Back to the future in patent licensing
In the wake of the patent market crisis, licensors can achieve success not with new business models but by re-embracing an old one from the 1990s – the IBM model of licensing
Four years ago, author and IP consultant David Kline wrote a cover story for issue 74 of IAM warning that the patent licensing industry was facing “an extinction-level event” in which “virtually all public and private standalone licensing companies” would wind up in crisis if not go extinct outright. Anyone with a passing familiarity with our industry over the last four years knows that the situation has proved every bit as dire as Kline predicted.
In his article, Kline analogised the crisis then confronting licensors to that faced by the dinosaurs during the Permian mass extinction of 250 million years ago. He suggested that as was true of the dinosaurs in the Great Dying, licensors who wished to survive the current IP extinction event would need to develop entirely new body plans (ie, business models).
He was right about the crisis but wrong about the cure. What neither Kline nor any other IP pundit expected was that one of the surviving licensors, Dominion Harbor Enterprises, would base its approach not on an entirely new body plan or business model but on the revival of an older one from the 1990s – what is now known as the IBM model of patent licensing.
Pioneered by IP Hall of Fame alumnus Marshall Phelps (one of the authors of this article), this model earned Big Blue more than $2 billion a year in licensing revenues in the 1990s – 97% of it pure profit. It also served as a clarion call that sparked corporate America to finally start monetising its previously dormant IP assets. It is no exaggeration to say that the model helped to launch the patent licensing gold rush of the last 25 years.
Since the advent of the licensor crisis four years ago, the landscape has been littered with small NPEs, most of which never managed to break out of the $5 to $10 million per year revenue ghetto – and some of which have even gone out of business. Among those expanding strongly – and even demonstrating a 50% annual revenue growth rate – is Dominion Harbor Enterprises, which was formed when its principals split from litigation chop-shop IP Navigation Group in 2013.
Today, the company has more than 12,000 patents in its monetisation arsenal, including:
- a former Kodak portfolio of more than 4,000 imaging patents;
- a high-value portfolio of 3,500 mobile, Internet of Things (IoT), LED and cloud-computing patents from Japanese technology giant Panasonic;
- an American Express portfolio of 1,000 payments and finance patents;
- a portfolio from NEC of 1,200 LCD and related patents;
- large portfolios originally developed by Konica-Minolta and Siemens; and
- the right to market Intellectual Ventures’ (IV) vast portfolio of patents to certain prospective licensees.
What is really different about the licensing market today compared to that of a decade ago that some licensors like Dominion have been able to leverage? What strategies and tactics can licensors employ to ensure their success in a market in which patent values are still reduced (though showing strong signs of life) – and in a legal environment in which patent enforcement is still constrained, in the United States at least, by the Supreme Court’s Alice decision and the inter partes review regime?
We have identified four key features of IBM’s 1990s licensing model that licensors can embrace to enhance their success in today’s market. These elements may be simple to grasp in concept, but they are often difficult to execute well in practice.
Four key elements
Offer an objectively good product
A ‘good product’ is one composed of high-value, curated patent portfolios that have both mass and significance. Blue-chip patent portfolios with mass and market applicability are those with significant numbers of open patent families that are relevant to high-value industries, such as wireless, the IoT, imaging and finance. The chances of licensing success are improved, of course, if your portfolios are broadly diversified across multiple technologies and industries, thereby increasing the opportunities for repeatable licensing deals. Your product value is even further enhanced if the portfolios have previously been validated (ie, licensed by major companies) and if complementary new patent prosecutions can buttress the portfolio’s overall value and longevity.
Offer reasonable terms that prospective licensees can readily accept
Licensors must recognise the realities of the current patent transactional market and not seek to extract more in royalties than what the real-world market will bear. This does not mean licensing on the cheap. Rather, it means recognising the reality of the current market and the value of compiling a global licensee base of market leaders. Beyond that, licensors will also find that there is far more value in building sustainable business relationships with licensees – relationships that can be leveraged to generate repeatable licensing deals – than in extracting the maximum value possible from any one deal.
Offer some added value beyond freedom to operate and relief from liability
In essence, this means taking a partner-based approach that generates value for both sides. Licensors should look for ways to sweeten licensing deals by offering something in return, whether that means high-value patent transactional or advisory services or some other benefit, such as a patent purchase or other value transfer.
In Dominion’s case, its IPedia analytics engine can rapidly assess patent portfolios from small to large in real time, ascertaining their relative legal quality and innovation value compared to other patents in related technologies. Using Dominion’s proprietary data sources, evidence-of-use metrics and valuation algorithms, it can also identify the most lucrative licensing opportunities for those portfolios.
Last year, for example, a deal with a major Hollywood entertainment company was cemented only after Dominion sweetened the terms with an offer of future access to IPedia intelligence products, which helped the licensee’s negotiating team sell the deal to its own management. Remember, every licence deal really requires two agreements – one between the licensor and licensee, and the other between the licensee’s team and its own senior management. Of course, the latter must be well-supported by the licensor in order to achieve the former.
The point is, as much as possible, to make the licensing deal a horse-trading situation that the licensee team perceives as fair and can sell to its own management.
Demonstrate rigorous due diligence in making a business case for licensing
In today’s market, licensors must do their homework exceptionally well and make a business rather than an infringement case for taking a licence. No licensee ever uncritically accepts a licensor’s claim charts without rebuttal, but they should be able to see that the licensor has done its homework. Without a high-level analytics platform, a licensor will find it difficult to succeed in today’s environment.
This sort of prudent, data-driven and business-like strategy is precisely the opposite of the weaponised approach to intellectual property taken by many licensors in the pre-crisis gold rush days of the early 2000s. Instead of asking, as IP Navigation Group and similar IP hubs used to – “what is it going to cost them to defend against us?” (ie, what is the risk-adjusted cost of litigation) – licensors should be asking: “What value can we offer them?”
There was no need for such a prudent, customer-focused licensing strategy during the patent licensing gold rush. Back then, the established model for licensing patents was for a licensor to acquire assets, the quality of which was often of little concern because the strategy was generally to sue first without prior warning and then aggressively pursue litigation. If the licensor was able to make the litigation uncomfortable enough for the prospective licensee, a settlement would be reached that was less than the cost of litigation and that resulted in a net profit to the owner of the patents.
Who is the customer: the court or the licensee?
The crucial point here is that in the pre-crisis days, the licensor’s true audience (or true customer) was not really the licensee. It was the court. Licensors were not concerned about making a case built around the quality and value of the patents to the prospective licensee; they were concerned primarily with claim construction, Markman hearings, summary judgment and expert reports. In many cases, licensors never once spoke to the licensee.
Indeed, the licensor’s objective in those days was to get through the legal motions and get before a jury. That was the game. If you could get to a jury, you had a good chance of profiting, especially in plaintiff-friendly venues. There was no patience for protracted licensing negotiations – certainly not with the licensee – so negotiations were almost always between the lawyers. Licensors knew that if they could get to a jury, the licensee’s legal team would likely settle because an adverse verdict would cost them a great deal more money.
In what other business do companies have the courts – the legal system – as their primary customer? We cannot think of a single industry other than the pre-crisis patent licensing business in which this was the case.
The licensor’s sales pitch in those days went something like this: “It’s going to cost you $7 million to defend. I can get before a judge and won’t lose any summary judgment motions. You’re never going to file a re-exam because it’ll take too long. And oh, by the way, our experts will say that based on our damage calculation you owe us $250 million, and we will seek an injunction regardless of what the patent actually covers.”
It was a pitch dependent entirely on leveraging the cost of defence and the legal complexities of the court system to license patents.
And for a time, it worked. A kind of get-rich-quick mania spread through the licensing sector. Everyone wanted to leverage the cost of legal defence to monetise even patents of dubious quality. It is no exaggeration to say that in some ways the patent licensing business was akin to an extortion racket. Patents were not marketable assets. They were hammers that could be used to bludgeon licensees into legal settlements.
But in the years that followed, this approach began to work less well and eventually produced strong pushback from industry, government and the courts. Lobbying by big technology companies accelerated dramatically on Capitol Hill and the result was an increase in anti-patent legislation and judicial activity. Licensors found themselves in an increasingly inhospitable legal environment that began with the Supreme Court cases eBay and KSR and eventually led to the America Invents Act, Mayo and Alice and the inter partes review regime.
Licensing then and now
To appreciate how dramatically the patent licensing business has changed in the last decade, consider two different negotiations conducted 10 years apart, between myself – David Pridham – and a major Japanese consumer electronics manufacturer, which we will call JapanCo to preserve confidentiality. Ten years ago, I was a principal at IP Navigation Group, a patent licensing company widely regarded as overly litigious and often described in the press as a patent troll. At that time, IP Nav’s first contact with JapanCo was to sue the company for patent infringement without warning. In response, JapanCo hired the law firm Amster Rothstein as counsel. IP Nav’s entire licensing discussion – actually, it was a litigation discussion – was with JapanCo’s outside lawyers. IP Nav never spoke with any officer or licensing executive at JapanCo itself. The technical merits of the patents and their real-world market value were never discussed, nor was any business case ever made for why JapanCo should take a licence. The technical merits of patented inventions in suit were never evaluated, nor was the applicability of the patents to any industrial application ever demonstrated. Throughout the process, IP Nav and JapanCo were irretrievably adversarial and no thought was ever given to establishing a business relationship of any kind.
Fast-forward 10 years and I am now chief executive at Dominion Harbor Enterprises, which contacted JapanCo in early 2017 about renewing its licence to Dominion’s 4,000 patent Kodak imaging portfolio. This time the entire licensing discussion was focused on the industrial utility, quality and market value of the patents – not the cost of legal defence. In fact, no lawyers were involved in the negotiation. Every step of the year-long negotiation was conducted between the principals at JapanCo and Dominion. These negotiations involved not only JapanCo’s licensing executives but also the technologists and engineers most concerned with evaluating the technical merits of the Kodak portfolio. The aim of both parties in the negotiation was to determine whether a mutually beneficial deal of some sort could be obtained. What is more, Dominion’s negotiation with JapanCo was conducted with an eye to producing a long-term business relationship between the parties. In other words, the more recent licensing negotiation was conducted along the same lines as deal negotiations in any other business between willing buyers and sellers in the free market. It was a licensing deal, not a litigation settlement.
David Pridham is CEO of Dominion Harbor Enterprises
Gold-rush model collapses
Ultimately, this court-centred model collapsed under the weight of pushback from deep-pocketed technology companies who influenced Congress and the courts. The result was the extinction-level event for patent licensors referenced at the beginning of this article.
In our opinion, this old model was destined to fail because it was ill-founded to begin with. Negotiating at gunpoint rarely works long term. You have to offer your customer – your real customer, meaning the licensee not the court – something of value, even if it is simply the clearing of patent risk. And you have to sell it in a way that makes sense to the buyer from both a technical and a legal perspective.
Indeed, for any licensor to build a sustainable business, it must be able to come back to licensees with future offerings. One cannot approach them in combat mode and make any one deal a fight to the death. In short, one must develop a licensing programme, not a litigation programme.
IBM’s desperate licensing beginnings
When I took over the IBM IP brief in 1992, patent operations were then housed in a department called industry and commercial relations. Its principal function was not to license patents for revenue but to serve as a complaints department for IBM’s major competitors. Despite owning one of the world’s largest and most valuable patent portfolios, at the time IBM was a net payer of licensing fees. Out-licensing had never been profitable at the company and indeed had often been compulsory.
For years, IBM had been forced to operate under the restrictions of a 1956 consent decree with the US Department of Justice, which then viewed patent rights through the prism of antitrust and treated them as anti-competitive tools of market power. The consent decree required IBM – and here we quote directly – “to grant to each person making written application therefore an unrestricted, nonexclusive license to some or all IBM existing and future patents”.
Today’s patent owners may complain of weakened enforcement power and a constrained market but what IBM had to contend with was more challenging by many orders of magnitude. Indeed, the only reason I was even given the chance to try to earn a return on IBM’s vast IP portfolio was because the company had just laid off half of its entire workforce – over 200,000 employees – and was reportedly only 100 days from bankruptcy. It was desperate to try anything, even the risky out-licensing of patents, to get cash.
Thus, when I began my effort to monetise IBM’s lucrative patent portfolio, I needed an approach suited to the highly defensive environment for IBM at the time. The company needed to avoid situations in which licensees might complain to the Justice Department that Big Blue was trying to tax it out of business. So we had to find a way to generate value from intellectual property in an environment in which licensors did not have a lot of power. Put simply, I had to develop a monetisation programme that relied on carrots not sticks.
First, I put together a strong product, making all of IBM’s world-class patent portfolio available for license. Remember, IBM had a patent portfolio significantly larger and more valuable than those of most other companies and it was especially strong in the chip sector, among several others.
Second, I rationalised royalty rates for the programme. Until then, IBM had employed variable pricing for different patents, based on their supposed quality as subjectively determined by IBM. For obvious reasons, licensees perceived this pricing structure as irrational and unfair. So I ordered that henceforth all patents would be offered at a 1% royalty rate. More patents would cost more, but no licensee ever paid more than a 2% royalty no matter how many patents we licensed. This was a pricing structure that licensees could embrace.
Third, I insisted that the licensing team always seek to offer some added value to the licensee beyond the removal of potential legal liability for infringement. As one veteran of the programme recalls: “We could not afford to create a hold-up situation, a stick up. Instead, what we always tried to create was a value transfer – we get something of value from them (a royalty), and they get something of value from us. That way the licensee could make an argument with its home office that it wasn’t just IBM holding a gun to their heads.”
That value transfer could be quite different from licensee to licensee. “We had to study every one of the companies we were dealing with,” explains the IBM veteran. “What about their patents? Did they have some that we might want to buy or license? Or did they have some technology – or perhaps even some relationships with other firms – that would benefit us? Sometimes we just flat out asked the licensee, ‘What do you have that you think we ought to be interested in?’ The main thing is, we tried to create a horse-trade situation. It was crucial that we had a licensing programme that the industry perceived as valuable, logical and fair.”
The fourth element of IBM’s programme in those days was exceptional due diligence. Despite being the 800-pound gorilla of the tech business at the time, the company had to avoid making threats at all costs. Instead, it worked hard to develop incontrovertible evidence that its patented technologies were being used by the licensee.
In one case, for example, I even employed the company’s Scanning Tunneling Microscope, for which IBM researchers Gerd Binnig and Heinrich Rohrer had won the Nobel Prize in 1986. Using the microscope’s atomic-level imaging capabilities, I was able to demonstrate to Fujitsu that it was using IBM’s patented technology to build its chips – there was simply no other way that it could have done so. Fujitsu had no choice but to take a licence.
Marshall Phelps is former chief of intellectual property at both IBM and Microsoft, and a member of Dominion's board of advisers
With this approach, patent quality becomes much more important. That is because the key element in the licensor’s sales pitch is not the cost of defence but the value of the patents and the ways in which the licensee is using the patented technology. The debate is not between two sets of lawyers over the next status conference in a lawsuit. It is between licensor and licensee over how the patented technology is being used, where and in what countries coverage exists, the revenues associated with the products, and the determination of a reasonable and appropriate value for the invention. The focus becomes the economic value of a patent licence, not the cost of defence. As a result, the venue for licensing discussions moves from the court to the market.
In today’s weakened post-crisis legal environment for patent owners, we have found this new market-oriented licensing approach to be most successful with licensees. Interestingly, this approach has close parallels with the model that IBM developed in the 1990s when it was faced with a similarly enfeebled legal environment. In fact, although few people realise it, IBM’s success as a patent licensor in the 1990s was born of unusually defensive, if not desperate, beginnings.
What licensors can learn from IBM
However, in the 2000s the patent licensing industry abandoned its roots and licensors rejected the IBM model in favour of a get-rich-quick litigation-based model. Licensors stopped caring about patent quality and lost sight of who their customers truly were. The eventual result of this drastic change in licensor behaviour was the extinction-level event that struck the patent licensing industry a few years ago.
However, in today’s post-crisis patent environment successful licensors will need to embrace five new realities of the new patent market.
First, although each licensor will have its own secret sauce – high-quality portfolios, superb analytics or flexibility on price – they must all recognise that while patented inventions are often valuable, patent values do have limits. Yes, you have a patent, but you have not split the atom or invented oxygen. A little realism about patent value can really help you succeed as a licensor.
Second, you need to achieve some scale, even if that scale is modest. If you have just one or two patents, no matter how good they are, there is little reason for a licensee to consider taking a licence at almost any price. That is because it is going to be cheaper for them to initiate inter partes reviews against those two patents and as a patent owner you are likely to lose those assets and end up with nothing. But if you have 20 or more patents (let alone hundreds or even thousands), the inter partes review regime is not as much a threat. That is because the licensee knows that it will cost more to subject those 20 (or more) patents to inter partes review than it would to just take a licence – especially if the evidence of use you have provided demonstrates the clear need for one. The fact that the patent market has become globalised only enhances the value of having a broad and diversified portfolio with assets in multiple countries.
Third, licensors need to approach licensees the same way that any other business approaches its customers (ie, with a focus on solving problems for them). When Dominion launched its licensing campaign for the Kodak portfolio, for example, it told licensees that it was solving a potentially serious problem for them. Which was that by acquiring 4,500 Kodak patents from IV they were ensuring that licensees would never have to worry about those patents being dispersed piecemeal to dozens of NPEs, each of whom could pose a significant litigation threat. This allowed prospective licensees to clear the risk of 4,500 patents and protect themselves from assertion attacks from multiple entities. And because the licences were offered in perpetuity, there would be no coming back in five years with another request for royalties.
Fourth, licensors should approach licensees with an eye towards establishing a long-term relationship with them. It does not take any creativity to point a gun at someone and demand a settlement that is less than the cost of litigation. But, as we all have learned from the experience of the recent patent marketing crisis, that is not a repeatable business model. To truly succeed as a licensor today, you must offer something of value to licensees not just once but repeatedly.
A career at the coalface
After a long career in intellectual property, including years spent negotiating multiple licensing deals, Marshall Phelps offers a few home truths about closing a licensing agreement:
You can’t go out there and try to confiscate people, take their first born from them in return for a licence agreement. But that’s how too many people in the licensing business used to do it. Their approach was to hold a gun to everybody’s head and then get the hell out of Dodge. They took advantage of the situation in the Eastern District of Texas and gave licensing a really bad name. And I think that’s partly why the industry fell apart five years ago.
You really can’t run a licensing programme that way, and the reason is because licence agreements are renewable. They are usually five years and with that approach, you can’t go back to the well again. If you were a complete jerk and you beat the living crap out of somebody and you left them with blood on the floor, what do you think they’re going to do in those next five years? Well, in addition to harbouring a very serious grudge against you, they’re going to go out and get some intellectual property to fight you with so you can’t do that to them again. That is not a repeatable business model.
On that point, many licensees are actually good corporate actors. If you show that they are infringing a number of blue-chip patents that are presumed valid, then they will probably talk to you about a licence if the evidence is clear and the deal terms seem fair. To be sure, there are some companies that will not play fair. But in our experience, most will be willing to pay for what they use, especially if you are able to clear their patent risk and provide them with something of genuine value.
Finally, licensors should make every effort to leverage the greater opportunities available to them in today’s newly globalised patent licensing marketplace. The globalisation of the patent market in recent years is a positive development that has created a large number of potential new licensees for patent owners to work with. The opportunities for deal making are that much greater, especially if you have portfolios with assets in dozens of countries.
With Chinese companies such as Xiaomi, Oppo and Vivo, you can market assets that are not only relevant to China and India, but in Xiaomi’s case, also applicable to the European market as well, especially Spain and Germany. Licensors cannot just roll out US patents and expect companies in foreign markets who have not yet penetrated the United States to take a licence (or at least pay you a lot for one). But if you concentrate on assets in global markets where companies need to secure IP rights to gain the freedom to operate, you can capitalise on many new business opportunities.
China presents special opportunities and challenges for licensors. That is because price is such an enduring challenge there, given the thin margins of many home-grown consumer electronics manufacturers. To respond effectively to this, licensors will need to show some flexibility on price. It will also help to have a Chinese partner if licensing in that country.
As the old saying goes, history may not repeat, but it does rhyme. When we speak of going “back to the future” in patent licensing, we mean re-embracing a once-practised approach in which patents are viewed as marketable innovation assets not litigation weapons. We believe licensors will be most successful if they re-embrace a customer rather than court-focused strategy that stresses high-quality assets, fair prices, rigorous due diligence and a partnership approach with customers, which provides genuine value for both sides in a long-term relationship.
Licensors in today’s constrained patent market can achieve success by embracing the old 1990s era IBM model of patent licensing, which was pioneered by IBM’s then-IP chief Marshall Phelps to respond to the similarly defensive patent environment at that time. This business model has four key features, which are simple to grasp in theory but often difficult to execute in practice:
Offer an objectively-good product – one composed of high-value, curated patent portfolios that have both mass and broad market applicability. The chances of licensing success are improved if your portfolios are broadly diversified across multiple technologies and industries, thereby increasing the opportunities for repeatable licensing deals.
Offer reasonable terms that prospective licensees can easily accept – recognise the realities of the current patent transactional market and do not seek to extract more in royalties than what the real-world market will bear. Remember, there is far more value in building sustainable business relationships with licensees – relationships that can be leveraged to generate repeatable licensing deals – than in extracting the maximum value possible from any one deal.
Offer something in return to licensees – some added value or benefit – beyond simply the freedom to operate and relief from potential infringement liability.
Demonstrate rigorous due diligence in making a business case for licensing – make a business rather than an infringement case for taking a licence.
The bottom line is that licensors must approach the licensing business the same way any other business approaches customers, that is with a focus on solving problems for them and establishing a long-term business relationship that allows for repeatable deal opportunities.