The Patents Act 1977 (as amended January 2005) provides a claimant with a choice between an enquiry as to damages or an account for profits. Should it choose the former, a component of the claim may include damages for price erosion. The complexity associated with quantification of patent damages is magnified when the effects of price erosion on the claimant’s (i.e., patentee’s) sales are included as a component of damages. This article addresses the relevant issues economic experts should consider when evaluating the effect of price erosion on the quantification of patent damages.

An economic description of price erosion

A patent provides its holder with the right to exclude others from making, using or selling the patented invention. The right to exclude is limited by the length of the patent and the scope of the patented invention. From an economic perspective, a patent confers upon its owner a limited monopoly or market power or, more simply stated, an ability to affect the price of its patented good. Price erosion occurs when a patentee is kept from raising prices or is forced to lower prices as a result of a competitor entering the market and decreasing the patent holder’s market power through infringement. The role of the economic expert is to determine what the price would have been “but for” the infringement.

In a monopoly, the patent holder has the ability to set price. Typically, the monopoly price is higher than the price that would have been set by the market in a competitive situation. Demand curves slope downward. As the price of a product increases the quantity demanded decreases. The elasticity of demand (i.e., the percentage change in quantity divided by the percentage change in price) is a measure of the slope of the demand curve. When the percentage decline in the quantity demanded is greater than the percentage increase in price, the elasticity of demand is greater than one and is considered elastic. Conversely, when the percentage decline in the quantity demanded is less than the percentage increase in price, the elasticity of demand is less than one and considered inelastic.

The economic relationship between the quantity demanded and price has important implications for quantifying price erosion damages. It is imperative that an economic expert forms an opinion on the elasticity of demand and the impact of a price change on the “but for” quantities. The First Law of Demand states, ceteris paribus, that as the price of a product increases consumers will purchase less. The price/quantity relationship poses an additional challenge for a claimant since he must also establish what proportion of the infringing sales, if any, he would have been able to achieve at the higher price.

Guidance from the court

As reaffirmed by the Court of Appeal in Gerber Garment Technology Inc. v. Lectra Systems Ltd. (1997) R.P.C. 443, patent infringement is a statutory tort, whereby damages are quantified by reference to the following rules:

“(1) that the overriding principle is that the victim should be restored to the position he would have been in if no wrong had been done; and (2) that the victim can recover loss which was (i) foreseeable, (ii) caused by the wrong, and (iii) not excluded from recovery by public or social policy.”

The issue of price erosion is dealt with in United Horse-Shoe & Nail Co. v. Stewart and American Braided Wire Co. v. Thomson (See McGregor on Damages Seventeenth Edition para 40-031). These two cases provide an indication of how the above rules are implemented in the framework of price erosion damages. For example, in United Horse-Shoe & Nail Co. the court found that the presence of non-infringing competition was the primary reason for the reduction in the claimant’s prices and denied the claimant from recovering price erosion damages. Conversely, in American Braided Wire Co. the court awarded price erosion damages on all the claimant’s sales on the basis that the defendant’s sale of infringing bustles caused the erosion of prices.

The court has also recognised the importance of the quantity/price relationship. In Gerber Garment Technology Inc. v. Lectra Systems Ltd. (1995) R.P.C. 383, it was noted that “…in considering the price depression claim I think it fair to assume that Gerber might not have sold so many machines if they had maintained higher prices.” The impact of the price elasticity of demand on price erosion damages has also been addressed by US Courts in Crystal Semiconductor Corporation v. TriTech Microelectronics International, Inc. 246 F.3d 1336 (Fed. Cir. 2001). Specifically, this case noted that:

“In a credible economic analysis, the patentee cannot show entitlement to a higher price divorced from the effect of that higher price on demand for the product. In other words, the patentee must also present evidence of the (presumably reduced) amount of product the patentee would have sold at the higher price…”

US courts have also held that that price erosion damages may continue even after the infringement ends (See Brooktree Corp. v. Advanced Micro Devices, Inc., 977 F.2d 1555, 1581 [Fed. Cir. 1992]).

Methodologies for quantifying price erosion

Based on a consideration of economics and guidance from the court, the claimant must establish what its price would have been “but for” the infringement. Broadly speaking, the methodologies employed by economic experts for quantifying the amount of price erosion damages can be grouped into three approaches: (1) the direct computation approach; (2) the before and after approach; and (3) the benchmark approach. Under the direct computation approach price erosion damages are quantified based on direct evidence of price reductions resulting from specific instances where the claimant and infringer competed on a head-to-head basis. The direct computation approach seeks to identify, on a customer-by-customer basis, instances where the claimant and infringer competed for the same business on the basis of price. In contrast, the before and after approach considers price erosion damages from a macro perspective, whereby price erosion damages are quantified by reference to a comparison between the prices achieved by the patentee prior to infringement and those achieved during infringement. The benchmark approach, quantifies price erosion damages by proxy to the prices in other markets or the prices of other goods that were not impacted by the alleged infringement.

Regardless of the specific methodology used, the patentee must demonstrate: (1) the price before infringement was higher, or the market would have supported higher prices, absent infringement; and (2) the price reduction resulted from the acts of the infringer and not from some other event. This is typically proven with corroborating evidence such as the pricing history of similar products, contemporaneous sales and marketing reports, correspondence (including emails), marketing documents and business plans, and proposals and quotes.

Putting the pieces together

It is important to remember that each damage case is unique and depends on the specific facts and circumstances facing the parties. Accordingly, it is not possible to distil the quantification of price erosion damages into a catchall generic model. However, in order to ensure the presentation of a robust damage calculation an economic expert should, at a minimum, consider the following steps: (1) understand the economics surrounding price erosion both generally and in relation to the specific facts and circumstances of each matter; (2) understand the relevant case law and the level of evidence required to prove a claim of price erosion; and (3) choose an appropriate damage methodology.

A final word

A reliable quantification of price erosion damages requires the effective integration of economics and law. Damages arising from price erosion can be substantial, require detailed and specialised analysis, and are often difficult to explain. It requires a significant investment of time to understand the issues, the relevant court guidance, and the economic theory surrounding price erosion damages. When viewed in this light, the importance of the role of an economic expert in quantifying the affect of price erosion on patent damages becomes all too apparent.

Gregory J. Urbanchuk is a Senior Manager in the Forensic Services Group of Baker Tilly and specialises in the quantification of damages surrounding intellectual property disputes. Gregory can be reached via email at gregory.urbanchuk@bakertilly.co.uk.

Richard J. Gering Ph.D. is a Principal in the Forensic & Litigation Group of Parente Randolph LLC, an independent member of Baker Tilly International, and provides consulting assistance including economic and statistical analyses related to intellectual property disputes and has testified in various courts in the United States. Richard can be reached via email at rgering@parentenet.com.