The Economics of Reasonable Royalty Damages: The Limited, Proper Role of the So-Called “Analytical Method”, 49 J. Marshall L. Rev. 1 (2015)

The John Marshall Law Review Volume 49 | Issue 1 Article 1 Fall 2015 The Economics of Reasonable Royalty Damages: The Limited, Proper Role of the So-Called “Analytical Method”, 49 J. Marshall L. Rev. 1 (2015) Mark Glick David Mangum Follow this and additional works at: http://repository.jmls.edu/lawreview Part of the Intellectual Property Law Commons, and the Legal Remedies Commons Recommended Citation Mark Glick & David Mangum, The Economics of Reasonable Royalty Damages: The Limited, Proper Role of the So-Called “Analytical Method”, 49 J. Marshall L. Rev. 1 (2015) http://repository.jmls.edu/lawreview/vol49/iss1/1 This Article is brought to you for free and open access by The John Marshall Institutional Repository. It has been accepted for inclusion in The John Marshall Law Review by an authorized administrator of The John Marshall Institutional Repository. THE ECONOMICS OF REASONABLE ROYALTY DAMAGES: THE LIMITED, PROPER ROLE OF THE SO-CALLED “ANALYTICAL METHOD” MARK A. GLICK AND DAVID G. MANGUM * I. II. INTRODUCTION .................................................................... 1 THE ANALYTICAL METHOD ................................................. 4 A. Pre-Federal Circuit Roots ............................................4 B. Post-Federal Circuit Creation Applications of the Analytical Method ........................................................8 C. Increased Incidence of Use of the Analytical Method ........................................................................14 III. ECONOMIC DEFICIENCIES OF THE “ANALYTICAL METHOD” ........................................................................... 22 A. Ascertaining an Appropriate Proxy for “Normal” Profits ..........................................................................22 B. Properly Attributing “Excess” Profits to the Patented Invention .....................................................................25 IV. THE FEDERAL CIRCUIT’S APPLICATION OF ECONOMIC PRINCIPLES IN THE LOST PROFITS ARENA AS A PATTERN FOR FUTURE DEVELOPMENTS IN REASONABLE ROYALTY ANALYSIS ........................................................................... 28 V. ECONOMIC INROADS TO FEDERAL CIRCUIT LAW ON REASONABLE ROYALTIES: PROPERLY LIMITING THE ANALYTICAL METHOD ....................................................... 32 VI. CONCLUSION ..................................................................... 37 I. INTRODUCTION The patent statute directs that “[u]pon finding for the claimant the court shall award the claimant damages adequate to compensate for the infringement, but in no event less than a reasonable royalty for the use made of the invention by the * Professor of Economics, University of Utah, and Trial Lawyer, IP Litigation Section, Parsons Behle & Latimer, respectively. The views expressed herein are those of the authors and do not necessarily reflect the views of their respective organizations or clients. The authors would like to thank Jeff Marowits and Samantha Price of Keystone Strategy for their valuable comments and input into this paper. 1 2 The John Marshall Law Review [49:1 infringer . . . .” 1 The statute, therefore, defines two general categories of damages recoverable for patent infringement—lost profits or a reasonable royalty. The requirements for legal causation (as well as the express language of the statute) compel that both forms of damages are properly tied and limited to the infringing activity. Upon proper proof, lost profits are recoverable, but those profits are only to “compensate for the infringement.” 2 The task of the trier of fact, and the lawyers and experts who inform the trier of fact, is to reconstruct the “but for world.” What would the patent owner’s financial condition have been had the infringer not infringed? The patent owner is only to be compensated for the infringement, not for factors extraneous to use of the patented invention. Reasonable royalty damages are similarly properly limited to compensate “for the use made of the invention by the infringer.” 3 Both the royalty base and the royalty rate must be circumscribed by the value added by the patented invention. Values attributable to non-claimed features of a product or method of manufacture, or to any other extraneous factor (e.g., business acumen, advertising, reputation) are properly excluded from the calculus. And it is the duty of the judge to make sure that reasonable royalty damages models presented to triers of fact are properly so circumscribed. While both forms of damages are properly limited to the value added by the patented invention, they do differ in terms of their focal point. Lost profits damages look to the benefit lost by the patent owner. Accordingly, it is the patent owner’s “but for” price, sales volume, manufacturing and marketing capacity, and profit margin—not those of the infringer—that are most relevant. 4 In contrast, reasonable royalty damages focus on the value of “the use made of the invention by the infringer” 5—or perhaps, more accurately, the anticipated value of the use to be made of the invention at the time the infringement began, for it is that anticipated value that drives half of the willing licensor/willing licensee analysis. Accordingly, the evidentiary and expert inquiry is properly focused on the infringer’s anticipated price, sales volume, cost structure, and profit margin. Microeconomic principles inform both of these inquiries and triers of fact confronted with either (or both) type of damages will benefit from cogent analysis from economic professionals. 1 35 U.S.C. § 284 (West 2012) (emphasis added). 2 Id. 3 Id. 4 Panduit Corp. v. Stahlin Bros. Fibre Works, Inc., 575 F.2d 1152, 1156 (6th Cir. 1978). 5 35 U.S.C. § 284. 2015] The Economics of Reasonable Royalty Damages 3 But, how does one go about determining what is “adequate to compensate for the infringement” or a “reasonable royalty for the use made of the invention by the infringer”? In recent years, the Federal Circuit has significantly reshaped the law of lost profits in a direction aligned with microeconomic principles. 6 More recently, the Federal Circuit appears to have initiated a similar overhaul of the rules for calculating a reasonable royalty. 7 That process is at an earlier stage of development, however, and, at least in our view, could benefit from a more fulsome understanding of the underlying microeconomic principles and a more careful application of their teachings. We offer this modest contribution to that quest. In particular, our thesis is that the so-called “analytical method” approach to a reasonable royalty, as applied by some damages experts and some courts, cannot be reconciled with basic economic principles. We argue that, once the economic flaws in that method are corrected, the analytical method is not, as some have professed, an entirely separate methodology from the willing licensor/willing licensee paradigm, 8 but rather resolves down to basically one o (...truncated)