An analogous transaction occurs when two patent holders cross-license their respective patent portfolios. Each patent portfolio commands a particular royalty payment from the counterparty. Typically, the royalty specified in a cross license is a net-balancing royalty that one party must pay to the other -that is, the difference between the one-way royalties that each party owes the other for the use of its respective patent portfolio.
The net-balancing royalty, or the cash exchanged, will equal the difference between the royalty for the more valuable portfolio and the royalty for the less valuable one.
The values that the parties’ patent portfolios generate for the other determine which party is the net payer and which the net recipient of royalties and the amount of the net-balancing royalty. As Figure 1 illustrates, the net-balancing royalty is analogous to the net price of the new Camry.
Cross-licensing portfolios of standard-essential patents (SEPs)
The parties’ patent portfolios might include standard-essential patents (SEPs) that they have committed to license on fair, reasonable, and nondiscriminatory (FRAND) terms. Standard-setting organizations develop and promote technical standards (for mobile phones, for example) that permit interoperability among standard-compliant products. A SEP is a patent that a manufacturer needs to use to produce a standard-compliant product.
SEP holders sometimes also manufacture the standard-compliant product that incorporates their own SEPs. It is common for SEP holders to cross-license their SEP portfolios to one another, enabling each party to manufacture its standard-compliant products without infringing the other’s SEPs, and to receive compensation for its contributions to the standard.
Holding all other factors constant (including each party’s revenue from sales of its licensed products), the party whose SEP portfolio contributes less value to the relevant standards will pay the net-balancing royalty. Like the car dealer, a net recipient will assess the “trade-in value” of the net payer’s SEP portfolio when offered in exchange for the use of the net recipient’s SEP portfolio. Just as the driver who is trading in a used BMW in poor condition will pay more for the new Camry than a driver trading in a used BMW in good condition, the weaker the net payer’s SEP portfolio relative to the net recipient’s, the higher the net-balancing royalty. The net-balancing royalty...