FormalPara Definition

Cross-licensing is an agreement between two or more parties in which each party grants rights to the others to use its intellectual property (IP). There are many types of cross-licenses. Most prevalent are bilateral patent cross-licenses used in complex technology industries such as information and communications technology (ICT) and pharmaceuticals.

Firms use cross-licensing to exchange rights to use each other’s intellectual property (IP). Cross-licensing may include all types of IP – patents, copyrights, trademarks and know-how. Most prevalent are patent cross-licenses used in complex technology industries to provide ‘freedom to design’ without risk of infringement, to avoid litigation or to round out product lines. Cross-licenses typically include balancing royalty payments based on the net contributions of each party’s patents to the other’s products. If contributions balance they may occasionally be royalty-free. Most often a cross-license is a bilateral agreement tailored to the specific needs of the parties. A patent pool, in which several firms license their patents for a technology as a group, is also a type of cross-license.

Types of Cross-Licensing

A main use of cross-licensing is in field-of-use patent portfolio cross-licenses (Grindley and Teece 1997). In complex technology industries such as ICT and pharmaceuticals many firms are active in the same technology area. Technological development is rapid and builds on existing technology with short life cycles. Firms generate large numbers of patents and may infringe each other’s patents, often unintentionally. It may be difficult to avoid other patents, especially if they are implicated in a standard. This leads to overlapping patent ‘thickets’ from different firms (Shapiro 2001; Ziedonis 2004). Firms, therefore, often cross-license entire portfolios of patents to ensure ‘freedom to design’ or ‘patent peace’ to develop technology without worrying about mutual infringement. This avoids the costs of firms designing around one another’s patents or of searching for possible infringements.

Portfolio cross-licensing simplifies the task of licensing large numbers of patents. Although cross-licenses may apply to specific patents, more often they include all of the firm’s patents for application in a field of use without identifying individuals, as well as new patents granted during the licence period. At the end of the patent period, say 5 years, there may be capture rights for the licensee to continue to use patents issued up to that date, or all rights may cease. Specific patents or fields of use may be excluded if the owner believes they are of exceptional strategic value.

Firms also use cross-licensing to round out their product offerings. Pharmaceutical companies might cross-license each other’s proprietary technology, providing each other with more balanced product lines. Firms might agree to cross-license each other’s rights to use brand names.

In a typical patent cross-license no know-how is exchanged. The firms already have the capabilities to develop technology and a cross-license is effectively an agreement not to sue each other for infringement. Other types of cross-license may also include knowhow and training in how to use a firm’s technology. Know-how licences are more complex than pure patent licences and typically have a higher royalty rate. They may be part of a more elaborate agreement or joint venture.

Royalties

Although cross-licensing provides freedom to design this does not mean that cross-licenses are royalty-free. Royalties are paid based on the relative contributions of one firm’s technology to the other’s products, with a balancing payment made to the party with the most valuable portfolio.

Royalties are typically assessed in licensing negotiations using a version of the ‘proud list’ procedure (Grindley and Teece 1997). This estimates the likely contribution of each party’s patents to the product earnings of the other. A sample group of each firm’s most valuable patents may be rated on a scale of 0–1 for quality, validity and economic contribution to the other firm’s products. These factors are multiplied by a reference royalty rate to develop an effective rate for each patent. The rates are calculated for all main patents and applied to the expected royalty base of affected product sales to determine a royalty amount per annum. The implied amounts for the two firms are balanced to give a net payment to the firm with the most valuable portfolio. From this base the parties negotiate a final balancing royalty, according to the firms’ bargaining powers. Final royalties may also allow for market pressures on royalties such as potential ‘royalty stacking’ if a licensee expects a series of claims from other licensors (Geradin et al. 2008; Lemley and Shapiro 2007). The royalty is typically expressed as a running royalty rate applied to the licensee’s total sales. Alternatively, the parties may prefer a lump sum or combination.

The final royalty payment represents the balance of the two portfolios rather than their absolute values so there may be some variation. Cross-licensing royalties paid by a firm with many patents to trade will be lower than for a firm with few valuable patents. This makes it difficult to compare royalties in different cross-licenses which depend on specific product and patent combinations. Occasionally, the contributions, or potential litigation strength, of each portfolio may be roughly equal and the parties may waive royalty payments.

Firms may strengthen their bargaining positions and reduce their royalty payments by building up their patent portfolios, either by research and development (R&D) activities or by purchasing patents from other firms, who either may have unused patents or who have now left the industry. Although buying patents can be expensive this can make good business sense as it would reduce a royalty bill.

Licensing and Competition

Firms should be aware of potential competition concerns related to cross-licensing. A cross-license should not act to raise competitors’ costs unfairly or be a front for collusion. However, different royalty rates for differently situated firms should not in themselves indicate unfair competition. An entrant with no technology to trade is likely to pay higher royalties than an established firm with an active R&D programme. Differences in royalties may reflect the true costs of technology needed to participate in the industry, paid either in cash or in kind.

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