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18.01 Analysis 164 18.02 Discovery 165

Price erosion is the poor stepchild of lost-profi ts analysis. It is all too oft en forgotten, and even when used is oft en misapplied. Where the plaintiff is in the business of selling products covered by the patent, but may have a hard time establishing that it has actually lost sales as a result of the defendant’s infringement, it may very well be able to show that that such infringement caused it to lower its prices or even that it was unable to raise its prices as substantially as it would have otherwise. Even if a plaintiff can show some lost sales, it may be able to supplement this award by showing price-erosion damages for sales that it did make, albeit at a lower price.

Th e remedy of price erosion has been around for well over 100 years and is based on the economic rationale that the defendant, which did not have to incur the expense of developing the patented invention, is able to sell the infringing item at a lower price than the plaintiff , which still has to recover these sunk costs. Th e plaintiff is consequently being deprived of its ability to assert patent monopoly and exclude rivals from competing with it using the patented invention, thus enabling it to keep prices high. Th e defendant’s infringement enables it to unfairly undercut the patentholder’s prices, forcing the patentee to lower its own prices and thus reduce profi ts.

Th e ability of a plaintiff to recover lost-profi ts damages for price erosion was specifi cally recognized as a remedy by the Supreme Court in Yale Lock Mfg. Co. v. Sargent , 117 U.S. 536, 551–53 (1886). As the court noted, “[r]eduction of prices, and consequent loss of profi ts, enforced by infringing competition, is a proper ground for awarding of damages. Th e only question is as to the character and suffi ciency of the evidence in the particular case.” Sargent was entitled to recover these price-erosion damages since the defendant, who was infringing

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Sargent’s turning-bolt patent “reduced the price of his lock, forcing Sargent to do the same, in order to hold his trade. Th e evidence shows that the reduction of prices by Sargent was solely due to the defendant’s infringement.”

Th e proof that the plaintiff must present to recover price-erosion damages is similar to that necessary to prove lost profi ts arising from lost sales: Th e patentee must show that, but for the infringement, it would have been able to charge and receive a higher price. It is not necessary that the plaintiff knew that the competing system infringed its patent when it reduced its prices. It need only establish that, but for such unfair competition, it would have been able to charge more. Vulcan Eng’g Co. v. FATA Aluminium, Inc. , 278 F.3d 1366, 1377 (Fed. Cir. 2002).

Th e burden for the plaintiff that is seeking price-erosion damages is, of course, to show (a) what its prices would have been absent infringement and (b) how much of this price decrease is attributable to the actions of the defendant, as opposed to normal market forces, such as technological obsolescence. As the Federal Circuit noted in Ericsson, Inc. v. Harris Corp. , 352 F.3d 1369, 1379 (Fed. Cir. 2003), “the patentee’s price erosion theory must account for the nature, or defi nition, of the market, similarities between any benchmark market and the market in which price erosion is alleged, and the eff ect of the hypothetically increased price on the likely number of sales at that price in the market.” Id.

Essentially, the plaintiff must establish a separate, hypothetical, market in which the defendant did not infringe the plaintiff ’s patent — either by not being in the market at all or by competing using another, non-infringing technology. Th e plaintiff must then take into account all of the real-world events that actually took place, including the existing competition from other, non-infringing, competitors and then attempt to prove what its prices would have been in this hypothetical world.

Th e task of convincingly presenting such an argument to a jury seems daunting, and it is. However, as the Ericcson court noted, one way parties have been able to present this argument is by using “benchmarks” — that is, by comparing the market for the patented product, where competition is tainted by the defendant’s infringement, with the market for a similar product (hopefully one of plaintiff ’s other products) where there is no competition from an infringer. Th e plaintiff will argue that the pricing for the patented product would have behaved similarly to that of the untainted product.

Th is was the methodology used by the plaintiff ’s expert in Ericcson : “To make out its theory of price erosion, Ericsson again relied on the expert testimony of Jackson, who used a ‘benchmark methodology’ to assess price erosion. Jackson compared the performance of the patented product, the Ericsson 3764 SLIC, in the market aff ected by infringement with that of a similar product, the Ericsson 3762 SLIC, in a market free of infringement.” However, the use of a hypothetical market methodology to forecast prices

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Paying Attention to the Demand Curve

is fraught with peril — even more than forecasting lost sales — because the selection of the proper benchmark market will never be exactly right, and all of the other economic implications of a plaintiff charging a higher price than it actually did must be factored in.

Th e fi rst problem — picking the wrong benchmark markets — was criticized by the Federal Circuit in Crystal Semiconductor Corp. v. Tritech Microelectronics Int’l , 246 F.3d 1336, 1361 (Fed. Cir. 2001). In that case, the hypothetical market in which the plaintiff would have competed even without the defendant’s infringement was still competitive, subjecting the plaintiff ’s product to some price pressures that would have kept the plaintiff ’s pricing in line. Th e bench- mark markets used by the plaintiff ’s expert to generate the plaintiff ’s prices absent infringement, on the other hand, were not substantially competitive and enabled the plaintiff to charge higher prices. Since the benchmark markets were substantially dissimilar to the hypothetical market, the court found that the plaintiff ’s expert’s opinion was unreliable. Th e Federal Circuit was unsym- pathetic to the plaintiff ’s inability to fi nd an appropriate benchmark: “However, just because the marketplace does not supply another market for compa- rison, a poor benchmark cannot supply suffi cient evidence to show the likely reaction of this PC market ‘but for’ infringement. Economists can defi ne hypothetical markets, derive a demand curve, and make price erosion approx- imations without relying on inapposite benchmarks.”

Th e more substantial problem, however, is incorporating the eff ect of the plaintiff ’s ability to charge higher prices into its overall claim for lost profi ts. As elementary economics points out, when a seller charges a high price for a product, its sales will tend to go down. Th e extent to which demand decreases as a result of prices going up is known as price elasticity. Th e situation in which demand is completely unaff ected by price increases (e.g., sale of bottled water aft er an earthquake) is called an inelastic market and is very rare.

What many a plaintiff has tried to do, however, is to separate its claims for lost profi ts and price erosion — claiming that the defendant’s infringement caused it to lose X sales and that the infringement also caused its prices to go down by Y amount. Th ese two claims were then added together.

However, in Crystal Semiconductor , the Federal Circuit called a halt to this practice, noting that “All markets must respect the law of demand.” Th e court emphasized the basic economic principle that “according to the law of demand, consumers will almost always purchase fewer units of a product at a higher price than at a lower price, possibly substituting other products.” Th us, since “in a competitive market, sales quantity reacts to price changes,” where a plaintiff is seeking to recover lost profi ts based on price erosion — claiming that “but for” the infringement its prices would have been higher — “a patentee must produce credible economic evidence to show the decrease in sales, if any, that would have occurred at the higher hypothetical price.”

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18.01 Analysis

Consideration of damages resulting from price erosion must be part of every plaintiff ’s lost-profi ts analysis. Because of the substantial roadblocks in showing that a plaintiff actually lost sales to a defendant because of its infringement and in recovering all of the injury suff ered by the plaintiff even if it is able to prove lost sales, the plaintiff must make sure that it has fully taken this factor into account.

Because of the Federal Circuit’s fi rm instruction that the hypothetical reconstructions of the market necessitated by any lost-profi ts analysis must be economically rigorous (and its willingness to strike down damages awards that do not meet this standard), the plaintiff must be very careful in its metho- dology and sacrifi ce economic rigor for seeking a damages award that, while high, will not stand up under close scrutiny. Conversely, the defendant should seek every opportunity to question the reliability of the plaintiff ’s analysis and dispute the comparisons the plaintiff makes between the benchmark market and the hypothetical market. Considering the number of hoops the plaintiff must jump through in order to obtain an award of price-erosion damages, the defendant’s ability to take potshots at the plaintiff ’s analysis can oft en bear fruit by making the plaintiff ’s entire analysis look questionable.

First, the plaintiff must choose the benchmark market with care. Th e products in the benchmark market must be as similar as possible to the patented product, and, even more important, the market structure must be similar in terms of the eff ect such competition would have on pricing. Obviously, there will never be a perfect match — the defendant should take advantage of every diff erence.

Second, the plaintiff must take proper account of the natural decrease in prices over the life of a product and of improvements in technology. Ascribing such natural price decreases to competition from an infringing product will make the plaintiff ’s entire analysis appear unreliable. Conversely, the defendant should argue, to the greatest extent possible, that all price decreases that the plaintiff claims were caused by infringement were, in fact, caused by the eff ect of technological obsolescence.

Th ird, the plaintiff must properly take into account the eff ects of legitimate competition from others in the market that do not infringe and that would have been present even in the hypothetical reconstructed market. Since, as has been shown, a truly two-player market is fairly unusual, this is fertile ground for a defendant to undercut the accusations that it was responsible for all, or even most, of the price-erosion damages claimed by the plaintiff .

Finally, it is extremely important that the plaintiff properly account for the eff ect of the elasticity of the market in claiming both price-erosion damages and lost profi ts from lost sales. Too many plaintiff s, in an eff ort to expand their damages claim, have posited an inelastic market that is uniquely immune from the competing pressures of price and demand. Th is analysis, even if it gets past the jury, is unlikely to hold up at the Federal Circuit.

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18.02 Discovery

Th e parties’ discovery on this point will be similar to that being done for other factors relevant to lost profi ts. Th e pricing and sales of the plaintiff ’s patented products as well as any benchmark products must be fully explored, in addition to the pricing and sales of the infringing product. Th e relationship between price and demand should become evident as a result of this analysis. Discovery on this relationship issue from third parties should also be considered.

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