State of Innovation

Patents and Innovation Economics

$120 Per Smartphone in Royalties – Outrageous!

An academic paper claims that the cost for royalties ($120 per phone) is about the same as the cost of the components in a smartphone.  This was accompanied by a number of articles suggesting this was outrageous and unsustainable.  For example see:

* High smartphone patent royalties undermine industry profitability: report 

* The $120 Smartphone Patent Tax: Patent Royalties Cost More Than The Actual Hardware In Your Phone:   This one from my favorite patent Luddite site, Techdirt.

* Smartphone royalties now equal manufacturing costs

The logical flaw underlying all these articles is that the value of products is determined by the amount of physical labor and/or the cost of the underlying materials.  On this basis, the actual material costs of a cell phone are probably less than $5 and the labor (unskilled labor in the US is worth perhaps $10/hr) involved in making the phone might be worth $5, let’s throw in $10 for distribution and the hard costs of a smartphone are about $20.[i]  The rest of the costs are the result of intellectual property, much of which is in the form of patents, but some is in the skilled labor, copyrights and trademarks.  The actual cost of the intellectual property in a smartphone is closer to $380.00.  Much of these costs are hidden.  For instance, when Intel sells a microprocessor they charge you $50, for example, but the labor cost and material cost of the microprocessor is pennies.  The reason they can charge $50 is because of the intellectual property, which means patents.  From an economic point of view you are paying a dollar or so for the manufacturing and $49 in patent royalties.

Another logical flaw in these articles is that this is an unsustainable business model.  First of all the underlying paper points out that sales of smartphones and tablets is now bigger than all the rest of the consumer electronics space, with over a billion smartphones sold in 2013.  Clearly the business model is not falling apart.  Second of all, the cost of Microsoft Office Home and Business 2013 is $219.00 and none of that is manufacturing cost.  The cost of Microsoft Office is essentially all IP (Patents, Copyrights, etc.).  Solidworks, which is 3D CAD software, cost $4000.00 and also has essentially no manufacturing costs, which means you are paying the equivalent of $4000 in royalties.  The argument that the model is unsustainable is absurd.

 

Actual Paper

The paper that started this economic stupidity is The Smartphone Royalty Stack: Surveying Royalty Demands for the Components Within Modern Smartphones.  The paper is clearly designed to sway public and Judicial opinion in a manner that will be beneficial for Intel.  Namely, Intel wants a patent system that emphasizes manufacturing, not inventing.  Another goal of the paper is to get courts to reduce the amount of royalties that inventors receive.

“In particular, there has been significant recent focus on “royalty stacking,” in which the cumulative demands of patent holders across the relevant technology or the device threaten to make it economically unviable to offer the product.”

This statement is absurd on its face, as the paper itself points out.

“The market for smartphones has exploded. Smartphones sales for 2013 topped one billion units globally for the first time ever.  In addition, global revenues for smartphone and tablet sales in 2013 are estimated to have surpassed for the first time revenues for the entire consumer electronics markets (e.g., televisions, audio equipment, cameras, and home appliances).”

Here is the real point that this paper is pushing:

“Further, the available data demonstrate a need for licensees to advocate and courts to rigorously apply methodologies for calculating royalties that focus on the actual value of a claimed invention put in context of the myriad other technologies in a smartphone and the components in which the technologies are implemented.”

I will admit that having courts set royalty rates is not ideal and the results can be squirrelly, which is why eBay  should be reversed.  The courts used to just prohibit the infringer from using the patented technology and then the parties had to work out a deal.  But the Supreme Court decided that enforcing the only right you get with your patent is an injunction – actually it is not an injunction it is an exclusion order requiring the infringer to not trespass on (use) the patent owner’s property.

The paper admits that its methodology is limited and the actual cash cost going to pay royalties could be higher or lower.  For instance, the paper does not track cross licensing, pass through, or patent exhaustion, all of which could significantly reduce the actual royalties paid.  They clearly made an error if they did not account for patent exhaustion.  If patent exhaustion was part of the royalty costs, then almost every high value component’s price is mainly due to patents.  Correctly accounting for patent exhaustion would show a royalty per smartphone closer to the $380.00 per phone as explained above.

The paper is just dishonest when discussing the growth in the number of patents issued and the number of patent lawsuits.  It shows in 20 years the number of patents issued in the US has increased from 100,000 per year to 250,000 per year.  The implication is that this is an absurd increase in the number of issued patents, but if you do the math this turns out to be a 4.75% annual increase, about the same as the increase in worldwide GDP over the same time period.  The paper also shows a graph depicting the number of patent lawsuits exploding around 2011.  This increase is due to the America Invents Act, which limited the joinder of defendants in patent lawsuits.  This has been well documented, as in the article  The America Invents Act at Work – The Major Cause for the Recent Rise in Patent Litigation.  The paper’s failure to point this out is just outright fraud.  The fraud is perpetrated again when the paper points to the increase in the number of NPE lawsuits.  These authors seem to have gotten their training from Al Gore and French economist Thomas Piketty.

 

 


[i] In fact you can buy cell phones for less $30.00 on the Internet.  The cost of materials in a smartphone and a $30 cell phone is essentially the same.  The material costs in a cell phone include the plastic which costs several cents, the metal for the conductors which might be worth a dollar, the silicon which in its raw form is worth almost nothing.

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June 1, 2014 - Posted by | -Law, -Legal, -Philosophy, News, Patents | ,

2 Comments »

  1. The point about the growth rate in patents being more or less the same as global GDP is very astute. There is a failure among the more vociforous opponents of IP to at least consider that other types of property claims also rise rapidly, such as filings for mineral rights, or transfers of physical property of various kinds, etc. Given so much of our wealth is, at root, about intellect (as Lysander Spooner, Ayn Rand and others grasped), none of this increase should be regarded as sinister.

    Keep up the good work.

    Comment by Tom Burroughes | July 11, 2014 | Reply

    • Thanks

      Comment by dbhalling | July 11, 2014 | Reply


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