Royalty Structure
The structure of a reasonable royalty reflects what parties would agree to in hypothetical negotiation. Common royalty structures include the lump-sum royalty and the running royalty.
Lump Sum Royalty
A lump-sum royalty is a fixed, upfront payment, with no restrictions on a licensee’s extent of use.
As generally employed, once a lump-sum license is duly executed, the licensee is obligated to pay the entire, agreed-upon amount for the licensed technology, regardless of whether the technology is commercially successful or even used.
— Lucent Technologies, Inc. v. Gateway, Inc., 580 F. 3d 1301, 1326 (Fed. Cir. 2009).
A judge’s power to correct a damages figure may be constrained when a jury awards a lump-sum royalty.
[T]his court cannot correct a damages figure by extrapolating a royalty rate from the jury's lump sum damages award and multiplying that royalty rate by a revised sales base. Except in those cases in which it is apparent as a matter of law that certain identifiable sums included in the verdict should not have been there...
— Energy Transp. Group v. William Demant Holding A/S, 697 F. 3d 1342, 1358 (Fed. Cir. 2012).
Running Royalty
A running royalty entails payments that are proportional to sales, profit, or the extent of use.
A running royalty structure shifts many licensing risks to the licensor because he does not receive a guaranteed payment. Royalties are dependent on the level of sales or usage by the licensee, which the licensee can often control.
— Lucent Technologies, Inc. v. Gateway, Inc., 580 F. 3d 1301, 1326 (Fed. Cir. 2009).
A running royalty generally has two components: a base and a rate. The total royalty equals the product of base and rate. In this way base and rate are related. Sometimes a rate is set on a schedule so that the effective rate varies with the extent of use. See, for example, CSIRO v. Cisco Systems, Inc., 809 F. 3d 1295, 1298 (Fed. Cir. 2015).
The base measures the extent of use while the rate measures the incremental royalty per unit of use.
Defendants argue that the jury ignored the fact that not all customers enabled proactive scanning modules[...] This argument confuses use by customers with use by infringers. […] Because Defendants included proactive scanning on every accused product, their use encompassed all of their sales, regardless of customer activation.
— Finjan, Inc. v. Secure Computing Corp., 626 F. 3d 1197, 1211 (Fed. Cir. 2010).
The base may be be a unitless count measuring the extent of use, or a monetary value measuring total revenue or profit.
The total royalty should be a quantity of money, so that when a base is a count the rate will be an amount of money, and when the base is a monetary value the rate is a percentage or share.
There is no rigid requirement that a royalty base be limited to specific instances of infringement.
[W]e have never laid down any rigid requirement that damages in all circumstances be limited to specific instances of infringement proven with direct evidence. Such a strict requirement could create a hypothetical negotiation far-removed from what parties regularly do during real-world licensing negotiations.
— Lucent Technologies, Inc. v. Gateway, Inc., 580 F. 3d 1301, 1334 (Fed. Cir. 2009).
Examples of bases in a running royalty include number of units sold, the amount of revenue earned, or the amount of profit earned.
The royalty may, for example, be measured as a percentage of Western's gross or net profit dollars, or as a set amount per infringing plate sold, or as a percentage of the gross or net price received for each infringing plate.
— Fromson v. Western Litho Plate and Supply Co., 853 F. 2d 1568, 1578 (Fed. Cir. 1988).
A per-unit royalty is a running royalty that scales with the number of units sold rather than per-unit price or profit. It ads a marginal cost for the licensee that does not depend on price.
A per-unit running royalty is paid based on the number of units ultimately sold (or made, etc.), which is of course directly related to product revenues. As more units are sold, more revenue is earned and more royalties are paid. If the licensee chooses to omit the patented feature from its commercial product, the licensee will generally owe no per-unit royalty.
— Lucent Technologies, Inc. v. Gateway, Inc., 580 F. 3d 1301, 1326 (Fed. Cir. 2009).
A per-unit royalty may be tied directly to the number of units sold, or it may be tied to a feature or component of the end product. One reason to tie a per-unit royalty to a feature rather than to an end product is that a feature may track the value of a patent claim more closely than the accused products.
For example, consider a hypothetical patent on the power socket. Suppose the patentee seeks to license their power socket patent to a power strip manufacturer. Since each power strip contains multiple power sockets, parties may be able to track use of the patented feature more closely by tying royalties to the number of sockets sold (rather than the number of strips sold).
The percentage-of-revenue and percentage-of-profit royalties are similar in they both compute a royalty by applying a percentage to a money-denominated base.
When a hypothetical negotiation would have yielded a running royalty, the classic way to determine the reasonable royalty amount is to multiply the royalty base, which represents the revenue generated by the infringement, by the royalty rate, which represents the percentage of revenue owed to the patentee.
— Whiteserve, LLC v. Computer Packages, Inc., 694 F. 3d 1, 27 (Fed. Cir. 2012).
With a percentage royalty, a reduction in the rate accompanied by a proportional increase in the base will leave the total amount of damages unchanged.
Simply put, the base used in a running royalty calculation can always be the value of the entire commercial embodiment, as long as the magnitude of the rate is within an acceptable range (as determined by the evidence).
— Lucent Technologies, Inc. v. Gateway, Inc., 580 F. 3d 1301, 1338–39 (Fed. Cir. 2009).
Comparison
There are economic differences between royalty structures that may affect incentives and risks for the parties involved including differing non-monetary benefits and incentives for both parties involved.
Significant differences exist between a running royalty license and a lump-sum license[.]
— Lucent Technologies, Inc. v. Gateway, Inc., 580 F. 3d 1301, 1326 (Fed. Cir. 2009).
Differences between a lump-sum and a running royalty include:
Lump-sum agreements enable the licensee to quickly raise cash;
A lump-sum license benefits the patentholder in that it enables the company to raise a substantial amount of cash quickly[.]
— Lucent Technologies, Inc. v. Gateway, Inc., 580 F. 3d 1301, 1326 (Fed. Cir. 2009).
Lump-sum agreements typically cap liability for the licensor;
A lump-sum license benefits the … target [i.e., the licensee] by capping its liability and giving it the ability, usually for the remainder of the patent term, to actually use the patented technology in its own products without any further expenditure.
— Lucent Technologies, Inc. v. Gateway, Inc., 580 F. 3d 1301, 1326 (Fed. Cir. 2009).
A running royalty discourages additional output for the licensee;
A fixed fee structure eliminates risk for both parties by severing the royalty amount from the realization of future unknowns;
Lump-sum agreements may lead to ex-post regret for either party;
The lump-sum structure also creates risks for both parties. The licensed technology may be wildly successful, and the licensee may have acquired the technology for far less than what later proved to be its economic value.
— Lucent Technologies, Inc. v. Gateway, Inc., 580 F. 3d 1301, 1326 (Fed. Cir. 2009).
Lump-sum agreements are generally less expensive to monitor than running royalty agreements; and
A lump-sum license removes any risk that the licensee using the patented invention will underreport, e.g., engage in false reporting, and therefore underpay, as can occur with a running royalty agreement. Additionally, for both contracting parties, the lump-sum license generally avoids ongoing administrative burdens of monitoring usage of the invention.
— Lucent Technologies, Inc. v. Gateway, Inc., 580 F. 3d 1301, 1326 (Fed. Cir. 2009).
Lump-sum agreements are less likely to distort pricing decisions.
Lump-sum agree agreements are less prone to generating deadweight loss in the marketplace.
No matter what structure is used, a reasonable royalty must reflect the value of the infringing features alone.
Under § 284, damages awarded for patent infringement must reflect the value attributable to the infringing features of the product, and no more.
— CSIRO v. Cisco Systems, Inc., 809 F. 3d 1295, 1301 (Fed. Cir. 2015).