By Jan Ozer
While there have been some heated arguments against the royalties announced by the new patent group, the payments appear to be appropriate. We break it down with real-world numbers.
As an overview, the initial royalty terms have two primary targets, consumer products such as mobile phones and tablets, 4K TV sets, and set top boxes, and content royalties on specific use cases of HEVC-encoded video which includes both subscription- and advertising-supported models. HEVC Advance is not seeking royalties on professional encoding products or professional decoding products, like Telestream Switch or the Vanguard Video Comparison Tool. HEVC Advance is seeking royalties on software decoders included in consumer products like browsers and operating systems.
Figure 1 contains the proposed royalties for Region 1, which includes the U.S., most of Europe, Japan, South Korea, Australia, New Zealand, and most other developed countries. The schedule will be finalized by October 1, which is when licensing agreements will be available. The first column includes both video and still image HEVC compression, and the second the cost for still image only. The rate for HEVC encoded video is 0.5 percent of attributable revenue, which I’ll define below.
Figure 1. Proposed Region 1 license rates for different devices and technologies.
Note that the rates for packaged devices assumes a 10 pecent labeling discount. That is, if you’re selling a 4K TV with HEVC Main 10 video, and you place the HEVC Advance label on the device, you pay $1.50 in Zone 1. If you don’t label, you pay $1.65. I asked Moller about streaming, and he responded that since you can’t label a stream, this assumed discount doesn’t impact content; in this case 0.5 percent means 0.5 percent.
All rates, however, assume a 25 percent “compliance discount.” That is, if you license promptly and pay your bills on time (and HEVC Advanced doesn’t have to sue to collect), that $1.50 for a 4K TV set is $1.50. If you force HEVD Advance to sue, the base royalty will be $1.50, plus 10 percent for failure to label, plus 25 percent for non-compliance, which adds up to $2.025 per TV (assuming that HEVC Advance doesn’t include the labeling discount in the price before adding the 25 percent surcharge, a question I didn’t ask).
Analyzing the Numbers
Let’s put these numbers in perspective, starting with the hardware royalties. The royalty on mobile phones is $0.80, and Apple’s iPhone 6 includes HEVC encode/decode capabilities, though it’s used solely for FaceTime. According to numbers available here, the $0.80 adds about .25 percent to the overall cost, or .21 percent to the total cost of the iPhone 6 Plus. According to the same schedule, Apple is already paying between $19 to $27 per phone in royalties for one technology or another, so the $0.80 adds about 4 percent to the existing royalty costs.
One rule of thumb for cost markups is to multiply the cost by 4 to determine the impact on retail price. For phones, this means that the $0.80 royalty translates to $3.20 at retail. For 4K TVs, it means as much as $8.00. Whether this will pass the FRAND test, discussed below, is one thing. But clearly it’s not going to have a significant impact on retail pricing or sales volumes.
There are several scenarios for content-related royalties; let’s run through them. Again, the big question is what is the “attributable revenue” against which the 0.5 percent attributable rate is applied.
Streaming. Here, attributable revenue is the total sales revenue for the video, multiplied by the number of bits of HEVC Video divided by the total number of bits delivered. This has many applications:
- Netflix. In the case of a subscription service, assume the customer is playing $10.00/month, and during the month, watches a 2GB of HEVC content and a total of 10GB. Applicable revenue is $10 x 2 / 10, or $2.00, against which you apply the 0.5 percent to reach $0.01, or one cent. Note that this doesn’t need to be calculated on a subscriber-by-subscriber basis; it can be computed on the video delivered as a whole. So, Neflix’s 2014 revenue was $5.5 billion. If ten percent of that was HEVC, the royalty would have been $5.5 billion x 10 percent x 0.5 percent, or $2.75 million. According to Forbes, Netflix had 57.5 million subscribers by the end of 2014, so the cost per subscriber is about $.05, or five cents.
- Facebook. Let’s look at this within the context of advertising-supported revenue. One analyst predicted that Facebook will generate $1.5 billion in video revenue from ads in 2016. While I think Facebook will likely resist HEVC to the bitter end, let’s assume 15 percent of that sum is delivered via HEVC. The royalty would be $1.5 billion x 15 percent x 0.5 percent, or around $1.125 million—around .00075 of revenue (.075 percent). The same formula would apply to CNN or ESPN; take the total video advertising-related revenue, multiply by the percentage delivered via HEVC to compute “attributable revenue,” then apply the 0.5 percent to that figure.
Title-by-Title HEVC Video. “In this case, ‘Attributable Revenue’ shall equal the total Sales Revenue for the title in question, regardless of how it is transmitted (via Media Storage Product, pay-per-view, video-on-demand, etc.).” This again has several applications.
- On-demand videos or events. This might be the M-GO or Amazon (non-Prime) scenario. You rent a movie delivered via HEVC for $4.00, it’s all considered attributable revenue to which the royalty applies; royalty per movie is two cents ($0.02).
- Ultra HD Blu-ray disks. Assume that you include HEVC video on a 4K Blu-ray disc sold for $30. All of this would be attributable revenue, and the royalty would be 15 cents ($0.15).
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