Thursday, May 19, 2011

Is Apple winning or losing the patent game?

I'm sure many Apple stakeholders (shareholders, employees, partners, app developers) are asking themselves the above question. There's news about Apple and patents all the time. Most of the time it's about litigation, or threats of litigation, and there's also a lot of interest in Apple's new patent applications, which often provide a clue to possible future products and features.

These days there's a lot of attention to the problems faced by app developers, and yesterday there was bad news for Apple because Eastman Kodak appears to be on the winning track against Apple (and RIM) at the ITC (I'll get to that further below).

This is a good point in time to take a look at Apple's different patent battlefields. Things can always change in any of those disputes, and new important disputes could come up any moment.

Before I look at those war theaters one by one, let me actually start with what my personal guess is. I believe the bottom line of the outcomes of Apple's different patent disputes will be a combination of light and shadow, and Apple may have overrated the strength of its own portfolio and underestimated the strength of its adversaries, but there's so much going on in connection with Android that others might still win the patent game to Apple's immense benefit.

However, Apple should take the Nortel patent auction seriously.

Eastman Kodak showing a strong finish against Apple before the ITC

Yesterday Eastman Kodak's shares rose by about 15% because of recommendations by the ITC staff that greatly increase the probability of a huge payday. Bloomberg did an article that explains those developments very well.

Kodak isn't going for Apple's throats but certainly for its wallet, big time. Apple might have to pay a billion dollars or so for past infringement of Kodak patents, and maybe hundreds of millions a year going forward. Kodak uses one of its relatively old digital photography patents to tax today's smartphone industry. Previously, Samsung paid about $500 million and LG $414 million to Kodak. But Apple's smartphone revenues are far greater than those of Samsung and LG, and the specter of Kodak getting the ITC to order an import ban against the iPhone creates a situation in which Apple may have to write a huge check plus commit to future royalty payments. That would be the costly version of the much-advertised "Kodak moment."

I have explained on various previous occasions, such as this one in March, that fortunes can change in an ITC proceeding. However, we are now approaching Judgment Day: June 23, 2011.

Apple could certainly hope until the last moment that things work out (which would still be a possibility), but if Apple really takes its chances and loses, Kodak could have an import ban in his hand, which would be huge leverage. At the same time, settling ahead of the decision would make sense for Kodak, which probably prefers a bird in the hand over two birds in the bush. Kodak's core business has been largely cannibalized by today's smartphones, so they really depend on monetizing their patents. They wouldn't settle for little because that doesn't help them, but they're probably not going to shoot for "all or nothing" because they can't responsibly afford to.

Apple tried to countersue Kodak, but isn't on the winning track in that process: the Administrative Law Judge on that case made a final initial determination that Kodak doesn't infringe Apple's patents (see this Reuters report). Actually, that was also the case in Kodak's case against Apple, but the ITC decided to review that final initial determination. It could also do so in Apple's case against Kodak, but the difference is that in Kodak's case against Apple that review was ordered and it's going well for Kodak, while a review of the decision in Apple's countersuit might not happen. Apple's case against Kodak is a few months behind, which is another tactical disadvantage.

Nokia doesn't let Apple off the hook, still wants to be paid

In 2009 Nokia wanted to do a license deal with Apple under which Apple would have had to pay royalties for Nokia's standards-related and other patents but would also have had to grant Nokia a license to its own patents, particularly the smartphone-related ones such as on multi-touch user interfaces. Apple wanted a one-way street, Nokia said no and went to court. What followed is a tit-for-tat of mutual claims, with lawsuits filed in different courts in the US and Europe, and the current battlefield looks like this:


The initial ITC complaints that the parties filed against each other more than a year ago appear to be heading for a "goalless draw". But Nokia filed a second ITC complaint, which the ITC recently voted (as expected)to investigate. This was a way for Nokia to show that it still has patents in stock to use against Apple, while Apple might slowly but surely be running out of patents to use in counterclaims.

Apple was the first one of the two parties to sue in Europe, but that may backfire because Nokia's patents may be stronger under European patent law, which allows software patents only if they are presented as "computer-implemented inventions", something that Nokia is pretty good at while Apple's asserted patents are pretty easily identifiable as straightforward software patents and therefore not necessarily enforceable in Europe.

But the biggest strategic problem is Nokia's game-changing move to adopt Windows Phone for its future smartphones. By the time Apple might get enforceable rulings against Nokia's Symbian-based products, it's possible that Nokia won't care too much. They might have to pay damages for past use, but they might not have a problem with taking those products off the market. If Apple wanted to attack Nokia's future Windows-based products, it wouldn't get anywhere because Microsoft (unlike Google) protects its licensees. Microsoft owns far more patents than Apple and files for about five times as many new ones at the current run rate.

So the situation for Apple is that Nokia has little (if anything) to lose while Apple would, if things go wrong, have a lot (if not everything) to lose. Time is now clearly on Nokia's side on various fronts, and I think Apple will most likely end up paying a "Nokia tax". And that one could easily exceed a potential "Kodak tax"...

Trolls attack Apple all the time

Apple is frequently named as a defendant in patent infringement suits, including many of the ones I blog about. It has to fend off dozens of such challenges every year. While this is a cost factor and distraction to Apple, it's actually not that important in the greater scheme of things. One Kodak deal could be more costly than dealing with dozens of little trolls, and in strategic terms, the damage that Android can do to Apple's business model dwarfs whatever problems little trolls can cause to Apple. Those are just like annoying little flies.

App ecosystem under patent attack by trollishly-behaving patent holders

While large players like Apple can deal with the excesses of the U.S. patent system, app developers have a fundamental problem: they lack the resources to defend themselves, so even if dubious patents and/or spurious infringement claims are used to threaten them, they have to pay up. They can't afford to defend themselves in protracted litigation and overturn bad patents (of which there are too many) or prove that they don't infringe. Nor could they reject economically unreasonable demands in hopes of getting a better deal if a court orders damages. If anything goes wrong, their companies will be out of business.

If large app developers like Amazon and eBay get sued, it's not an issue for Apple. But Lodsys's royalty demands and MacroSolve's strategy of suing little app developers even without advance warning are really problematic.

All of that can discourage app development. Normally the capital requirements to do an iOS app are in the hundreds of dollars; if app devs have to fend off patent litigation repeatedly, they need a capital base of many millions. Unless someone behaves likes MacroSolve and sues right away, app devs might be able to just get away with royalty payments. Each one of those may be bearable, but it is a major injustice that little guys can be threatened without any chance to defend themselves. Even though it will take a number of patent royalty demands before app devs pay a similar amount to trolls as Apple's 30% app store cut, the legitimacy of Apple's cut is greater because app devs know beforehand what they have to pay and it's take-it-or-leave-it, while the trolls only go after them later and they're defenseless at that point.

The Lodsys issue could even drive a wedge between Apple an some of its app devs for four reasons. One, it appears that it's not easy (or even impossible) to implement Apple's in-app purchasing API without Lodsys demanding royalties. This has already prompted app devs to post "bug reports" to Apple's developer platform. Two, Lodsys says that Apple has a license to the patent for its own "nameplate" products and services. Three, Apple itself is an investor in Intellectual Ventures, which acquired those patents from the original "inventor" and sold them. So Apple's money was involved in the chain of transactions that led to this mess. Four, while Lodsys hints between the lines that assertions against developers on other platforms (such as Android) may follow, its assertions are limited to iOS apps at this stage, while MacroSolve already targets multiple platforms.

Apple can't accept responsibility for each and every patent infringement by an iOS app, but the only chance that app devs have to get peace of mind concerning patents is for Apple to take care of them. Some have recently asked the question of whether app devs could solve the problem through an insurance, but as I told TiPb's Rene Ritchie in an interview, the average app dev doesn't even have enough revenues to afford an IP insurance. However, Apple would be in a position to play the role of that insurance, given that its strategic interest in its app store goes way beyond its 30% commission.

The best outcome for the app devs would be for Apple to play the Godfather role and strike down on the likes of Lodsys and MacroSolve, indicating that the app ecosystem is a territory where they shouldn't mess around. In MacroSolve's case, most of the apps are cross-platform, but Apple could protect at least those defendants who do Apple-only apps, and they should try to work out something with Google and RIM (whose app markets are also under attack by MacroSolve) so that cross-platform apps will be jointly protected.

If Apple doesn't do this, there's a risk of further exacerbation of the problem. If all it takes to collect money from app devs is a patent no matter how weak it may be, and an infringement assertion no matter how questionable it may be, there will be trolls around all the time. Maybe they won't all claim to own a patent on something that a very large number of apps do, but I've learned that some trolls have already gone after little app devs in connection with functionality that only smaller numbers of apps use. Those cases just didn't get the publicity that Lodsys did.

Apple's fight against Android

I can see why Apple would view Android as an iPhone/iPad rip-off and fight it. But it's another question whether Apple really is enough of a patent powerhouse to do that.

Apple's first target was the patently weakest one of the three major Android device makers: HTC. Things aren't going well for Apple in its ITC proceeding against HTC. If Apple doesn't win that one, it will have to wait for future decisions by federal courts.

More than six months after suing HTC, Apple tackled Motorola. Actually, Motorola sued first, but that looked more like a pre-emptive strike as they knew what Apple was preparing for. Motorola, a pioneer in mobile devices, made a lot of counterclaims against Apple. The battlemap of Apple's fights with HTC and Motorola looks like this:

Apple vs Android 10.12.02

That diagram shows that HTC is much weaker, but Motorola is mounting significant resistance. I'm pretty sure Apple will win against HTC, and that could be devastating for HTC because Apple might not give them a license for any amount of money that HTC could possibly pay, but it may take much longer than Apple hoped. I think Apple can prevail over Motorola, but Motorola's own patent portfolio may be strong enough that Apple may have to content itself with a cross-license deal in which Motorola may or may not be the net payer.

Most recently, Apple took on Samsung despite the fact that it's one of Apple's most important suppliers. Apple's complaint against Samsung is a piece of art (even in the eyes of a software patent critic like me) because it masterfully asserts different types of intellectual property rights and convincingly exposes Samsung as a copycat.

However, it took Samsung only about a week to retaliate in Korea, Japan and Germany, and another week later, in the United States. The current battlemap looks like this:

Apple vs Samsung 11.04.28

It was obvious that Samsung owns a lot of patents. It's an electronics industry giant. I'm not even too impressed by the kinds of patents they assert; nor is Nilay Patel, a lawyer by training and former Engadget editor. But it's quite remarkable how quickly Samsung orchestrated countersuits in four countries on three continents.

Apple is now suing all of the three big Android device makers. It could also try to sue some smaller ones, and I actually wonder why they didn't name some of those as additional defendants in their suits against HTC and Motorola, just in order to discourage companies from adopting Android. There are three dozen Android device makers out there, and it's likely that Apple will several more of those over time.

Android is a fundamental threat to Apple's business. Android has already surpassed the iPhone in terms of daily activations in all of the major markets in the world, while the iPad is still selling almost as well as if it were the only game in town. But the next generation of Android-based tablets could already be much more successful than the current one.

There are analysts who speculate about Apple's stock price possibly reaching $2,000 in a few years (it's now trading around §340). The reality is that Android has the potential to take Apple down to $200, if not less, within a couple of years.

Patents are certainly a strategic weakness of Android. Apple itself may not achieve the results in its own patent battles against the major Android device makers that it hopes for. But the overall patent situation surrounding Android -- with patent holders of all kinds and sizes asserting their rights -- could affect Android's competitiveness and help Apple sustain its margins.

For instance, things are going according to plan so far for Oracle against Google. Oracle isn't on a mission to destroy Android. It wants to make money and assert its control over Java (including any transformations of Java class files into other virtual machine executables). But the fallout could be that Google has to pay so much per Android unit to Oracle that it may not even be able to provide Android to device makers free of charge after such a settlement. And that's just one patent holder of many. By my most recent counts there are 42 Android-related patent infringement suits that have been filed since March 2010. It's the combination of all of that enforcement activity that may seriously hamper Android's ability to commoditize Apple's business.

About 6,000 patents, a number of them LTE-related, are on the auction block now as a result of Nortel's bankruptcy. Google won a pre-auction market test with a $900 million bid and is, therefore, in the pole position now as the so-called "stalking horse bidder" who would get a compensation of $25 million if others do outbid them in the real auction, which will take place next month.

Other companies will be bidding against Google. Most recently, Ericsson was reported to be evaluating possible alliances for entering the contest, possibly on Google's side.

Apple has cash reserves of $60 billion and could replenish its coffers from a successful Nortel bid within roughly a month. It would make a lot of sense for Apple to buy those patents. While a number of patent holders asserting their rights against Android would not be affected by a possible acquisition of those patents by Google (for example, I can't see how Google could use those patents against Oracle, and there may be licensing commitments in place that limit whatever buyer's ability to assert them against some other players), the psychological effect would be that a lot of people in the industry as well as analysts and journalists will think that Google all of a sudden has a sufficiently strong patent portfolio. Google's patent portfolio would grow by a factor of about 10. That cannot be in Apple's interest. If Google has to acquire patents at smaller auctions (which they try all the time), it will take a long time before another Nortel-like opportunity to buy a huge patent portfolio in just one deal will come along.


I already stated at the start of this post that Apple may ultimately benefit from all of the patent disputes going on, although this will most likely turn into an example of "you win some, you lose some".

If it weren't for Android, Apple would probably be better off in a world without patents. But if a multitude of patent holders, all of whom but Apple only pursue license deals, collectively has the effect of significant cost increases for Android-based devices, Apple may even (although it would never say so) be glad to pay "taxes" to players like Kodak and Nokia, as well as to a number of little trolls attacking Apple directly.

It remains to be seen how Apple deals with the problem of patent assertions against defenseless little app devs. Taking good care of its ecosystem would pay dividends in my opinion, but Apple knows its business inside out and its own cost-benefit analysis may yield a different result.

Concerning the Nortel auction, I continue to think it would make sense for Apple to outbid Google. But so far it's not publicly known whether Apple will make a serious effort at all.

We will see how all of this plays out. There will be lots of Apple-related events involving patents, and maybe the picture looks very different later this year, or next year. I just tried to describe the situation as I see it today.

If you'd like to be updated on the smartphone patent disputes and other intellectual property matters I cover, please subscribe to my RSS feed (in the right-hand column) and/or follow me on Twitter @FOSSpatents.

Share with other professionals via LinkedIn: