Quick Thoughts: Thermonuclear War – The Only Winning Move is Not to Play

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–          Mobile device innovation moves faster than due process on patent litigation, leaving plaintiffs to play “Whac-A-Mole” as defendants appeal verdicts and design around infringement.

–          Apple’s global settlement with HTC is an abrupt about face from previous policy and possibly an acknowledgement that Steve Jobs’ thermonuclear war against Android is unwinnable.

–          Comprehensive cross-licensing is inevitable given the IPR complexity of mobile.  The top portfolios will command net royalties, with HTC’s rumored $6-8 payment a start for negotiations with others.

–          Obama’s 2nd term may see patent reform, potentially tightening patent standards, making it more difficult to win damages, and pushing mobile industry litigants closer to negotiated licensing.

 

Hell froze over under Cupertino this past Saturday as Apple and HTC ended all litigation between the companies and agreed to a 10-year cross-licensing deal on current and future patents.  Details were not disclosed, as the companies only issued a terse press release with single-line quotes from the CEOs.  Despite the veil of confidentiality, the blogosphere lit up with speculation on the terms of the agreement.  Most common estimates are that HTC will make payments in the $6-8 per handset range, toward the lower end of the $5-10 band that most assume HTC already pays Microsoft for its even stronger patent portfolio.  For HTC, the deal brings cost predictability relative to the uncertainties of the never ending cycle of litigation, where it had been on a bit of a losing streak despite having been assigned a passel of patents by software partner Google.  For Apple, the move to settle represents a departure from the “Thermonuclear War” launched by Steve Jobs against the Android ecosystem in his last year at the helm of Apple. Jobs’ calculus in fighting a patent war against a host of players across several jurisdictions was largely personal as indicated in Walter Isaacson’s biography of the man.  I’ve written extensively on the patent wars (here, here and here) and believe that negotiated settlements for all of major mobile industry IPR conflicts are inevitable.

Why settle?  The best analogy is the amusement park arcade game “Whac-A-Mole,” where a player using a rubber mallet tries to hit the moles emerging from many directions, forcing them back into their holes.  The problem is that they keep coming up again faster and faster – there is no end game.  Success is measured by the highest score, not an outright victory.  It is an unwinnable game, unless you are the arcade owner.  The patent war game is similar, with Apple wielding its lawsuit mallet against a swarm of Android licensees that keep popping up with new products in myriad geographic jurisdictions.  Win a lawsuit, and the mole tweaks its device to work around the specific patent in question and circumvent the litigation.  After the US International Trade Commission (ITC) handed Apple a victory ordering an import ban of select HTC devices earlier this year, HTC quickly replaced the infringing features with alternative solutions and began shipping the modified devices to the US.  The shipments were held up for a short while as US Customs inspected the devices against the order, but were eventually let into the country.  For HTC, the litigation was a nuisance representing added costs and some hassle to update compliant devices, and may have contributed to the brand losing its’ leadership position in the US market to Samsung.  For Apple, the case was far from a decisive battle in the “thermonuclear war” and represented one mole down and one back up.

The impetus for settlement between the companies may have come from HTC rather than from Apple, a function of the company’s deteriorating competitive position.  HTC’s market share dropped from 21% in Q3 2011 to 14% in Q2 2012 during the brunt of Apple’s legal assault.  Amongst the Android ecosystem partners, HTC has the weakest IPR portfolio and had come to rely on a trove of patents assigned to it by Google, after that company had acquired the IPR in a series of its own acquisitions.  Earlier this year, the ITC ruled that HTC could not assert these “borrowed” patents in a counter complaint against Apple, leaving the company seriously undermanned in conflict with Apple and its $121 billion cash hoard.  Beyond Apple, HTC had also been the target of litigation from both Nokia and Microsoft, settling with the latter for a licensing fee estimated to be $5-10 per device.  Meanwhile, the Nokia lawsuit is still winding its way through the courts.  Settling with Apple stops the bleed of legal costs and management distraction, and allows HTC to get back to focusing on its products.

The licensing deal with HTC is a major milestone for Apple, finally acknowledging the right of an Android-based smartphone competitor to exist, essentially a reversal of Steve Jobs’ “thermonuclear war”.  This rapprochement smacks of Tim Cook, whose aversion to litigation is widely known, and may portend a pragmatic and lasting policy shift.  If so, Apple can pare back the several hundreds of millions of dollars that it spends on litigation each year, and begin cashing royalty checks on the more than 1.3 million Android devices being activated every day.  Emotion aside, this would be unequivocally good for Apple.  With over 50 cases filed in more than 10 jurisdictions around the world, “thermonuclear war” was expensive both in lawyer’s fees but also in executive attention.  Even when a favorable verdict is rendered, such as the recent headline grabbing $1B jury award in the recently concluded trial with Samsung, the case is far from over.  Most of the 28 Samsung products named in the trial are no longer available, and while new products can be added to Apple’s bid for a permanent injunction, technical work arounds make that a moot point.  Meanwhile, Apple may never see its $1B once the case winds its way through the appeals process.  Samsung is looking for a complete retrial on the basis of juror misconduct while the US Patent Office has tentatively invalidated one of the key patents used in the trial: US Patent No. 7,469,381, otherwise known as the “bounce scroll” patent, and is reviewing several others.

The timing of the deal could also reflect a belief that a second Obama term makes significant patent reform more likely.  Silicon Valley firms have been vigorous supporters of the administration, and Apple aside, have advocated major changes to patent law to protect tech companies from aggressive IPR holders.  The argument, which has gained increasing momentum in both legislative and judicial circles, is that the complexity of technology products makes the traditional enforcement of intellectual property law impractical and harmful.  Over the past 30 years, the US patent system has increasingly granted patents for conceptual approaches to addressing computer problems, often referred to as software patents.  These patents can be exceptionally broad, and the underpinnings are often technically sophisticated and difficult to evaluate.  A single product, such as a smartphone, may touch upon hundreds of thousands of patents, many of which are typically these conceptual software patents.  Opponents argue that the overburdened patent office awards far too many patents for so-called innovations that are either too obvious to deserve protection or based on concepts already established by others, moving to tighten standards and invalidate broad swaths of questionable existing patents.  Similarly, patent reformers believe individual patents are granted far too much value given the complexity of modern technology, and that infringement awards should be limited and that injunctions should not be allowed.  For example, the Samsung/Apple jury awarded more than $1B as damages for the infringement of just 7 patents.  Finally, the most aggressive reformers argue that technology patents should be eliminated, or at least, that their duration should be significantly shortened from the current 20 years or that patent holders should be forced to deliver commercial products containing the innovation within a set period of time or lose their intellectual property rights.  Movement toward patent liberalization on each of these fronts is a real possibility.  Indeed, Samsung’s appeal of the Apple verdict could find its way to the US Supreme Court as a potentially precedent setting challenge to traditional patent law, with many influential jurists siding with the movement for reform.  Such an outcome would be obviously bad for Apple if it continued along its litigation happy path, and would seriously undermine any subsequent licensing negotiations.

Assuming that the $6-8 per device royalty number that is floating around the web is a reasonable estimate, it will be used as a point of reference by other negotiators.  Given HTC’s weak hand, it would seem likely that stronger members of the Android ecosystem with better IPR portfolios – e.g. Samsung and Motorola/Google – would end up paying less.  Even so, the sheer volume of Android device sales would put a rapidly growing multi-billion dollar stream of pure profit royalty payments onto Apple’s income statement, augmented by a significant reduction in legal expenses.  Considering that the Jobsian approach had, essentially, no chance of eliminating Android-based competition and that patent reform could render Apple’s litigation strategy impotent, Tim Cook has apparently decided to take the money and run.  Good for him and for Apple shareholders.

For our full research notes, please visit our published research site.

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