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Buying Freedom to Operate (and Regulate, Tax and Kill)

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The Nortel Auction

On June 30, the results of the Nortel bankruptcy auction were announced. A consortium of Apple, Microsoft, RIM (Blackberry), Ericsson, Sony and EMC put up $4.5 billion to acquire Nortel's remaining portfolio of 6,000 patents.

This is not a story about patents motivating invention, or licenses enabling technology to spread. This is about patents as blunt legal instruments, options to sue -- in this case, the last remaining assets of a failed company offered to the highest bidder.

The winner: a consortium including three of the four smartphone platforms, including two companies (Microsoft and Apple) with huge cash reserves and a growing record of suing for patent infringement. The loser: the open-source Android platform promoted by Google, who lost the bidding at the Nortel auction.

Portfolio Power

This is the patent system at its ugliest. It is about how low standards and low quality lead to absurdly high numbers of patents for a technology whose products are inherently complex and rich in functions and components. It is about vast numbers of patents that would cost tens of millions just to hire lawyers to read and evaluate -- with no guarantees. It is about huge portfolios whose primary function is to intimidate, not to inform; and incumbent portfolio owners ganging up on the relative latecomer (pity poor Google, with its mere 1,000 or so patents, most of which have little to do with smartphones).

This has nothing to do with patents protecting the little guy in some small niche. Little niches are fine for the little guy, but the portfolio, not the individual patent, is the driving force in today's ecosytem. Portfolios serve to entrench incumbents, especially for large and complex platforms that keep growing in scope and functionality. As patents are added, they evergreen the portfolio so that it never expires.

Portfolio building begins innocently enough, spurred by the need for "freedom of action" (as IBM used to call it) or, more commonly, "freedom to operate." You don't get freedom to operate from a single patent. Your patent does not even give you the right to practice the technology it covers. It only gives you the right to keep everybody else from practicing it, including the lesser rights to regulate and tax. If they are inadvertently practicing it, then it's a license to kill. Portfolios provide "freedom to operate" to the extent that they provide weapons to fight back.

In a complex IT product in which a thousand patents may be owned by a hundred different entities, many people have many opportunities to block others -- and all the way down the value chain to end users. In principle, if everybody enforced their patents, not only would innovation come to a standstill, but all systems at work and at home would grind to a halt (see Michael Heller's "The Gridlock Economy").

Portfolio Strategies

Producing companies have addressed this problem -- in effect bartering their way out of the patent system -- by offering each other access to their respective portfolios. This is done in one of three ways. They can do it formally by cross-licensing their patents. They can simply agree not to sue each other (non-assertion agreements). Or they can just silently acknowledge the likelihood of mutually assured destruction -- the understanding that if you sue me, I will sue you back, and it will cost both of us big-time.

This reciprocity works pretty well for similarly armed and positioned portfolio owners. But the détente breaks down in an increasingly heterogeneous ecosystem. It doesn't work against trolls; they have no need for access to anyone else's patents because they aren't producing anything. It also doesn't work for newcomers who have little to trade. On the other hand, if you have a very big portfolio, you may be able extract licenses simply by intimidating your competitors (read Gary Reback's classic account of IBM's shakedown of Sun ["or do you want to make this easy and just pay us $20 million?"]).

Or you can simply rail about how competitors are infringing your patents, and thereby sow fear, uncertainty and doubt among their customers and users. Try searching "Microsoft threatens Linux." Note that individual patents are not identified, because that would give alleged infringers an opportunity to search for prior art that might invalidate the patent, the option to design around the patent, or the possibility of filing for a declaratory judgment. When Microsoft threatened Barnes & Noble over B&N's innovative Android-based Nook, it claimed that its patents dominated Android but would not reveal how unless B&N signed a non-disclosure agreement!

The irony here is that one of the key benefits of the patent is supposed to be public disclosure, but patents are far more powerful if you can use them to keep everybody worried and guessing -- without exposing individual patents to public scrutiny and possible invalidation.

With many patents, many potential infringers, and high costs of evaluating and contesting patents, there are many possible strategies for "extracting value" (or "abuse," depending on your perspective). You can sell non-exclusive licenses over and over -- and in stages, first to allies, insiders and first-comers, then on to the slow-moving, unsuspecting and the great unwashed. The trick is market segmentation on a grand scale, staged so that licensees are induced and pressured to buy in early.

The "catch and release" model is common among patent aggregators, whether their hat is black or white. The aggregator acquires patents, licenses them nonexclusively to its investors, members, or other insiders -- and then sells them back into the burgeoning market. There the patents may be acquired by bottom-feeders who have no compunctions about aggressive tactics, including attacks on businesses too small to defend themselves.

By its own admission, Microsoft already had a non-exclusive license to Nortel's patents before the auction, so it had no need for the portfolio -- except to use it against others, directly or indirectly. Microsoft is already vigorously suing Android makers over patents, so why not pile on a few more? Or sell them to speculators willing to start new fronts in the war against innovative products?

Let's be honest about it. It's in your shareholders' interests for trolls to wreak havoc on your competitors. It's about money.

Next, even more money: the sovereign patent fund.