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[Breaking news - On February 3, 2010, MPEG-LA announced a continuation of free pricing for free Internet distribution of H.264 video. Read the release here, and an interview with Larry Horn, MPEG-LA CEO, here.]

Whenever I speak at industry groups about H.264, and detail the upcoming royalty obligation, some attendees are invariably surprised that using H.264 will generate royalties. Here's what you need to know about H.264 and royalties, in an except from an article that I wrote for StreamingMedia.com.

Royalties

The final factor that may be slowing H.264 adoption is the potential for royalty payments starting in 2011. This became a major issue during a recent consulting engagement I had with a multinational equipment manufacturer. Let’s start with what we know and why it was so scary for my client; then, I’ll recount a conversation that I had with Allen Harkness, director of licensing for MPEG LA.

Briefly, MPEG LA represents the patent holders of AVC/H.264 technologies. It is the sole licensing authority for the technology. Typical customers include consumer equipment manufacturers (Blu-ray Disc players and recorders), software developers (encoding programs, DVD players), and content developers. According to the “Summary of AVC/H.264 License Terms,” which you can download from the MPEG LA site (www.mpegla.com/ avc/avc-agreement.cfm), there are no royalties for free internet broadcast (there are, however, royalties for pay-per-view or subscription video) until Dec. 31, 2010. After that, “the royalty shall be no more than the economic equivalent of royalties payable during the same time for free television.”This makes royalties payable for “free television” the best predictor of where internet royalties will stand in 2011. Under the terms of the agreement, you have two options: a one-time payment of $2,500 “per AVC transmission encoder” or an annual fee starting at “$2,500 per calendar year per Broadcast Markets of at least 100,000 but no more than 499,999 television households, $5,000 per calendar year per Broadcast Market which includes at least 500,000 but no more than 999,999 television households, and $10,000 per calendar year per Broadcast Market which includes at 1,000,000 or more television households.”

According to my discussions with Harkness, the AVC transmission encoder has no applicability to on-demand delivery. So the most likely result will be a yearly fee per broadcast market, which may be the internet as a whole, but, logically, it could also be applied on a per-country basis. In the case of my multinational equipment manufacturer client, which has more than 25 international subsidiaries, each with its own website, the potential royalty charge exceeded $250,000. When I outlined my findings with the client, it was clear that this would be a major factor in its decision to change over to H.264.

When I spoke with Harkness, he stated that the patent group hadn’t yet decided the license provisions for internet broadcast, or even if there would be a license, though he conceded that it would make little sense for the patent group to forego this revenue. The only thing certain is that the royalty provisions must be announced by January 2010 for royalties that would be payable the following year.

I asked about MPEG LA’s definition of “broadcast market” since this has such a significant impact for multinationals. Harkness felt that the group would make a case-by-case analysis of each business to determine if the internet as a whole was a single market or if each country represented a different market. Factors would include legal ownership and the uniqueness of the business in each country.

From an ownership perspective, if all subsidiaries were owned by a single parent company, it would move toward a single license, while a consortium of locally owned companies might need separate licenses. In terms of unique business, if a manufacturer sold a single product worldwide with basic sales and service offices in each country, one license might apply. If a manufacturer customized products for each country and operated almost as stand-alone businesses in each country, each entity might need a separate license.

Harkness cautioned, however, that the royalty group may go in a totally different direction when it came to license terms for internet usage. He did note, however, that the reference to royalties for free television was meant as an indicator of the appropriate dollar amounts, if not collection schemas.

Harkness also made it clear that it was the company that delivered the video to the end user that paid the royalty, not the content owner. For example, in the cable TV world, individual networks such as ESPN or the Golf Channel don’t pay the royalty; the cable provider pays. In this regard, hosting providers that actually deliver the streams to target viewers would likely bear the royalty obligation, with the ability to price it into their hosting services and spread the cost over all viewers. For a more detailed discussion of H.264 licensing costs and issues, see Tim Siglin’s "The H.264 Licensing Labyrinth."