European Commission’s proposed top-down approach would massively reallocate SEP royalties to China

[Keith Mallinson]

European Commission’s proposed top-down approach would massively reallocate SEP royalties to China

By Keith Mallinson, WiseHarbor. July 3, 2024

This is the second in of a pair of postings on aggregate SEP royalties and shares of those received among licensors. The first article, published yesterday, is an update on how much in royalties are paid and how these have declined, with a reminder on why these are so much lower than maximum rates headlined. This second article is on how these payments would be reallocated with the European Commission’s proposed rate setting using the top-down approach based on simplistic patent counts. I’m doing this to show the hypothetical extent of such reallocations and who the winners and losers would be. Please let it not be construed that I advocate such a disruptive and harmful intervention. I do not.

Adverse disruption

The European Commission’s scheme to regulate royalties by setting aggregate royalties and apportioning them with the top-down approach based on standard-essential patent counts would very disturbingly and harmfully effect SEP licensing. My analysis shows that apportioning current levels of aggregate royalties based on declared-essential patent counts would massively reallocate royalties received by US and European licensors to Chinese companies.

US and European companies account for 94% (i.e. $8.1 billion) of $8.6 billion in total licensing revenues reported in public annual filings by the five largest SEP licensors. Total royalties are estimated to be $16 billion including unreported amounts paid and cross-licensing value, as indicated in the Exhibit. Royalties to US and EU licensors would reduce by at least $3.8 billion when reapportioned on the basis of declared-essential patent counts with Chinese firms — including Huawei, BBK Electronics (with brands Oppo, Vivo OnePlus, Realme), Xiaomi and Lenovo — being the dominant recipients with over 40% of the total 5G patent count among Top-20 declarers alone. Royalty reallocations to Chinese companies would likely be even much larger because some of the additional $4.3 billion of value in “Other licensors’ cash royalties” and $3.1 billion in “Cross-licensing value”. This represents nearly half of total royalty value. I have not been able to quantify individual amounts of that being obtained by particular companies or nations. However, some of that value is being captured by US and European companies, such as Philips with a relatively low 0.12% share of 5G SEPs, that would also have their royalties reduced with reallocation by patent count.

Exhibit: Global royalty payment reallocation based on top-down apportionment by 5G patent count share is mostly China's gain

All dollar figures in billions per annum. Patent count shares are of declared patent families with a 5G grant in US, Europe, China, Korea or Japan declared to ETSI as of 18 October 2023, as published in "5GEssential Patents: Key Findings for facilitating 5G licensing negotiations globally – Q3 2023; Lite version”, PA Consulting.

Most SEP licensing revenues are generated by four large public companies — Ericsson, InterDigital, Nokia and Qualcomm that disclose these every year, and by Huawei that has disclosed these for 2022. My previous analysis on those since 2013, followed by that in other published research and in light of overall licensing market and foreign exchange rate trends since then, leads me to believe that total cash royalties paid would be no more than $12.9 billion in 2023. That is one third more than approximately $8.6 billion in total these five currently generate annually. Grossing figures up also to include non-cash royalties notionally considered in cross-licensing SEPs owned by implementers including Huawei, Samsung and others, I estimate total SEP licensing value of $16 billion per annum.

As also explained in my previous article, my grossing up is to a total SEP licensing value figure less than that indicated in the European Commission’s Impact Assessment. According to the European Commission, “The largest share of royalty payments for SEP licenses comes from the mobile telecommunications industry, which generates an estimated patent royalty yield of EUR 14 – 18 billion per year with additional EUR 4 billion of non-monetary benefits from cross-licensing (Impact Assessment Report, p.9). However, the sources cited for these figures are based on licensing around 2015 when total royalties for the four largest licensees were 40% higher and the Euro was rather stronger against the dollar than it is now. My current figures are consistent, approximately, with those old figures after prorating for these changes.

Implications

Exactly who all the winners and losers would be, and to what extent — among various different licensors, as well as between licensors and licensees in general— with a top-down approach in SEP royalty rate setting depends on the aggregate levels set and which patent counts are used. Nevertheless, the reallocation of royalties to Chinese companies is so pronounced that these firms would be the overall winners — with any conceivable aggregate rates and patent counts. For example, my previous research indicates that essentiality checking only somewhat mitigates rather than eliminates the effects of over declaration on patent counts.

My above analysis is of global impact on licensing revenues. If this readjustment is applied only to royalties derived from European product sales, readjusted royalties would be in line with Europe’s approximately estimated 15% volume share and 25% value share of global smartphone sales.

Top-down approach royalty apportionment would massively reallocate to Chinese patent owners much of the SEP royalty income US and European licensors currently receive. Patent portfolio strength comes from technical contribution to standards, value in implementation and validity rather than simplistic patent counts — with or without essentiality checking. It would be shooting itself in the foot and a great shame for Europe to make such a harmful change. The money is vital to fund ongoing US and European R&D investments in 5G and 6G technologies.

Keith Mallinson, founder of WiseHarbor, has more than 25 years of experience in the telecommunications industry as a research analyst, consultant and testifying expert witness.