FRAND Licensing of Standard-Essential Patents: Comparing Realistic Ex-Ante and Ex-Post Contracts

Abstract The paper presents a bargaining model that compares two forms of licensing of Standard Essential Patents (SEPs) in terms of their ability to deliver Fair, Reasonable and Non-Discriminatory (FRAND) royalties. The first is a profit-based or ad valorem contract signed ex-ante, before the product market entry of the implementer. The second is a lump sum contract signed ex-post, after implementers’ profits have been realized. Both contracts are realistic, i.e. compatible with the typical timing of standardization activities. We find that the ex-ante contract dominates the ex-post one in many but not all situations. It does when the imbalance in bargaining power between the parties is not too strong, independently of how the latter is distributed. In more extreme situations of bargaining power imbalance (typical hold-up and hold-out situations), ex-ante contracts are again better when the level of litigation costs relative to profits is very high or very low. However, for intermediate levels of litigation costs relative to profits, the threat of litigation may be useful to set royalties that are closer to FRAND. This finding is relevant in light of current regulatory initiatives over-emphasizing ex-ante licensing, like the European SEP Regulation.