Nickels, Dimes, Billions

A brief update from the tech battlefields: PC makers Hewlett-Packard and Gateway are each suing the other for infringing each other's PC patents. Toronto's All Computers has sued Intel for violating its patents on the ways high-speed microchips operate. In June, another Canadian firm, Wi-LAN, sued Cisco for trampling its Wi-Fi patents. And earlier this year Microsoft got nailed in federal court with a $565 million penalty (the company is appealing) for infringing the patents of a Chicago company, Eolas, which has one employee and claims to own the way Web browsers work with other programs.

There have always been patent lawsuits, stretching back to the undocumented but likely stone-age fracas over the wheel. But in a networked world where everyone's technology must work together, patents have become the reigning currency. Last week, Microsoft chairman Bill Gates told Wall Street analysts that patent are "a very important part" of the innovation that will fuel the company's future growth, and predicted it would file 3,000 patent applications next year, up from 1,000 several years ago. Today tech companies are using patents to directly tap new revenues; they're selling licenses, for a regular tithe, that grant others the right to use or connect to their patented technology. In the last year, both Microsoft and Hewlett-Packard have started licensing programs. In the process, they have struck fear in the hearts of some who consider such programs akin to blackmail: pay us for the right to interact with our technology, or else you'll hear from our lawyers. "The crux for these companies is, do they protect their innovation or not?" says Kevin Rivette, coauthor of "Rembrandts in the Attic," a 1999 book about exploiting patents.

IBM set the standard for patent licensing in the early '90s. While Big Blue was in a steep decline, veteran employee and lawyer Marshall Phelps got the company to raise the fees it charged others for piggybacking on its ubiquitous technology. Phelps recalls that incoming CEO Lou Gerstner was skeptical of the program; at RJR Nabisco, he had been involved in a patent dispute with Procter & Gamble over soft chocolate-chip cookies. Phelps changed Gerstner's mind by cracking open an IBM PC and showing him all the components that came from other companies. In other words: hardware companies were interdependent, and as the biggest fish in the sea, IBM should exploit that fact. A few years, later IBM was raking in $2 billion a year of almost pure profit from licensing revenue.

By the late '90s, businesses like wireless firm Qualcomm and memory-chip company Rambus were doing almost nothing but this: inventing and patenting a cornerstone technology such as the popular mobile-phone protocol CDMA, offering a license to it, then enforcing the license with implicit (or explicit) threats. Last year even Hewlett-Packard--once known for the gentle "HP Way"--jumped into the fray, consolidating all its intellectual property from its own R&D labs and from its purchase of PC maker Compaq, and offering licenses. "We're not here to shut people down," says Joe Beyers, HP's vice president of IP licensing, "but we'll do it if we have to." Surprise: it has to. HP says it owns some of the key innovations in, among other things, lightweight laptops, and has sued archenemy Gateway, which won't pay the license fee.

No company has been less litigious when it comes to patents, while inspiring more fear, than Microsoft. To jump-start his licensing program, Bill Gates hired pioneer Phelps after he retired from IBM. "It was an opportunity do the same thing twice and find out if the first time was a fluke or not," Phelps says, who adds that he had a "more interesting negotiation at home than I had with Bill" about moving part-time from Connecticut to Seattle. In the past year, Phelps has accelerated the number of patent applications at Microsoft and played a key role in three massive cross-licensing deals (we use your patented technology, you use ours) with Sun, Siemens and SAP.

This is where the little guys start to quake. The patent portfolios of Microsoft and HP are so substantial that it becomes impossible to take a drive without passing through their toll booths. The overtaxed U.S. Patent and Trademark Office often grants absurdly broad patents that reflect little actual innovation. (For example, Microsoft owns a patent for activating a program on a handheld device by holding a button down for several seconds). And because it costs less to pay the toll than to hire lawyers and resist, smaller firms have no choice but to pony up.

Supporters of open-source software also worry that Microsoft will soon have enough patents to sue vendors of rival operating system Linux. Under the contract which govern the distribution of free software, called the GPL (for general public license), vendors can't buy any license which charge royalties for each copy. And open-source software likely does violate the patents of the big guys. In a study to be released this week, New York based Open Source Risk Management will announce it has studied the Linux "kernel" and discovered it infringes on about 283 issued patents. Twenty-seven of those patents are owned by Microsoft. Patent attorney Dan Ravicher, who conducted the study, advises the open-source community to either design around those patents or to start preparing to knock them down in court. (Recent research reveals that about half of all patents are invalidated in the courtroom--more evidence that the federal government is too lenient with patent applications.)

Marshall Phelps tries to dispel the notion that Microsoft is preparing a patent assault on open-source software. He notes that at IBM he never initiated a single lawsuit and says, "I'm not running a litigation shop, I'm running a licensing shop." He adds he took the job only when Gates promised him he wanted to change the way Microsoft "interfaced" with the technology world and argues that licensing "is inherently pro-competitive." But when asked if Microsoft would license its technology to rivals in the open-source community, Phelps says that "somebody who is taking software pursuant to the GPL cannot take a license ... Section 7 [of the GPL] is its own world."

Open-source supporters like Ravicher say that Microsoft misunderstands the GPL, and that it accommodates some creative ways to compensate big companies for using their intellectual property. Microsoft employees like Phelps claim the open-source folks misunderstand their affable intentions when it comes to patents. Such discord is often the precursor to future legal imbroglios. As history amply shows, when it comes to wielding something as valuable and dangerous as patents, it's hard to play nice.