Thursday, November 24, 2016

Standard-essential patents: more rationality and a shift to China, but where are tech's titans? (guest post)

Preliminary Note

How's that for a holiday special? Right below this introduction you'll find the first guest post ever on the FOSS Patents blog, authored by Richard Kramer, the main founder of Arete Research, and Brett Simpson, one of Arete's co-founders. Founded in early 2000 by experienced research professionals, Arete is the pioneer in independent equity research, and has the largest team of experienced analysts specializing in global technology, telecoms and alternative energy sectors. Arete is the trusted source of equity research to over 100 of the world's most sophisticated tech investors.

The FOSS Patents blog started as a one-man show but it will, over time, become a more inclusive platform. Guest authors' opinions are not necessarily my own. In fact, Richard and I have previously disagreed, which included his 2011 prediction that the "smartphone patent wars" weren't going to have devastating impact, a fact I also recognized about two years ago. Even in areas where we still disagree, I always find his insights interesting, and I hope so do you.

Happy Thanksgiving! And now:

Guest post by Richard Kramer and Brett Simpson, both of Arete Research

Standard-essential patents: more rationality and a shift to China, but where are tech's titans?

Despite a long campaign on the part of the smartphone players from outside of the traditional telecom industry to "de-value" standards-essential patents, a period of irrational inflation of patent assets (Rockstar Nortel patents for $4bn+, anyone?), and the largely Quixotic efforts of a range of patent "re-sellers" (often an indirect negotiating tactic of the large IPR holders), we have gradually seen a more sensible "clearing price" for SEPs get established in the deals of the past few years.

We said in 2011 that "this Cold War around IPR relating to mobile devices is not over, but we think it will reach a phase where settlements will be preferable to all-out warfare." The past few years have seen this view become mainstream. (Perhaps aggressive law firms, like investment bankers, simply are less successful in their business development efforts in egging clients on to undertake massive litigations.)

We seem to be entering a period of more tactical lawsuits, realise that pursuing litigations to the bitter end carries too many business risks to justify the rewards. One can see this with Apple, where for all its initial aggression around design patents, it has more recently adopted a pragmatic approach, coming to agreements with Ericsson (avoiding extensive and messy litigation in West Texas), Huawei, and even Kudelski (over OpenTV patents). Perhaps the business risks of extended litigation are now being weighed in the calculation over "defending" rather nebulous design patents, which often draw attention to, and sympathy for the sued party. Nokia also made it clear that it sees itself in a "new world" given that its prior major licensing deals were struck when it needed cross-licenses for its own smartphone business, with a critical renewal at Apple forthcoming.

Yet the new wrinkle in global SEPs has been the emergence of Huawei as the primus inter pares of the Chinese technology world. If we trace back the origins of the most relevant SEPs in wireless technology, they stem from a combination of infrastructure vendors and chipmakers (Siemens-Infineon; Motorola-Freescale, Ericsson-EMP, etc.), Huawei has not only established itself as top three wireless networks vendor (in a now largely consolidated market), but also continually invested in chip-level technology at the device level with its HiSilicon unit (now gradually seeking merchant silicon sales).

In the past two years Huawei has filed more patent applications than even Qualcomm, a key output of its $8.6bn R&D investment. By securing a licensing deal with Apple, and pursuing ZTE and others in China, Huawei is signalling that it must abide by the same rules in all markets. In Jan. '16, Huawei agreed a broad cross-license deal with Ericsson, in Sept. '16 it settled a long-standing dispute with InterDigital and is current engaged in counter-suits with Samsung. In this context, it will be interesting to watch how it resolves the Samsung situation, and handles cross-licensing with Nokia, as well as resolving a rather salacious lawsuit involving T-Mobile, where Huawei staff were caught breaking into a T-Mobile office, while Huawei responded by taking the unprecedented step of suing T-Mobile, a prominent infrastructure and smartphone customer.

The emergence of Huawei as a leading force in global IPR claims is good news for traditional IPR holders like Qualcomm and Nokia, where the quid pro quo for Huawei collecting royalties outside of China must surely be that leading Chinese smartphone brands must now pay royalties on domestic shipments, something that has been deftly avoided by previous (Xiaomi) and current (Oppo) market share leaders, from a combination of focus on the domestic market and exporting to equally IPR-unfriendly markets through "agents". Qualcomm is suing Meizu in China, Samsung and Huawei are suing each other in China, while Nokia sub-licensees WiLAN, Sisvel and Vringo all brought suits either in China or against Chinese vendors like ZTE, Haier, etc. Not only are the Chinese, most notably Huawei, becoming more assertive, but China is increasingly becoming a critical venue alongside the traditional US, UK, Dutch and German courts. The gravitational forces of IPR have now inexorably begun shifting Eastwards, both as a source and claimant of royalty income; one now has to rank Huawei alongside Qualcomm, Ericsson and Nokia as the stalwarts of an increasingly rational wireless SEP environment.

One of the big surprises to us is the lack of involvement in standards setting (and patent generation) from the most influential companies in global tech: Apple, for its $160bn smartphone business, has exerted zero influence on 5G development. Google, Microsoft, Intel, Amazon, Facebook have collectively doubled R&D in the last two years – reaching $30bn+ excl. stock comp - but choose to focus on emerging technologies such as machine learning, VR, AR, driverless cars, robotics, drones, where there are no standards, but instead a loose commitment to open source technology (often as a fig leaf for proprietary technology). It’s even more surprising when considering how much their businesses have profited the most from 4G, and how much more they stand to gain from 5G. Data is the new gold and 5G will enable data to be used in “near real time” that will be essential for applications like driverless cars, or even assisted driving.

Why sit on the sidelines? Perhaps it is that 5G offers few “insertion points” in this global SEP licensing process, since it largely continues the use of the 4G air interfaces, making renewals more of a pro forma matter. This leaves wireless heavyweights – Qualcomm, Huawei, Ericsson, Nokia, et al – remaining firmly in control of the standards setting process in 5G and thereby controlling one of the most lucrative profit streams in tech, as seen in the $8bn revenue base at Qualcomm’s QTL unit, or the $1bn+ licensing streams of Nokia and Ericsson.

This is important since the hyper-scale data centre players have squeezed the OEM business model down to ever lower margins; this creates a rising incentive to seek royalties for SEPs, and also extract value from implementation patents which are largely unlicensed today.

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