22 Feb 2012

(by Bruce Lyons) The European Commission and US DoJ have approved a (mainly) vertical acquisition of Motorola Mobility (MM) by Google because the specific transaction would not lessen competition. They did so with weary resignation that it is part of the patent arms race into which they will be drawn to adjudicate in the coming months and years. The underlying problem is that ‘fair, reasonable and non-discriminatory’ (FRAND) royalty commitments are not fit for purpose as part of standard setting agreements.

Why IPRs become a competition issue

Google was a 63% premium on closing prices for Motorola Mobility and was so desperate it threw in a $2.5b break fee in case it could not close the deal. Its own shares fell 1.2% when the acquisition was announced last August. Google had recently been outbid by a consortium including Apple for 6,000 wireless patents from Nortel. MM has 17,000 patents plus 7,500 pending. Without doubt a very few patents are very much more valuable than others, but my back-of-the-envelope calculation suggests that going rate is $750k per patent for a multi-billion dollar job lot.

Patents have become front line commercial weapons and they are weighed in their thousands. Most are held as a reserve arsenal for use in future bargaining games with rivals. It is the absence of clear rules for this game that so often draws in the world’s competition authorities to adjudicate. The reason they get involved is not because patents confer monopoly rights – that is part of the deal to encourage invention in a market economy – but because these individual rights gain a whole new power when incorporated into industry standards. They become essential for downstream manufacturers. It is that incremental power that is a proper concern for competition policy.

To allow seamless interoperability, Standard Setting Organizations (SSOs) choose standardised technologies for interconnectivity. Many existing patents are included in such standards, and these are known as Standard-Essential Patents (SEPs). Once selected, holders of SEPs have the power to ‘hold-up’ others and charge exploitative prices by threatening to withhold a licence. My earlier cases explains the inefficiencies caused by hold-up as investment incentives are eroded by fear of renegotiation. [See also my (now in partnership with Microsoft).]

Google-MM and the mobile connectivity market

Google’s Android operating system is licensed freely to manufacturers including Samsung, which has become the world’s biggest smartphone manufacturer. Google’s Android (through Samsung, HTC, etc) has a fast rising 46% of the US smartphone market and Apple (iPhone) has 30%. RIM (Blackberry) and Microsoft have just 15% and 6% so it looks like a duopoly emerging, unless Microsoft’s partnership with Nokia gains traction. Android tablets are also catching Apple (iPad), with others a long way behind.

Manufacturers who use Android software over MM, saying that Google was protecting its partners (though I suppose they are hardly likely to come out publicly against the supplier of their core open source operating system technology, which they use without monetary charge). Not least since its acquisition of DoubleClick, Google’s great expertise is in earning its money through advertising and online services rather than from direct users.

The EC and DoJ worked closely on the deal and came to the same conclusion. The that Google would not have an incentive to foreclose other makers of Android phones as its business model is to push its online and mobile services. Harming Samsung or HTC would not help it to do so. More broadly, the EC did not find that the balance of power with SEPs would fundamentally change as a result of the acquisition. Thirdly, Google already had sufficient ways to get people to use its search and advertising services without having to use MM’s patents.

The on the ability of Google to use MM’s patents to raise rivals’ costs or foreclose competition. It concluded that the acquisition would make no difference because MM “has had a long and aggressive history of seeking to capitalize on its intellectual property and has been engaged in extended disputes with Apple, Microsoft and others. As Google’s acquisition of MM is unlikely to alter that policy” there would be no lessening of competition due to the merger.

FRAND is not fit for purpose

You can sense growing frustration in competition regulators who are caught in the middle of patent wars. over its tablet design (let alone its patents). Only three weeks ago, the EC said it would be investigating Samsung for refusal to supply rivals access to SEPs on FRAND terms. Who was complaining? Oh yes, Apple. Then as soon as the all clear was given to Google over MM, Apple against MM about violations of FRAND. A day later, by filing against MM (and so also Google).

EC Commissioner Almunia says pointedly in the EC press release allowing the merger that “the Commission will continue to keep a close eye on the behaviour of all market players in the sector, particularly the increasingly strategic use of patents.” The DoJ is also worried. It notes that Apple and Microsoft had committed to license SEPs on FRAND terms and not to seek injunctions to enforce them. Google surrounded its superficially similar offer with multiple conditions. The DoJ felt compelled to say that it “will not hesitate to take appropriate enforcement action to stop any anticompetitive use of SEP rights”.

These globally leading competition agencies were slow to realise the obvious frailty of FRAND as an operative concept to remedy anticompetitive pricing. It draws competition authorities into complex commercial disputes. It is time to require openly declared and binding royalty pricing before new standards are agreed.