Wednesday, March 7, 2012

Apple reportedly offered license deals to Samsung and Motorola -- but differentiation remains key

Today's Wall Street Journal reports that, "according to people familiar with the matter", Apple "has put forth proposals to Motorola Mobility Holdings Inc. and Samsung Electronics Co. to settle some pending litigation in exchange for royalty payments to license its patents, among other terms".

As the article accurately notes, Apple also made an offer to Samsung (at some point before starting litigation). But I found out in Australian court documents that Apple's former IP chief, "Chip" Lutton, testified that Apple was only going to license "low-level" patents.

The three words "among other terms" in the sentence I quoted at the start of the article are very key. Those other terms could include restrictions of two kinds:

  1. restrictions on the use of certain patents (for example, a patent might only be available for implementation on tablet computers but not on smartphones, or another patent might only be available for implementation in email clients but not in other apps)

  2. exclusion of patents that Apple may consider indispensable to the differentiation of its products

Such "other terms" can ultimately be far more important than the question of whether a per-unit royalty would be $5 or $15.

Since the article also quotes a source as saying that Apple doesn't offer a license to all its competitors (for example, it appears that it has not made such an offer to HTC, a company it's been suing for two years) or build a royalty business, it's reasonable to assume that Apple has not backed down on its plans to ensure a reasonable degree of product differentiation.

This assumption is further supported by the words "for some of its patents" in the following passage:

"Apple, of Cupertino, Calif., has asked for between $5 and $15 per handset for some of its patents in one negotiation with Motorola [...]"

Apple does not appear to be offering an all-you-can-eat buffet.

If one compares the purported offer to what Steve Jobs communicated to Google's then-CEO Eric Schmidt two years ago, one may be led to think that Apple has softened its stance, but I'm not sure there's any inconsistency here. Assuming it's true that Jobs told Schmidt he wasn't interested in license fees but wanted Google to stop using Apple's ideas in Android, a total refusal to discuss licensing at all is always easier said than done and rarely meant literally.

At this stage, Apple is still in the process of identifying its winning patents. These lawsuits take time, and in the meantime, Apple gets new patents, some of which appear pretty strong. This is an ongoing process. Should it turn out that Apple actually can enforce some very broad patents without which no one else could offer multitouch devices, Apple would ultimately have to grant licenses to those basic patents in order to steer clear of antitrust trouble. Patents that aren't related to industry standards don't come with a general FRAND licensing obligation, but there comes a point at which a patent holder could be considered to eliminate competition. Antitrust theories involving non-standard-related patents are much harder to develop and to prove in court than those relating to industry standards (since the process of defining a standard already raises the question of whether a cartel abuses its power). But if a company that is dominant in a relevant market abuses its power, there can be a case under competition law for a "duty to deal": an obligation to grant licenses on FRAND terms.

Royalty rates for standard-essential and other patents aren't comparable

The WSJ article mentions that Apple's purported per-unit royalty demand of $5 to $15 would correspond to "roughly 1% to 2.5% of net sales per device" and then notes that Motorola has been criticized (in fact, it's drawn formal antitrust complaints) for demanding a 2.25% royalty.

Obviously, an article can't elaborate fully on all of the issues. In this case, I saw that people commenting on the story elsewhere totally failed to understand that any comparison between those royalty rates is, at best, an apples-to-oranges kind of comparison.

One key consideration here is the royalty base: what is the percentage applied against? The baseband patents Motorola accuses Apple of infringing relate to a limited subset of the overall functionality of a modern smartphone (or tablet computer). They cover a part of the functionality of a baseband chip, and those components typically sell between $10 and $15 for everything (the hardware as well as a license to the relevant patents). That functionality is implemented in everything from low-end feature phones to high-end smartphones and tablet computers, but Motorola wants to be paid based on the value of entire end products, potentially even including airplanes and cars that implement certain standards without a separate wireless product necessarily being identifiable. By contrast, Apple's patents largely relate to the functionality that makes the difference between a feature phone and a smartphone, and that price difference is hugely greater than the $10-$15 market value of a baseband chip.

The value of standard-essential patents has little to do with the innovations they represent. It's all about access to the market or, as Motorola would put it, "it only takes one bullet [one standard-essential patent] to kill". The value of a bullet in this respect is the damage it can do, not the value of its material or design. By contrast, if anyone wants to license patents from Apple that aren't subject to the aforementioned "duty to deal", it's really up to the market to determine what the commercial value of a license to those patents is. After all, Apple would always be free to withhold a license to such patents.

Simply put, the reasonableness of a demand is not a question of the percentage alone. It depends on what royalty base the percentage is applied against and the technological merit and commercial value of a patent per se (as opposed to a mere gatekeeper function).

The ability of holders of non-standard-essential patents to withhold licenses, impose restrictions on licensees and to demand pretty much any amount of royalties (though the market would set a practical limit) was reaffirmed by the ITC last week. The U.S. trade agency dismissed, on a definitive basis, Barnes & Noble's "patent misuse" allegations against Microsoft.

If anyone can prove that Apple holds certain patents that should be treated under antitrust law just like standard-essential patents, then the royalty Apple can demand for those patents could also be judged based on the criteria that apply to standard-essential patents. But even if this applied to some of Apple's patents, Apple would still be free to demand anything (or withhold a license) for its other patents.

So far, the jury is out on just how powerful Apple's patents are. Apple has won some rulings based on patents that can be worked around, such as slide-to-unlock. At this stage, Apple has not enforced patents that would shut competitors out of the market altogether.

By making the purported offers, Apple has certainly made a smart move because it demonstrates to antitrust regulators that it plans to be a reasonably cooperative patent holder. Obviously, regulators wouldn't want to support a crusade of the kind that Steve Jobs's biography outlined in an oversimplified form.

Licensing will be the end game -- but the end isn't near only because of Apple's offers

Apple won't be litigating against companies like Samsung and Motorola forever. At some point, there will be license agreements that will ensure peace at least with respect to the largest part of the issues (limited areas like design-related rights might still be left out). But the fact that Apple has made offers to Samsung and Motorola doesn't mean that an agreement is on the horizon at this stage.

In particular, there are fundamental differences between the situations of those two companies. Samsung is a multi-platform company that would likely replace Android with another operating system any day of the week if there was enough demand. Motorola has bet entirely on Android and is in the process of being acquired by Google. Google promised last August that it would use Motorola's patents to protect Android at large. If the first thing Google did now was to strike a deal with Apple that benefits only Motorola (but not the likes of HTC), it would have a huge credibility problem. While I doubt that Google will ultimately be able to protect Android at large, it has to make at least some reasonable effort and can't give up at this stage (and especially not right after laying down $12.5 billion).

There are some reasons for which I believe Samsung and Apple may indeed settle before Apple and "Googlorola" reach an agreement. But even Samsung just filed a new lawsuit against Apple in South Korea and told the Korea Times today that there would be "no compromise" with Apple. Of course, the filing of new lawsuits and the use of such rhetoric wouldn't stop them from secretly negotiating a deal with Apple and, at some point, announcing it as the best way forward. Still, it says something that Samsung does not respond more favorably to Apple's purported licensing offer. If a $5 or even $15 per-unit royalty solved the whole problem for Samsung, I believe it would elect to pay -- but the unspecified "other terms" the Wall Street Journal mentioned may just be too restrictive for Samsung's purposes.

So don't hold your breath. At some point we'll see settlements, like last June between Apple and Nokia, but it's impossible to predict when this is going to happen. The purported offers appear more likely to be rejected, at least at this stage (maybe companies will take Apple up on them once Apple has more leverage in the courts).

Whenever those settlements happen, most of the talk will be about rumored royalty rates. But the strategic value in those deals to Apple will be in those "other terms", not in the difference between $5 or $15. Even $15 doesn't offset the opportunity cost to Apple from the sale of an Android device. The "other terms", however, are what Apple needs to ensure that its offerings have unique characteristics and exclusive benefits.

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 and Google+.

Share with other professionals via LinkedIn: