Modeling Patent Damages: Rigorous and Defensible Calculations

1. Modeling Patent Damages: Rigorous and Defensible Calculations Roy J. Epstein, PhD www.royepstein.com American Intellectual Property Law Association Annual Meeting, Washington, D.C. October 31, 2003 .

2. Roadmap • Growth of Patent Damages • Statutory Guidance • Reasonable Royalty and Lost Profits: Key Elements • Recent Advances .

3. Patent 6,469 (May, 1849) “A new and improved manner of combining adjustable buoyant air chambers with a steamboat…” .

4. Patents Issued, 1836–2003 2003 1849 Lincoln Patent

5. Damages and Prior Statutes • 1793: At least three times the price. • 1836: No more than three times actual damages. • 1870: Actual damages plus defendant’s profits. .

6. 35 U.S.C. 284 (1952) • “…damages adequate to compensate for the infringement, but in no event less than a reasonable royalty.” • “Expert testimony” to aid the court. .

7. Role of Economics in Damages • Help make the injured party whole. • Quantify the harm as reliably as possible. • Avoid overcompensation. .

8. The Reasonable Royalty

9. Hypothetical Negotiation • Allow infringer a reasonable profit. (Georgia Pacific v. U.S. Plywood) • Use only information available prior to first infringement — no hindsight. (Integra Lifesciences v. Merck KgaA) .

10. Georgia-Pacific Factors • Dominant royalty damages framework. • 15 factors of varying relevance to a given case. • Guidance, but not methodology. .

11. Limitations of G-P • Range of outcomes too often is too wide. • No procedure to quantify factors for a bottom-line royalty. • Growing dissatisfaction among practitioners. .

12. Royalty Surveys • Market based, but: • Problem of comparability. • Can yield wide range of rates with no way to choose. .

13. The 25% and 5% “Rules” • Convenient, low-tech, but: • Mutually inconsistent. • Often require extensive and subjective adjustment. .

14. Lost Profits

15. “But-For” Causation • Damages: difference between “but-for” and actual financial position of the patent holder. (Aro Mfg. v. Conv. Top Replacement) • Requires “sound economic proof.” (Grain Processing v. Am. Maize Prods.) .

16. Panduit Lost Profits Test • Demand for the patented product. • No acceptable alternatives. • Mfg. and marketing capability. • Patent holder’s profit margin. (Panduit v. Stahlin Bros. Fibre Works) .

17. Market Share Rule • Emerged to allow lost profits despite Panduit (2). (State Industries v. Mor-Flo) • Infringer’s sales awarded to patent holder in proportion to market share. .

18. Market Share Example • Shares: 20% infringer, 40% patent holder, 40% non-infringing alternatives. • Patent holder: credited with 50% of infringing sales. .

19. Price Erosion • Occurs when infringement lowers price received by patent holder. • Stands on same ground as damages caused by lost sales. (Panduit; Crystal Semiconductor v. TriTech) .

20. Price Erosion: Two Issues • Proof of amount of price erosion. (Brooktree; Lam; 3M v. JJO) • Federal Circuit: need “credible economic evidence” on decrease in sales at higher but-for price. • “Price elasticity” effect. .

21. Damages and Unpatented Products • “Entire market value” rule. • Damages increasingly permitted on other sales that do not embody the infringed patent. (Rite-Hite v. Kelley; King Instruments v. Perego) .

22. Grain Processing Defense • Infringer in but-for market  No lost profits. • ‘Design around’ not allowed post-infringement. • Delay in non-infringing entry eliminates defense. (Micro Chemical v. Lextron) .

23. Recent Advances

24. Royalties: FIRRM • Financial Indicative Running Royalty Model • Roy J. Epstein and Alan J. Marcus, 85 Journal of the Patent and Trademark Office Society (2003). • Infringer’s next-best investment determines royalty. .

25. SmithKline Diag. v. Helena926 F.2d 1161 • Defendant: 3% royalty. • Plaintiff: 48%. • Court “may reject the extreme figures proffered by the litigants as incredible.” (Federal Circuit) .

26. FIRRM Analysis • Indicates royalty from 23.7% to 36.5%. • Defendant and plaintiff royalties possible but extreme. • Clarifies assumptions needed for extreme outcomes. • Court awarded 25%. .

27. Lost Profits: PERLS • Price Erosion and Lost Sales • Roy J. Epstein, 31 AIPLA Quarterly Journal (2003). • Integrated analysis. • Key idea: market share logic compatible with price elasticity. .

28. Crystal Semiconductor 246 F.3d 1336 • Involved audio chips used in personal computers. • Crystal sought: • $35+ million price erosion; • $14 million lost sales under market share rule. .

29. The Elasticity “No-No” • Actual: Units Profit/unit Patent holder 800 $4 Infringer 200 1,000 • But-for market: $1 price erosion • Lost profits NOT $1,800 ignores elasticity. .

30. PERLS Lost Profits .

31. PERLS Elasticity Adjustment • Depends on: • Infringer’s market share • Patent holder’s revenues • Patent holder’s profit margin • Amount of price erosion (in %) • Magnitude of the price elasticity .

32. PERLS and Crystal ($ Millions) PERLS Lost Profits Range $7.9 $21.8 $49.0 Defendant Claim Court Award Plaintiff Claim

33. Damages: The Road Ahead • Need for increasingly sophisticated economic analysis. • Federal Circuit receptive to new analyses for “market reconstruction.” • Academic research applies directly to lost profits and reasonable royalty. .

34. Slide deck can be downloaded from www.royepstein.com • To contact Roy Epstein: email: rje@royepstein.com phone: (617) 489-3818 .