MPEG LA's AVC/H.264 licensing terms: further analysis

There's still a lot of controversy over the video codec question, in connection with HTML 5 and generally. I have commented on this on several occasions, most recently on Google's announcement of the "free" WebM (VP8) codec (this posting) and the subsequent modification of the WebM license.

I have received some useful clarifications from MPEG LA concerning its AVC/H.264 licensing terms and would like to share that information and comment on it in this posting. Prior to doing so, let me explain my approach to the controversial subject.

Separating politics and economics

As a long-standing opponent of software patents, I'm all for patent-free formats but I want to understand from a pragmatic point of view what the risks and opportunities are for the average software developer (FOSS as well as non-FOSS) when adopting one video codec or another:

• For WebM/VP8, there's a vague assurance by Google that its own patents, which are licensed on a royalty-free basis, are all you need. But Google doesn't publish a detailed analysis, nor do the license terms include indemnification. So it's pretty much a "trust us" story. I've seen opinions that agree with Google's view, and others who disagree. If Google offered indemnification, that would change the situation, but they don't.


• For MPEG LA's AVC/H.264 codec, patent royalties are due unless one does something that falls under an exception (such as certain kinds of non-commercial use) or the number of units sold is below a certain threshold. The patent pool is huge and from many companies, mostly large ones. Since AVC/H.264 is already extremely widespread, third parties owning patents that read on it would likely have enforced them already, which makes it reasonably likely that MPEG LA controls all of the essential patents.

From a philosophical point of view, I wish there weren't any software patents. In that case, there wouldn't (have to) be an MPEG LA. But I try hard (and encourage everyone else to try equally hard) to separate my political/philosophical preference from practical/economic considerations under the circumstances we have to live with.

In that respect, the licensing terms for AVC/H.264 play a key role. If they are reasonable (under the circumstances), then one might accept them as a practical, totally unemotional choice. There are patent holders who don't make licenses to their patents available on any terms, or not on any reasonable terms. Those strategic patent holders with an exclusionary strategy are the biggest problem as I recently explained.

Further analysis suggests the AVC/H.264 royalty cap works the way it should

MPEG LA has a royalty cap so that companies selling high-volume products know beforehand the maximum amount of royalties they'll have to pay to MPEG LA in a given year. The current $5 million cap really isn't much for a big player possibly generating many billions of annual revenues with products that include an AVC/H.264 encoder and/or decoder.

More importantly, this makes it economically possible for entities like Mozilla and Opera to give away huge numbers of web browsers to end users on a free-of-charge basis (note that Mozilla, unlike Opera, offers truly free software -- free as in free speech, not just free beer).

Two weeks ago I attended an event at Google's Brussels office: a roundtable on open source business models. Its roughly 30 participants were from a diversity of companies as well as the European Commission. When the codec question came up, I mentioned the AVC/H.264 royalty cap, and someone at the event basically claimed that I shouldn't believe what MPEG LA's website says about it because MPEG LA could charge different fees for different types of products. According to the house rules of the event, I can quote what was said but without naming the person who made the statement. So I asked that person for permission to name the source when quoting that particular statement on my blog, but the person prefers not to be named and clarified that "for most companies, they probably don't see much more than one overall fee."

That was basically a retraction of the original claim. Nevertheless I wanted to know from MPEG LA, the licensing firm that manages the AVC/H.264 pool, whether the $5M per-customer per-year royalty cap has anything to do with product categories such as smartphones versus other devices.

Here's the answer I got from an MPEG LA spokesperson:

The royalty cap for AVC Product in our AVC License includes the combined sales of all of a Licensee’s AVC Product (encoders, decoders or combination device equals one unit) in that calendar year. Therefore, a Licensee would not pay more than $5 million in royalties for any combination or amount of AVC Product it sells in 2010, regardless of what type of device it is. It should be noted that caps and royalties are subject to possible increases to be determined for the renewal term 2011-2015.

I'd like to add that MPEG LA made a commitment to keep those increases within a specified limit (see the last item on this FAQ page).

That answer suggested the cap works the way it should. I still wanted to know more about the cap: Are there any customers who for whatever reason may have to pay more than $5M in a given year? And if so, why?

And this is what MPEG LA told me:

Caps apply to each of AVC Product, OEM AVC Product distributed through a PC operating system incorporated in the end PC product of another party, and AVC Video. While rare, there are instances of a Licensee and its affiliates being subject to caps for both AVC Product as well as AVC Video in a given year. There is also instance of a Licensee being subject to caps for both AVC Product and OEM AVC Product for PC operating system product.

To avoid a misunderstanding, that doesn't mean there's a cap for each product (in which case a company with 20 products could pay up to $100 million). The term "AVC Product" means a license type. MPEG LA has three types of licenses that are relevant here and I'm quoting from the license agreement, which was provided to me on a confidential basis with permission to quote these definitions:

• AVC Product(s): "any product or thing in whatever form which constitutes or contains one or more fully functioning AVC Decoder(s), AVC Encoder(s) or AVC Codec(s). AVC Product(s) shall not include OEM AVC Products."


• OEM AVC Product(s): "AVC Product(s) sold to an OEM Licensee Customer."


• AVC Video: "video encoded in compliance with the AVC Standard"

Let me put it in more colloquial terms: If you obtain an "AVC Product(s)" license, it covers the products you build that include an H.264 codec in some form. The "OEM AVC Product license" category is a special case for companies selling a PC operating system to OEM customers (computer manufacturers who then bundle the product). And "AVC Video" is a license for those offering H.264 video content. All licenses relate to the same patent pool but to different business models.

In terms of the cap, there can be cases where companies need more than one of those three licenses. Most companies won't, but those who do may pay, for an example, twice the cap. But that doesn't mean that their costs are totally unlimited. They simply have more than one license fee account and each account has a cap.

I asked a third question about the cap: Is it true that if companies infringe your patents and have to pay back-royalties, the cap doesn't apply but they may have to pay more?

MPEG LA answered:

That is not correct. The caps applicable to any given year in which a new Licensee owes Back Royalties (with applicable interest, if any) still applies. For example, a new Licensee owes AVC Product royalties for 2007 would be subject to the cap of $4,250,000 for that year.

All things considered, the royalty cap appears reliable to me and I don't have the impression that MPEG LA tries to mislead anyone about it.

Patent enforcement: are licensees protected against infringing competitors?

I recently talked to someone who said that MPEG LA goes after some but not necessarily all patent infringers, which means that if you're a company in a given market that is forced to pay royalties and you have competitors that are not, you may be at a strategic disadvantage with others undercutting your prices. Therefore, my fourth and final question to MPEG LA was: Is it true that if a company pays royalties to you and faces significant competition from an infringer of your patents in its core market(s), the legitimate licensee has no contractual basis to require MPEG LA to go after the infringer?

MPEG LA answered:

It is correct that there is no requirement in the AVC License for litigation to be brought against an unlicensed, infringing company or organization. We actively pursue unlicensed companies or organizations that may be using the AVC standard to offer them the license, but, any litigation against a non-Licensee would brought by patent rights holders, not by MPEG LA.

The first part confirms that a licensee doesn't have a guarantee that his infringing competitors will be pursued. The second part is a legally technical thing: MPEG LA collects royalties on behalf of the actual patent holders but can't assert those patents against infringers in court. That's why litigation would have to be brought by the actual patent holders. I understand, but nevertheless I think it would be good for MPEG LA's licensees to have a legal commitment from the patent holders that they will either collect royalties from all significant players in a given market or from none of them.

One might assume that MPEG LA's obvious desire to maximize its royalty income would practically guarantee that all significant companies infringing its patents would be pursued. But the worldwide market is huge and if you have a country that's only medium-sized, then MPEG LA may decide for efficiency reasons to collect royalties only from the market leader. That one would face a risk of litigation if refusing to pay, but if that licensee's competitors don't pay because MPEG LA doesn't go after them for the time being, then that's an awkward situation for the licensee.

So while I'm (for now) satisfied with MPEG LA's answers on the royalty cap, I would like them to give some real protection to licensees in the scenario I just described, for the sake of undistorted competition. Even though litigation would be the prerogative of the actual patent holders, the license agreement could alternatively waive the obligation to pay if a licensee faces significant competition from infringers who don't pay.

I will keep following the codec debate and continue to look at licensing terms and practices.

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