimes, accounting 5. All else equal the size of punitive damages awards should be inversely related to the probability of detection 6. Provide for pre-judgment interest 22

24 Patent Valuation How much should a patent owner be compensated by an infringer or by a company granted the use of a patent under Articles 49 or 50 of the Chinese patent law? Techniques could include statistical comparison of products that do and do not use the patent and surveys 23

25 Example of Statistical Analysis: How Much Is a Faster Chip Worth? $70 $65 Clock Speed $80 $75 $110 Company A s Video Chip $100 Company B s Video Chip 24

26 Potential Licensee s Maximum Willingness to Pay for Standard Compliant Chip $120 $100 Price Per 1,000 Chips ($/(Chips*10 3 )) $80 $60 $40 $20 Clock Speeds without Patent Clock Speeds with Patent $ Clock Speed Price and performance of alternative technologies 25

27 Potential Licensee s Maximum Willingness to Pay for Standard Compliant Chip $120 $100 $80 Clock Speed of Next Best, Non-infringing Alternative Price Per 1,000 Chips ($/(Chips*10 3 )) $60 $40 $20 Clock Speeds without Patent Clock Speeds with Patent $ Clock Speed Price and performance of alternative technologies 26

28 Potential Licensee s Maximum Willingness to Pay for Standard Compliant Chip Price Premium for Faster Microprocessor $120 $100 $80 $106 $88 Price Per 1,000 Chips ($/(Chips*10 3 )) $60 $40 $20 Speed When Using the Next Best Alternative Technology Speed When Using Patented Technology $ Clock Speed Price and performance of alternative technologies 27

29 Cost Savings Determine the Licensee s Maximum Willingness to Pay $120 Licensee Willing to Pay Up To $18 Per Thousand Chips $100 Price Per Chips $90 $80 $70 With the Patent With the Next Best Alternative 28

30 Licensee s Maximum Willingness to Pay Maximum Willingness to Pay is usually just part of the determination of what a user would actually pay in an arm s length transaction for a license Other considerations include: Cost of implementing the technology Value that the licensee brings to the product Number of other patents that may also be required Other factors 29

31 Contact Us Alan J. Cox, Ph.D. Senior Vice President NERA San Francisco, California Copyright 2006 National Economic Research Associates, Inc. All rights reserved.