In patent infringement cases, damages are to be awarded in an amount that is adequate to compensate the claimant for the infringement but never less than a reasonable royalty. A key element in analyzing lost profits and reasonable royalties is an "adequate reconstruction of the market"– which requires a thorough investigation to uncover and piece together the facts that tell a true story of how and why the products at issue are bought and sold.

"To prevent the hypothetical from lapsing into pure speculation," says Doug King, senior manager at Gleason & Associates, "the courts have required sound economic proof of the nature of the market and the likely outcomes with the infringement factored out."

Available Acceptable Alternatives
Establishing demand for the patented product is the first proof point in reconstructing the market. While actual sales and sales growth can identify demand, when acceptable alternative products are available, it must also be evident that customers purchased the product because of the patented features.

"Alternatives are typically available, but are they acceptable?" notes King. By definition, acceptable alternatives provide the benefits of the patented product. But when alternative products can be demonstrated as having less utility or dependability or significantly higher prices or maintenance costs than the patented item, they may flunk the acceptability test.

Recently, Gleason & Associates conducted a lost profits analysis in a case involving the infringement of a patent for an antimicrobial chemistry that kills salmonella on meat. Because the plaintiff's patent didn't provide benefits that differentiated it among at least 10 other actively used competitive products on the market, lost profits were denied. In addition, the value of the patent and resulting reasonable royalty damages was limited.

However, acceptable alternatives do not preclude a patent holder from rightfully claiming lost profits, says King, as long as it demonstrates that it would have made the sales the infringer had made.

An adequate reconstruction of the market must also take into account the availability of alternatives, not just alternative products that are actually produced and sold. "A sound analysis considers the lawful actions an infringer would have undertaken if it hadn’t infringed," King explains. "It's potentially likely that a rational would-be infringer would have offered an acceptable non-infringing alternative in order to compete with the patent holder rather than leave the market altogether."

Quantifying Lost Sales
Once product demand and the availability of acceptable alternatives are established, the next step is quantifying lost sales. Lost sales revenue involves both quantity and selling price. Typically, the infringer's sales volume of the patented product sets the upper limit on the quantity of the patent owner's lost sales. Other methods for calculating lost sales volume include an estimation based on market share or an analysis of the patent holder's actual sales compared to reasonable sales projections prior to the infringement.

The sales price of the product in question is also important. "If the infringer made product improvements or offered a warranty that customers deemed valuable, an accurate analysis must separate out the portion of the sales price that was unrelated to the patented features," says King. "At the same time, if the infringer's entrance into the market depressed the price of the patented product, a patent holder may be able to demonstrate price erosion and a higher dollar value of lost sales."