Microsoft’s Patent Problem

Two weeks ago a U.S. federal jury in San Diego California found Microsoft guilty of infringing on two patents held by equipment manufacturer Alcatel-Lucent; the verdict brings with it damages of $1.52 billion. Some see this as Microsoft finally getting what it deserves, however, many more, thinking about the precedent that could be set are expressing their concern and raising questions about the efficacy of the patent system. At this point, nothing is written in stone, Microsoft plans on appealing.
The patents that Microsoft was ruled as violating both relate to MP3 technology, one for the compression of digital audio signals and the other for its encoding and playing. The amount of the fine, equal to a 0.5 percent royalty on Windows operating systems sold since 2003, was determined based on the number of Windows operating systems multiplied by the average selling price of a range of PCs. The fine could be halved pending a verdict in a case still pending which will determine how patent damages are calculated, if they are at all, for U.S. software companies with overseas sales. However, the fine could have been much higher, Alcatel-Lucent originally sought $4.5 billion, if the jury had determined Microsoft willingly violated the patents.
That Microsoft did not willingly violate the patents is not in question. When they decided to use the technology in their Windows Media Player, they licensed the technology from the Germany-based Fraunhofer Institute for $16 million. According to deputy general counsel for Microsoft Tom Burt, “The whole industry understood that that was where you went.” This is not an idle defense, Fraunhofer has granted hundreds of licenses for MP3 technology. Unfortunately, and perhaps not just for Microsoft but to all those holding licenses similar to theirs, the jury determined that Fraunhofer was not in a position to offer such licenses. The technology developed by Fraunhofer was done in conjunction with Bell Labs, a predecessor to Lucent Technologies which is now part of Alacatel-Lucent. When the two organizations parted ways each walked away with its own patents. A decade later Alcatel-Lucent dusted off its patent, took Microsoft to court, and won.
What has analysts talking is that Microsoft and others paid for licenses and therefore felt they were protected. According to Michael Dever, a chair of the intellectual property group at the Pittsburgh law firm Buchanan Ingersoll & Rooney, these companies, “have been relying on the fact that they thought they had critical licenses necessary to practice the technology.” If Microsoft is held accountable for using what it thought it had paid for so could any other company. According to the New York Times, in addition to Microsoft, “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.” Companies on the list of who could be next include, Cisco, Dell, Hewlett-Packard, Sony, RealNetworks, Napster, and the darling of the MP3, Apple. How is one to know if they are protected or not? In the case of MP3 technology it appears that the industry consensus was, “go to Fraunhofer.” So for a court to decide otherwise makes the future very uncertain.
In its analysis of the issue the Economist points out, “The huge complexity of even the most humble piece of technology today means that they contain hundreds of patented parts. Each big tech firm cannot but help infringing patents held by rivals.” In the past companies have held off on filing against each other, adopting instead a, “sort of cold war situation of deterring each other with the threat of legal retaliation.” This was seen as easier than getting entangled in legal battles. This has also, according to the Economist, led to the rapid release of innovation. Though it does not think that such toe-stepping be completely ignored by the law, it does suggest that, “making patent law more effective could encourage precisely the sort of innovation that will deliver the next generation of devices, whatever they may be, for music distribution.” In short it may be time to address the situation effectively. A piece in the Financial Times entitled, “Patent Imperialism” gets this point across as well. “There is a growing consensus in America that the U.S. patent system has gone haywire.”

A more complete version of this posting, with journal articles, and research reports can be found at the website of Analyst Views Weekly.

More information on this topic can be found in the Software section of Northern Light’s Software, Computers, & Services Market Intelligence Center.

And in the following articles:

Microsoft Loss in MP3 Case Sets Dangerous Precedent
BetaNews, February 23, 2007
With Alcatel-Lucent having been awarded $1.5 billion from Microsoft by a Jury in San Diego yesterday, the other hundreds of companies who hold Fraunhofer/Thomson licenses to the MP3 audio format whose names aren’t “Microsoft” must be asking themselves whether similar fates await them in the near future.

Down the Road, Collateral Damage from Microsoft Ruling
Forbes, February 23, 2007
In the aftermath of a California federal jury’s decision on Thursday that mandated Microsoft give Alcatel-Lucent $1.52 billion for infringing on two audio compression patents, the question is: who else might have to pay up? It may be Apple, some analysts say. Indeed, the majority of songs downloaded from Apple’s iTunes digital music service use the MP3 format.

A Scrap over Patents
Economist, February 23, 2007
While the technology has moved on, the patent system that is supposed to protect it, is badly in need of reform. A reminder of this fact came on Thursday February 22nd, when an American court decided that Microsoft should pay out $1.52 billion, the largest-ever such award, for infringing patents related to MP3 technology held by Alcatel-Lucent. That is a lot of money and the ruling could eventually allow Alcatel-Lucent to pursue other firms that use the MP3 technology such as Apple and Sony.

Microsoft Hit with $1.52 Billion Patent Suit Damages
Reuters, February 23, 2007
A U.S. federal jury found that Microsoft Corp. infringed audio patents held by Alcatel-Lucent and should pay $1.52 billion in damages, the No. 1 software maker said on Thursday. Microsoft said it plans to first ask the trial judge to knock down the ruling and will appeal if necessary. It said the verdict is unsupported by the law and that it had already licensed the technology in question from Germany’s Fraunhofer.

Alcatel-Lucent Gains after Victory over Microsoft

Bloomberg, February 23, 2007
“The jury’s decision, if confirmed, would open the way for Alcatel-Lucent to file a large number of lawsuits against other companies using these patents illegally,” analysts Frank Maccary and Eric Beaudet at Ixis Securities wrote in a note.

Alcatel-Lucent Wins $1.5bn Microsoft Suit
Financial Times, February 23, 2007
Microsoft has been hit with a $1.52bn patent infringement award, one of the biggest on record, in a case that it warned would have sweeping implications for many technology companies involved in digital music. The award was won on Thursday by Alcatel-Lucent after a jury in a U.S. district court in San Diego agreed with its claim that the software giant had infringed two of its patents.

Microsoft Found Guilty of Infringing Alcatel-Lucent Patents
Telecommunications Today, February 23, 2007
That said, Microsoft is reportedly planning to appeal against any ruling on the grounds that it had previously licensed the technology from German research company Fraunhofer for a fee of US$16 m. The final outcome may not be known for months, depending on how quickly the court judge makes his ruling, and any appeal could take up to year after that.

AT&T-Microsoft in Patent War
Forbes, February 21, 2007
The Supreme Court is expected to rule soon on a relatively obscure point of patent law that could have wide effects on the amount consumers pay for computer software and other intellectual property licensed overseas.


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