Does the Entire Market Value Rule Make Sense when Applied to Apportionment Analyses?

By Dennis Crouch

I struggle to understand the mathematical logic in the debate over the recent expansion of the entire market value rule (contemporary EMVR) for calculating damages in patent cases. The entire market value rule is a tool that – in most cases – prevents a patent holder from using entire market value of a product as the starting point (i.e., the “base”) when calculating patent damages. In its newest incarnation, the court has rejected use of the entire market value of an infringing product as the starting point for damage apportionment. In his Patent-Damages blog, Fish & Richardson Partner Justin Barnes provides his bottom line:

[I]f a product is not separable into constituent parts, the plaintiff is not necessarily entitled to a royalty base on that product (e.g., Outlook in the Lucent case), but that if a product is separable into constituent parts, the plaintiff almost certainly is not entitled to a royalty base on the overall product (e.g., [LaserDynamics and] Cornell).

The entire market value rule makes sense when it is being used to stop a patentee from unduly claiming the bulk of the infringer’s profits. However, the absolute rule doesn’t make sense when the entire-product royalty base provides a fine starting point for calculating the value of the incremental benefit provided by the invention in suit.

Patent damages are most often calculated as a percentage royalty rate multiplied by some “base price” of the infringing product and then multiplied again by the total quantity of infringing products. This approach is suggested by the Patent Act requirement that “the court shall award the claimant damages adequate to compensate for the infringement but in no event less than a reasonable royalty for the use made of the invention by the infringer, together with interest and costs.” 35 U.S.C. § 284.

The contemporary entire market value rule debate focuses on what base price to use in a situation involving a patent whose innovation is directed toward a component of a larger product. In particular, the inquiry is whether the base price should be the price of the entire multi-component product or instead some price associated with the component itself. The name for the rule comes into play because the price of the entire product is also known as the “entire market value.” Unfortunately, the name for the rule masks an important element in the royalty calculus – that the percentage royalty rate is shifted downward anytime the base price is shifted from the component price to the price of the larger multi-component product. A patented innovation may have a large impact on the value of a particular component (and thus receive a high royalty rate). Of course, that component will fit within a larger product having many other valuable components. Because so many other factors contribute to the value of the multi-component product, the percentage of value that the patented innovation adds to the multi-component product will be considerably lower. So, as the base price moves toward capturing the entire market value, the percentage royalty rate drops.

In a model with a few assumptions about rational behavior and spillover benefit allocation, the arithmetic works-out so that a small percentage royalty of the entire market value of a multi-component product is equivalent to the appropriate corresponding larger percentage royalty of the component of that product. In one scenario the patentee receives a small percentage of a large sales base and in the other case receives a larger percentage of a smaller sales base. As we drill-down to smaller component pieces, the two variables in question – percent royalty and price-per-unit – vary inversely such that the product of the two stays constant. Since the damage award is based upon the product of those two factors, the choice of whether or not to use the entire market value as a base should not impact the actual damage award. I.e., there is no mathematical sense behind a rule that favors one approach over the other. With a reasonable royalty, we are usually looking to find the infringed invention’s marginal contribution to the infringer’s activities. That marginal contribution will not vary regardless of whether base is the value of the entire product or the relevant component.

Despite this simple analysis above, the courts have begun to severely limit the use of the entire market value in calculating reasonable royalties damages. The entire market value rule stops patentees from calculating damages based upon the entire market value of an infringing product to cases where the patented feature is the basis for customer demand. This is a shift in the law that may have begun with Lucent (2009) and Uniloc (2011). In the most recent case of LaserDynamics v. Quanta Computer, Inc., the Federal Circuit added-on to the rule by confirming that the royalty base used to calculate a reasonable royalty should be the “smallest saleable patent-practicing unit.” Further, the entire market value of a product can only be used when the patented feature is provide to be the “motivating factor” for the customer purchase of the product. Merely being a but-for or “important” cause of the purchase was insufficient. The Laser Dynamics decision is likely the first major patent decision written by Judge Reyna. For his conclusion, Judge Reyna relies heavily on 2009 decision by Judge Rader where he sat by designation as a district court judge in Cornell Univ. v. Hewlett-Packard Co., 609 F. Supp. 2d 279 (N.D.N.Y. 2009). In that case, Judge Rader wrote that “counsel would have wisely abandoned a royalty base claim encompassing a product with significant non-infringing components. The logical and readily available alternative was the smallest salable infringing unit with close relation to the claimed invention—namely the processor itself.”).

Limits on using the entire market value for calculation have been traced back to the 1884 Supreme Court case of Garretson v. Clark, 111 U.S. 120, 121 (1884). In that case, the patentee was awarded only nominal damages because the patentee failed to prove that it had suffered any loss or that the infringer had profited from the patented mop head improvement. In rejecting the appeal, Justice Field wrote:

When a patent is for an improvement, and not for an entirely new machine or contrivance, the patentee must show in what particulars his improvement has added to the usefulness of the machine or contrivance. He must separate its results distinctly from those of the other parts, so that the benefits derived from it may be distinctly seen and appreciated. The rule on this head is aptly stated by Mr. Justice Blatchford in the court below: “The patentee,” he says, “must in every case give evidence tending to separate or apportion the defendant’s profits and the patentee’s damages between the patented feature and the unpatented features, and such evidence must be reliable and tangible, and not conjectural or speculative, or he must show by equally reliable and satisfactory evidence that the profits and damages are to be calculated on the whole machine, for the reason that the entire value of the whole machine, as a marketable article, is properly and legally attributable to the patented feature.”

The plaintiff complied with neither part of this rule. He produced no evidence to apportion the profits or damages between the improvement constituting the patented feature and the other features of the mop. His evidence went only to show the cost of the whole mop and the price at which it was sold. And, of course, it could not be pretended that the entire value of the mop head was attributable to the feature patented. So the whole case ended, the rule was not followed, and the decree is therefore Affirmed.

Garretson. Now, one major difference between now and then is that in 1884 a patentee was still allowed to seek disgorgement of the defendant’s profits – something that is no longer allowed in utility patent law. Setting profits aside, Garretson appears allow use of the entire market value so long as the patentee explains the added value of the particular patented invention and how that added value contributes to the value of the whole product “so that the benefit derived from [the invention] may be distinctly seen and appreciated.” The driving factor in Garretson as in contemporary cases is to prevent overcompensation. However, the contemporary courts have not (and perhaps could not have) explained how the entire market value used as part of an apportionment analysis leads to overcompensation.

We might consider the availability of evidence. In the usual case, the value-added by an invention may be easier to see and understand at the component level because there are fewer issues to consider. On the other hand, base price information tends to be better available when looking at the entire market value of a product because that is what customers purchase – rather than looking at the value (or profit) associated with an integrated component. In situations like these where there are various legal theories available, we usually let the parties decide how to present their case according to what they believe is the best and most convincing evidence. The usual approach to intellectual property valuation is to use a variety of methodologies in the hopes that there will be some convergence on a best estimate and this is one useful methodology. In the larger context of the hypothetical negotiation, it just doesn’t make any sense that neither party would have considered the price of the final product as part of their negotiations.

Cognitive Bias: In many multi-component cases, the correct royalty rate will be <<1% of the market value. Economists would have no problem with that result, but jurors might. In particular, it may be cognitively difficult for a juror to award a royalty rate of <<1% of the base price because that number seems so small. Again, in our adversarial system we normally rely on opposing counsel to help juries through their cognitive difficulties. In the multi-component situation, what’s wrong with allowing the defendant to make the (seemingly easy and intuitive) showing that the accused product is based on thousands of innovations and equally important underlying patents that each deserve (and have received) their share of royalties and that the stacking problem means that royalties for the particular invention in question certainly could not be above say 0.002%. To avoid the small number bias problem, defendants can rescale their calculation to be something like $5 per thousand products sold. This provides a whole number base that we are all comfortable with.

Law Professors Brian Love has a nice pre-2009 article on the entire market value rule and its role in preventing patentee overcompensation. Brian J. Love, Patentee Overcompensation and the Entire Market Value Rule, 60 Stan. L. Rev. 263 (2007). However, the analysis has changed somewhat since then.

To be clear, I’m not arguing that the court should jettison the whole of the entire market value rule – just the post-2009 contemporary conception that applies the rule to prevent use of the entire product value base in an appropriate apportionment analysis.

Notes:

  • Although none of them completely agree with my analysis, Professors Thomas Cotter (UMN), Amy Landers (UFL), and Brian J. Love (SCU) all provided very useful comments on this essay.
  • Although I’m critical here of the damage jurisprudence of the Federal Circuit, at the time it was important for the court to take some steps to control damage calculations. In the background, Congress was a debating patent reform package that included provisions that would have significantly altered patentee’s damages arguments and the FTC had argued forcefully for further restrictions on patent damages. The court’s decisions then relieved the political pressure so that those provisions were eventually removed from the patent reform bill that was passed as the America Invents Act in September 2011.
  • The LaserDynamics case is also important because of its repudiation of settlement data in the damage calculation – especially when the settlement came at a point where the defendant was in a strategically disadvantageous position.

39 thoughts on “Does the Entire Market Value Rule Make Sense when Applied to Apportionment Analyses?

  1. Citation, please?

    Almost too basic for citation – does the phrase “make whole” indicate anything to you?

    Please tell me that you know how to do more than just surface think.

  2. The number one thing to keep in mind concerning the principles of equity is that the remedy should as closely approximate the right as humanly possible.

    Citation, please? Seeing as how this is the number one thing to keep in mind, a citation should be pretty easy to provide?

  3. There is nothing reasonable about the purposeful misrepresention and ideological stance towards patents that IANAE has.

    And what exactly was the insult…?

  4. You really need to understand the context of the law you are dabbling in, and really need to not so blindly want to apply your surface understanding of remedies to this area of law.

    You really need to stop insulting other commenters who are expressing their reasonable opinions.

    But you’re never going to do that, are you?

  5. Where we should be headed is uspto immediate shutdown of pirate startups before sufficent exclusive market damages occur this is the only was to create sufficient incentive to create and for the startup inventor to gain sufficient funds to fully realize his creative potential.weve seen in the last 8 years in particular the total drop off of marketable valuable patent applications b ecause of this and the other 40 methods of cheating the inventor

  6. What if a license is NOT ultimately freely negotiated going forward, yet past damages need to be determined?

    I understand what you’re getting at, but it’s only part of the story.

  7. It’s the right to have the defendant stop doing a particular thing.

    How many causes of action are you aware of that don’t relate to the plaintiff’s right to have the defendant do a thing or stop doing a thing? Other than rights involving only the payment of money, why do you think those cases are less deserving of an injunction than patent infringement?

  8. Patenting around should be quickly identified as a parent patent violation and be rejected by courts until the 14 year term of the patent expires then they can use the existing or improve it and patent to gain entre into the market

  9. The entire market value rule definately makes sence in willful infringement cases particularly because thats the damages to the patentees exclusive market. Tripple damages are also in order to prevent the infringement from occuring in the first place. The problem is many infringers are indegent pirates representing a large scale threat to the genuine concievers and the congress intentionally has done nothing to correct the root problem of fourty methods of cheating the inventor. Wild west reassignment of deceased inventors patent applications estate intrests is a wholescale consperacy of murdering thieves in congress

  10. the right in all (other) areas of law is different than the patent right.

    Defendant does something. Plaintiff asserts a right to not have that thing done. Plaintiff asks judge to tell defendant to stop. Is that unique to patent law on your planet?

  11. Actually, IANAE, it is a fundamental precept. And no, it does not mean that injunctions would be an automatic remedy in all areas of law, because the right in all (other) areas of law is different than the patent right.

    You really need to understand the context of the law you are dabbling in, and really need to not so blindly want to apply your surface understanding of remedies to this area of law.

  12. Dennis, I think many would view the royalty agreed upon under the injunction as highly informative if the reasonable royalty to consider for purposes of calculating back damages. And if the infringer quickly and easily invents around the claim, rather than agreeing to a royalty, that ought to also serve as evidence of a low value if a reasonable royalty. The same might even be said when the infringer chooses to simply eliminate the infringing feature or product, rather than pay a royalty of any amount.

  13. The number one thing to keep in mind concerning the principles of equity is that the remedy should as closely approximate the right as humanly possible.

    That is very much not a principle of equity. If it were, injunctions would be an automatic remedy in all areas of law. They’re not. There’s a test for them. Based on the actual principles of equity. Something along the lines of “how bad is the situation we’re trying to fix, and how bad is the situation we’ll create by fixing it?”

  14. Compulsory licensing merely means a “copy of” mentality. There is plenty of time for that after the patent’s limited time of exclusivity has elapsed. Providing for a copying sooner does not promote the progress.

  15. Further, there are strong policy arguments for not having compulsory licensing. The mixture of having the state play nanny and letting market forces play may yield the necessity of invention. “What the market will bear” let’s a truer value be ascertained. If infringers want to use the patented item, let them pay the price that the patent holder demands. If the patent holder demands too high a price, perhaps the infringer will invent a way around the patented item.

    I think far too many people overlook this benefit of an exclusive right.

  16. PLN,

    Not sure how you get to “this thread is ridiculous” from the fact that the statute allows for recovery of attorney fees in certain instances, or from the fact that some patent holders push litigation where there clearly isn’t infringement (and such case – if so clearly – already have rules in place to control, so the argument on that is misplaced here).

  17. PLB,

    You also need to realize that “punish someone for not taking a license upfront” is called patent infringement, and is an offense at law that is punuishable.

    As of yet, the US does not officially have a compulsory licensing law (as may be vididly compared to other nations). It is not up to the Court to write that law (either directly or in effect). Constitutionally, that is the domain of Congress.

  18. This thread is ridiculous. It’s also true that some patent holders will push litigation where there clearly isn’t infringement.

    If there truly was or wasn’t infringement, the statute allows for recovery of attorney fees in certain instances.

    This all goes both ways.

  19. You seem to want to punish someone for not taking a license upfront. That’s not allowed by the patent act under the reasonable royalty (i.e., you are calling for an unreasonable royalty).

    Now, that is what we have wilfullness and treble damages for.

  20. according to the principles of equity

    The number one thing to keep in mind concerning the principles of equity is that the remedy should as closely approximate the right as humanly possible. Granted in most cases the default is money. But the whole conversation here circles around the fact that deciding that money level is fraught with trouble.

    Why bother with the trouble when the solution that is nearly identical to the right is readily available? We are generally not talking about a case in which infringement is yet to be proven. We are generally talking about someone who has violated a found-valid patent.

    Also, make note that there is a clear distinction between the patent right (a negative right) and a forced-to-perform remedy for a contract right (in other words, let’s keep the non-sequiturs out of the discussion).

    Why would anyone not think that the best equitable decision is the one that restores the right most completely?

  21. Inane, “Also, “without a harsher remedy, people will take a chance and litigate” isn’t a valid argument, strictly speaking, because you could say it about anything.”

    It is true that an infringer will push litigation on the hope that they can clock out the patent holder. It is a risk/reward argument. The reward remains constant. But the risk is substantially different if that risk can shut down a product line. If a product line is shut down the CEO will be beheaded. If they lose a couple of million more than anticipated, nobody is the wiser.

  22. without a reasonable possibility of an injunction, license royalties go to near zero as the deep pockets infringer adopts the attitude that he can outlast you in court, and, if he loses, he will only have to pay the same royalty as everyone else, peanuts.

    He should wind up paying three times the royalty everybody else pays.

    Also, “without a harsher remedy, people will take a chance and litigate” isn’t a valid argument, strictly speaking, because you could say it about anything. “Without a reasonable possibility that the infringer’s CEO will be beheaded, the deep-pocketed infringer will take a chance and litigate”.

    It doesn’t demonstrate why a patentee should get an injunction if he’s not entitled to one according to the principles of equity. It sounds like this is a cost of enforcement issue, which is much more easily dealt with by awarding treble damages against anybody who clearly infringes a patent everybody else has licensed, and making the losing party pay the winning party’s attorney fees starting on the day he rejects a settlement offer that turns out to be better for him than the judgment.

  23. The rate could be determined by free negotiation between infringer and patent holder post injunction and then applied backwards to calculate back damages. That would make it simple math and as close to a fair market value for the invention as possible.

  24. True, but the point is that without a reasonable possibility of an injunction, license royalties go to near zero as the deep pockets infringer adopts the attitude that he can outlast you in court, and, if he loses, he will only have to pay the same royalty as everyone else, peanuts. It is this attitude that exists in the patent system since eBay. It is, more than anything else, destroying the value of patents.

    Then there is the rule that a RR is to be determined from a time before infringement began. Really? The copier can get away with m*rd*r and still pay the same royalty?

    A patent issues, and without conducting a clearance study, the infringer thereafter incorporates the patent into his product? Where are the equities here? Can he still avoid an injunction? Is he entitled to a calculation of a RR as if he were completely innocent, as if his infringement began before the patent issued?

    Where is equity in all this?

  25. 1. The Georgia-Pacific factors analysis is not simple either.

    2. What or how to “apportion” for the “invention” is further complicated by the claim scope of “omnibus” claims to an entire composite product which the PTO now allows. As in the famous joke example of someone who invents a novel car cup holder but gets an issued patent claim to “A motor vehicle comprising [old] A,B,C,C,E, F and a cup holder therein comprising …”

    3. Apportionment is unavoidable for products like “smart phones” which are collections of hundreds of different features and functions, many having nothing to do with being a “phone.”

    4. Isn’t there at least one Fed. Cir. decision where the panel suggested that if apportionment was not practicable that the awarded royalty rate on the whole product could be appropriately lowered instead?

  26. I think this is the “right” that you are referring to – the right to get an injunction… “To promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries”

    “Exclusive right” to “discoveries” means simply that the inventor can exclude others from the invention (an injunction).

    I’m having trouble applying the appropriate mental gymnastics that will bring me to conclude that “Exclusive right” really means that a third party can simply ascribe a cash value and eliminate my “Exclusive right”.

    Perhaps someone can torture their thinking to the degree that it can be explained in a way that I can understand it.

  27. With injunctions now difficult to obtain, where we seem to be headed is general compulsory licensing of patents, with the value of the patent based on the value of the licensed components. This is already the case in patents infringed by the Government under 28 USC 1498, which provides for “reasonable and entire compensation”, which is interpreted narrowly.

  28. Correction… The ONLY way to arrive at an appropriate value is to grant an injunction. Then the infringer can negotiate a fair market value with the patent holder and neither side gets screwed.

  29. The best way to arrive at an appropriate value is to grant an injunction. Then the infringer can negotiate a fair market value with the patent holder and neither side gets screwed.

  30. Just as an example, a microprocessor with low power consumption will vary in value to the computer manufacturer depending on just how critical to his application are the low power features.

  31. Dennis, “overcompensation.” That is the key.

    The EMVR came from a time where profits were awarded. Clearly, the profits had to be apportioned. That does not mean that components cannot have different values depending on different uses, justifying different RRs.

    We saw this in the famous vacuum tube case where the value of the tube to commecerical amplifiers was much greater than the value to home users. The same tube could be sold at two different prices. The Supreme Court recognized there that disparity of value depended on markets, the use of the component.

    There then is no justification for excluding evidence of value disparity depending on use of a patented component.

Comments are closed.