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It has to be the greatest licensing story ever told. In 1980 IBM Corporation needed an operating system to launch a line of personal computers, and its executives thought Microsoft Corporation had built one. Wrong. Twenty-five-year-old Bill Gates and company didn’t have what IBM sought, but they wanted to please IBM. So, in a fit of business genius, they figured out a way to make IBM happy and themselves wealthy. For $50,000, Microsoft bought the complete rights to a rudimentary operating system called QDOS from an outfit called Seattle Computer Products and then agreed to license it to IBM-and anybody else-for about $50 a computer. This was the deal that launched Microsoft into the stratosphere of wealth, power, and ultimately arrogance. How ironic then that, when Microsoft recently decided it needed help with licensing, the company turned to the executive largely responsible for IBM’s licensing success. IBM earned $1.1 billion in licensing fees in 2002, and over the past ten years it has consistently generated the most U.S. patents. Last June, Gates named 28-year IBM veteran Marshall Phelps corporate vice president and deputy general counsel for intellectual property. Six months later Microsoft announced that Phelps-who retired from his post as vice president for intellectual property and licensing at IBM in 2000 and had been doing consulting work-would be heading up Microsoft’s new intellectual property licensing initiative. If Phelps’s ascension at Microsoft is ironic, it is also fitting. When technology companies become as dominant as Microsoft, they must learn how to license responsibly-or be forced to. IBM created a lucrative revenue stream by voluntarily licensing its patents and technology in the 1990s, but before that it had been compelled by an antitrust consent decree to issue licenses. AT&T Corporation also operated under a compulsory licensing regime until it was deregulated. Likewise, as part of its 2002 consent decree with the government, Microsoft agreed to license various sets of rules, or protocols, that let software work with its Windows operating system. Phelps’s hiring suggests that Microsoft is ready to leave behind-or at least soften-some of the hard-nosed practices that made it a target of antitrust regulators for most of the past decade. “There’s a recognition that Microsoft is in a different place and a different time in an industry that’s matured,” says David Kaefer, director of business development in Microsoft’s intellectual property and licensing group. “We’re now saying we’re willing and ready to work with others. This includes our customers, partners, and our competitors.” The rise of Linux and the open source movement also spurred the company into action. Linux competes with Windows. Its low cost and relatively open licensing terms, make Linux more attractive to a growing number of software developers and customers. Microsoft would rather have other companies developing software for Windows. At a company as large as Microsoft, it can sometimes be difficult for potential licensees to reach the right person to strike a deal. Microsoft has tried to lower that barrier by publishing a catalog of what it is licensing on the Web at microsoft.com/mscorp/ip. Among the offerings are ClearType, a font-rendering technology, which improves the sharpness of text on liquid-crystal displays, and the File Allocation Table system, a format that organizes information on a hard drive. Afga Monotype Corp. and Lexar Media Inc. were the first licensees of ClearType and FAT, respectively. Phelps is responsible for many of the changes. “Phelps has brought a fresh perspective to us on how to do IP licensing,” says Kaefer, who works for the former IBM executive in developing licensing programs with other companies. Phelps reports to Microsoft general counsel Brad Smith. But his group isn’t just made up of lawyers; there are business development managers working in each of the following areas: trademarks, trade secrets, patents, licensing, standards, and copyrights. “Intuitively we know that licensing businesses require a mix of expertise if they are to be successful,” says Kaefer, who is not a lawyer. Each Microsoft business unit has a patent lawyer responsible for keeping up with developments that might eventually produce a licensing revenue stream. “They go in with their sleeves rolled up and ask the developers to identify all the interesting innovations,” Kaefer says. For example, a team of patent attorneys is assigned to the group working on Longhorn, Microsoft’s next generation of Windows. Phelps is not just making changes within Microsoft, but also outside. In the past, Microsoft has had as many as 50 different firms doing prosecution work worldwide. Phelps wants to bring the work in-house. “I believe that internal lawyers who are sitting physically with the developers are going to do a better job than just throwing the technology over the wall to an outside law firm, saying, ‘Make the best of it,’ ” Phelps says. “ At IBM, we had lots of lawyers doing preparation and prosecution around the world. At Microsoft, we don’t have anyone doing that, but we are going to start.” The new policy may be modeled on IBM’s methods, but Microsoft isn’t expecting to make IBM-league licensing revenues. “We’ll be happy if it helps offset some inbound licensing costs and patent settlements, and then after we recoup our costs we can channel what’s left into R&D,” Kaefer says. Those costs can be significant. In 2003 the company was hit with the two largest patent infringement damage verdicts of the year. In November, a jury ordered the company to pay $62.3 million to Imagexpo LLC, a company that makes real-time conferencing software. Microsoft ultimately settled the case for $60 million. In August it lost a $521 million verdict to Eolas Technologies, which it is appealing. The company’s R&D costs are expected to rise, and patent prosecutions will likely follow. Microsoft plans on spending about $7 billion on R&D this year-up from $4 billion in 2000. Right now the company holds about 3,500 patents and has 6,500 patents pending. Microsoft has always licensed some of its technology. It has held a number of cross-licenses with such businesses as Hewlett-Packard Company and Cisco Systems, Inc. These have been broad deals, in which Microsoft agrees to license significant portions of its software portfolio in exchange for receiving a similarly broad license back from the other company. The agreements were handled on a case-by-case basis, creating an environment rife with criticism from competitors and smaller companies, which complained that Microsoft gives better access to favored partners. The recent changes have yet to quiet the critics. “The purpose of Microsoft [licensing patents] is not for people to compete against them. It’s a predicate for going around and squeezing [competitors] for money and cross-licensing or to deflect criticism,” says Gary Reback, a former Wilson, Sonsini, Goodrich & Rosati lawyer who is best-known for helping convince the Department of Justice to file antitrust charges against Microsoft. “Microsoft hasn’t really started to lower the boom on anybody, but it’s early yet,” he says: Microsoft has enough patents to “do significant damage to ongoing research in Silicon Valley, the same as IBM [did],” says Reback, who is of counsel at Palo Alto boutique Carr & Ferrell. Phelps maintains that until the company proves it has a first-class licensing operation, there will always be skeptics. “We’re not always going to find a win-win proposition that makes sense for Microsoft and a company interested in licensing our technology,” Phelps says. “But that won’t stop us from trying.”

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