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The Analytical Approach

As a remedy for damages to plaintiffs, reasonable royalties have been developed through statutes and by the court, although the former have not mandated how to determine a reasonable royalty. The analytical approach to determine a reasonable royalties is based on comparing the profits expected by the infringer prior to the alleged act, with a normal or reasonably expected profit margin, such as profits typically earned in its industry; the difference is the infringer’s excess profits above a normal return. This difference becomes an amount from which a reasonable portion can be derived as royalties.

A key concept in this approach is that it leaves the infringer with at least a normal profit while also assigning a return to the owner of the intellectual property. The analysis considers the profitability of the infringer and its affordability to pay a royalty to avoid infringement by determining whether there was expected to be excess profits above a normal return. Another key element of this method of determining reasonable royalties is the use of anticipated profits from infringement, not the actual profits, thus-aligning the analytical approach with the hypothetical negotiation approach generated by the 15 factors enumerated in the Georgia-Pacific case. Indeed, the analytical approach is often used in conjunction with the hypothetical approach.

An application of the analytical approach is found in TWM MFG.Co. v. Dura Corp. [789 F.2d 895, 899, 299 U.S.P.Q. 525 (Fed. Cir. 1986)]. The special master in this suit determined that an internal memo of the infringer projected a gross profit on the infringing sales of 52.7 percent; after over head expenses were deducted, the net profit on infringing sales ranged from 37 to 42 percent. A reasonable royalty of 30 percent was concluded based on deducting 12.5 percent as the high end of the range for the industry normal net profit margin, from the high end of the net profit of 4 percent. A reasonable royalty of 30 percent was awarded, which was affirmed on appeal.

In using this method to determine reasonable royalties, consideration is given to the determination of which profit level of the infringer’s profits is the appropriate one for analysis; for example, the TWM case used net profits rather than the frequently used level of gross profit. In certain situations, there may be little or no industry data to develop a norm for comparison to expected profits. There may be no other products outside the company in question of comparison to the expected return. Also, situations arise in which the comparison of the expected profit level of a new product is made to the profits from a prior product to determine the difference between the expected return and the prior of normal return. There also may be no “normal” profits to compare to the expected profits. For example, as pointed out by Russel L. Parr in the 2d edition of Intellectual Property Infringement Damages, industry data for “normal” profits may not include the additional costs needed to introduce a product into the market.

The elements included in the analytical approach to determine reasonable royalties are matters of judgment that will depend on the facts and circumstances of each individual situation. This method is bur one of several approaches determining reasonable royalties and evaluation of the situation and judgment is also involved in deciding the amount of weight to apply to conclusions from this approach and the extent to which other methods are used.

An example of applying the analytical method to determine reasonable royalties appeared in Michael Mard’s Financial Factors column published in the January 2001 edition of The Licensing Journal. Mard was a damages expert retained by All Pro Sports camps in its suit against Walt Disney Company for theft of trade secrets and breach of contract and breach of confidential relationship. To determine reasonable royalties for damages purposes, Mard applied the analytical method to his estimate of Disney’s margins for theme park operations, and he also applied a market approach by comparing royalty rates derived from his firm’s Intellectual Property Transaction Database. From Disney’s 10-K report, Mard determined profit margins during the damage periods for the theme parks and resorts business segment to establish the profitability and affordability of Disney to pay royalties for a new sports complex in Orlando. He compared Disney’s operating margins with median operating margins for relevant SIC codes during the same periods to determine under the analytical method, Disney’s excess margins available for incremental payments to a licensor.

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