The other IP

English author and philosopher Sir Thomas Barton opined in the late 16th century that knowledge is power. A more contemporary perspective embraced by today’s movers and shakers suggests that power yields moneymaking opportunities. But turning knowledge into cash in the wireless industry is a much more difficult task than these truisms might suggest.

Indeed, the archives of patent offices worldwide are littered with innovations that provided little or no monetary gain to their inventors. In some cases, the inventors lacked business sense or were unable to solicit support from players who could transform their visions into commercial success. In other instances, the inventions were so far ahead of their time that their useful applications would not emerge until after the innovator’s death.

For those who have the right idea and the necessary resources at the right time, the prospect of building a successful business is achievable. Doing so in today’s fast-moving wireless industry is particularly lucrative, as technological breakthroughs potentially are worth billions of dollars.

But such riches can be realized only when innovators are able to navigate the minefields of the industry while using a variety of tactics to protect their intellectual property so that its value can be maximized in a business environment that at times resembles a jungle.

“What’s easy to forget about Qualcomm is that we were a very small company when we started and first got into this market — it took us 16 years from the founding of the company to become cash-flow positive,” said Derek Aberle, senior vice president and general manager of Qualcomm’s CDMA licensing business. “We took enormous risks, and there were enormous failures along the way to get to where we are, but that’s part of the rewards of innovating and competing.”

TOOLS OF THE TRADE

Companies use myriad methods to protect their intellectual property. Prior to being bought by Motorola in a deal announced in November 2004, MeshNetworks was a small start-up. Before the acquisition, it employed a decision-making procedure — implemented each time its lab achieved a breakthrough — designed to protect the company’s interests, said Peter Stanforth, director of technology for Motorola’s mesh-networks product group.

“When we started MeshNetworks, we started to file patents pretty much from Day 1. … We were patenting initially just to protect what we were doing, so no one could tell us we couldn’t do it,” Stanforth said.

Indeed, patenting is the best-known method to protect intellectual property. In the wireless arena, patent holders have exclusive rights to their innovations for 20 years — plenty of time to leverage the knowledge for business purposes. But securing patent rights does not necessarily mean intellectual property is safe in the commercial realm, especially if a company with greater resources challenges the patent, said Rick Mooers, CEO of xG Technology.

“Most small companies can’t afford to win — they go out of business before [the dispute is settled],” he said. “They couldn’t build a business. They couldn’t build anything because they spent their whole life suing the big company.”

Even when companies win a patent case in court, they can lose in the bigger picture, Mooers said. For example, Virginia-based patent holder NTP last year negotiated a $612.5 million settlement — a third of which likely went to NTP’s lawyers — from Research in Motion (RIM), which agreed to the deal under the threat of an injunction that could have halted sales of RIM’s popular BlackBerry push e-mail service, he said.

“So what did NTP net out of that, $400 million?” Mooers said. “A lot of people think that is a lot of money, but RIM’s valued at about $25 billion. Who won?”

Others viewed the situation differently, calling NTP a “patent troll” — a company with a weak patent position that files lawsuits against commercially successful companies with the hope of extracting settlement money from the larger company. Bill Brewer, a partner in the law firm of Bickle & Brewer, refers to the tactic as “risk arbitrage,” although he did not use the term in association with NTP.

“I represent large companies that are often in a position where they’re being shaken down by small companies who apparently are enamored with playing the risk-arbitrage game,” he said. “They may not have much belief in their intellectual property, but they have quite a bit of belief in the risk-arbitrage game that so often gets played out in litigation.”

In short, the problem with patenting technology is that intellectual property is placed in the public domain for anyone to view and use until stopped via the legal system. With this in mind, companies often utilize other tactics to secure intellectual property (see flow chart on page 50), including the practice of withholding key information from the public, i.e., keeping a trade secret.

Perhaps the most famous corporate trade secret is the formula for Coca-Cola, which has escaped the public for more than 50 years — decades longer than the intellectual property would have been protected by patent.

“I know how they protect that — [Coca-Cola leaders] don’t ever let anybody know,” Mooers said. “I think there’s only like two people who know that formula.”

And it’s critical that such an approach is maintained for a trade secret to be effective. Once a trade secret is leaked, it can be more difficult to protect in court.

“If you were trying to maintain a trade secret and someone disclosed it who had an obligation not to, then you have claims,” Brewer said. “But, if I’m sitting on a bus and leave my notebook behind that has my secret-sauce recipe in it, and some guy picks it up, mimeographs it and sends it all over the world, I don’t know that I have any recourse. That was my mistake. I shouldn’t have had it out there in public.”

Other ways to keep intellectual property out of the unprotected public domain are to publish white papers — which provide tangible evidence as to the originator of an idea — and by requiring each person viewing the technology to sign a nondisclosure agreement (NDA). Of course, several sources said the latter tactic is only as valuable as the legal staff retained to enforce it.

“Many people misunderstand the process and don’t recognize that it’s a great process — the trick to it is that you better pay attention to your selection of lawyers,” Brewer said. “And that’s no different than finding somebody to build a deck on your house or mend your crooked fingernail. Not everyone is as capable as everyone else.”

PROOF AND CONSEQUENCES

Of course, it takes money to retain good lawyers. Money also is needed to patent ideas — each patent can cost a company more than $20,000 to reach the approval stage — operate the business and develop intellectual property into a product that can generate revenue.

The difficulty for unknown start-up companies is that money often is in short supply at a time when strong — and often high-priced — legal help is necessary to ensure the viability of the company and protect its intellectual property.

“Protecting [intellectual property] or a technology usually contrasts with the need for cash,” Mooers said.

One common way to secure funding is to seek money from investors. Venture capitalists (VCs) are willing to place bets on small companies with breakthrough technology in a potentially prosperous market, but only if their consultants are comfortable that the technology works.

That means explaining the technology to outsiders in enough detail so they understand how it works so that the investors are comfortable in supplying funds. But proving that a new technology will work at this level without supplying information that could compromise the start-up’s intellectual property rights is a difficult tightrope to walk — especially when funds are badly needed, Mooers said.

“Everybody’s swearing that they won’t tell anybody and signing NDAs,” he said. “But an NDA is only as good as your ability to sue on it or catch somebody to begin with. If you just told a bunch of VCs, how do you know which one did it? And the person you sue may not have the deep pockets to pay a penalty, if found guilty.”

For xG, this scenario was not a problem because the company was founded by Mooers’ merchant bank. Established in 1999, the company operated in stealth mode, developing and patenting its xMAX solution that is designed to provide low-cost wireless connectivity at power levels low enough to operate in unlicensed spectrum (MRT, September 2005).

As many of its patents were on the verge of being published, xG made its first public statements about its technology during the summer of 2005, only to be met by naysayers wanting more detailed explanations of how xMAX could fulfill the company’s remarkable claims. While xG garnered the support of a well-known Princeton professor, Mooers decided the company generally should decline to address the flood of criticism — a business tactic that was contrary to his personal instincts.

“Don’t you think that I would have loved to prove to people that this works, out of my own personal pride?” Mooers said. “But again, I have everything to lose. You have to keep your ego in your back pocket and just move forward.”

Instead, xG Technology plans to dispel industry concerns by providing mobile voice-over-IP wireless services over commercial networks, starting this month.

“There’s nothing we can do to make it absolutely sure [that xMAX works], and we gain nothing by proving to these guys that it works,” Mooers said. “We have everything to lose if we were stupid enough to do that. We [prove that it works] by commercializing it.”

TALE OF TWO BUSINESS MODELS

It’s a similar strategy to the one employed by Qualcomm two decades ago. Now a giant in the wireless industry, the company began as a start-up trying to transform old CDMA technology into something that would be commercially viable technology for the wireless industry. To do so, Qualcomm briefly entered the equipment business to prove that CDMA would perform as promised.

“Many companies were saying that our technology didn’t work, that it would never work,” said Qualcomm’s Aberle.

Qualcomm had wanted to pursue a business model based on leveraging a healthy patent portfolio by licensing technologies to various established wireless manufacturers, which would pay Qualcomm royalties. When early agreements with major manufacturers such as Motorola and Lucent Technologies (then part of AT&T) did not yield the desired results, Qualcomm entered the manufacturing business temporarily.

“They never intended to be in the equipment business, except to be able to prove what they are doing,” said Robert Syputa, a senior analyst at Maravedis who is preparing an extensive report on intellectual property rights for WiMAX and 4G. “Nobody wants their chip supplier to be a competitor to them. Qualcomm saw that early on and didn’t want to compete with the equipment suppliers, except to be able to prove out the systems.”

Indeed, Qualcomm soon exited the equipment business and licensed its CDMA advancements, which became the core of 3G standards worldwide. But Qualcomm’s royalty-based business model is very different from that of product manufacturers, which generally pursue patents to avoid infringement lawsuits and reduce — or better still, eliminate — royalty payments, which translates to lower product costs.

“Those companies tend to trade patents royalty free or with fairly low royalties,” Aberle said. “The value that they’re obtaining for those patents is not a royalty; it’s protection for that business — the vehicle for making money in the market. … Those are the two fundamentally different business models. One is not right or wrong — just different.”

In recent years, the differences increasingly have become more apparent, as some manufacturers — most notably, giant European handset-maker Nokia — have expressed frustration with the royalty payments they make to Qualcomm on 3G handsets.

Aberle said Nokia simply wants to back out of deals it negotiated with Qualcomm. But Nokia and other manufacturers have claimed that Qualcomm is acting in a monopolistic manner in assessing royalty rates that are not “fair and reasonable” and have taken their case to the European Commission.

“What is fair and reasonable?” Syputa asked. “Nokia says [Qualcomm is] extolling too much revenue, they’re holding the industry up, and they’re preventing trade. … The basic argument for Qualcomm is, ‘Look at the success of the industry. Look at how many people are using cell phones.’”

To date, the European Commission has not launched a formal investigation into the matter, but the situation is one that Mooers has noted while plotting xG Technology’s future business along a path similar to Qualcomm’s, but with a few refinements — most notably, maintaining control over the xMAX chip instead of depending on intangible intellectual property to generate revenue.

“What Qualcomm makes for its profits is no different than what Intel makes on a chip,” Mooers said. “But it’s all the difference in the world if they’re buying something tangible like a chip, compared to a royalty that they could start arguing is a tax. [Qualcomm] would have saved themselves a lot of grief” had it followed Intel’s model.

In addition to appealing to the European Commission for relief from Qualcomm’s royalties, manufacturers also are trying to get standards bodies to establish caps for royalties vendors pay on a given standard, Aberle said. Also, the manufacturers want the royalties divided by the number of patents included in the standard, regardless of how important they are — a scenario that could retard innovation from emerging companies, he said.

“If you look at a small company that may come up with a very, very valuable invention that is worth a lot, under this framework, they’re basically subject to this arbitrary cap and allocation based on the number of patents” Aberle said. “So, what they’re going to end up getting out of this is some tiny return because they may only have three or four patents — even if those patents may be extremely valuable.

Aberle added that this would lead to two problems. First, some companies will decide it doesn’t make sense to invest money on innovative technology; second, some will abstain from participation in the standards bodies because they won’t want to be subject to those rules. “I think that results in bad things for everybody,” he said.

MERGER MANIA

The Qualcomm/Nokia spat has some important long-term implications, although most media coverage has focused on its impact on 3G pricing. That’s because the resolution to the current dispute likely will serve as a precedent that will be cited when the wireless industry turns to 4G technologies.

Initially, Qualcomm wanted to advance its CDMA technology to a 4G level, but it became apparent that the industry was favoring the idea of moving to orthogonal frequency division multiplex (OFDM) technology for the next generation. To cover its technology bases, Qualcomm agreed in August 2005 to pay from $1.4 billion to $1.6 billion for Flarion Technologies, a company boasting a mobile OFDM solution.

“The merger just made a lot of sense — there were a lot of synergies, and it basically strengthened our position going forward,” Aberle said. “If these technologies evolve to OFDM and those get deployed, we’re just increasing our position to be a leader in that area as well, just as we were in CDMA.”

Some analysts expressed the opinion that Qualcomm overpaid for Flarion, but it would be a mistake to look at the deal solely based on Flarion’s meager sales numbers, Syputa said.

“This isn’t just about whether the value of this OFDM [intellectual property] is worth $1.5 billion,” Syputa said. “The question is: Is it worth $1.5 billion to end up getting an extra $20-30 billion out of the industry by extending CDMA licenses past where maybe they should be extended into the future? The answer is: ‘Probably so.’”

And the impact of intellectual property on mergers is evident in deals other than Qualcomm/Flarion. Mobile virtual private network providers NetMotion and Padcom merged their companies just weeks after a judge ruled in their patent-dispute case. And Stanforth said Motorola did not decide in November 2004 to pay a reported $200 million for the handful of customers MeshNetworks had at the time.

“They bought MeshNetworks because of its technology and its patent portfolio, not because of its products and markets,” he said.

Extracting value from intellectual property is critical in today’s wireless market, whether that value is realized via merger, organic company growth or protection of established markets. It promises to become an increasingly more complex task, as innovators scramble to sort through advances on several fronts to develop solutions that will provide the voice, video and data services needed to keep customers happy and operators profitable.

“There’s just an amazing amount of activity going on,” Syputa said. “It’s hard to tell how long it will take technology to evolve, because, now, it’s like we’re working in super Internet time — developments are occurring very rapidly. So, what you might think would take 10 years to develop a field of technology may only take five years.”

In such a fast-moving environment, companies willing to take the time to monitor intellectual-property rights activity stand to benefit the most because doing so can shed light on a competitors’ true strategic and tactical direction much more than official statements cleansed by the competitor’s public-relations staff, Syputa said.

“[Intellectual property rights] is kind of a window on the world, in terms of the development of these industries and understanding what’s going on,” he said. “You can get a sense of what’s really important to a company and how much they believe in their technology.”

MESHNETWORKS’
FOUR BUCKETS

Intellectual-property tactics for new ideas

1. PATENT

   “We tended to do that more if we felt someone might be able to reverse engineer it.”

2. TRADE SECRET

   “If we thought it was something that was a key ingredient or secret sauce that we didn’t think someone could reverse engineer.”

3. DO NOTHING

   “Idea not worth a patent or trade secret.”

4. PUBLISH WHITE PAPER

   “If the idea was interesting, but we weren’t sure how to patent or protect it.”