Self-Regulation in Standard-Setting Organizations: FRAND Royalties in the Process of Discovering Standards

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Standard-setting organizations (SSOs) typically require their members to declare whether they hold standard-essential patents (SEPs) or disclose which SEPs they own, and to commit to licensing SEPs on “fair, reasonable and non-discriminatory” (FRAND) terms. The apparent vagueness of FRAND commitments has animated much policy debate. Some advocate for antitrust to invest these commitments with meaning according to an ex ante incremental value rule (IVR). A main thesis of this article is that the meaning of a FRAND commitment is commonly understood by SSO members in the context of the particular standards and parties involved, and compliance is self-enforced through repeat dealing among SSO members. The optimal standard is not “given data” in the Hayekian sense, but emerges from a costly discovery process that gives rise to a public goods (or moral hazard) problem. The core function of an SSO is to provide a platform for the discovery process and to induce broad participation and robust engagement in this process of information exchange. FRAND royalties balance the incentives of members on both sides of the SSO platform to undertake non-contractible investments in collaboration, a key function overlooked by proponents of the IVR. The analysis illuminates why SEP holders prefer to license to final-goods manufacturers over component manufacturers; how tying and bundling SEPs with non-SEP licenses or other transactions can improve contract efficiency by approximating lump-sum transfers (so that their prohibition would distort royalty rates); and how court interpretation of FRAND commitments may have no effect on standardization, or—if the interpretation departs greatly from the intent of the contracting parties—can undermine self-enforcement by encouraging opportunistic litigation to the detriment of consumers.