30 April 2012

Apple v Android Part V: Open standards, IP strategy, Resolution?

Chess knight. Photo: Petr Novák, Wikipedia
The patent landscape maps in part four of this series showed that the key Android advocates – including Samsung and Motorola/Google – are massively superior to Apple in terms of the sheer numbers of patents in their portfolios.

But, as we explain in this fifth and final part, many of these patents are encumbered by licensing obligations arising from their relationship to industry standards.  While the scope of these obligations is yet to be fully tested in court – and may differ from country to country – it is already clear that such encumbrances can significantly complicate the deployment of patents for both offensive and defensive purposes.

With neither Apple nor any of its Android-supporting rivals having clearly established an upper hand, we can no doubt look forward to more strategic manoeuvring on all sides before any final resolution of the ongoing disputes.

Samsung’s FRAND dilemma

Samsung’s patent portfolio is by far the largest in the mobile communications space. It is common wisdom now that one justification for building a portfolio is to provide a strategic defence against infringement suits brought by competitors – a.k.a. the MAD (mutually-assured destruction) theory of patent stockpiling. However, the ongoing litigation with Apple is revealing a strategic weakness of Samsung’s portfolio, in the form of the company’s involvement in the setting of industry standards for mobile communications protocols and technology. Samsung has been extensively involved with the 3rd Generation Partnership Project (3GPP), which is responsible for maintaining and developing standards for mobile communications from GSM onwards. Over time, it has developed and contributed many technical solutions to the various challenges and problems encountered in the implementation of workable, robust and widely supported standards. The R&D effort involved in making such contributions is not insubstantial, but also not without reward.

Contributors to 3GPP standards are not prohibited from obtaining patents protecting adopted technologies. However, they are required to undertake that they will make licences available to all comers on fair, reasonable and non-discriminatory (FRAND) terms. The patents cannot be used to exclude competitors from the market or to price them out of it. Anybody willing to pay the going rate must be granted a licence. This is a double-edged sword. While having patented technology adopted into a standard provides a guaranteed royalty stream, it also effectively prevents the patents from being selectively enforced to obtain injunctions against competitors. The alternative – of keeping the technology as part of a closed, propriety solution – is not viable in a market dependent on open standards for interoperability.

In this context, it is arguable that Apple is not playing by the rules. Its products build on the mobile communications standards in which others – including Samsung – have invested huge amounts of money and effort. Indeed, without the broadband wireless systems which make so many applications possible and compelling, there would be no market for devices such as the iPhone and iPad. Yet Apple has not itself contributed to the standards. And to a large extent, they are implemented within Apple’s devices by baseband processor chips made by companies such as Qualcomm and Infineon. By segregating its closed ecosystem from the open standards, Apple may have effectively inoculated itself against liability for infringement of standards-related patents, although this remains to be tested in court.

Certainly, Samsung has thus far had little success in asserting its standards-related patents against Apple, either defensively or offensively. It faces many issues in doing so, including whether it has attempted to negotiate in good faith with Apple regarding FRAND terms; whether Apple requires a separate licence in the case that its baseband processor suppliers are licensed (which also raises potential issues of international exhaustion of patent rights); and how the terms of Samsung’s FRAND agreement – executed under French law – can be applied in other countries. There are factual and legal issues in all of this which will not be straightforward for the courts to resolve.

While some commentators have expressed a view that Samsung is acting in bad faith by even attempting to assert its standards-related patents, it is not apparent that it has any real alternative. The complexity and uncertainty of the scope and reach of FRAND terms work strategically in Samsung’s favour since – accounting for appeals – these issues are unlikely to be finally decided in the near future, increasing the likelihood of an alternative resolution of the global dispute with Apple in the meantime.

IP and market value

Forbes recently reported that for the first time, Apple had become the world’s most valuable company, measured by market capitalisation. However, in October 2011 Apple reported quarterly earnings of US$6.62 billion, while the word’s second most valuable company, Exxon Mobil, reported a US$10.3 billion profit for the same period. So Apple’s number one spot cannot be attributed solely to earnings. Nor can it be attributed to R&D spend, with its total investment in R&D over the four years to December 2010 being US$4.6 billion, compared with Microsoft’s spend of US$31 billion over the same period. And, as the landscape maps clearly show, Apple’s patent portfolio is dwarfed by those of a number of its major competitors. Even supposing that Apple’s R&D effort, and its patent portfolio, are focused only upon the most strategically significant areas of innovation, it does not have this space to itself.

Apple’s greatest intangible assets – and the source of its huge market value – are more likely its brand and its customer base. In the WPP 2011 BRANDZ Top 100 survey, conducted by Millward Brown Optimor, Apple ranked first, with an 84% year-on-year growth in brand value to US$153 billion – equivalent to nearly half its market value. Part and parcel of Apple’s value proposition is locking customers in to its closed ecosystem – where all of the music, movies, books, apps and other content ever purchased is accessible only, or primarily, on Apple devices. Device ownership drives content purchases, and content ownership drives future device purchases. The customer experience helps to build the brand, and the brand draws in new customers.

Ultimately, then, the ecosystem is self-sustaining – at least for as long as Apple continues to provide its customers with a great user experience. But what happens right now is vital to Apple, because Android has an ecosystem of its own – albeit one which provides a more open and less integrated experience. Apple’s litigation strategy will therefore pay off, even if it achieves only short-term gains, because of the likelihood that these will persist into the future. It can ensure that it does not become the largely irrelevant 5% player in the mobile devices market, as it did on the desktop.

And Apple has at least one other trick up its sleeve – or, more precisely, in the cloud. The cloud-based iTunes Match service ensures that all of the user’s music, whether purchased through the iTunes store or obtained from other sources, is continuously available online on all Apple devices in a high-quality format. Services such as this, partly enabled by Apple’s equal access to open formats and standards, make the transition into the Apple ecosystem a much more viable proposition than transition in the other direction. And because agreements with rights-holders wary of losing control of digital content are made possible by the closed nature of Apple's ecosystem, prospects for a competing service offering within the open Android ecosystem would appear to be more limited.

End game

Apple cannot win a patent war predicated on market exclusion. With the Android source code being open, Apple might just as well be fighting a Hydra – cut off one device from the market and two more will appear to replace it. Ultimately, Apple’s best course of action will most likely be to enter into licensing agreements with its competitors, which will not only result in significant revenues, but also push up the prices (or reduce the margins) on competitive products.

In the denouement of War Games the computer Joshua concludes that nuclear warfare is “a strange game. The only winning move is not to play”. “How about,” it suggests, “a nice game of chess?” Of course, with evenly matched opponents, even a game of chess can end in a stalemate. But the path to victory, defeat or draw is paved with many strategic plans, twists, turns and surprises, and destruction is certainly not mutually assured.

Jobs may have wanted to “go thermonuclear war” on Android, but a better metaphor for global litigation is a long, drawn-out game of chess. And currently, while a few pawns have been sacrificed, there is no sign of check or mate.


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