You thought paying Sisvel ended your license concerns?

In earlier posts, I described the mp3[1] patent area as a minefield. One big landmine has been added to the terrain, the mp3 patents of the French company Alcatel. Last Friday Alcatel won a US Federal Court Jury verdict for US$ 1.52 billion damage award for patent infringement by Microsoft. The largest patent infringement damage award ever (the last record was the Kodak damage award of approx 900 million US$). According to reports, about half of the damage award is based on foreign sales under US patent law section 271(f).

At issue is the way the Windows Media Player software from Microsoft plays audio files using mp3 compression technology. If the ruling stands, hundreds of other companies that make products that play mp3 files, including portable players, computers and software, could also face demands to pay royalties to Alcatel. That will be most likely the next big thing for consumer electronics manufacturers: Alcatel knocking on the door of companies like LG, Samsung, SanDisk, NEC, Matsushita, Nokia, Huawei, ZTE to collect the next round of royalty fees for mp3 technology.

Those companies already had their share of unpleasant surprises when they were forced to pay Sisvel, Philips’ licensing arm, for Philip’s mp3 patents. Most of them paid the license fee, adding to the manufacturing costs of consumer electronics. That made Alcatel’s attorney tell the US jury: "We invented it and everybody else is making money off of it."

What's the point?
The point to make is this. MP3 technology has been already developed as early as 1987 (EUREKA project) by Fraunhofer Institute, Germany. Only much later, basically when Apple began to popularize the use of digital audio through its iPod around 2000, mp3 became ubiquitous, a tool to be used in any digital device. That popularity provoked companies like Philips, who were running short in licensing income from their previous IP cash cows, CD and DVD technology, to look in their portfolio for patent license potentials.

Philips, through their licensing arm Sisvel (Italy) and MPEG LA (US) used their mp3 patent portfolio (basically mp2, but asserted against mp3 players) to generate their next generation licensing income. The intellectual property was developed around 1993, after the main development in mp3 was started by Fraunhofer in the late 80’, and even after BBC Research experimented with digital transmission systems in as early as 1985. Philips’ main patent in the area, EP 0 402 973 and its US counterpart, granted in 1994 for the use of “padding bits” in a digital transmission system, EP 0 599 824 (for intensity stereo encoding and decoding), and EP 0 660 540 (for a decoder) became at the heart of an impressive licensing program. Fraunhofer already launched a less aggressive licensing program –together with Thomson of France- under their mp3 patents earlier.

What normally happens when a successful product enters the market happened in the service industry (in this case IP licensing) as well: other mp3 patent holders follow suit, lured into money making licensing programs similar to the Philips/Sisvel deals.

Alcatel now uses its mp3 patent to launch its licensing program. To convince the market they need a license under Alcatel patents as well, Alcatel did what most successful licensing strategies do: you take up against a giant first, gets him on his knees, get a court order against the alleged infringer and use that outcome against others to convince them they should not fight the patent but take a license (“the giant defender already lost, so what’s the point duplicating that?”). If the patent is also part of a standard and you can assert it as an “essential” patent, as Philips and Sisvel do, than your licensing program is complete. The license fee must be against RAND (reasonable and non discriminatory) conditions, but still, when hundreds of consumer electronics companies take the license, you are in for a more then lucrative license outcome.

What are the lessons to be learned from this?
First and foremost that companies ought to get their patent portfolios in “hot” technical areas ready in a very early stage and not wait until the technology gets mainstream. That requires foresight by management and a clear intellectual property strategy to acquire the necessary IP support for that technology in an early stage. It requires participation in standard setting procedures as well as actively managing the IP surrounding that technology. Although many companies may lack the necessary R&D output necessary to back up own IP, an alternative, much underused and undervalued, is to engage IP merchant bankers to allocate and acquire that necessary IP for them.


[1] popular digital audio encoding, lossy compression format, and algorithm, designed to greatly reduce the amount of data required to represent audio, yet still sound like a faithful reproduction of the original uncompressed audio to most listeners