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Shortly after Louis Gerstner became chief executive of IBM Corp. in 1993, he wondered why the company, struggling at the time to regain its luster, was licensing key technologies to competitors. For a time, after a 1956 antitrust consent decree, IBM was obligated to license its patent portfolio, but by the early 1990s the company was free from that obligation. Gerstner had just come from RJR Nabisco Inc., and was new to the computer industry. So Frederick Boehm, who is now the assistant general counsel for IP and licensing, gave his new boss a visual lesson in patents and computers. He took an IBM ThinkPad and attached red tape to each component containing technology that IBM had not developed. The laptop was colorfully decorated with about 150 pieces of tape. The point of the exercise was that IBM lived in an interdependent world, in which companies necessarily borrowed from one another. Even if Big Blue was more of a lender than a borrower, it was not an island. Gerstner understood. Rather than stop IBM’s licensing activities, he helped accelerate them. His first management decree was devoted to the importance of innovation and intellectual property. Gerstner retired last year, but the IP legacy lives on. In 2002, for the 10th year in a row, IBM received more U.S. patents than any other company, securing more than 3,000 for the second straight year. The company also collected $1.1 billion in licensing revenue, about one-fifth of ongoing earnings — and nearly three times what the company took in as licensing revenue in Gerstner’s first year on the job. ( See chart: Ten IBM Patents That Changed the World) Increasingly over the years, IBM has licensed not just its patents, copyrights and trademarks, but its know-how. In essence, IBM is giving competitors both a license to compete and an instruction manual. (Of course, IBM doesn’t have to pay the license fee, so it has a financial head start.) This is a bold move, made somewhat more palatable by a smart decision. All licensing revenue is returned to the business unit where the technology originated. There is a subtle side to licensing technological know-how. Selling yesterday’s technology helps breed innovation. If engineers know that what they develop will be licensed to competitors, they are more likely to stay on top of their game. While the money may return to the business units, IBM’s overall IP and licensing activities are managed at the company’s Armonk, N.Y., headquarters. Gerald Rosenthal, IBM’s vice president of IP and licensing, oversees a staff of more than 100 U.S. patent lawyers and about 65 patent professionals (not all of them are lawyers) outside the United States. His unit also includes 35 licensing executives. Boehm, Gerstner’s former IP tutor, handles the group’s law issues. Rosenthal and Boehm, both 62, started their IBM careers in marketing and gravitated to IP only after earning law degrees at night from Pace University School of Law, located in White Plains, N.Y., down the road from headquarters. Often emulated but rarely duplicated, IBM’s success at licensing is the worst-kept secret in corporate strategy. Many imitators take away the wrong lessons from the IBM model. They are seduced by the possibility of striking it rich quickly and don’t understand that success at licensing takes a long time, hard work, smart decisions — and, most important, a steady flow of great technology. IBM began licensing more than 50 years ago. But the motivation was not money so much as the freedom to operate, according to Rosenthal. The company generally entered cross-license agreements that gave its engineers the ability to experiment freely without fears of infringing on other folks’ IP. This mind-set changed in the mid-1980s, when other companies began making IBM-compatible personal computers at lower cost. These companies didn’t have their own IP to trade in a cross license. IBM could either try to keep them out of the PC business and, as a consequence, slow the adoption of technology in this key market, or collect royalties from them. IBM decided to collect the royalties. Today, licensing for profit extends across IBM’s major product lines: servers, storage, microelectronics and software. Within each business unit, there are teams of engineers and lawyers in search of infringers. In the microelectronics unit, for instance, engineers slice and dice competitors’ semiconductors looking for infringing technology. When engineers find what they think is an infringement, the lawyers don’t rush off a cease-and-desist letter. Rather than the Big Foot approach, they employ the Big Blue Velvet offensive. A group of licensing executives prepares an infringement analysis that they present to the potential licensee. They let the company make a case for why they believe they don’t infringe or why the patent is invalid. And they give the company time to make a decision. Almost without fail and without resort to litigation, IBM persuades the company to take a license. “Our negotiators are business people,” Rosenthal says. “They are looking for a business solution.” They also have the law of large numbers on their side. With more than 20,000 U.S. patents and nearly that many foreign patents, IBM has many arrows and lawyers to pull from its quiver. Daniel McCurdy is the chief executive of ThinkFire Services USA Ltd., an IP licensing firm. He previously oversaw licensing at Lucent Technologies Inc., and was an IBM executive. “It is too easy and economical to analyze a small number of patents and come up with reasons why a patent is not infringed or invalid,” McCurdy says. That becomes exponentially more difficult when “there are hundreds, thousands, and tens of thousands of other patents.” And at a place like IBM, the inventions and the patents keep flowing. So even if a company dodges one license bid, others may follow. Licensing does not necessarily win IBM any popularity contests, especially at standard-setting bodies. Patented technology often forms the basis for many industry standards, but excessive royalties can impede the acceptance of a standard. Several standard-setting groups involving Web technology have had to grapple with this dilemma in recent years. IBM handles standards case by case, sometimes charging a royalty, sometimes not. It makes a decision, Rosenthal says, “in view of the benefits to IBM, its customers and the industry.” At IBM, patenting is not an afterthought but a deliberate, planned activity ingrained into the workweek of engineers. Inventors file so-called invention disclosure forms. Within each business unit, teams of engineers and lawyers meet regularly to review these forms. About half of the reviewed inventions ultimately are filed as patent applications. Inventors receive $1,000 or so as an award when this happens. There is another bonus if a patent is issued. Each year, the company chairman identifies three or four inventors who have made a special contribution. Their rewards can reach as high as $100,000. Money is just one variable in the equation that helps produce patents. Accountability plays a big part, too. IBM manages the patent process through its worldwide patent tracking system, a customized Lotus Notes database that monitors a patent from birth to death. The system tracks licensing revenue, highlights when prior art has emerged, and helps the company decide which patents to renew. Steven Voldman has been an IBM engineer for 20 years and holds more than 100 patents. In his early days, Voldman says, IBM was looking mostly for “Holy Grail” patents covering fundamental inventions. Now, IBM is more comprehensive and rigorous in its patenting activities. The process resembles an assembly line. “There is accountability for meeting dates, schedules, and deliverables,” he says. IBM relies on in-house lawyers, outside firms, and its “virtual law firm” to prosecute patents. The virtual firm consists of about 40 retired IBM patent lawyers who work from their home and are paid by the patent. These retirees now handle a large chunk of IBM’s patenting, according to Boehm. Boehm declined to discuss what the company pays or identify its preferred prosecution firms, but a review of recent patents suggests that, when it’s not using its retirees, IBM often relies on small boutiques. There is accountability built into the prosecution practice, too. In-house patent lawyers examine outside counsel’s work with an eye toward such issues as whether the claims have needless limitations. Firms that don’t measure up are replaced. Related Chart: Ten IBM Patents That Changed the World

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