Keynote Speech by Marshall Phelps

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October 21, 2011

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Transcription:

I am delighted to be here today, back in this beautiful part of the earth, to discuss intellectual property and some of the trends developing around its ascendancy as a critical asset of companies and countries. I will do this from an historical point of view, starting with IBM and ATT, moving to Microsoft and, finally, to the world of NPE’s (or patent trolls) and smart phones. I’ll finish up with some general “rules” based on today’s discussion, which may be of assistance to those of you in the trenches dealing with IP issues, followed by questions, until we run out of time.

It is especially great to be in front of a “general” audience. It demonstrates the importance of the concerns over intellectual property assets and their role in the competitiveness of companies and nations. Just a few short years ago, i would give speeches somewhat similar to this but almost always to audiences of IP specialists—to the point I could identify the “usual suspects” by name. No more.

Right from the get-go, I realize that doing “history” by use of illustrative examples is somewhat limited by those examples, but I am forced to do it this way because of time constraints. And more to the point, these examples are what I know!

I want to start in the 1950’s--1956 to be exact. In that year, the two biggest us research and high tech outfits, IBM (Watson) and ATT (Bell Labs) signed consent decrees with the United States government, governing how they would conduct business going forward. In the U.S., consent decrees are judicially enforced settlement agreements. A key provision in each provided that the companies would license their IP (principally patents) to all comers, worldwide, under “reasonable and non-discriminatory terms and conditions” (rand). Over the course of the next few decades, this provision would produce enormous competitive consequences on a number of fronts; two being:

- the rise of Japan

- the development of pervasive and broad-based licensing practices in the computer and communications industries

Because antitrust issues and continued scrutiny were the order of the day for the two companies, and because they were making most of the profits in their respective markets (by a long shot), these “rand” licenses passed without significant financial burden to the recipients as IBM and ATT merely sought “freedom of action” in return in almost every case.

Their antitrust worries were well justified, as IBM and ATT soon found themselves right back in the judicial “soup” just a decade or so later. But the results of the virtually free licensing programs were, to large measure, that the worldwide C&C industries followed the architectural dictates of the two behemoths. And, by then, there were hundreds upon hundreds of licensing agreements between the two and their competitors, partners and suppliers.

By the early 1980’s, ATT had begun divesting itself. IBM was more successful with the U.S., and the European Union and managed to stay intact. But its cautious nature, now judicially enhanced, would cause it to miss new trends in the industry, such as mini-computers and to some extent, the full breadth of the personal computer phenomenon; however, throughout this period, both ATT and IBM continued to amass huge IP portfolios due to the energy and output of their world class research divisions.

By the early 1990’s, IBM was patent-rich, product-poor (mainframes were declining apace) and quickly running out of money. Lou Gerstner would become the new CEO. He faced an unsupportable, bloated company with about 100 days of cash left in the bank. IBM would shortly lay off some 200,000 employees.

This was the arena I found myself in when i took over IBM’s IP and licensing operations in 1992. IBM desperately needed cash, and one way to get that would be to monetize its great IP asset by changing the way licensing was done to reflect IBM’s huge R&D investment, i.e., move away from the freedom of action model to one that financially rewarded the company. This, combined with an effort to achieve the number one ranking for patents issued in the U.S., would become hugely successful. By 2000, we were realizing about $2 billion in profit annually for a cost of about $36 million.

But this was not accomplished without difficulty. First the traditionalists and the cautious were very negative about this approach. And our new CEO was openly skeptical, to say the least. His early view was (and still is) common among most senior business leaders—patents are “negative rights”—used to block erstwhile competitors from following your approach. Lou learned this lesson from his stint as CEO of Nabisco and the results of the “cookie wars”.

Lou was not an exception. His (and my) generation of business leaders, accountants and lawyers never learned the positive nature or the magnitude of this class of asset for one simple reason—it does not appear on the balance sheet. It never shows up unless some transaction identifies a part of the asset class as good will. Today, IP assets are widely recognized as comprising less than 70% of the asset value of high-tech companies. But if you can’t see them, they cannot be measured. Indeed, they do not exist and cannot be deployed effectively. It is like telling a general you do not know where 70% of your troops are!

So our dilemma was framed by a rather abrupt call from Lou on his second day on the job asking me just what i thought I was doing licensing our IP to competitors. How to explain the positive nature of our new approach without crawling through the history and requirements of the consent decree, led us to ripping the cover off an IBM laptop and gluing little toothpick flags on the patented inventions of other companies. We ran out of real estate at about 150 flags, but this visibly demonstrated we couldn’t even build our own architected designs without using the IP of others. It didn’t take lou more than a few seconds to get the point and allow us to proceed. By 2000, we had 1826 licensing agreements generating the profit noted above along with vast freedom of action—all with zero litigation.

The Microsoft story was different but no less intriguing. Microsoft was a young company in a young industry. Patents for software were just coming of age. It certainly had no cash needs. Licensing was largely a foreign concept. When i arrived in 2003, Microsoft had not a single active licensing arrangement. Outside of their development community and customers, they had virtually no relationships-commercial and certainly not political. They were and are hampered by the “gold disc” problem. They were iconoclastic and remote with few, if any, portfolio needs. They had a very small IP portfolio outside the world of copyright.

What they did need were relationships. The very thing IBM had in spades because of its many licensing arrangements, Microsoft lacked. In this context, think of licensing arrangements as mini peace treaties between companies. Companies with licensing arrangements rarely sue each other, in my experience.

But first, Microsoft needed a critical mass of patents and technologies to proceed. We put a crash effort into patenting inventions to the point that the company is now the second largest us based patent holder-quite an accomplishment from whence they started just a few years ago.

Moreover, by 2009, Microsoft, in a more limited market than IBM, had about 600 licensing agreements, with 600 different companies around the world; arrangements that hopefully will serve them well on many fronts going forward. And, like IBM, they got to that point without litigation.

What makes these two stories important is they demonstrate that, irrespective of your particular industry, you are never too late, nor too underdeveloped to compete in this new world of IP ascendancy.

Which brings me to the next chapter: where are we today with the latest kerfuffle’s over smart phones and NPE’s (non-performing entities or trolls), and a world characterized by many as litigation overload?

I mentioned earlier that this is a “general” audience, albeit largely here because of interest in this particular subject. Why? Look no further than recent stories and headlines: “Android no longer a free agent after the (Microsoft) Samsung deal”; “Microsoft-Samsung deal strikes a blow at Google”; "Google acquires Motorola Mobility and its 17k patents for $12.5b"; "Microsoft and Apple purchase 880 Novell patents for $450m"; "Google buys 1000 patents from IBM"; "Apple, Microsoft, RIM et al, buy Nortel’s patents for $4.5 b" (P.S. that is $750 thousand per patent); "Oracle sues Google for $6b over Android’s alleged infringement"; on and on!

Just look at the chart you each have, courtesy of The Guardian; a veritable circular firing squad of industry participants! It is only a month old yet is not even complete!

Why? One principal reason is that mobile phones are providing a new platform for computing power. Yet this is a platform of very recent vintage, coming on the scene quickly and without any leveling effects like those provided by the IBM and ATT forced licensing practices discussed earlier.

Overlay this with a troublesome new class of litigation--suits brought by the so called trolls (NPE’s) and things become quickly interesting. You have some examples on your handout. NPE’s have IP but no actual products. Hence they can practice a sort of asymmetric warfare. But NPE’s are very hard to define. Do you include research universities, companies that do not practice each and every patent they own, development and design shops? In truth the boundaries are murky. But at their worst, trolls seem to have as their sole purpose the exploitation of the legal system by demanding license fees from operating companies eager to avoid costly litigation.

Let’s look on the bright side. Even with all this legal activity, the U.S. court system is not out of control. A couple of weeks ago, I wrote a piece for Forbes, in which I quoted the Hon. Paul Michel, recently retired head of the CAFC, the U.S.’s highest IP court. He notes that the number of suits is actually quite modest. Some stats here: the number of patent infringement suits in the U.S. has held steady for seven years at under 3,000. 90% of those suits are abandoned or settled. Of the 300 remaining, two thirds never see trial but are decided on pretrial motion. That leaves about 100 patent infringement trials annually, fairly modest for a country with millions of patents in force and hundreds of thousands of companies in competition with each other.

Second, the highest courts in America (the CAFC and the U.S. Supreme Court) have begun to make it more difficult for the trolls to be successful by making it harder to gain injunctive relief and by strengthening the criteria for determining whether an invention is really “non-obvious”- a condition for patentability.

Finally, a prediction; in short order, surely within a decade, the platform wars will sort themselves out. The vehicle; a cascade of license agreements between the major participants allowing participation without the threat of litigation. My guess, also, is that the NPE threat will remain, perhaps with a broadening of their targets and subject matter.

So with that prediction out of the way, here are a few quick thoughts and pieces of advice for those of you laboring in the IP trenches:

Unless you are a design house like Qualcomm, your IP must serve your business, not be the business. Our IBM and Microsoft efforts were largely successful because we found ways for the ip to support the needs of the business;

Leverage inclusivity not exclusivity. IBM and Microsoft were far more successful when they opened up and licensed out. Today’s open innovation world just makes this even more of a priority;

Money isn’t money anymore. Value surfaces in many ways. Relationships, common ventures, market access, standards, political necessity, etc., all are important;

Licensing is really deal-making;

Licensing equals collaboration, not sales; And finally,

Leadership cannot be outsourced-if a company is to embark on a leading edge IP journey - top management must own the process and the results.

Thanks so much for listening. Now i’ll be happy to try and answer questions from the audience.