Beyond the Smallest Salable Unit: How Surveys Provide a Path from Recent Case Law to an Appropriate Royalty Base

Vol. 6 No. 5

By

Alexander L. Clemons is an associate with Ocean Tomo’s expert testimony practice in the firm’s Chicago office, where he quantifies economic damages arising from intellectual property disputes and provides general litigation support.

In recent opinions, the U.S. Court of Appeals for the Federal Circuit (CAFC) has increasingly scrutinized reasonable royalty calculations and demanded that both royalty bases and royalty rates be closely tailored to the specific facts of the case at issue. In Uniloc USA, Inc. v. Microsoft Corp., the CAFC prohibited the use of the 25 percent rule,1 while in LaserDynamics, Inc. v. Quanta Computer, Inc., it provided for a very restricted application of the entire market value rule (EMVR).2 These rulings, and others like them, challenge parties, counsel, and damages experts to find new and reliable sources of evidence that can be used to more closely tie damages calculations to the unique facts of each patent infringement case.

Market research surveys, long used in trademark litigation, have begun to emerge as a promising wellspring of case-specific evidence for patent infringement litigation. Courts, parties, counsel, and experts have been quick to recognize that surveys are an ideal evidentiary tool for establishing that demand for a product is driven by its patented features, in order to support the application of the EMVR in a royalty base analysis. Conversely, a survey can refute a proposed EMVR calculation. Proponents of surveys have also advocated their use as quantitative indicators in the Georgia-Pacific factors royalty rate analysis.3 However, recent opinions emanating from various district courts interpreting LaserDynamics have indicated that there may be yet another critical role for survey evidence to play: apportioning the royalty base beyond the smallest salable unit.

LaserDynamics and the Smallest Salable Unit

In LaserDynamics, the CAFC stated that “in any case involving multi-component products, patentees may not calculate damages based on sales of the entire product, as opposed to the smallest salable patent-practicing unit, without showing that the demand for the entire product is attributable to the patented feature.”4 The court ruled that the plaintiff’s damages expert improperly employed the EMVR by failing to present evidence demonstrating that the patented component drove demand for the entire product. In an apparent nod to the usefulness of survey evidence as a measure of consumer demand, the court specifically noted that the plaintiff’s damages expert “never conducted any market studies or consumer surveys to ascertain whether the demand for [the entire product] is driven by the patented technology.”5

The court also explained the rationale behind the EMVR, stating that the rule “is derived from Supreme Court precedent requiring that ‘the patentee . . . must in every case give evidence tending to separate or apportion the defendant’s profits and the patentee’s damages between the patented feature and the unpatented features, and such evidence must be reliable and tangible, and not conjectural or speculative.’”6 In order for the EMVR to apply, “the entire value of the whole machine, as a marketable article, [must be] properly and legally attributable to the patented feature.”7 The CAFC also explained that the “fundamental concern of the entire market value rule” is to “ensure that the royalty rate applied [to the royalty base] does not overreach and encompass components not covered by the patent.”8

In accordance with this explanation of the purpose and the underpinnings of the EMVR, parties have used the smallest salable patent-practicing unit as an efficient and effective way to “apportion the defendant’s profits and the patentee’s damages between the patented feature and the unpatented features” and calculate an appropriate royalty base.

The Smallest Salable Unit Is Not Always Small Enough

In the last few months, however, district courts have begun to struggle with the question of whether a royalty base that includes the entire revenue attributable to the smallest salable patent-practicing unit is appropriate when faced with cases in which the smallest salable patent-practicing unit is an entire multicomponent product. Three cases in particular that have wrestled with this issue are Tomita Technologies USA, LLC v. Nintendo Co.,9 Dynetix Design Solutions, Inc. v. Synopsys, Inc.,10 and Network Protection Sciences, LLC v. Juniper Networks, Inc.11 In all three of these cases, the smallest salable patent-practicing unit was the entire accused product, and, under the guidance of LaserDynamics, the damages experts utilized revenues from the smallest salable patent-practicing unit—i.e., the entire accused product—as the royalty base in their reasonable royalty calculations.

In Tomita, the court remitted a jury award for patent infringement by half. The court stated that the damages expert “properly looked to the 3DS itself as the ‘smallest salable patent-practicing unit,’ and therefore did not rely on the entire market value rule.”12 The court’s rationale was that “Nintendo neither purchases nor sells components of the 3DS that infringe the [patent-in-suit]; the individual components cannot practice the patent before they are assembled and programmed with Nintendo’s software; and the 3DS is imported to the United States fully assembled.”13 However, the court went on to state that “although the entire market value rule does not apply on the facts of this case, the concerns that motivate the doctrine nonetheless speak to whether the jury’s damages award was appropriate.”14

The court noted that only the 3D camera and AR games application infringed the patent-in-suit and that these features were ancillary to the core function of the 3DS. Due to the ancillary nature of the infringing features, the mixed reception of consumers to the infringing features, and the 3DS’s lack of profitability, the judge reduced the damages award by half. Although the court did not specifically require that the royalty base be apportioned beyond the smallest salable unit, it was clearly concerned with the EMVR and the issues raised by LaserDynamics. Had the damages expert further apportioned the royalty base between infringing and noninfringing features, the resulting reasonable royalty would have been more tailored to the infringement of the patent-in-suit and the jury verdict would have been far more likely to stand.

The court in Dynetix wrestled with a similar fact pattern and excluded the plaintiff’s damages expert’s testimony specifically for failing to apportion the royalty base beyond the smallest salable unit. As in Tomita, the court recognized that the smallest salable unit was also the entire multicomponent product and that courts have “struggled with whether and how to evaluate an apportionment of the royalty base in this scenario.”15 After a discussion of several cases leading up to and including LaserDynamics, the court found that in the present case “the alleged smallest salable unit plainly is not closely tied to the patented feature” and that “LaserDynamics supports the premise that an apportionment is required even where . . . the accused product is the smallest salable unit or where whatever the smallest salable unit is it is still a multi-component product encompassing non-patent related features.”16

In light of its interpretation of LaserDynamics, the court stated:

Because [the plaintiff’s damages expert] relied on the blanket assumption that, once he selected the smallest salable unit—in this case the entire VCS product—he could end the analysis, his determination of the royalty base is fundamentally flawed. Here, the alleged smallest salable unit is not, in fact, any smaller or any different than the entire multi-component product, but rather is the multi-component VCS product. As such, “the difficult task of determining [the infringing feature’s] value relative to all other components of [the entire VCS product] remains.” [The plaintiff’s damages expert] improperly skipped this task of apportionment, and his opinion may be excluded on this basis alone.17

Ultimately, the court struck the opinion of the damages expert and granted five days to submit a new report on damages. While this may not have been completely fatal to the plaintiff’s case, having only five days to perform an apportionment of the royalty base beyond the smallest salable unit certainly put the plaintiff at a severe and unnecessary disadvantage compared to its position had it performed such an apportionment in its initial damages report.

Similarly, in Network Protection Sciences, the court excluded the plaintiff’s damages expert’s testimony for using revenues from the entire accused product as the royalty base for his damages calculation. The court noted that the damages expert “did not admit that he used the entire market value rule in his report.”18 Rather, the damages expert relied on sales data and deposition testimony to conclude that the smallest salable unit was the entire accused product. He accordingly used as the royalty base the revenue associated with the entire accused product. The court found that the expert’s “analysis was therefore based on the entire market value of the overall unit.”19 While the plaintiff argued that the damages expert had “correctly performed the apportionment analysis required by the Federal Circuit by first ascertaining the smallest salable patent-practicing unit, and then analyzing the proportion of product value derived from the allegedly infringing technology,” the court found this analysis to be incomplete.20

The court stated that “[w]hen using a multi-component product as a royalty base, even if it is the smallest salable unit, a patentee must still show that the patented feature drives demand for the entire product.”21 Although the damages expert concluded that the “patent in suit either directly or indirectly drives demand for [the accused products],” the court held that “‘[i]ndirectly’ is not good enough.”22 The court focused on the damages expert’s admissions that “product attributes enabled by the patented technology are not the only drivers of demand for the accused products,” that the accused products “contain numerous, valuable unpatented features,” and that “not all customers use the accused products in an infringing manner.”23 The court concluded:

Accepting these admissions as true, it cannot be the case that the accused features drive demand for the accused products within the meaning of LaserDynamics. . . . Using the accused products as a royalty base therefore raises the same specter of error and jury prejudice as in LaserDynamics and runs afoul of the entire market value rule.24

However, unlike in Dynetix, after striking the plaintiff’s damages expert’s report and excluding his testimony, the court refused to grant the expert leave to correct the fatal flaws in the royalty analysis, leaving the plaintiff to attempt to “cobble together a royalty case based on other disclosed witnesses and evidence.”25

While these cases dealt with instances in which the smallest salable patent-practicing unit was the entire multicomponent product, the same concerns raised by the courts arguably apply to instances in which the smallest salable unit is smaller than the entire product but still encompasses noninfringing components.

Surveys Offer a Solution

The Network Protection Sciences, Dynetix, and Tomita cases are prime examples of the useful role surveys can play for both plaintiffs and defendants when determining a proper royalty base. In the current patent infringement damages environment, judges will likely continue to closely scrutinize the nexus between the chosen royalty base and the value or demand attributable to the infringing features of the accused product. Such an environment requires a response that looks beyond the smallest salable unit. Survey results can provide a useful evidentiary basis for further apportioning the royalty base beyond the smallest salable unit that infringes the patent-in-suit. As courts begin to insist that parties demonstrate that the patented features drive consumer demand for the portion of the entire accused product accounted for by a chosen royalty base, the most intuitive solution is to simply ask consumers what portion of their demand for the accused product is driven by which features. Surveys can accomplish exactly that task.

A survey can be constructed that elicits from respondents the percentage of their demand for the smallest salable unit of an accused product that is driven by the patented features, as opposed to nonpatented features. Based on the results of such a survey, the revenue attributable to the smallest salable unit can be apportioned between the percentages of demand driven by infringing versus noninfringing features. Furthermore, in many cases there may be certain noninfringing features that, together with the infringing features, “constitute a functional unit”26 and substantially derive their value from the infringing features, according to industry data or the opinion of an industry expert. These features could arguably be considered “convoyed features” and included in the royalty base. Such an analysis should result in a royalty base that is closely tied to the demand for the accused product specifically generated by the infringing features, satisfying the recent district court interpretations of LaserDynamics.

The relationship between the product-at-issue, the smallest salable unit, the infringing features, and the convoyed features can be illustrated with the following figure. In this figure, the revenue attributable to the smallest salable unit is apportioned based on the percentage of demand for the smallest salable unit that is driven by the infringing and convoyed features. This leads to a royalty base that is apportioned beyond the smallest salable unit to the demand generated by the infringing features.

Surveys have been used in a number of recent patent infringement cases,27 often to demonstrate “that the demand for the entire product is attributable to the patented feature” as required by LaserDynamics in order to apply the EMVR.28 In these cases, district courts have at times engaged in their gatekeeping role under Daubert to exclude survey evidence deemed unreliable or irrelevant. Common errors in survey methodology generally concern the failure of the survey expert to adequately tie the survey to the specific facts of the case and often specifically concern the determination of what features to include in the survey29 and the nexus between the actual language of the patent claims and the contours of the features included in the survey.30 By working together closely from an early point in the litigation process, parties, counsel, damages experts, and survey experts can overcome these and other difficulties in designing, executing, and presenting reliable surveys to the court and use the resulting survey evidence as a principled basis for apportioning the royalty base beyond the smallest salable unit.

Endnotes

1. Uniloc USA, Inc. v. Microsoft Corp., 632 F.3d 1292, 1315 (Fed. Cir. 2011) (“This court now holds as a matter of Federal Circuit law that the 25 percent rule of thumb is a fundamentally flawed tool for determining a baseline royalty rate in a hypothetical negotiation. Evidence relying on the 25 percent rule of thumb is thus inadmissible under Daubert and the Federal Rules of Evidence, because it fails to tie a reasonable royalty base to the facts of the case at issue.”).

2. LaserDynamics, Inc. v. Quanta Computer, Inc., 694 F.3d 51, 67 (Fed. Cir. 2012) (“Where small elements of multi-component products are accused of infringement, calculating a royalty on the entire product carries a considerable risk that the patentee will be improperly compensated for non-infringing components of that product. Thus, it is generally required that royalties be based not on the entire product, but instead on the ‘smallest salable patent-practicing unit.’ The entire market value rule is a narrow exception to this general rule.” (citation omitted)).

3. See Georgia-Pacific Corp. v. U.S. Plywood Corp., 318 F. Supp. 1116 (S.D.N.Y. 1970).

4. LaserDynamics, 694 F.3d at 67–68.

5. Id. at 69.

6. Id. at 67 (emphasis added) (quoting Garretson v. Clark, 111 U.S. 120, 121 (1884)).

7. Id. (alteration in original).

8. Id. at 70.

9. Tomita Techs. USA, LLC v. Nintendo Co., No. 1:11-cv-04256-JSR, 2013 WL 4101251 (S.D.N.Y. Aug. 14, 2013).

10. Dynetix Design Solutions, Inc. v. Synopsys, Inc., No. 5:11-cv-05973-PSG, 2013 WL 4538210 (N.D. Cal. Aug. 22, 2013).

11. Network Protection Scis., LLC v. Juniper Networks, Inc., No. 3:12-cv-01106-WHA (N.D. Cal. Sept. 26, 2013), ECF No. 334.

12. Tomita, 2013 WL 4101251, at *8.

13. Id.

14. Id.

15. Dynetix, 2013 WL 4538210, at *3.

16. Id.

17. Id. at *4 (footnotes omitted).

18. Network Protection Scis., LLC v. Juniper Networks, Inc., No. 3:12-cv-01106-WHA, slip op. at 10 (N.D. Cal. Sept. 26, 2013), ECF No. 334.

19. Id.

20. Id., slip op. at 11.

21. Id.

22. Id., slip op. at 13.

23. Id.

24. Id.

25. Id., slip op. at 14. The plaintiff ultimately dropped the lawsuit.

26. Rite-Hite Corp. v. Kelley Co., 56 F.3d 1538, 1550 (Fed. Cir. 1995).

27. See TV Interactive Data Corp. v. Sony Corp., 929 F. Supp. 2d 1006 (N.D. Cal. 2013); Microsoft Corp. v. Motorola, Inc., 904 F. Supp. 2d 1109 (W.D. Wash. 2012); Apple, Inc. v. Samsung Elecs. Co., No. 11-CV-01846-LHK, 2012 WL 2571332 (N.D. Cal. June 30, 2012); Apple, Inc. v. Motorola, Inc., No. 1:11-CV-08540, 2012 WL 1959560 (N.D. Ill. May 22, 2012); Oracle Am., Inc. v. Google Inc., No. C 10-03561 WHA, 2012 WL 850705 (N.D. Cal. Mar. 13, 2012); Lucent Techs., Inc. v. Microsoft Corp., 837 F. Supp. 2d 1107 (S.D. Cal. 2011); Lucent Techs., Inc. v. Microsoft Corp., No. 07-CV-2000, 2011 WL 7664416 (S.D. Cal. June 16, 2011); Fractus, S.A. v. Samsung, No. 6:09-cv-203-LED-JDL, 2011 WL 7563820 (E.D. Tex. Apr. 29, 2011); Mirror Worlds, LLC v. Apple, Inc., 784 F. Supp. 2d 703 (E.D. Tex. 2011), aff’d, 692 F.3d 1351 (Fed. Cir. 2012).

28. LaserDynamics, Inc. v. Quanta Computer, Inc., 694 F.3d 51, 67–68 (Fed. Cir. 2012).

29. See TV Interactive Data, 929 F. Supp. 2d 1006; Oracle Am., 2012 WL 850705.

30. See Fractus, 2011 WL 7563820.

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