Big Blue’s new groove

Way back in 1992, IBM decided to make a change. By the final decade of the 20th century, the IT giant nicknamed Big Blue – an icon of US industry – had fallen on tough times and was struggling to remain relevant, despite the boom in personal computing. A senior executive named Marshall Phelps – who had headed the company’s government relations operation in Washington DC and helped to set up its Asia-Pacific headquarters in Tokyo – was given a new portfolio to work with, in more than one sense of the word.

As IBM’s new vice president for intellectual property and licensing, Phelps was tasked with maximising the value of IBM’s vast trove of patents and other IP assets, built up over many years of high investment in R&D.

The rest, as they say, is history. A net payer for using third-party IP rights at the time of Phelps’ appointment, IBM was generating net IP licensing revenues of as much as $1.9 billion by the time he stepped down in 2000. As part of a wider technology licensing drive, the corporate patent monetisation programme developed and implemented by Phelps and his colleagues became a blueprint for similar strategies which were rolled out by large high-tech companies throughout the early 2000s.

Much has changed since then – both at IBM and in the wider IP world. Even before Phelps’ departure in 2000 (he would be appointed as Microsoft’s corporate vice president and deputy general counsel for intellectual property three years later), IBM was plotting a future that was less reliant on selling hardware and software products to consumers and more focused on enterprise IT solutions and related services. Just as its business strategy had to shift, so did its IP strategy (although it would continue to build a reputation as a leading patent deal maker: research from Envision IP reveals that between 1991 and 2015, IBM sold more than 15,000 patents – 16% of which were assigned to Google).

Outside Big Blue, patent monetisation became a multimillion-dollar industry, with operating companies and non-practising entities (NPEs) alike litigating and licensing assets for big money. However, it would prove to be a poisoned chalice: the welcome injections of bottom-line cash and high returns for investors became tied to negative press and accusations of trolling, anti-innovation and anti-competitive behaviour, culminating in calls for the system to be reformed to remove the supposed attractions of patent assertion as a business model.

Fast forward to the current day and pessimists might claim that we have made a full 180-degree turn. The combined effect of anti-patent advocacy, legislative reform and arguably prohibitive jurisprudence means that patent owners now face more difficulties and uncertainty in trying to enforce, license or sell their IP rights in the United States than at any time in the past 30-plus years.

As for IBM itself, the ship is again changing course. The company is increasingly concentrating the bulk of its investments in what are widely regarded as the game-changing technologies of tomorrow: cognitive computing, blockchain, cloud computing, the Internet of Things, big data and similar. Once again, patents and IP assets more generally are playing a central role in this transition – although the continually shifting patent landscape requires a characteristically novel approach from Big Blue’s IP professionals.

New frontiers

Mark Ringes
Vice president and assistant general counsel, intellectual property

“Like any other business, we’re constantly challenged to do more with less and reduce costs, and we’ve been trying to find the optimal structure”

Leading the charge is IBM’s vice president and assistant general counsel for intellectual property, Mark Ringes. On paper, he appeared to have little in the way of IP-specific experience when he took over the reins of the company’s IP law group almost four years ago. However, having spent close to 26 years in the legal department at IBM, he has worked on more IP-related matters than many heads of intellectual property at other companies could ever claim to have encountered.

“Intellectual property has been extremely important for IBM for many, many years,” he points out. “That has certainly evolved over time, with it taking on somewhat different roles.” Up until the 1970s, IBM’s main motive in obtaining IP rights was to protect innovation around proprietary products, he explains.

However, this situation began to change as IBM moved into the PC space. With the IT sector and adjacent areas beginning to take off, convergence accelerated and the need to leverage inventions from third parties, rather than just using those generated internally, became increasingly important – and increasingly difficult to avoid. “At that point, our IP strategy began morphing towards securing freedom to operate and cross-licensing relationships,” he recalls. The upshot of this was a growing realisation of the potential strategic significance of intellectual property: “As a result of our PC and semiconductor work, we discovered that intellectual property alone had a great deal of independent value.”

In the 1990s, while Phelps and his team were adding bottom-line revenues from existing IP assets, IBM’s IP law team was busy increasing the quantity and quality of the company’s patent filings. It was during this period that IBM gained its reputation for patent leadership and commenced its 24-year reign as the top recipient of US-issued patents, which continues to this day and is a source of particular pride for the group.

“As the years have gone by and our business has changed, we think of intellectual property as providing other strategic value to the company in addition to freedom to operate,” Ringes expands, “particularly as we enter new markets and exit old ones. The business has continued to morph over time, and we have to look at our intellectual property for each of those new areas to ensure that it allows us to protect our competitive edge, maintain our freedom of action and provide added value for our clients.”

This continued investment in obtaining and managing patents has been crucial in facilitating IBM’s multiple reincarnations over the years – not least by enhancing the sale value of assets that are no longer core to the company’s forward plans. “We have divested whole business units and that has often included divesting significant IP assets to the acquirers, and in most instances that increased the purchase price and allowed IBM to generate cash flow that allows us to invest in and grow our new businesses,” says Ringes.

Manny Schecter
Chief patent counsel

“We need a more targeted way to curb those abuses and eliminate those bad patents without implicating perfectly good inventions at the same time”

Licensing, not selling

Some of those high-profile M&A deals involving a significant patent component include IBM’s sale of its server business to Lenovo in 2014 (nine years earlier, it had sold its PC unit to the Chinese company) and, most recently, the massive divestiture of its semiconductor fabrication business to GlobalFoundries.

Beyond these, IBM continues to make money from licensing its patents, while pure patent sales have also helped to add bottom-line value. Research from Allied Security Trust revealed that Big Blue was the biggest vendor of US patents between 2010 and 2014, selling a total of 6,111 assets in 57 discrete transactions (it also clocked the third-biggest single transaction in the same period, with its sale of 2,379 patents to Google in 2011 – although this has subsequently been overtaken by the number of patents transferred in the aforementioned GlobalFoundries deal).

However, granting patent licences and transferring patents are no longer the simple, standalone transactions that they once were. For one thing, IBM has already licensed to much of the industry. “While we may not have the largest number of patent assets, we may well have the largest number of patent licences,” suggests Manny Schecter, IBM’s chief patent counsel. Moreover, today’s harsher US patent environment means that it is tougher than ever to sign up those companies which have yet to take a licence. Given this, straight out-licensing revenue is becoming increasingly harder to come by.

Marc Ehrlich
Associate general counsel, intellectual property, patent enforcement and monetisation

“We’re able to look through the whole of the portfolio to identify valuable intellectual property and create situations where we preserve revenue and bring in partners”

As Big Blue seeks to secure income while it continues its transition, many of its IP deals thus appear to have a more complex strategic backstory. This was alluded to by chief financial officer Martin Schroeter in an October 2016 conference call just after the company released third-quarter results indicating a significant jump in IP-related revenue. Noting that IBM had been looking to reinvigorate its IP monetisation business, Schroeter commented: “We’ve had success in rebuilding our IP income base… We’re licensing, not selling, our intellectual property to partners who are allocating their skills, to extend the value of these assets… Licensing as part of a broader partnership, to drive future innovation, is a relatively new model for us. It allows us to retain and potentially grow the revenue stream, while shifting our spending profile to a more variable cost structure.”

As assistant general counsel in charge of patent enforcement and monetisation, Marc Ehrlich has helped to direct this new approach to monetising IBM’s considerable IP assets. His team works in tandem with the company’s non-legal deal-making executives – including the IP business group headed by general manager of intellectual property Bill LaFontaine – in order to extract maximum value from IBM’s patents in the context of broader technology deals. “One of our main jobs is to go out there with the licensing team to present evidence of use or other patent collateral to companies that we want to consummate licences with,” he explains. “I differentiate us from the contract negotiators by saying that we are the opening act – we’re there to help the customer understand the value of the licence or the assignment agreement that the negotiators are trying to progress.”

Bigger picture

While IBM is proud of its ‘patent factory’ reputation and the perception that it is a business driven by IP-related revenues, Ehrlich points out that straight patent monetisation has always been just one element of its broader IP strategy: “We have a larger group in IBM that monetises our intellectual property and the patent facet of that – in terms of straight patent licensing and sales – is a significant, but relatively small portion of our overall IP monetisation efforts.” The company’s IP and technology licensing programme serves other functions than direct generation of income, he adds. “We have been licensing for decades, and that grew out of a traditional mentality centred on preserving freedom of action and balancing payments if our IP portfolio was superior to a licensee’s or vice versa. That attitude has changed as we’ve been able to make more money off our portfolio – but it changed incrementally, not totally. Getting freedom to operate for the wider company is still one of the main drivers for us.”

In other words, it would be wrong to interpret Schroeter’s words as indicating a sea change in IBM’s approach to patents. Ehrlich suggests that what is shifting is rather the way in which IBM is leveraging its patent assets to monetise its wider portfolio of intellectual property and technology. “Patent licensing undergirds our other tech licensing programmes. For a long time, we made most of our IP-related income from know-how licensing. But if we didn’t have strong patent protection, we couldn’t have such a strong know-how licensing programme. A typical IBM tech licence which leads with know-how likely has a complementary patent licence behind it. And in some cases, patents are the driver for those licensees coming to us to get that tech.”

Figure 1. IBM’s IP law group

Letting go

IBM rid itself of what had likely been its largest source of technology and know-how licensing income when it agreed to divest its semiconductor fabrication business to GlobalFoundries in late 2014. Big Blue paid its US competitor $1.5 billion to shed the unit – pointing perhaps to the less-than-stellar state of the business, as well as its desperation to dispose of it. GlobalFoundries also took ownership of thousands of IBM patents as part of the deal, which not only made this one of the largest patent transfers in history, but also prompted many analysts to question how IBM could continue generating IP revenues at its previous rate.

Yet despite the divestiture, IBM’s IP income has remained strong – as indicated by its 2016 third-quarter results and Schroeter’s talk of a reinvigorated IP monetisation strategy. “What you can see now, just a year later, is that we’ve responded and have been generating IP income results that are actually better than what we had towards the end of the semiconductor programme,” insists Ehrlich. “We have successfully addressed the loss of that valuable intellectual property.”

Looking more generally at the current state of play, the divestiture of the semiconductor unit and the related intellectual property was just one example of IBM’s transition into newer business areas – which are labelled ‘strategic imperatives’ – and the resultant sell-off of assets which no longer feature in its forward plans. “What ends up happening is we have these excellent legacy products that our customers still want and that are still providing us with tremendous revenue – but if we look at the trajectory of our R&D budget, it doesn’t make sense to keep spending on some of these areas,” explains Ehrlich. “So for some of these products, we’ve got a bit of a problem – we’ve no more money to commit to further development, but don’t want to lose those revenues.”

Here again, IBM’s IP law team has stepped in with an innovative solution. “We’ve found trusted partners and we grant them an IP licence under these products so that they can pick up future development and they get to share in revenues,” Ehrlich explains. “This will typically comprise a source code or broader tech licence, undergirded by a patent licence. It has been an interesting pivot for us, because as the company transitions to these new platforms, we are able to look through the whole of the portfolio to identify valuable intellectual property and create situations where we preserve revenue and bring in partners to keep our customers satisfied.”

This would appear to be what Schroeter was referring to when he said that IBM is shifting from patent monetisation to “licensing as a part of a broader partnership”. Looking at IBM’s more recent patent assignments (see Table 1), what is striking is the number of transfers it has made to companies which might typically be thought of as competitors, particularly in the networking space. Alongside large-scale divestitures to GlobalFoundries and Lenovo, the top recipients of IBM patents in the past year have included A10 Networks and Servicenow.

Package deals

Another option for monetising IP assets is to tie licences – and increasingly assignments – into the company’s broader product and service offerings. Glance again at Table 1 and one can see that another group well represented among assignees of IBM patents is the new breed of internet and digital media businesses, many of which have undergone extremely rapid growth and, as a result, have found themselves exposed to attack without patent coverage befitting their market share and profile. These types of business are often customers for IBM’s enterprise solutions and consulting services.

“What our sister department does best is to recognise the role of a patent licence in building a bigger, longer-term relationship,” explains Ehrlich, in reference to IBM’s non-legal licensing operation. “So early-stage companies that need patents might sign a licence, buy patents from us and enter into a longer-term relationship with us. When you have all of those components to offer, you can take a really expansive view.”

Steve Mortinger
Associate general counsel, intellectual property, systems, solutions and research

“Recent US court decisions have made patent licensing a bit more challenging… In response, we have worked on other, broader IP offerings”

As Steve Mortinger puts it: “We now have a lot of products that incorporate intellectual property as a key selling point within them.” Associate general counsel, IP law, for IBM’s systems, solutions and research operations, Mortinger is working directly at the coalface, linking the company’s IP function and its customer-facing businesses. He is responsible for one of the largest groups of attorneys in IBM, providing IP legal support to the product development functions and ‘brands’ – “that’s IBM parlance for groups that sell things, whether services, products or intellectual property,” he explains. “My team is especially focused on sales and licensing of know-how and copyrights. As many of us would probably agree, recent US court decisions have made patent licensing a bit more challenging. So in response, we have worked on other, broader IP offerings.”

Mortinger’s group often works directly with external clients which have licensed patents from IBM, assisting them to implement the covered technology in their own businesses. “We spend time with customers doing know-how development and then helping them to understand how the things we have developed work,” he says. The group tends to work on deals that go beyond a simple IP or technology transaction to include various add-ons, such as service agreements. “A different type of IP deal that has been a focus for our business is a large-scale source code licence where, as part of the deal, the licensee will provide us and our customers with services related to that code,” he continues. “Those kinds of deals had a big impact on our business the last few quarters, so they appeared a bit more in the headlights. But this type of deal has actually developed over time. So I wouldn’t say that generating different types of IP deals in reaction to challenges with patent deals is a new strategy – it’s more a fulfilment of attempts to diversify our IP portfolio. Obviously the patent business will always be important for us, but today you need a bit more of a diversified portfolio. We have a great opportunity as IP lawyers to work with the business team to help develop these new IP offering ideas.”

Figure 2. US patent grants, 2016 – IBM and select competitors

Source: IBM

Figure 3. IBM US patent grants 1993-2016

Source: IBM

For Ehrlich, IBM’s long-term – and early onset – commitment to patenting is one of the crucial factors in its ability to weather the storms of economic downturns, adverse court decisions and the like. “One of the cool things about IBM, and something we do a particularly good job at, is we have a lot of different levers to pull when it comes to generating IP income,” he points out. “If you think about a company with only patent assets – an NPE – it is less flexible than IBM, which has this bigger picture. On the other hand, an enterprise company that generates a lot of technology, but has not invested much in obtaining patents also runs into problems, because it can’t offer its customers a complete package. As a patent law group and a patent monetisation business, we are experiencing the same challenges that everyone else is running into. But because we have the ability to rely on other factors, other portions of our IP and technology portfolio, we have the luxury of sitting back and taking the long view.”

Another factor clearly in IBM’s favour is its long experience and record of leadership in the patent marketplace. “We’re not a newcomer,” adds Ehrlich. “We’ve seen the market go through contractions and expansions before. So while things are tough, we’re focusing on our fundamentals – we know that across the company we’ve got the best innovation going on in the business. And on top of that raw material, we know that we write good patents and that our licensing work product is the best in the industry.”

New look

One of the main ways in which IBM is achieving its latest transformation is through an extensive reorganisation of its IP function. Previously, the IP law group tended to have teams focused on each of IBM’s business units, as well as a central team with oversight on issues such as patent procurement, trade secrets management, copyright and open source. Additionally, there were geographical IP legal functions supporting regional research labs and commercial units worldwide, along with a dedicated licensing team responsible for helping the company’s broader licensing business to monetise its IP assets.

Recently, this sprawling structure has been significantly streamlined in order to enhance its efficacy and responsiveness in the face of IBM’s shifting business interests. “Like any other business, we are constantly challenged to do more with less and reduce costs, and have been trying to find the optimal structure to provide the best service to internal clients,” Ringes explains. “We currently have a single senior lawyer assigned to each of our primary businesses, who is responsible for working with the leaders of those units to understand the business strategy and develop an IP strategy.”

Another structural innovation that the IBM IP law group has introduced over the past two years is to unite most of the roles that were formerly embedded in business units in a central ‘cross-brand’ team. “All our lawyers now have the opportunity to work on IP legal matters supporting a variety of our different businesses, rather than being solely focused on any single one,” says Ringes. “While they will still have a primary business responsibility, we get more flexibility with this new structure, and it enables our lawyers to understand the other parts of IBM’s portfolio and develop additional skills. In the space of just a couple of years, we are starting to see big benefits. It has allowed us to smooth out the workload across our team, create efficiencies and build a stronger team with more cross-brand knowledge.”

In his second role as managing attorney, Ehrlich is responsible for personnel management, hiring, training and career counselling within the IP law group, and as such has been at the centre of the roll-out of the team’s fluid new structure. “Look back just six or seven years ago, and you had an IBM Corp which had a software business, a systems business, a services business – a number of technology-focused business units,” he says. “Now we’ve got one unit focused on healthcare, Watson Health; we’ve got Watson Financial, as a result of our acquisition of Promontory Financial Group; we also acquired the Weather Company, so we now have this enormous consumer-facing entity inside IBM.” Altogether, Big Blue now operates in around a dozen non-traditional business areas – and the broader transition plan means that more look likely to come its way.

For all this, the IP law group has seen no substantial corresponding rise in headcount – it has had to adapt in order to provide the requisite service levels. “In response, we’ve broken down the silo approach and have a centralised bench in the form of the cross-brand team, which gives us tremendous agility and great feedback from our internal clients and customers,” Erlich explains. “But most gratifying for me as managing attorney is that we’re noticing the role this system plays in the development velocity of our lawyers. It means that we have the ability to make sure that the next thing that comes to our attorneys’ desks isn’t something they’ve seen already. So our team can become domain experts in five years, since they have gained broader, deeper expertise which might have taken 15 years under the older, siloed model. Our young professionals are exposed to working on major deals and liaising with senior executives at a much earlier point in their career.”

Core matter

One thing that has certainly remained constant at IBM since Phelps’ day is its prodigious procurement of patents. In 2016 IBM topped the list of recipients of US-issued patents for the 24th consecutive year, with a record-breaking 8,088 grants (to put this industry lead into perspective, second-placed Samsung Electronics received 5,518 grants). Over one-quarter of these patents relate to artificial intelligence, cloud computing and cognitive computing – a clear indication of the company’s strategic direction and focus on Watson, its question-answering computing system, which can process natural language enquiries.

Procuring the lion’s share of these patents is the IP law group’s patent centre. Headed by chief patent counsel Schecter – who also oversees local IP legal teams in each of IBM’s countries of operation – this hub of over 100 professionals is responsible for drafting and prosecuting around one-third of IBM’s US patent applications, with the remainder of the filing workload handled by business unit attorneys and outside counsel. Schecter acts as intermediary between IBM’s huge patent filing operation and the other parts of its IP business. “The boundaries between some of our responsibilities can be fuzzy, as in any good organisation,” he says, in reference to colleagues Ehrlich, Mortinger and Ringes. “So we work closely together to best pool our respective expertise and experience. One of the age-old things you hear in the patent world is that no prosecutor can really do a complete job unless they have lived through the enforcement of the patents that they procure. You also hear the opposite – that you can’t be a good litigator if you don’t understand the patent prosecution perspective.”

Figure 4. IBM assigned patents citation analysis – select buyers

NB: Analysis performed in March 2015

Source: Envision IP

This adage informs Schecter’s day-to-day role heading up virtually the whole of IBM’s patent procurement and management activity. “I am responsible for the company maintaining a strong patent portfolio in the technology areas and geographies that we believe we need to be in,” he explains. Being able to apply assessments from the corporate strategy, customer service, enforcement and monetisation viewpoints, among others, is vital to ensuring that IBM’s patent portfolio is as strong, high quality and valuable as it possibly can be.

Another channel through which Schecter seeks to maximise the value of IBM’s patents is through advocacy on the policy front. “I also spend a lot of my time on external-facing matters,” he points out. “We frequently do things like consider amicus activity, offer responses to federal register notices requesting comment, publish opinion pieces or attend events, and ensure that IBM coordinates and properly delivers its message when it comes to intellectual property.”

Environmental issues

As such, Schecter has become a well-known speaker and writer on patent law issues, and a prominent figure in the ongoing debates surrounding IP policy in the United States – particularly with regard to jurisprudence and legislative action on patentability and dispute resolution. “We have been rather public saying we are concerned about the current state of subject-matter eligibility in the United States,” he notes. “Some of the recent Supreme Court case law has resulted in quite a bit of chaos, in the wake of which we have seen treatment by the US Patent and Trademark Office examining corps, the Patent Trial and Appeal Board and the federal district courts that is quite inconsistent – with themselves and across one another.”

Schecter does not blame any of these groups for the confusion; he believes that they are coping as best they can in the aftermath of recent Supreme Court findings. “The Alice decision in particular just does not lend itself to clarity, to transparency or to consistency – it set a standard which frankly has very little hope of achieving those kinds of things,” he continues. “Suffice to say, we are very concerned. The computer arts are among the most innovative we have. Software is one of the industries in which the United States is most successful. The licensing and sale of intellectual property is one of the few areas in which we have a trade surplus. I don’t know why we would want to have a patent system which risks discriminating against those particular technologies.”

Many of those who welcomed Alice argue that it has contributed – along with the legislative reforms introduced by the America Invents Act 2011 – to the elimination of low-quality patents, which are supposedly the favoured tools of the trolls misusing the patent system. While Schecter sympathises with the cause of reducing patent abuse, he believes that this is the wrong way to go about it. “We are throwing out many babies with the bathwater,” he argues. “It is too coarse an instrument for doing the job some people say it is doing. We need a more targeted way to curb those abuses and eliminate those bad patents without implicating perfectly good inventions at the same time.”

Schecter praises the US Patent and Trademark Office’s outreach efforts, such as roundtables and calls for public comment, which have allowed IBM and other rights holders to provide input on how to improve the current state of the patent system. However, while he agrees that the America Invents Act did appear to help curb certain unbecoming behaviour, further dialogue is needed to ensure that all stakeholders get the best outcome from any future legislative reforms or administrative changes: “We made no bones about the fact that we think this justifies congressional consideration, though we recognise of course that we have a new Congress and new president, who have lots of to take care of and may have different priorities.”

With the situation as it stands, it is inevitable that US tech companies such as IBM will turn their attention elsewhere if they think they can more effectively protect their R&D investments. “Obviously, to the extent we perceive that an invention may no longer be within the bounds of patentable subject matter, we’re not going to persist in filing lots of applications in that area,” Schecter concludes. “We had already scaled back, especially in the business method area, about 10 years ago – we made a very public pronouncement that we would ensure a higher level of technical content in our inventions and in some way anticipated that some change would eventually have to happen. On the other hand, we have certainly been considering increasing the portion of money that we have to spend on patent procurement to spend a higher percentage outside of the United States.”

Big Blue is a phenomenal US success story – it would be a shame if the fruits of its decades-long commitment to innovation could no longer be adequately recognised on its home turf.