Court: District Court, W.D. Wisconsin; March 27, 2012; Federal District Court
SanDisk Corp. holds several patents related to flash memory technology and licenses them under broad agreements. Defendants Kingston Technology Co. Inc. and Kingston Technology Corp. contested these agreements, claiming they imposed unreasonable trade restraints beyond the legal scope of patent monopolies. For Kingston to succeed, it needed to demonstrate that SanDisk's licensing terms exceeded patent boundaries and had an anticompetitive effect on the USB flash drive market in the U.S. Kingston failed to prove the latter, resulting in a judgment in favor of SanDisk on Kingston's counterclaims under Section 1 of the Sherman Act and the California Unfair Competition Law.
Regarding evidentiary matters, both parties disputed the inclusion of certain deposition testimonies submitted instead of live testimony. The judge addressed these objections, favoring the party who presented the testimony, and ruled that depositions from certain witnesses who also testified live could be used as per Federal Rule of Civil Procedure 30(b)(6). One significant dispute involved Kingston’s attempt to submit deposition testimony from Brett Reed, SanDisk's damages expert in previous cases. The court deemed Reed's testimony inadmissible due to hearsay, as SanDisk had not provided expert reports or listed him as a trial witness. Kingston argued SanDisk's objection was untimely, but the court found no merit in this claim since Kingston was aware of the objections prior to trial and did not call Reed as a witness.
Kingston argues for the admissibility of Reed’s prior deposition testimony as a party admission under Fed. R. Evid. 801(d)(2), but none of the criteria for such admissions are met. Kingston fails to demonstrate that SanDisk believed Reed's statements to be true, that Reed was acting as SanDisk's agent, or that SanDisk authorized Reed to speak on its behalf. The mere retention of Reed as an expert witness does not imply SanDisk's endorsement of all his statements. Previous cases cited by Kingston do not support its argument; in In re Hanford Nuclear Reservation Litigation, the expert’s prior testimony was deemed admissible because it was presented at a prior trial, while in Glendale Federal Bank, the court found that a party could be tied to an expert's testimony only if the expert was retained through trial. Since Reed’s deposition was from a different case and not presented by SanDisk in the current proceedings, it cannot be considered a party admission. Therefore, Reed’s deposition testimony is classified as inadmissible hearsay and will be excluded.
The document also establishes the background of the parties involved: SanDisk Corp. and Kingston Technology Co. are competitors in the USB flash memory market, with SanDisk as a vertically integrated manufacturer and Kingston as a privately owned company producing memory products since 1987. Additionally, it describes flash memory technology, which retains information without power and comes in various formats, including USB flash drives.
USB flash drives are composed of flash memory chips and a controller on a circuit board, encased for consumer sale. The controller facilitates communication between the host system and the memory chips for data storage. The flash memory industry has experienced significant technological advancements, with capacities increasing from 16-256 megabytes to 1-4 gigabytes between 2003 and 2009. From 2000 to 2010, NAND flash memory device shipments grew at over 125% annually, while average sales prices dropped by over 56.5%. Major players in the industry include chip manufacturers, system aggregators, and resellers, with six companies—SanDisk, Intel, Toshiba, Samsung, Micron Technology, and Hynix—accounting for 99% of flash memory chip revenue in 2010. High fixed costs limit the number of chip manufacturers, with facilities costing up to $8 billion and taking years to build. Most major manufacturers are vertically integrated, producing chips, controllers, and systems, while other firms specialize in manufacturing flash memory controllers. System aggregators assemble components into flash memory systems for sale, and resellers brand and sell these completed products.
In terms of market substitutes, USB flash drives have few alternatives in portable memory storage. Rewritable compact discs and DVDs are less capable, while external hard drives serve different functions and require external power, making them bulkier and pricier for similar capacities. SD cards and Compact Flash cards are the closest substitutes but are limited in compatibility and often require adapters, making them less convenient. Price changes in these alternatives do not significantly impact USB flash drive pricing or market dynamics. The market for USB flash drives in the U.S. is characterized by a multitude of firms with no dominant player and low barriers to entry, as reflected in the growing market share of smaller firms and private label sales from 2006 to 2010.
Between 2000 and 2010, the output of USB flash drives grew over 125% annually, while prices fell by more than 56.5%, despite rising demand for flash memory devices. The flash memory technology market includes the production of flash memory chips and the assembly of these into systems like USB drives. SanDisk holds significant market power in this sector with 1,700 U.S. patents related to flash memory technology and asserts that all flash memory systems sold in the U.S. require its licensing, a position it reinforces through litigation. SanDisk licenses the manufacturers of 89% of the world's flash memory chips, with the exception of Micron, which does not have a license; however, SanDisk charges royalties on Micron chips used in other systems.
Since 2007, SanDisk has averaged around $400 million annually on flash memory research and development—over half allocated to chip technology. In 1995, SanDisk had 30 U.S. patents and 36 pending applications; by 2011, this increased to over 1,700 patents and more than 1,100 pending applications in the U.S., with additional patents in several foreign countries where most flash memory products are produced or shipped. SanDisk's market share in USB flash drives peaked at 34% globally in 2006 and 40% in the U.S. in 2009, but decreased to 18% worldwide and 34% in the U.S. by 2011.
From 1995 to 2009, SanDisk earned $2.5 billion in royalties from licensing its patents, matching its research and development expenditures. Together with its licensees, SanDisk accounted for 89% of global flash memory chip revenue in 2010. SanDisk's licensing strategy typically involves worldwide, non-exclusive cross-licenses, granting both parties rights to each other's existing and future patents, while maintaining the freedom to license to third parties without offering individual patents or varying royalty rates based on patent usage.
Licenses granted by SanDisk encompass either a “device-level” or “system-level” field of use, with device-level royalties based on a percentage of the sales price of flash memory chips and system-level royalties based on the sales price of flash memory products containing the chip. Additional royalties apply if a licensee sells systems with unlicensed chips. SanDisk prohibits the separate sale of controllers. Notable licensing agreements include a 1995 portfolio cross-license with Intel, 1997 agreements with Toshiba and Samsung (the latter requiring a 2.5% royalty on sales regardless of chip licensing), and a 2007 cross-license with Hynix. In 2002, Toshiba’s cross-license became royalty-free due to a joint venture with SanDisk.
In 2007, SanDisk pursued patent infringement litigation against multiple flash memory aggregators, including filing cases 07-cv-605 and 07-cv-607. SanDisk offered a non-negotiable “standard card license” to defendants, requiring a system-level royalty of 4% on global sales of flash memory products and additional royalties for unlicensed chips, capped at $4.00 per unit. The license duration was five years, with no obligation for aggregators to use SanDisk technology. Several defendants, including Ritek and Trek, subsequently negotiated settlements, with Ritek agreeing to a lump sum and royalties, while Trek committed to a 3% royalty on USB flash drive sales. SanDisk continued to enter licensing agreements with other companies, ensuring worldwide royalty coverage at both chip and system levels. Buffalo Technology USA, despite denying patent violations, consented to a judgment in March 2008, ceasing sales of non-SanDisk products in the U.S.
In April 2010, SanDisk voluntarily dismissed Buffalo from ongoing litigation due to Buffalo's compliance with a consent order. Kingston, initially a reseller of flash memory products starting in 2003, transitioned to an aggregator model in 2005, assembling its own systems from chips and controllers. Kingston's revenue from USB flash drives surged from $336 million in 2006 to $814.8 million in 2008, aided by an oversupply of flash memory chips that allowed for low purchasing costs. Kingston adopted an aggressive pricing strategy to gain market share, which resulted in it surpassing SanDisk in USB flash drive sales by 2008, achieving a 13% market share in the U.S. However, after reverting to a reseller model in 2009 to mitigate legal risks from SanDisk, Kingston's U.S. market share declined to 9% by 2010, although its global revenue share increased from 28% to 31%.
On May 4, 2010, SanDisk filed a lawsuit against Kingston for patent infringement. In response, Kingston filed counterclaims alleging violations of antitrust laws. The court granted summary judgment in favor of Kingston regarding SanDisk's infringement claims and in favor of SanDisk concerning Kingston's monopolization counterclaims. Kingston proceeded to trial on its counterclaims under Section 1 of the Sherman Act and California Unfair Competition Law, arguing that SanDisk's licensing agreements impose unreasonable trade restraints by requiring double royalties. Under Section 1, liability requires proof of a conspiracy to restrain trade and an unreasonable restraint, evaluated under the "rule of reason," which considers market power and structure to assess the actual effect of the restraint.
Kingston is required to identify the relevant market and demonstrate that the restraint in question negatively impacts competition within that market. It does not need to prove that SanDisk holds a monopoly or is likely to achieve one, but must meet a market power threshold, which may be inferred from a substantial market share or direct evidence of anticompetitive effects. Kingston must also show that SanDisk will likely use its market power to reduce output or raise prices. In patent cases, a patentee's legal monopoly allows for some restraints on competition, but unreasonable restraint occurs only if it extends beyond the patent's scope. Kingston's argument hinges on SanDisk's licensing practices that allegedly require royalties on worldwide sales, even in countries where SanDisk lacks patent rights, and a “field of use” licensing system that generates double royalties. To succeed in its Section 1 claim, Kingston needed to prove both that these licensing terms exceeded the scope of SanDisk's patents and that they would likely harm the USB flash drive market. Kingston failed to establish the latter, making it unnecessary to examine the former. Additionally, two relevant markets were identified: the USB flash drive market, with no close substitutes, and the U.S. market for flash memory technology, where SanDisk has significant market power. Kingston posited that SanDisk's licensing practices could raise costs for aggregators, potentially leading to higher consumer prices or market exits.
Prices for USB flash drives are expected to rise or stabilize due to the efficiency of aggregators who have leveraged their cost advantages. SanDisk has incentives to eliminate aggregators, as this would increase both the market price of its USB flash drives and the royalties it receives, which are based on a percentage of the sales price. Kingston argues that higher royalty costs for aggregators will lead to increased market prices, with expert testimony suggesting that rising supplier costs typically result in higher prices or reduced supply. However, Kingston's analysis is criticized for oversimplifying the situation by focusing solely on increased costs for aggregators without considering their overall contribution to the market supply or the behavior of other market participants.
The excerpt raises several critical questions regarding the impact of SanDisk's royalty demands on competition and market dynamics. It questions whether aggregators would continue operations, transition to reselling, or exit the market if faced with increased royalties. Additionally, it inquires about the potential effects on the price and quantity of USB flash drives and the responses of remaining market players. Kingston's evidence regarding the impact of SanDisk's licensing on aggregator performance is deemed insufficient. It cites a decline in the number of firms and sales among notable aggregators like Memorex and Imation following their licensing agreements with SanDisk, suggesting that these agreements may have contributed to reduced production and market exit. However, Kingston fails to provide compelling evidence linking these trends directly to SanDisk’s royalty demands, leaving critical questions about the competitive effects unanswered.
Buffalo sold $400,000 worth of USB flash drives in 2007 but ceased sales following a consent judgment. Welldone, Add-on, and Infotech halted U.S. sales after accepting licenses, with Welldone paying $788,000 in royalties in 2009 but none in 2010 or 2011, while Add-on paid about $20,000 in 2008 and 2009 but nothing thereafter. Interactive Media, Kaser, and TSR agreed to licenses but did not pay royalties and either stopped selling USB flash drives or became resellers, with no evidence provided by Kingston regarding the specifics of their actions. Kingston claims that SanDisk’s licensing program negatively impacted competition in the USB flash drive market. However, Kingston's expert, Dr. Mangum, did not assert that SanDisk’s program caused the sales reductions among aggregators and clarified that he did not analyze the reasons behind these sales changes, acknowledging that some reductions were unrelated to SanDisk’s actions. For instance, Memorex's sales dropped by nearly 25% prior to signing a license with SanDisk, and Imation significantly reduced its sales before entering a licensing agreement. Mangum also did not provide an opinion on the impact of SanDisk’s licenses on prices or market output since 2007, despite the opportunity for analysis presented by the initiation of SanDisk's licensing program. Evidence indicates that the USB flash drive market remains competitive, with many firms, none being dominant, and a notable share held by smaller companies. Kingston presented no evidence that SanDisk’s licensing harmed competition since 2007, focusing instead on future competition concerns, claiming that royalties would drive aggregators out of the market. Testimony from aggregator executives was primarily conclusory, including that of Jeff Thompson from Edge Tech, who expressed concerns about being unable to compete under SanDisk's royalty terms.
Edge Tech paid royalties of $190,871 in 2008 and $28,650 in 2009, but made no payments in 2010 or 2011. During this period, its gross profit from USB flash drives declined by about 70%, and it reported no profits in 2010. If Edge Tech had continued paying royalties similar to those in 2008, it would have incurred annual losses of approximately $200,000. Thompson, representing Edge Tech, indicated that paying such royalties would hinder competitiveness and might lead the company to exit the USB flash drive market. Despite this, Thompson's deposition did not establish that SanDisk's licensing terms directly caused Edge Tech's operational issues, which began in 2009, nor did he assert that SanDisk's royalty demands exceeded the scope of its patents.
Separately, PNY, led by Vice President Mark Ciano, has been selling flash memory products in the U.S. since 2000, averaging $150 million in annual sales. After being sued by SanDisk in 2007, PNY was offered a standard licensing agreement which it initially signed, believing it wouldn't affect their operations. However, after adopting an aggregator model in 2009, PNY now only purchases 10-15% of its systems as complete. Following an audit, SanDisk claimed PNY owed between $21 and $30 million in withheld royalties, equivalent to PNY's profits over the last two years. PNY contests this claim and maintains it would suffer competitive disadvantages if forced to pay the disputed royalties, yet Ciano acknowledged that PNY has never considered leaving the U.S. market. Notably, PNY's prices have decreased by 20% and sales have risen since obtaining the license. Additionally, PNY has filed antitrust counterclaims against SanDisk, suggesting dissatisfaction with the licensing terms.
Ciano's testimony regarding the alleged impact of SanDisk's licensing on PNY's USB flash drive sales and market presence in the U.S. is deemed unconvincing, particularly given Ciano's conflict of interest. Kingston asserts that SanDisk’s licensing demands may compel it to exit the U.S. USB flash drive market, based on two main arguments: the inability to continue as a reseller and the inability to afford SanDisk's licensing royalties. Kingston's domestic performance has declined since reverting to a reseller model, leading to a drop in market share from 13% in 2008 to 9% in 2009 and 2010, despite a stable and increasing global market share.
Testimony from Darwin Chen, Kingston’s Vice President of Sales and Marketing, suggests that the reseller model is unsustainable due to challenges in sourcing competitive components, which limits pricing strategies and competitive positioning. However, Mangum's testimony, which claims the reseller model has led to stagnation in sales, lacks reliability as it is based on informal conversations and theoretical comparisons without direct analysis of Kingston’s performance metrics. Kingston failed to provide substantial data to support its claim that remaining an aggregator would enhance competitiveness or to adequately analyze its cost structures. The correlation between Kingston's declining market share and its switch to a reseller model is weak and insufficient to prove that Kingston must exit the market to avoid licensing fees. Kingston's argument primarily compares profit margins without offering a thorough empirical analysis of market conditions.
Kingston faces an annual royalty obligation of approximately $40 million on worldwide sales, which would significantly reduce its average net profit margin from 3.2% to 0.9%. Kingston contends that this royalty should be treated as a U.S. sales royalty, arguing that SanDisk is improperly leveraging its U.S. license to claim royalties in countries where it lacks patents. Kingston's analysis suggests that the effective royalty rate on U.S. sales would be around 40%, resulting in a negative profit margin of -19.2%. However, this calculation is deemed misleading, as it fails to account for valid royalties based on SanDisk’s existing patents in regions where Kingston operates.
Kingston claims that if it only paid U.S. royalties, its profit margin would decline from 1.6% to a 0.7% loss, but this figure is also criticized for being misleading. It includes lower margins from years when Kingston acted as a reseller, which would exempt it from royalty payments. Furthermore, Kingston's calculations overlook SanDisk's entitlement to royalties based on its valid patents.
In assessing the impact of SanDisk’s licensing on the market, Kingston must demonstrate that increased costs for aggregators would lead to higher prices or reduced supply of USB flash drives, which it has failed to do. The federal antitrust laws prioritize the competitive process rather than the welfare of individual competitors. Kingston has not presented compelling evidence to show that the USB flash drive market would suffer in terms of pricing or output if aggregators incur higher costs or adopt a reseller model. Overall, the evidence suggests that market dynamics would remain stable despite the changes in royalty obligations.
Kingston became a reseller in 2009, but Mangum failed to assess the market price or output impacts following this switch. Despite many aggregators accepting SanDisk's licenses in 2007, no analysis was conducted on the market effects of their royalty payments. Kingston's evidence suggests that market prices are unlikely to change with the switch to a reseller model or the payment of royalties, as demonstrated by Edge Tech's unchanged prices after starting royalty payments in 2008 and PNY's price decrease despite switching back to an aggregator model. Kingston itself did not increase prices after becoming a reseller. The USB flash drive market is highly competitive, preventing firms from passing on cost increases through higher prices, as confirmed by Kingston's witnesses. The market is largely commodified, with consumer preferences focusing on storage capacity and price, leading firms to set prices based on market rates rather than costs. Mangum concluded that a 4% royalty would not enable Kingston to raise prices due to market competitiveness. Although paying SanDisk’s royalties may reduce aggregators' profit margins, Kingston did not demonstrate that market prices or supply quantities would be negatively impacted. Kingston also questioned whether the exit of aggregators would affect USB flash drive prices or output but failed to prove any adverse effects on competition. Kingston’s arguments posited that aggregators are more efficient than vertically integrated manufacturers, which enhances price competition and that U.S. prices are higher than those in foreign markets due to greater aggregator competition abroad. However, Kingston's theoretical analysis overstated the advantages of aggregators and overlooked the benefits of vertical integration, particularly in light of the fixed and marginal cost dynamics of fabricators that can lead to competitive pricing advantages for aggregators during oversupply periods. SanDisk's licensing strategy aimed to counteract this competitive threat posed by aggregators.
Vertically integrated firms benefit from reduced resource expenditure on component sourcing by utilizing internal channels, though they still incur some costs for tracking and pricing inputs. Their engagement in both upstream manufacturing and downstream retail enhances competition and minimizes profit margins for intermediate supply chain firms. Kingston's analysis exaggerates the advantages of aggregators during oversupply periods, as declining market prices also lower component costs universally. For vertically integrated firms, the internal valuation of components reflects the opportunity cost—the price they could gain by selling to third parties. Many of these firms also sell flash memory chips, benefiting when aggregators purchase chips and stabilize prices.
In times of supply constraints and rising prices, aggregators lose any alleged cost advantages. A thorough cost-benefit analysis of production methods was not conducted by either Mangum or Kingston. Kingston's internal documents indicate a recognition of potential efficiency advantages tied to vertical integration, contradicting its claims of higher costs due to investments in facilities and patents. Kingston's assertion that aggregators have lower costs relied on unsubstantiated employee statements and a dated market report from 2007, which did not demonstrate consistent advantages in purchasing or efficiency over time. Kingston failed to provide evidence supporting its claims of superior efficiency as an aggregator, particularly regarding the costs associated with assembling, marketing, or distributing USB flash drives. Ultimately, Kingston did not establish that aggregators are more efficient than vertically integrated firms, nor did it substantiate its claims of being an exceptionally efficient firm in the USB flash drive market.
Kingston provided only first-quarter 2008 data regarding its component costs and failed to demonstrate that it had competitive advantages in assembling, marketing, or distributing USB flash drives compared to SanDisk and other firms. It did not establish that the loss of aggregators would lead to price increases or that aggregator prices were lower than those of vertically integrated manufacturers. Kingston's expert did not analyze how increased costs or the exit of aggregators might affect market dynamics, particularly the responses of unaffected firms. The potential for market price increases following a large aggregator's exit depends on whether other firms can or will increase production. Evidence suggests that the USB flash drive market could absorb the loss of Kingston or other aggregators without significant impact, as smaller firms have increased their market share significantly. Additionally, flash memory chip manufacturers are incentivized to maintain high production levels and could easily fill any output gaps left by exiting aggregators. Kingston’s expert, Mangum, did not adequately assess these market dynamics or the capacity of other firms to respond to changes in output. Past exits of major players, such as Memorex and Imation, did not correlate with price or output changes. Although Mangum highlighted SanDisk's internal assessment regarding Samsung's reluctance to expand in certain areas, he overlooked Samsung's incentives to ensure downstream demand and its partnerships with downstream firms. Ultimately, Kingston's case relied heavily on SanDisk executives' statements about the importance of aggregators for competition, lacking empirical support for its theoretical claims.
Kingston's arguments rely on statements from SanDisk’s founder, Dr. Harari, regarding competitive pressures affecting profit margins and pricing in the USB flash drive market. Harari noted that competition from firms like Kingston, Imation, and Transcend creates significant pricing pressures, but his comments do not support Kingston's claims about aggregators' efficiency or competitive advantages. SanDisk's Vice President of Retail Sales, Douglas Hauck, acknowledged that aggregators have historically priced lower than SanDisk and that SanDisk had to reduce its prices due to competitive pressures. However, Hauck’s testimony lacks sufficient evidence to substantiate Kingston’s claims regarding aggregators’ roles in the market.
Kingston also argued that USB flash drive prices in the U.S. are higher than in foreign markets due to greater aggregator competition abroad. They presented a price chart from April 1, 2011, showing prices from four aggregators, but this chart is deemed unreliable as it does not represent average prices or account for broader market differences. Kingston's Vice President of Sales and Marketing, Chen, suggested that lower European prices result from more aggregators, yet his argument is undercut by the limited basis for his conclusions. Although Kingston demonstrated that its prices were higher in the U.S. compared to Europe and Latin America, the reasons for this price disparity remain unclear, with Chen attributing it to litigation costs and the reseller model.
Kingston failed to provide empirical evidence to support its claim that increased competition from aggregators leads to lower international prices for USB flash drives compared to U.S. prices. Consequently, it could not demonstrate that SanDisk’s licensing terms adversely affect competition, justifying the court’s decision to rule in favor of SanDisk on Kingston’s Sherman Act counterclaim.
Under California’s Unfair Competition Law, which defines unfair competition as any unlawful, unfair, or fraudulent business practice, Kingston alleged that SanDisk’s system-level royalties impose unfairly discriminatory royalties on downstream firms. However, the California Supreme Court established a test whereby "unfair" conduct must threaten an incipient violation of antitrust law or significantly harm competition. Kingston's assertion that the Cel-Tech test is limited to direct competitors is unsupported by case law, and it did not cite cases indicating the old balancing test's applicability to vertical supplier relationships.
Since Kingston has not shown likely harm to competition from SanDisk’s licensing practices, the court ruled in favor of SanDisk regarding the California law claim. Additionally, SanDisk’s patent licensing terms may benefit from the "safe-harbor" doctrine, which allows patent owners to engage in price discrimination to maximize licensing income, provided there are no demonstrated anti-competitive effects.
Kingston contends that the California legislature has not explicitly permitted price discrimination by patent holders, arguing that the California Unfair Competition Law cannot render lawful practices, recognized by federal courts as permissible under patent law, illegal. If the law were to prohibit discriminatory pricing without evidence of anticompetitive effects, it would be preempted by federal patent laws, which reserve policy decisions regarding patent use for Congress. The case Biotechnology Industry Organization v. District of Columbia supports this view. Kingston's counterclaim either qualifies for the Unfair Competition Law "safe-harbor" or is preempted by federal law, leading to SanDisk being entitled to judgment as a matter of law. Consequently, it is ordered that SanDisk Corp. receives judgment in its favor against Kingston Technology Co. Inc. and Kingston Technology Corp. for their counterclaims under Section 1 of the Sherman Act and California Unfair Competition Law. The clerk of court is instructed to enter judgment in favor of SanDisk on these counts.
