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It has to be the greatest licensing story ever told. In 1980, the IBM Corp. needed an operating system to launch a line of personal computers, and its executives thought the Microsoft Corp. had built one. Wrong. But 25-year-old Bill Gates and company wanted to please IBM. So, in a fit of business genius, they bought for $50,000 the rights to a rudimentary operating system called QDOS from an outfit called Seattle Computer Products and agreed to license it to IBM — and anybody else — for about $50 a computer. That 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 licensing help, the company turned to the executive largely responsible for IBM’s legendary licensing success. (IBM earned $1.1 billion in licensing fees in 2002.) 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 had retired from IBM in 2000 and had been doing consulting work — would be heading up Microsoft’s new IP licensing initiative. If Phelps’ ascension at Microsoft is ironic, it is also fitting. When technology companies become as dominant as Microsoft, they must learn how to license — or be forced to. Before IBM created a lucrative revenue stream by voluntarily licensing its technology in the 1990s, it had been compelled to issue licenses by an antitrust consent decree. The AT&T Corp. also operated under a compulsory licensing regime until it was deregulated. And as part of its 2002 consent decree with the government, Microsoft agreed to license various protocols that let software work with its Windows operating system. Phelps’ 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.” TIME TO PARLAY The rise of Linux and the open-source movement has also spurred the company into action. Linux competes with Windows. Its low cost and open licensing terms make it attractive to a growing number of software developers and customers. Microsoft, of course, would rather have other companies developing software for Windows. But at a company as large as Microsoft, it can sometimes be difficult for potential licensees to reach the right person. So Microsoft has tried to lower that barrier by publishing an online catalog of what it’s licensing. Phelps is responsible for many such changes. He has brought “a fresh perspective” on IP licensing, says Kaefer. Phelps reports to Microsoft General Counsel Brad Smith, but his group isn’t just made up of lawyers. He has business development managers in the following areas: patents, trademarks, copyrights, trade secrets, licensing, and standards. Kaefer, who is not a lawyer, develops licensing programs with other companies. Each Microsoft business unit also has patent attorneys responsible for keeping up with developments that might eventually produce licensing revenue. A team of lawyers is assigned, for example, to the developers of Longhorn, the next generation of Windows. MAKING THE BEST OF IT Phelps is not just making changes inside Microsoft. In the past, Microsoft has had as many as 50 outside law firms doing prosecution work. Phelps wants to bring that 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 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. Microsoft’s R&D costs are expected to rise and patent prosecutions will likely follow. The company plans on spending about $7 billion on R&D this year — up from $4 billion in 2000. Right now Microsoft holds about 3,500 patents and has 6,500 patents pending. CRITICS REMAIN Microsoft has always licensed some of its technology. It has held a number of cross-licenses with such companies as Hewlett-Packard and Cisco Systems. These have been broad deals, in which Microsoft agreed to license significant portions of its software portfolio in exchange for a similarly wide-ranging license back. Agreements were handled on a case-by-case basis, which led to much criticism from competitors and smaller companies 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, who helped convince the Justice Department to file antitrust charges against Microsoft. “Microsoft hasn’t really started to lower the boom on anybody, but it’s early yet,” adds Reback, now of counsel at Palo Alto, Calif.’s Carr & Ferrell. Microsoft has enough patents to “do significant damage to ongoing research in Silicon Valley, the same as IBM [did],” he says. Phelps acknowledges that until the company proves it has a first-class licensing operation, there will 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,” he says. “But that won’t stop us from trying.” Lisa Shuchman is a free-lance writer in New York City.

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