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Operators join royalties debate while patents war shifts to email

Published: Monday 28 November, 2005

In the enterprise technology world, we increasingly see large vendors donating at least a token sample of key patents to the open source process for free in order to accelerate uptake of their favored platforms. The same trend will undoubtedly come to mobile communications eventually, driven by the increasing interest in Linux, Java and other open or semi-open systems. However, for now ownership of intellectual property remains critical to the balance of power among the vendors, and an increasingly important focus of the battles between them. When margins are falling on equipment and competition is rising, a strong patent store not only provides a very high margin revenue stream, but also a barrier to entry for would-be challengers with no such patents. Thus the emphasis on royalty issues is intensifying as mobile vendors come under pressure, and is particularly marked in Europe, the region that has generated the greatest wealth from cellular services, and stands to lose the most to competition from the US and Asia.

This was seen when a group of vendors, including European giants Nokia and Ericsson, grouped together to accuse Qualcomm, the most successful exploiter of mobile intellectual property, of anti-competitive practises, and to petition the European Union for support. Then, last week, the major European operators joined the battle, with a group of cellcos, led by Vodafone, T-Mobile and Telefónica, calling on the European Commission to protect them and their customers from huge royalty bills.

They demanded an overhaul of how ETSI, the European standards maker, agrees standards, to avoid intellectual property traps where companies contribute technology to a standard and then later reveal patents and claw back huge royalties. This is a looming issue for broadband wireless, with nobody certain whether, and how, companies like Samsung may seek to derive revenue from their patents in emerging technologies like WiMAX and fast Wi-Fi (see related item).

According to a document leaked to the Financial Times, Vodafone and its allies suggest that IPR terms should be agreed before a standard is even set, and state: “Cumulative patent royalties or ‘patent stacking’ can raise the licence burden to an extent unbearable to our industry. IPR licence fees have become a commercial issue that is limiting the industry’s ability to continue to drive down costs. The issue has the potential to limit competition through direct and indirect impact on pricing.”

The operators are acting against a backdrop of various battles – not just the Qualcomm battle but also the recent debacle of the Open Mobile Alliance’s standard for digital rights management, which produced an unexpectedly large license fee.

Mobile handset makers get hit with patent payments for processor technology, radio modulation schemes, codecs, storage designs, interfaces, development kits, Java, DRM and many others, all in a device that is made for between $100 and $400, and that needs to get far cheaper for poor nations. For handset makers like Nokia, with significant patent holdings, the figure is considerably less, and they also have a revenue stream to compensate for some of the pressure on phone margins. At some point, the giants will be unable to make the margins they require from basic handsets, no matter how efficient their supply chains and cost structures, but they will still be able to collect revenue on every phone sold by their low cost rivals from China and elsewhere.

In complex 3G, royalties are a greater slice of the cost of production than in earlier technologies, giving Nokia and other patent owners an even greater cost advantage – estimated at around 15% over rivals with no patents of their own. That could give Nokia a $30 buffer on a $250 handset, which can be used to maintain its margins or cut its prices to gain market share. This factor alone prompted Paul Sagawa of Sanford Bernstein recently to recommend buying Nokia shares, since most analysts have misunderstood the value of the intellectual property and the barriers it creates for challengers. He estimates that patent holders – mainly Nokia, Ericsson and Qualcomm in W-CDMA – will trade rights and so will end up with a total royalty bill of 7% of costs or less. By contrast, a non-patent holder could pay 25% of the wholesale price in GSM and W-CDMA royalties.

However, the royalty payments that are incurred are passed on to the operator in terms of higher overall handset costs. In addition, cellcos are frustrated because they want to buy more of their devices from second tier phonemakers, which tend to be more amenable to making heavily operator-defined models, but which, without the benefit of patents to trade, are less able to be flexible in their pricing than their larger competitors.

The group of operators wants to see ETSI rules on intellectual property rights tightened up or they say Europe risks losing the benefits of standardization. They suggest that intellectual property terms must be agreed before a standard is set, rather than after it, and want to see caps on maximum royalties, something that Nokia has made a lot of noise about, and has been rebuffed by Qualcomm. The proposal is also apparently being backed by Alcatel, Hutchison Europe, Orange, Portugal Telecom, RIM, SFR, Swisscom, TDC, Telecom Italia, Telenor and TeliaSonera.

Behind all these debates over the principles of royalties, there is a major landgrab going on for patents in areas that are seen as critical to revenue growth in mobile systems. Vendors are seeking intellectual property not just to generate new revenues but to disadvantage their rivals as they race after new and lucrative markets. Most prominent among these is currently mobile push email, and beyond that, cellphone-based integrated messaging incorporating email, voicemail, instant messaging, presence capabilities, SMS and future techniques like videomail, under a single telephone directory and user interface. This is seen as a major driver of mobile data revenues in both the enterprise and consumer markets and is being hotly chased by the handset majors and by the companies that are extending integrated messaging strategies from other platforms such as the internet PC. Microsoft, in both its Windows Mobile and MSN guises; the internet players Google, Yahoo and AOL; Nokia with its quest for the mobile enterprise space; Qualcomm seeking to make its CDMA platform more attractive to operators; and the specialist RIM are all fighting for the sector from different angles (see Wireless Watch November 21st issue). One key element of their battle, and one that highlights the more general issues surrounding patents in the mobile world, revolves around intellectual property.

So, earlier this month we saw Nokia acquiring Intellisync for its push email technology. There were some obvious motivators – allowing the Finnish giant to sideline RIM and control its own platform in this crucial market being the key one. Since Intellisync is mainly implemented by carriers, with Verizon Wireless its largest customer, it also gave Nokia a welcome foothold in its weakest base, the CDMA operators, which could drive future sales of high end CDMA handsets. But as an added bonus, and helping to justify the $430m purchase price, Nokia not only gains Intellisync’s store of 60 patents to add to its existing hoard in this market, but also wins control of the platform on which arch-enemy Qualcomm has built its own mobile email offering, Eudora2Go. Nokia could potentially force its rival to re-engineer Eudora2Go around a different technology, losing it valuable time to market, or charge it high fees for licensing.

But there are other patents in this area that are up for grabs. Of course, there is the long running saga of RIM’s battle with patent hoarder NTP over some core push email intellectual property. RIM claims it has devised a workaround, and if it has, this would certainly boost its value and potentially, the likelihood that a larger company will acquire it as it sees its huge market share start to dwindle. RIM has leveraged its own patents to try to keep other minor players out of the space it pioneered, and its IP remains attractive if it can be freed of legal burdens.

Then there is Wireless Science, the intellectual property sister company to mobile content specialist Wireless2Web. This company claims to have 1,600 patents or pending patents, including the LinkPush user-controlled content mechanism, and has indicated that it is keen to gain an acquirer or exclusive licensee for them. It works in areas including push email, mobile multimedia, voice-email integration, music download and others.

Microsoft could be on the look-out for acquisitions in this area, although it is relying on its own market weight rather than patents to spread its integrated communications platforms, including its new DirectPush email function – now the basis of future offerings from the other surviving major independent alongside RIM, Palm. The giant has no significant patents in this market, but does, of course, license its Windows Mobile Media Audio and Video technologies to third parties, such as Qualcomm and various phonemakers, which use these partly to underpin multimedia messaging and other data services.

If Wireless Science’s patents are as valuable as the company claims, they could be a good purchase for a handset maker, providing a headstart in an increasingly pivotal and competitive market and a way to keep other rivals out. All of which shows that patents are becoming more, not less, important to the way that vendors compete in the mobile market, and that the royalties issue will not be easily solved. Rather than relying too heavily on the slow processes of the European Commission and standards bodies, the cellcos may do better to emulate Japan’s NTT DoCoMo and Korea’s SKT and acquire some IP of their own, so that they too have something to trade with the increasingly royalty-dependent equipment makers.

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