How Licensing a Portfolio of Standard-Essential Patents Is Like Buying a Car
A driver wants to replace her old BMW 328i with a new Toyota Camry. At the dealership, she decides to accept the dealer’s offer to trade in her used car and receive a credit (a “trade-in allowance”) toward the price of the Camry. The dealer and the driver are each, in effect, simultaneously buying and selling in this transaction. The dealer offers to buy the used BMW at a price equal to the trade-in allowance. The better the condition of the used BMW, the higher the credit the dealer will grant the driver toward the net price—that is, the total amount of cash exchanged for the new Camry. If the BMW’s fenders were rusted, the dealer would offer less than he would pay if the car were in pristine condition.
An analogous transaction occurs when two patent holders cross-license their respective patent portfolios. Each patent portfolio commands a particular royalty payment from the counterparty. Typically, the royalty specified in a cross license is a net-balancing royalty that one party must pay to the other -that is, the difference between the one-way royalties that each party owes the other for the use of its respective patent portfolio.
The net-balancing royalty, or the cash exchanged, will equal the difference between the royalty for the more valuable portfolio and the royalty for the less valuable one.
The values that the parties’ patent portfolios generate for the other determine which party is the net payer and which the net recipient of royalties and the amount of the net-balancing royalty. The net-balancing royalty is analogous to the net price of the new Camry.