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Bryan Mistele remembers the moment the idea for his company took shape. “It came out of left field,” he says. “Literally.” It was October 2004, and the field was filled with 5-year-olds playing soccer. Mistele was standing on the sideline, watching his son, and chatting about his plans with another soccer dad — Rick Rashid, Microsoft Corporation’s senior vice president in charge of research. Mistele spent nine years at Microsoft and had left a few months earlier, determined to start a business of his own. He was thinking of putting together global positioning system (GPS) data to construct traffic reports, he told Rashid. Then you’ll be interested in this, Rashid replied, pulling out a cell phone and demonstrating a traffic prediction program his researchers were beta testing at that very moment. Commuter science meets computer science: Mistele knew right away that this was a combination he could sell. Had the conversation occurred a year earlier, he would have been out of luck. Microsoft’s research division, with more than 700 researchers worldwide, is one of the largest in the world, and for decades has developed technology that doesn’t fit in with Windows, Office, or other core company products. Before last year, however, the traffic prediction software would have been relegated to a shelf. But the law department of the Redmond, Washington — based software colossus was about to launch a new unit designed to change all that. And Mistele was about to get in on the ground floor. Microsoft calls the group IP Ventures, and everything about it is unusual. Researchers at most companies work closely with product groups to produce only the IP they need; Microsoft turns its researchers loose to follow their interests. As a result, they create more technology than the company can use. What if Microsoft set up a matchmaking Web site to list some of the more promising software and invited start-ups and small businesses to make them an offer? That’s essentially what IP Ventures has done. The group works closely with the companies it licenses to — before and after the deal is signed. In some cases, it helps create a company from scratch. At press time IP Ventures had closed six deals (including one with Mistele’s company, Inrix, Inc.) — with another dozen in the works. Almost everything about this initiative challenges conventional wisdom about Microsoft. The deals probably aren’t going to make a pile of money, and that’s not the point. The approach is innovative — from a software maker known less for new ideas than for making billions from concepts developed by others (Apple Computer, Inc., first popularized an operating system using “windows,” but Microsoft made it ubiquitous). And the enterprise famous for fighting across the globe to protect its software code is now licensing it out — and training people to modify it. Though the program probably won’t end the company’s tussles with antitrust regulators, or show the way to beat back its new archenemy, Google Inc., IP Ventures just may help improve the company’s image and relationships in the tech community. It all began in June 2003, when Microsoft hired IP star Marshall Phelps. Phelps spent 28 years as an in-house lawyer at International Business Machines Corporation, where he made his reputation in the 1980s and 1990s by catapulting the company’s annual revenue in IP licensing from a few million dollars to more than a billion. He retired from IBM in 2000, worked briefly at a couple of venture capital funds, and at age 58 was snapped up by Microsoft to be its IP czar. As Phelps puts it: “I’m pretty good at running an IP engine.” The portfolio Phelps inherited at Microsoft was surprisingly small — about 2,300 patents in 2002. So he revved up annual applications from 1,000 to 3,000 (putting Microsoft in the top ten worldwide), and the company broke the 5,000-patent barrier this year. Once he had the “sausage machine” running properly, Phelps says, he focused on return on investment. The patents were valuable protection against the current industry epidemic of infringement suits. But they weren’t yet helping defray a research budget of more than $6 billion per year. In December 2003 Phelps announced on the corporate Web site: “Microsoft is open for business when it comes to IP licensing.” The plainspoken exec adds, with characteristic humor: “I will license my mother.” Since Phelps’s arrival, Microsoft has done more than 200 licensing deals. He declined to discuss how much they’ve brought in, but most are with large companies, and their purpose is to generate revenue, avoid litigation, and create strategic partnerships that open business opportunities for Microsoft and thwart the advance of rivals. The company has licensed IP to competitors like Palm, Inc., TurboLinux, Inc., and Nokia Corporation, and has signed cross-licensing deals with NEC Corporation, Toshiba Corporation, and Sun Microsystems, Inc. On the other hand, the IP Ventures group’s deals aren’t likely to boost the business or influence litigation. And the six deals signed so far will only make money for Microsoft if the start-ups succeed. Yet Phelps says they’re among the deals he’s proudest of, because they’re so innovative: “We’re trying to create companies around the technology.” IP Ventures was his idea, and he believes it can change the way Microsoft interacts with other companies, and even countries. If Phelps sometimes sounds like an IP evangelist, not everyone is genuflecting. Microsoft’s detractors are ever-suspicious of its motives, even when its actions appear benign. Critics also tend to see Microsoft’s new get-along attitude as a kinder, gentler way to extend its dominant Windows-based “ecosystem” and fend off the challenge of open source software like Linux [see "Open Sesame," page 69]. Stanford Law School professor Lawrence Lessig also casts a wary eye at Microsoft’s burgeoning IP stockpile. Though the patents haven’t been used offensively to sue possible infringers — and Phelps vows that they won’t be — Lessig worries that the company, prevented by antitrust regulators from controlling the software market, may attempt to use patents to achieve the same end. “The parts we see,” he says, referring to the public actions of the company, “seem to be moving in the right direction.” But, alluding to the patents as though they were weapons of mass destruction, he adds: “So long as [they're] invisible, it’s hard to say with confidence where Microsoft is.” IP Ventures is really a start-up business itself. Months before the team’s official christening last year, the prep work began in the five far-flung research labs. Each was asked to cull technology that might be unsuitable for Microsoft products, but enticing to entrepreneurs. The lab in Cambridge, England, winnowed 15 possibilities over the first six months. The labs in Beijing, Bangalore, Silicon Valley, and Redmond have followed suit, and all continue the review as new inventions roll in. The researchers in the labs provide documentation on the code being offered, and then the research department in Redmond works with IP Ventures to ensure that the offering and paperwork are complete, and that the company’s product groups have no objections to licensing the technology. General descriptions are then posted on the IP Ventures Web site. At press time 35 technologies were featured [see "Have We Got Mobile Aggregation for You!" page 67]. There’s no cookie-cutter package, nor one-click shopping. The in-house lawyers that the Ventures team taps have learned to be flexible as they negotiate each deal. One of those attorneys, Deborah Chapnick, explains that some start-ups are cash-starved but will share future revenue; others want to pay $1 million once and be done with it. “There are enough licensing structures out there so you can find a different one for each company,” she says. When the unit launched in May 2005, its members thought they’d simply post a list of their offerings and sort through inquiries, says Salah Dandan, the only lawyer who is officially on the six-person team. But press coverage of their new operation elicited unanticipated interest from government development agencies, in the United States and abroad. The team quickly recognized that these organizations were in a much better position to vet prospective partners than Microsoft. “That’s the great value of these agencies,” Dandan says. They were especially important, he notes, because Microsoft has always thought that the companies it partners with would be scattered around the globe. This discovery meant that Dandan, in effect, became the group’s government relations guy — spending about a third of his time meeting with these development organizations. He’s worked extensively with groups in Ireland, Finland, Singapore, Hong Kong, and Malaysia, and has talked with their counterparts in another five countries, he says. One of the earliest alliances he established was with Enterprise Ireland, whose mission is to help fledgling Irish companies take flight. The result: In January, Microsoft announced a deal with Softedge-Systems Ltd, a Dublin-based start-up. The licensed technology, born in the company’s Beijing lab, allows Softedge customers to extract people or objects from a photograph and insert them into a document without the background. It was a perfect fit with the product they were already developing, which allows individuals to create multimedia documents that can include text, photographs, audio, video, and animation, says Softedge CEO Vikas Sahni. The five-year license — “In software, that’s practically forever” — instantly lifted their profile, he says. And it’s a permanent foot in the door: “We no longer have to explain to people who we are.” The most recent deal closed in April. A start-up named Wallop, Inc., obtained social networking software. Headed by Karl Jacob, a former Microsoft manager, the San Francisco — based company aims to compete with sites like MySpace and Facebook, which allow their members to create personal profiles through which they build networks of online friends. Wallop was funded by a venture capital firm; Microsoft took a minority stake and a nonvoting seat on the board. IP Ventures leader David Harnett declined to provide details about the remaining three deals, citing the terms of the contracts, other than to describe the technology. One is used in film editing and postproduction television work; another in handwriting recognition; and the last in turning photographs into caricatures. What gives IP Ventures the feel of an old-fashioned business is that it’s all about relationships. They may not have been a priority for Microsoft in the past — and may not be in other parts of its business — but clearly relationships are crucial in this sliver of the software behemoth. They dictate the way IP Ventures finds partners, structures deals, and stays in touch. The aspect of the deals likely to turn the most heads is the way they’re structured. Microsoft has a well-documented reputation as a fierce competitor. Small companies sometimes view it the way Main Street hardware stores think of Wal-Mart. “The conventional view of how Microsoft deals with small companies,” says John Gantz, chief research officer at IDC, the Framingham, Massachusetts — based IT research firm, “is they either buy them or stomp them.” IP Ventures represents a distinct departure. “This is one way they can be seen as more benign,” Gantz says. Microsoft says that it doesn’t seek to control the companies — it doesn’t even request a voting seat on their boards. That’s something the IP team seems particularly proud of, and it’s caught the eye of venture capitalists. “We do everything we can to let the [licensing] company take our technology and bring it to market without having any strings attached,” says Harnett. Tony Sun, managing general partner of Venrock Associates, the first fund that Bryan Mistele turned to, says, “Most successful deals are ones where people’s interests are aligned.” He finds it particularly attractive that Microsoft can make money only if Mistele’s company does. So does Mistele. In 2004 he was eager to learn about Microsoft’s traffic prediction software, but he also had plenty of questions. Without funding, he couldn’t afford an up-front licensing fee. And he was loath to give Microsoft an equity stake. He hoped to make Google and other Microsoft competitors his customers. How likely would that be if they viewed his company as an extension of the enemy? And though the traffic prediction program was important, “it was only the starting point,” he says. “We knew that we would be extending the code.” He was very skeptical that his old company would let him incorporate his own ideas into their technology. So skeptical that, when he was told they would, Mistele thought: “You’ve got to be kidding me.” But the experience convinced him that Microsoft really has changed: “From the top down, there’s an acknowledgement that Microsoft has to play better, and can’t do everything by itself.” The negotiations were remarkably swift — about three months. Inrix secured perpetual rights to use about a dozen patents. Microsoft receives a percentage of the company’s revenue — in the mid — single digits, says Mistele, the company’s CEO. Inrix doesn’t have to limit its software development to benefit Microsoft, and it doesn’t have to share its own inventions with anyone: “The idea was that as we make money, Microsoft makes money, and they would be incented to help build the company.” When Mistele went shopping for venture capital, it helped that he wasn’t starting from square one — that he already had technology with the Microsoft imprimatur. He got five offers, and chose two Silicon Valley venture capital firms, which contributed a total of $6.1 million. When it celebrated its first anniversary a few months ago, Inrix had grown from three to 35 employees, and had landed a $10 million infusion from another VC. Mistele says the company’s revenue the first year was “several million,” and he anticipates “many times that” in the second year. Still, veteran VCs know better than anyone the difficulty of forecasting financial success. The partners at the firms that invested in Inrix are nothing if not realists. Venrock’s Sun says: “I am cautiously optimistic that this will be a good investment for us.” But he adds: “It’s a long way from being a profitable company.” Phelps, once a VC himself, adds: “Someday one of these things is going to hit it big . . . [but] you have to look ten years out.” Fair enough. But in the meantime, are these deals really likely to improve Microsoft’s image? The short answer is, maybe; the longer version is that they can’t hurt. Lucinda Stewart of OVP Venture Partners in Kirkland, whose firm is not involved with Inrix or the other start-ups, thinks the deals can only bolster Microsoft’s reputation. IP Ventures demonstrates that the company produces quality technology beyond what the public sees, she says. And when Harnett and his colleagues make the rounds, looking for feedback from people like her (as they do every couple of months), they chip away at the image of a company that doesn’t listen. These aren’t the only benefits. Some are more tangible. Releasing technology does more than raise the morale of the research department. Inventors get to see their creations in action, and learn from the experience — which often leads to additional patents. Mistele, who has met with Microsoft researchers regularly since his company launched, says he may soon acquire more IP. Tanya Moore, Microsoft’s senior director of IP licensing, also stays in touch with him. “One of our missions here,” she says, “is that while we’re focusing on outbound licensing, it really is about forming long-lasting relationships with companies.” And the bonds Microsoft forges with people like Mistele sometimes help in unexpected ways. It was Mistele who introduced Wallop’s Jacob to the Ventures crew. Given the company’s history, no one is suggesting that Microsoft has suddenly turned altruistic. “This is not Doctors Without Borders,” says Laura DiDio, a research fellow with the Yankee Group Research, Inc., in Boston. “They’re not pulling lepers out of the gutter.” It all began, it’s worth remembering, when Microsoft bucked its tendencies. Instead of playing with the organizational chart, as it’s been known to do when looking for new leaders, it brought in what OVP’s Stewart calls “a fresh dose of non-Microsoft DNA.” It hired Marshall Phelps, “a corporate success story,” Stewart notes — but not homegrown. It was Microsoft learning to reach out, and that may be the most important lesson of all.

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