Navigating the Patent Minefield Through Consortia

Technology companies increasingly face situations in which developing new products involves navigating around dozens or even hundreds of different patents owned by several companies. As a result, innovation is frequently prone to litigation. In addition to making innovation more costly, the looming threat of lawsuits increases strategic complexity and market uncertainty.

The mobile and Internet sectors offer useful examples of how companies can contain the threat of patent litigation. By joining technology consortia, companies such as Apple, Cisco Systems, Ericsson, Google, and Qualcomm pool their patent portfolios to develop markets for technology together. In doing so, they not only become more effective innovators but also augment their chances to capture the value these new markets offer.

There are specific challenges associated with participating in technology consortia. For example, managers must identify which technological areas to target for developing patents and which kinds of licensing agreements are most beneficial. Perhaps more importantly, companies need to balance the enforcement of their own intellectual property (IP) rights with the pursuit of the collective good, as it is in every participant’s interest to make sure that no party carries its private interests too far and fractures the patent pool by refusing to contribute a critical technology.

Therefore, managers need to understand the implications and nuances of being part of a collective if they are to innovate effectively, create new markets together, and compete successfully in these markets.

Mitigating Patent Risks

In developed economies, patent systems give inventors temporary monopolistic rights to profit from their patented inventions. But the current patent paradigm seems misguided for high-tech industries where products are increasingly complex and made out of components developed by multiple companies. A product such as Apple’s iPhone, for example, embeds hundreds of patents that encompass everything from the touch screen interface to photo sharing and 4th generation (4G) wireless communications. Similar examples can be found in the pharmaceutical industry. This leads to what University of California at Berkeley professor Carl Shapiro refers to as “the patent thicket effect,” which he defines as the “dense web of overlapping intellectual property rights that a company must hack its way through in order to actually commercialize new technology.” In such settings, the development of new technologies depends on a company’s ability to assemble numerous components, with each involving one or more patents that may be owned by different companies.

The result is that companies can face a legal and financial labyrinth that seriously restricts their ability to innovate. There are two main causes of concern: (1) royalty stacking risk and (2) injunction risk. Royalty stacking risk refers to the high costs technology producers might bear due to the cumulative effect of many patent holders exercising their IP rights over the same technology. Injunction risk refers to the power patent holders have to obtain legal injunctions to force downstream producers to pull products from the market. Such threats can seriously affect licensing negotiations, especially in cases where the patent in question covers a minor element of a complex, profitable, and popular product. In some cases, companies may discover after they have introduced new products that they have infringed on numerous patents at once, thereby subjecting themselves to large, unexpected costs due to patent licensing fees or litigation.

Large corporations such as Apple and Microsoft have traditionally mitigated these risks by developing extensive patent portfolios, which they use as bargaining tools in negotiations. However, that tends to be very expensive. Moreover, it is difficult for most companies to develop technological depth in multiple areas (for example, cell batteries, displays, and communications). A number of technology consortia have addressed this problem by adopting open IP policies, making patents associated with actual, or derived, innovations accessible to everyone. Examples include the Linux operating system, which is central to Google’s Android platform, and Apache Hadoop and Spark, which are core technologies for big data. Technology consortia provide another way by which companies can navigate the patent minefield, using patent pools and rules that avoid royalty stacking and minimize injunction risks.

The Role of Patent Pools

Companies in technology consortia typically waive some of their IP rights in order to reduce patent search, costs of licensing, and litigation with other stakeholders. The Open Handset Alliance, a technology consortium established by companies including Google, Samsung, HTC, and Sony to develop mobile technologies for the Android operating system, offers a case in point. By having a large set of patents and software easily available, Samsung has been able to concentrate on hardware manufacturing for mobile phones. Google, meanwhile, has used the shared IP to develop an extensive line of smartphones from which end customers can access Google’s services.

In practice, patent pools and the associated management practices on intellectual property rights are structured around three main instruments: (1) essential patents, (2) fair, reasonable, and nondiscriminatory licensing (otherwise known as FRAND), and (3) alternative licensing models which allow companies to license sets of patents in one transaction.

1. Essential Patents

A patent is considered essential if it is needed to manufacture a standard-compliant technology and if it is not technically possible to make, sell, or operate products complying with the standard without infringing on those IP rights. Essential patents are pivotal in the development of well-functioning technology consortia, since they facilitate the transfer of know-how. By providing a legal instrument that complements the transfer of knowledge, they mitigate opportunistic behavior. Essential patents tend to delineate standard interfaces through which modules and components (such as radio technologies) interconnect within larger systems (such as mobile networks).

The 3rd Generation Partnership Project (3GPP), an industry consortium that sets technical specifications for the mobile telecom industry, provides a good example of a coherent set of collective practices around IP rights management in patent pools. Members of the 3GPP select the essential patents on a consensus basis, which then become the industry standards for areas such as access, interoperability, and security in mobile communications.

The Internet Engineering Task Force (IETF), the technology consortium responsible for the design and operation of the Internet, provides another example of successful patent pool management. As with the 3GPP consortium, proposals for new technologies are promoted by the community as Internet standards.

2. FRAND Licensing

Under FRAND licensing, members of a consortium agree to license their technologies on a “fair, reasonable, and nondiscriminatory basis.” This agreement serves two purposes. It facilitates innovations, and it effectively limits the monopolistic power of owners of essential patents. In the 3GPP, for example, FRAND licensing is compulsory, and it even applies to essential patents. In one sense, the essential patent and FRAND mechanisms are complementary, serving to advance collaborative innovation among companies and work against holdup situations.

The IETF, however, takes a less rigid approach to FRAND. Rather than imposing FRAND on patent holders, it makes sure that (1) at least two independent software implementations of the standard exist and (2) these have been broadly accepted by the community before they are proposed as Internet standards. In addition, all of its standards, discussions, and technical documentation are freely available online. As a result, IETF reduces the barriers to entry, mitigates dominance positions, and speeds up negotiations among consortium members.

3. Alternative Licensing Models

In addition to company-to-company patent licensing in which prices for each patent are negotiated separately, technology consortia also promote the development of alternative licensing models in which companies can license sets of patents in a single transaction (for example, the patents required to develop a 4G mobile phone). This approach not only mitigates royalty stacking but also results in simpler procedures and fewer delays — costs that are often associated with the implementation of a new technology when numerous companies hold essential patents. However, in order to avoid antitrust concerns that would stem from the possibility of price-fixing, neither the 3GPP nor the IETF explicitly sets a fixed maximum royalty rate for sets of patents.

The Advantages of Consortia

Companies involved in technology consortia are able to achieve several benefits. They minimize and share the inherent risks associated with new technology development, discover complementary technologies, and tap into the deep knowledge of specialized stakeholders, such as research centers. What’s more, companies whose technologies are adopted as open standards are sometimes able to influence how technology is taken to the market and to reinforce their strategic positioning.

Such collective arrangements aren’t free, however. Participating organizations need to have a thorough understanding of the policies and protocols ruling the consortium and must be prepared to strike a balance between the company’s commercial interests (for instance, licensing fees) and those of the group (for example, market development and interoperability).

Companies involved in technology consortia tend to rely on three generic patent strategies: proprietary strategies, leveraging strategies, and expansive strategies.

Proprietary Strategies

Companies such as Apple, Cisco, Ericsson, and Huawei build strong patent portfolios around core technologies that are embedded in products and value-added services. By contributing to patent pools within technology consortia, companies gain better access to complementary technologies (via FRAND) while ensuring that core patents remain protected (via essential patents). However, defining essential patents relies heavily on human resources and impacts time to market; this explains why technology consortia, such as 3GPP, tend to be dominated by large companies.

Leveraging Strategies

Rather than building watertight barriers or enforcing patents aggressively, some companies (such as Qualcomm) take advantage of patents obtained in the course of the company’s efforts to generate revenue. For them, technology consortia provide well-defined markets in which patent commercialization can take place, although mechanisms such as FRAND effectively limit the ability to maximize economic returns from their patents. Indeed, Qualcomm specializes in patent licensing as a very significant source of revenue.

Expansive Strategies

Still others view technology consortia as a context through which they can achieve freedom to design and innovate without being constrained by the patents owned (or likely to be owned in the future) by others. Such companies — Google and Facebook among them — often develop technologies for internal use rather than to sell. Therefore, they find patent pooling to be an ideal framework for articulating expansive patent strategies based on partial preemption of IP rights and extensive cross-licensing with others (for example, Google releasing Android as open source for use at no cost). Moreover, they have economic incentives to support FRAND and open-source licensing as strategic mechanisms to erode market dominance by incumbents such as Microsoft and to facilitate mass adoption of their own services.

For technology consortia, the governance model and the instruments for managing IP rights must find a balance between (1) providing enough incentives to innovating companies and (2) nurturing the development of patent pools available to the collective. In this sense, policies such as FRAND licensing and models that involve licensing a set of patents in one transaction can discourage companies from contributing to the consortium; both approaches limit a company’s ability to capture the full economic value of its innovations. Absent sufficient incentives for individual companies, the technology consortium will hollow out as companies stop contributing to the collective. On the other hand, if the private interests of innovators prevail over the collective, a consortium may have difficulty building patent pools, and it will not succeed in launching new technologies in the market.

There is a delicate balance between the interests of individual companies and those of the collective. For instance, FRAND licensing models that limit economic returns run counter to the interests of pure innovators like Qualcomm. On the other hand, technology adopters (for example, telecom operators) or product-based innovators (for example, Ericsson or Cisco) may be satisfied with “low-return” licensing policies for IP rights. Also, while policies that facilitate licensing a set of patents together rather than one at a time are arguably beneficial to technology adopters, they may raise antitrust concerns due to potential cartel-like, price-fixing practices by technology producers.

When joining technology consortia, companies stand to benefit by taking advantage of well-defined regulatory instruments and industrial practices that address the limitations of current patent systems, while also gaining access to patent pools upon which they can build new technologies. In exchange, companies must be prepared to accept binding rules affecting how their technologies will to be licensed to others. They must be willing to accept slower innovation processes due to consensus building and limits to the maximum royalty rates they can charge for their patents.

Innovation in high-tech markets involves working with many patent holders, each of which can affect how new technologies can be brought to market. To prosper in this environment, companies must be prepared to loosen up their rights to intellectual property and embrace collaboration with other companies, even if it means working with competitors.