Microsoft, Qualcomm & ARM: Licensing Business Model mastery

ARM Holdings Ltd. is one of those invisible giants in plain sight. They might be one of the least known companies that everybody uses products of. Every day you are likely using several dozens of their products and interacting with hundreds more. And while you don’t see them, they have become indispensable in your daily life. You may have guessed it by now: ARM is a microchip company. But not one that competes on mass-manufacturing and lowest unit cost. They compete on a very sophisticated business model.

You may have guessed it by now: ARM is a microchip company. But not one that competes on mass-manufacturing and lowest unit cost. They compete on a more sophisticated business model.

Over 50 billion (!) ARM microchips have been manufactured by 2014. But yet ARM has manufactured exactly zero of these 50 billion themselves. ARM is one of very few microchip companies that follows a pure licensing business model. And out of those, they are the biggest one.

You will find their microprocessors within your iPhone (and many other smartphones), in most smart watches, in many tablets, laptops, personal computers, supercomputers, car controls and many other electronic goods.

What is the licensing business model good for?

First, let’s be precise here. ARM actually uses several business models. Most notably the licensing business model and an intellectual property (IP) business model. Today we will focus on the licensing business model.

Your chances are 50/50. A survey of the European Commission among companies holding patents shows that 56% of patent-holding companies license out (see chapter 2 of the report). This means there is still lots of untapped potential.

What are the goals of this business model?

The most common form is for companies to license out their IP to others. This generates revenues through licensing fees (royalties). IP can mean different things in different jurisdictions. Most commonly we are talking about patents, copyrights, trademarks and potentially trade secrets.

In this article we will distinguish between two key objectives of this model:

1. Patent licensing to generate revenues
2. Patent licensing for strategic objectives

1. Patent licensing to generate revenues

And it is not uncommon to commercialise your IP and license it out in parallel, Qualcomm is one example for this.

Qualcomm, a giant of the licensing business model

Qualcomm is a widely known company. Most people think they are a pure microchip manufacturer. The truth though is more interesting. Yes, they have a manufacturing division, Qualcomm Technologies, Inc (QTI). But they also have a separate, wholly owned, division called Qualcomm Technology Licensing (QTL). Well, you can guess what their job is.

Qualcomm makes most its revenue from selling their processors. Remarkably though, most of their profits come from their licensing business model ($6.8b in FY15). This is a compelling testament to the licensing business model.

Be aware of the downsides

But there are also downsides. In recent years Qualcomm has started to become the victim of their own success. A number of regulators have launched anti-trust (or other) charges against Qualcomm. China has fined Qualcomm $975m for using their dominant position to impose their conditions on customers and for charging too high licence fees. Similar investigations have started in South Korea, Europe and even the US (see link above).

Licensing out can appear to be the ideal business model for those who hold valuable IP but not necessarily the means to commercialise their IP. A well-known example is the Fraunhofer Society in Germany. While they have 67 institutes focusing on applied sciences, internationally they are widely known for inventing the MP3 music format.

Through this licensing, they generated over €100m in revenues in 2005. However, they too had their “Qualcomm” moment when open source communities boycotted Fraunhofer for restricting creativity by protecting this IP through patents. The consequences were not just reputational. Fraunhofer’s efficient video format has been avoided by Google and many others. Google has acquired WebM and uses their video format on the YouTube platform (YouTube is wholly-owned by Google.)

It would have been a major brand boost to have a “Fraunhofer Inside” claim on YouTube. It may have caused also caused hard to determine damages to the other institutes of the Fraunhofer Society. Consider they are a €2.1 billion annual revenues (and 70% funding through projects) organisation.

2. Patent licensing for strategic objectives

Your IP may generate you good revenue. But it may be much more valuable when used strategically.

Increase your IP through cross-licensing

The most frequent strategic use of IP is likely cross-licensing. This is a frequently-used pattern in Silicon Valley. Two companies grant licenses to each other’s IP portfolio (or to be more precise: to an agreed subset of it).

These agreements are very well-defined in scope. They may or may not have a royalty structure and may be between direct competitors. E.g. Intel and their biggest competitor (by revenue) AMD have had cross-licensing from 1976. This may include reciprocal access to their patents (after a certain protection period). In the last patent deal, Intel granted AMD access to certain patents in their portfolio.

Cross-licensing is also often done to avoid charges and counter-charges. Cross-licensing (with one company) can also be combined with licensing-out to another one. Further on you can use the patent yourself for commercialisation (and this should be clarified in the license agreement).

Example strategic licensing: Microsoft

First step: foot in the door

Here’s an example how Microsoft has used their IP to obtain valuable strategic objectives.

Starting from 2011 Microsoft has been asserting Android smartphone manufacturers that they are infringing on some of their patents (which they had incidentally purchased a few months earlier). They applied pressure on smartphone companies as well as Google as the owner of the Android platform. In fall 2011 Microsoft announced an agreement was reached with Samsung on their claims. (I know technically the terminology “Android manufacturer” is not correct – but in this case, I am choosing simplicity over accuracy.)

This deal came shortly after a similar agreement with HTC, the second largest Android phone manufacturer at the time. Encouraged by their success Microsoft continued knocking at the doors of many other Android manufacturers and reached further agreements with many of them.

These companies have agreed to pay royalties to Microsoft of an assumed $5 – $15 per sold Android device. The fee would partly be based on the extent of the IP usage. All up these annual royalties have been estimated to be $2 billion by analysts (in 2013). This meant a higher profit through licensing than Microsoft made through their own phones. (When consumer increasingly switched to lower cost smartphones, Microsoft Android license revenues dropped in 2016.)

Second step: crack the door open

Google as the owner of the Android technology has commented on this in a fairly defensive way. They have called it an “organised campaign against Android.” Google accused Microsoft of aggressive litigation tactics “Instead of competing by building new features or devices, they are fighting through litigation.”

Microsoft has celebrated the expansion of their software onto Android as strategic partnerships. However, it has also been speculated that Microsoft has reduced the licensing fees for some of the Android phone manufacturers in exchange for having their MS Office apps preinstalled on those devices. This would, of course, be a very smart, strategic use of their IP to expand their installed base onto the Android platform.

A link between licensing patents from Microsoft and pre-installing Microsoft products has also been drawn in a deal with Xiaomi. In this case, Xiaomi was bolstering their strategic objective to expand internationally. For this purpose, they agreed to buy 1500 patents from Microsoft (all packaged into one deal).

So, my aim here is to give you a taste to the various licensing and IP strategies that are being applied. If you are interested you can read more about Google missed out on bidding on important patents and how Microsoft and Apple successfully bought these for $4.5b which was the enabler for them to apply the aforementioned strategies.

Your opportunity

Downloads

Download infographic and worksheet as pdf (here)

Take action now & boost your innovation skills:

Even a 5-minute brainstorm will help trigger your subconscious thinking and broaden your horizon for bigger, better ideas over time. Copy & paste to your note-taking app and jot down what comes into your mind.

1. Which IP does your company hold? This can be patents, trademarks, copyright. Research your companies patents on Google Patents.
2. Which of these could be licensed out? How could you generate revenues with these?
3. Who might be interested? Which strategic objectives could you use the patents they are interested in for?
4. Is there any IP of value that you could license in (esp IP you could get or develop at low cost with universities, research institutes)?

On a parting thought

Bloomberg, 22nd Dec 2016 reports about the Nokia vs Apple lawsuit over licence patenting. “Nokia’s intellectual property business added patents through its Alcatel-Lucent acquisition, making it a more significant profit contributor. In the third quarter, Nokia’s technology unit, which licenses its patents, generated about 40 percent of the company’s total adjusted operating profit.

Apple said that after it entered into a cross-license agreement with Nokia in 2011, the Finnish company launched “secret plans to monetize” patents that weren’t part of the accord. Apple said Nokia has transformed itself out of desperation, based on its own “failure as a supplier of cell phones.””

I believe that with companies trying to extract more revenues from the IP we will continue hearing a lot about these lawsuits. Next time we will talk about more strategic IP management options with more of a focus on sharing and collaborating and the massive opportunities that lie therein.

Qualcomm – Apple dispute

As of 20th Jan 2017, there is wide media coverage on Apple suing Qualcomm $1b over patent disputes. Some of the charges show you the practices applied stated directly from one tech giant:

• Apple states that Qualcomm refuses to sell certain chipset to customers that don’t accept their “extortion level royalties.”
• Double dipping of royalties: where Apple suppliers already take a licence on Qualcomm products Apple is forced to take a separate licence.
• Qualcomm overcharges on royalties and then offers rebates for exclusivity, i.e. if Apple stays with Qualcomm as the sole supplier of those chipsets. This reduces competition and increases dependency on Qualcomm.
• According to a Bloomberg view Apple practices to get lowest prices from vendors by sourcing from multiple vendors and then playing them out against each other. According to this comment (see the video) Apple is not happy that Qualcomm achieves profit margins of 60% where Apple “only” reaches 40% margins on their phones.

This is the Apple email statement on their lawsuit:

“For many years Qualcomm has unfairly insisted on charging royalties for technologies they have nothing to do with. The more Apple innovates with unique features such as TouchID, advanced displays, and cameras, to name just a few, the more money Qualcomm collects for no reason and the more expensive it becomes for Apple to fund these innovations. Qualcomm built its business on older, legacy standards but reinforces its dominance through exclusionary tactics and excessive royalties. Despite being just one of over a dozen companies who contributed to basic cellular standards, Qualcomm insists on charging Apple at least five times more in payments than all the other cellular patent licensors we have agreements with combined.

To protect this business scheme Qualcomm has taken increasingly radical steps, most recently withholding nearly $1B in payments from Apple as retaliation for responding truthfully to law enforcement agencies investigating them.

Apple believes deeply in innovation and we have always been willing to pay fair and reasonable rates for patents we use. We are extremely disappointed in the way Qualcomm is conducting its business with us and unfortunately after years of disagreement over what constitutes a fair and reasonable royalty we have no choice left but to turn to the courts”

Qualcomm – Apple dispute update 7 July ’17

Quoting from Bloomberg, 07/07/’17

“Qualcomm Inc. is suing Apple Inc. for patent infringement, the latest volley in an increasingly bitter legal battle over whether Apple should pay for Qualcomm technology used in the iPhone.

The chipmaker claims that Apple infringes six patents covering various aspects of mobile phone technology.

Qualcomm’s legal strategy has two aims: increase pressure on Apple to pay up, and demonstrate that the San Diego-based chipmaker still makes cutting-edge technology rather than milking old inventions, as Apple has charged.

The broader legal dispute revolves around patents that let Qualcomm take a cut of the sale of every modern smartphone — even if the device doesn’t have one of its chips. Apple argues the system is unfair and that Qualcomm has used licensing leverage to illegally help its semiconductor unit.

Apple has cut off technology license payments to Qualcomm and filed an antitrust lawsuit that accuses the chipmaker of trying to monopolize the industry.

The technology covered by the six patents in the new complaint isn’t related to any industry standard, meaning there’s no limit on how much Qualcomm could demand in royalties and no legal argument over whether the rates are reasonable. Some of the patented inventions help phones efficiently transmit data — such as video files — over cellular networks without killing the battery, Qualcomm said.”

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