U.S. FTC: Unpacking Technology Companies Acquisition of AI-related Technologies

The U.S. Federal Trade Commission is gathering information from major technology companies regarding their acquisition of technology from other companies concerning artificial intelligence.  The FTC press release states:

The Federal Trade Commission announced today that it issued orders to five companies requiring them to provide information regarding recent investments and partnerships involving generative AI companies and major cloud service providers.

The agency’s 6(b) inquiry will scrutinize corporate partnerships and investments with AI providers to build a better internal understanding of these relationships and their impact on the competitive landscape.  The compulsory orders were sent to Alphabet, Inc., Amazon.com, Inc., Anthropic PBC, Microsoft Corp., and OpenAI, Inc.

“History shows that new technologies can create new markets and healthy competition. As companies race to develop and monetize AI, we must guard against tactics that foreclose this opportunity, “said FTC Chair Lina M. Khan. “Our study will shed light on whether investments and partnerships pursued by dominant companies risk distorting innovation and undermining fair competition."

The FTC issued its orders under Section 6(b) of the FTC Act, which authorizes the Commission to conduct studies that allow enforcers to gain a deeper understanding of market trends and business practices. Findings stemming from such orders can help inform future Commission actions.

Companies are deploying a range of strategies in developing and using AI, including pursuing partnerships and direct investments with AI developers to get access to key technologies and inputs needed for AI development. The orders issued today were sent to companies involved in three separate multi-billion-dollar investments: Microsoft and OpenAI, Amazon and Anthropic, and Google and Anthropic. The FTC’s inquiry will help the agency deepen enforcers understanding of the investments and partnerships formed between generative AI developers and cloud service providers.

The FTC is seeking information specifically related to:

• Information regarding a specific investment or partnership, including agreements and the strategic rationale of an investment/partnership.
• The practical implications of a specific partnership or investment, including decisions around new product releases, governance or oversight rights, and the topic of regular meetings.
• Analysis of the transactions’ competitive impact, including information related to market share, competition, competitors, markets, potential for sales growth, or expansion into product or geographic markets.
• Competition for AI inputs and resources, including the competitive dynamics regarding key products and services needed for generative AI.  
• Information provided to any other government entity, including foreign government entities, in connection with any investigation, request for information, or other inquiry related to these topics.

The companies will have 45 days from the date they receive the order to respond.

The Commission voted 3-0 to issue the Section 6(b) orders and conduct the study of AI investments and partnerships.

Microsoft Threat Intelligence Report on Cybersecurity Attacks Against Universities

On January 17, 2024, Microsoft released a threat intelligence report concerning cybersecurity attacks against certain university researchers across the West and other countries.  The threat report states, in part:

Since November 2023, Microsoft has observed a distinct subset of Mint Sandstorm (PHOSPHORUS) targeting high-profile individuals working on Middle Eastern affairs at universities and research organizations in Belgium, France, Gaza, Israel, the United Kingdom, and the United States. In this campaign, Mint Sandstorm used bespoke phishing lures in an attempt to socially engineer targets into downloading malicious files. In a handful of cases, Microsoft observed new post-intrusion tradecraft including the use of a new, custom backdoor called MediaPl.

Operators associated with this subgroup of Mint Sandstorm are patient and highly skilled social engineers whose tradecraft lacks many of the hallmarks that allow users to quickly identify phishing emails. In some instances of this campaign, this subgroup also used legitimate but compromised accounts to send phishing lures. Additionally, Mint Sandstorm continues to improve and modify the tooling used in targets’ environments, activity that might help the group persist in a compromised environment and better evade detection.

The report is available, here. 

The U.S. Industrial (Technology) Military Complex is Alive and Well: Microsoft and the Defense Innovation Unit

The LA Times recently published an article titled, “Microsoft will Give the U.S. Military Access to ‘All the Technology We Create'.”  The article discusses Microsoft’s recent announcement as well as the tension in some U.S. technology companies concerning working with the U.S. military.  For example, some Google employees have expressed displeasure with Google’s decision to work with the U.S. military.  The article notes that:

The Defense Department has established the Defense Innovation Unit, which is intended to provide capital — without taking an ownership stake — to companies that want to work on prototype projects that help address problems faced by the U.S. military.

The Defense Innovation Unit’s website is here.  The Defense Innovation Unit focuses on five areas: artificial intelligence, autonomous systems, human systems, information technology and space.  Their team includes: “about 75 military and civilian personnel. Prior to joining DIU, we’ve launched and sold companies backed by tier-1 VCs; led teams at the Joint Staff, the Office of the Secretary of Defense, and the White House; served with our military around the world; and helped build some of Silicon Valley's most iconic companies.”  Notably, the program is built around speed—a contractor will know if they have a “pilot” agreement within 30 days with a quick follow-through for a more involved contract.  The 2017 Annual Report states the mission of the Defense Innovation Unit:

The U.S. Department of Defense (DoD) established Defense Innovation Unit Experimental (DIUx) to accelerate commercial innovation to the warfighter in order to meet the changing demands of today’s strategic and technological environments. The Department’s 2018 National Defense Strategy (NDS) boldly acknowledges that our nation’s military-technical advantage is eroding as our competitors and adversaries have the same access to the global technology marketplace driving innovation. Without significant changes to DoD’s acquisition culture and processes, the U.S. military will continue to lose its long-held technological superiority.

Military-technical competition is dramatically different from past decades when key technologies were developed in government labs, often exclusively for military use. A technology first-mover up until the end of the Cold War, DoD must now adopt a fast follower posture to keep pace with commercial refresh cycles. The commercial sector leads the way in many cutting-edge areas from artificial intelligence to autonomous systems to space, the convergence of which generates the prospect of dramatic changes to the character of warfare. The implications of global access to advanced commercial technology are visible in today’s conflicts and the loss of exclusivity means the likelihood of technological surprise is far higher.

It is DIUx’s mission to lead DoD’s break with past paradigms of military-technical advantage to become fast adapters -- as opposed to sole developers -- of technology, integrating the advanced commercial capabilities necessary for strategic advantage. In this hyper-competitive environment, DoD needs to prioritize speed of delivery, rapid and modular upgrades, and quick operational adaptation on the battlefield. Success in this new era of military-technical competition no longer goes to those who seek the most exquisite systems, but rather to those who move fast and think creatively.

Headquartered in Mountain View, CA, with offices in Central Texas (Austin); Boston, MA; and in the Pentagon. . . . 

On intellectual property, the Frequently Asked Questions page states:

How is intellectual property treated and protected?

Prior to the start of a project, it is important that a company identify rights in pre-existing data. In general, companies retain ownership of IP assets created during the effort. DoD is usually licensed certain rights to use these assets in accordance with the agreed OT (i.e., pilot contract) terms and conditions. These rights control, inter alia, how DoD can use, disclose, or reproduce company-owned proprietary information.

What are the different ways IP is licensed under an OT agreement (i.e., pilot contract)?

Unlimited Rights. These give DoD the ability to use, disclose, reproduce, prepare derivative works, distribute copies, and perform publicly, in any manner and for any purpose, and to have or permit others to do so (absent any separate security classification or export control restriction). We usually don't need this and do not anticipate awarding any OT agreements (i.e., pilot contracts) with unlimited rights.

Government Purpose Rights. These give DoD the ability to use, modify, reproduce, release, perform, display, or disclose data only within the Government (including competitive re-procurement). However, DoD cannot release the data for any commercial purpose.

Limited Rights. DoD may use the company’s data, other than computer software, within DoD but not release the data outside of DoD except in limited circumstances. DoD may not use the data for manufacturing additional quantities of the item. Data may not be released without company permission/associated nondisclosure agreement.

Restricted Rights. These apply to noncommercial computer software only. DoD may only run the software on one computer at a time, and may make only the minimum copies needed for backup. The software may not be released outside of DoD except with company permission/associated nondisclosure agreement.

The Nokia-Microsoft Transaction: Further Thoughts on Strategy and Valuation

Fellow blogger Mike recently discussed ("Microsoft Acquires Nokia Handset Business and Licence-Related Patents"), here, the high-profile acquisition by Microsoft of Nokia's handset business. Permit me to offer my own view of certain aspects of this blockbuster transaction. To remind readers, Microsoft paid 3.79 billion EUR for the mobile phone and smart devices business units plus certain support assets and activities (the business "itself") and an additional 1.65 billion EUR for a 10-year non-exclusive licence (subject to possible extension in perpetuity) to use certain Nokia patents. I scratched my head and did a lot of on-line digging in search of a previous example where multiple billion dollars were paid for a non-exclusive licence, but my efforts came up empty. Whether or not these licence arrangements, having regard to the sums paid, are indeed without precedent, the more interesting question still remains: what do we make of these licence arrangements, given that the previous mega-patent transactions of recent years have focused in whole, or nearly in whole, on the acquisition of patent ownership of large patent portfolios? Two reports of this transaction offer somewhat different perspectives.

First, let's consider the 3 September Reuters report by Dan Levine ("Why Nokia didn't sell its patents to Microsoft"), here. Until the transaction, it is claimed, Nokia had not widely licensed its handset-related patents, instead using its patents as a shield against competitors. That will change, said a Nokia spokesman, "[o]nce we no longer have our own mobile devices, following the close of the [Microsoft] transaction, we would be able to explore licensing of those technologies." That is well and good, but it takes two enter into a non-exclusive licence arrangement, so why did Microsoft agree to take such a licence rather than to acquire the patents?

One answer may simply be that, when compared with several of the mega-deals for patents, most notably the Google-Microsoft Mobility transaction, Nokia simply did not receive an offer for the amount that it wished to receive for sale of its patent portfolio to Microsoft. Maybe yes, maybe no, given all of the second-guessing about the amount actually paid by Google that are attributed to the patents. The better answer, as suggested in the article, is not simply a case of the licence arrangement being the best available option. Rather, the licence was part of a strategy for the exploitation of the company's patents.

In particular, it is connected with Microsoft's attack on Android manufacturers. Thus, it turns out that Microsoft has already succeeded in convincing approximately 20 Android manufacturers to pay royalties, thereby adding a further cost to the overall Android system. The argument is that, by leaving the patents in the ownership of Nokia, the company can separately sue the same Android manufacturers, with the intention of obtaining a royalty and further adding to the cost of the device. The article called this step a "pincer movement" made possible by the ownership of Nokia in the patents. If this be correct, we can expect to witness, over the next several months, multiple law suits for patent infringement and filed by Nokia.

A somewhat different approach is offered on the FOSS patents blog post of 3 September ("1.65 billion euro patent licensing portion of Microsoft-Nokia validates Nokia's portfolio"), written by the perceptive Florian Mueller, here. Of particular interest are two slides set out in the post, taken from a "strategic rationale" document furnished by Microsoft (Mike's post provides a link to the document). Most notable are the following claims by Microsoft:

1. Microsoft is taking an assignment of more than 8500 design patents;

2. The utility patent portfolio that is the subject of the Nokia licence to Microsoft consists of more than 30,000 granted patents and pending applications and is described as one of the most valuable portfolios in the wireless connectivity industry.

3. Microsoft will taken an assignment of the benefits of more than 60 third-party patent licenses.

Mueller observes that Microsoft, unlike Google, already has a strong patent position (witness its success in smart-phone litigation and convincing 20 Android device manufacturers to take a licence with recourse to litigation). Thus it had no interest in acquiring the Nokia patents, but merely in ensuring that it would be free from interference based on these patents, whoever ultimately owns them. The blog also suggests (and others have apparently discussed more directly), that Nokia now is in a position to assert its patents against other parties for the purpose of obtaining royalties (and thereby becoming a "patent assertion entity" or even a "patent troll"?).

Despite the stark differences between the Google-Motorola Mobility transaction, in which the portfolio was acquired by Google, and the Microsoft-Nokia transaction, which emphasizes the grant of licences by Nokia, there are still some common nagging questions: (i) how did Microsoft reach the 1.65 billion EURO valuation for the licences; (ii) how did Microsoft assign a value to the design patents acquired; and (iii) how did Microsoft reach the conclusion that the Nokia portfolio is a particularly strong one?

More generally, Florian states that "Google grossly overpaid for Motorola's patents", apparently based on the thin record of successful litigation resting on these patents. Maybe yes, maybe no. Perhaps Google assigned a large value to the fact that in acquiring the patents, it precluded acquisition by someone else. Perhaps Google has other metrics by which it is valuing the success of its patent acquisition. As for Microsoft, the entire acquisition may make sense only if the company can make a go of it in the smartphone industry. If Microsoft fails, then not only can it be claimed that it "overpaid" for the Nokia patents, but in doing so, it precluded these amounts from being utilized by the company to develop other product categories. Seen from this vantage, the ultimate strategic concern is not the potential benefits flowing from the grant of the licensed rights, but rather the very transaction itself. As such, the issue of the licensing is at most a matter of high level (and expensive) tactics. Without being trite—"only time will tell."

Microsoft Acquires Nokia Handset Business and Licenses Related Patents: Microsoft's Strategic Rationale

Microsoft has acquired Nokia’s handset business for about $5 billion and has licensed related Nokia patents for about $2.18 billion (supposedly 8,500 design patents and 30,000 utility patents and applications).  Discussion about the deal can be found here, here, here and here.  Interestingly, The New York Times notes that, as partners, Microsoft and Nokia have not been very successful, but that Microsoft’s acquisition of Nokia may “make things run more smoothly.”  Why?  The New York Times states that the issue concerned slow development in the fast moving mobile market because of “friction” caused by intellectual property rights. 

According to Microsoft’s Strategic Rationale document, Microsoft is acquiring “Nokia’s Qualcomm and other key IP licenses”; “licens[ing] Nokia’s patents for use across all of Microsoft’s products”; and “licens[ing the] ability to use Nokia’s HERE broadly in its products.”  The document notes that “Nokia retains NSN, HERE, its CTO Office and its patent portfolio.”  The document also states:

IP Acquisition and License Agreements with Nokia

                Intellectual property is an important element of the smart devices business

                                Unless managed proactively patent issues can create uncertainty for smartphone shipments

                                Unless managed creatively, patent royalties can add over 10 percent to the costs of a smartphone Bill of Materials

                Microsoft is acquiring over 8,500 design patents, ownership of the Lumia & Asha brands, and a ten-year license to use the Nokia brand on feature phones.

                Microsoft is paying 1.65 billion [Euros] for a fully paid-up license to Nokia’s utility patents

                                Covers all of Nokia’s patents and patent applications as of the closing date (except NSN)

                                The total license price includes an option to convert coverage from a ten-year to a perpetual license

                                The agreement provides for a broad, five-year, two-way standstill, including NSN

                Nokia’s patent portfolio is one of the most valuable in the tech sector

                                Nokia’s portfolio has approximately 30,000 utility patents and patent applications; we consider it to be one of the two most valuable portfolios relevant to wireless connectivity

                                The license also provides significant value for Microsoft’s existing businesses, replacing after 2014 Microsoft’s existing annual license payment to Nokia

Microsoft also secures other Valuable Patent Benefits

                Nokia is assigning to Microsoft benefits under more than 60 patent licenses with third parties

                                Nokia is assigning its existing license with Qualcomm, which is the other company that ranks with Nokia at the top of having a valuable wireless patent portfolio

                                Nokia is also conveying rights under its agreements with IBM, Motorola Mobility and Motorola Solutions

                                These give Microsoft the benefit of attractive royalty arrangements Nokia negotiated

                Microsoft will combine the new Nokia license and these agreements with its existing patent agreements

                                Microsoft’s agreement with Samsung will provide coverage for these additional devices without added payments

                                Microsoft will also benefit from its prior or continuing agreements with Apple, LG, Nortel, Kodak, and others at no additional cost

                                Put all together, Microsoft will have the most cost-effective patent arrangements for smart devices

Another interesting point is that this deal may take Microsoft out of contention for the BlackBerry patent portfolio.  And, at least one commentator placed the highest value for the BlackBerry portfolio as a potential target for Microsoft for around $5 billion.  BlackBerry’s stock is up since the Microsoft and Nokia announcement. 

More on Microsoft's IP licensing strategy

As we commented here last week, Microsoft has been making a series of important announcements recently concerning the licensing of its patent portfolio and asserted its ambitions on the smartphone market. But since all the eyes are presently turned toward Steve Jobs' soon to come biography and its now famous "I'm willing to go thermonuclear war on this" quote, Microsoft recent actions and statements went a little unnoticed. But Microsoft has its anti-android strategy all planned out and technology website dailytech revealed it all yesterday in a very detailed article entitled "Of Lawsuits and Licensing: The Full Microsoft v. Android Story". Contending that "Microsoft is essentially a failure in today's market from a pure unit sales perspective", Jason Mick explains that "Microsoft has turned from primarily being a producer of smartphones to primarily being an R&D-based litigator on the smartphone market", since it makes more money through licensing agreements than from selling devices running his own Windows Phone OS.

This article gives us the list of all the companies that Microsoft is licensing to and suing and highlights the interesting fact the company led by CEO Steve Ballmer is "double dipping" - that is "seeking licensing fees both from the "original equipment manufacturer" (OEM) who mostly designs the device (e.g. Samsung) and from the "original device manufacturer" (ODM) who primarily handles manufacturing the device (e.g. Foxconn)" - with a certain success since 55 percent of the Android ODMs and 53 percent of Android OEMs entered into licensing agreements. The following paragraph, which a quick outline of the 9 main patents that Android is said to infringe, is also definitely worth a read.

Finally Jason Mick argues that the validity of Microsoft patents will be much harder to call into question, since they appear to reach a high threshold of novelty and non-obviousness (contrary to Apple) and finishes with an interesting comment "(...)one crucial thing to remember is that these patents will expire. Many are expiring within two years, and almost all will be expired within a decade. As a result, within a decade Microsoft's license agreements with Android OEMs and ODMs will almost certainly be drastically restructured. (...) Microsoft can revel in its licensing successes for now, but if it doesn't continue to push ahead in the mobile realm, its gains will be short-lived." It seems that Microsoft understood that fact very well, since the company received more than 3000 patents in 2010...

A new IP dawn for Microsoft?

Whereas being most definitely one of USA's patent champions with 3,094 patents awarded in 2010 (in 3rd position behind IBM and Samsung), Microsoft is not making the IP headlines as much as its US counterparts such as Google - in the midst of acquiring Motorola Mobility which is now being sued by Intellectual Ventures, or Apple - embarked in an all-out and global patent war against all its competitors on the smarphone market with Samsung as primary target. However two interesting item of news are revealing that this situation might be about to change.

On September 29th Microsoft announced in a press statement a landmark agreement with Samsung 'to cross-license the patent portfolios of both companies, providing broad coverage for each company’s products'. Given the current difficulties encountered by South-Korea's top smartphone seller to launch its products quickly (if at all) on various markets all around the world notably in Germany, the Netherlands and in Australia, such an agreement will certainly provide Samsung with the necessary patent ammunition against its newfound archenemy Apple, while bringing a large amount of money in the bank accounts of the Redmond-based corporation. Well-informed Joff Wild of IAM Magazine speaks of a royalty-based deal ranging from 10$ to 15$ per android device sold. Moreover the announcement also reports the cooperation of Samsung in the development and marketing of Windows Phone, whose latest OS version called Mango received very encouraging critics.

More interesting is another piece of news published on IAM Magazine's blog which reveals that Microsoft hired Florian Mueller to conduct a research on standard-essential/FRAND-related patents. The unorthodox choice of well-known anti-software patents activist Florian Mueller to perform such a research certainly demonstrates Microsoft's keen awareness that negotiating in fair and reasonable terms with all its competitors will help the company exploiting its heavy patent porfolio at its full potential, instead of using it primarily as defensive leverage.

Microsoft active patent licensing strategy could be another sign showing that 'IP really starts taking centre stage in corporate thinking' as many IP licensing specialists start believing after the groundbreaking Nortel patent auction...

Adieu 25% rule? At least in US litigation

Licensing and litigation experts are well acquainted with the 25% rule for calculating a reasonably royalty which a licensee might be prepared to pay to the patent proprietor when licensing a patent. The rule has had a long genesis and was apparently originally formulated by Robert Goldscheider's analysis of patent licensing rates made by a Swiss subsidiary of a US company to around 18 companies licensees throughout the world ("Use of the 25% rule in valuing IP", 37 les Nouvelles 123, 123 December 2002). A number of other empirical studies have appeared to confirm the general applicability of the rule - and many licensing executives use the rule when establishing their baseline for negotiations.

The underlying assumption is that a licensee should maintain a majority - say 75% - of the profits of a patented product because the licensee has undertaken substantial development, operational and commercialisation risks. The other 25% should go to the patent holder as a licence fee. The 25% rule can be used for calculating a reasonable, running royalty rate by first of all estimating the licensee's profits for the product incorporating the patent and then dividing the total profit by the total cost of sales. This gives a profit rate - of which 25% is the running royalty rate. This rate is then applied going forward for licensing deals - or backwards for calculating damages in litigation

The Court of Appeals for the Federal Circuit (CAFC) - the Appeals court in US patent cases - looked into the validity of the rule in a case Uniloc v Microsoft Corp. and concluded that the rule was - for the purposes of the calculation of damages in litigation - fundamentally flawed. The CAFC noted that the court (and lower courts) had accepted the rule in the past because it had never been effectively challenged. The CAFC noted that there had been a number of criticisms of the rule over the years:

• The rule failed to take into account the unique relationship between a patent and an accused (allegedly infringing) product
  
  
• The rule failed to take into account the unique relationship between the parties in the litigation
  
  
• The rule was essentially arbitrary

The CAFC pointed out that patent proprietor has to prove the level of damages and that any arguments regarding the level of damages must be tied to the facts of the case. Citing a whole raft of case law, the CAFC concluded that the 25% rule of thumb was an abstract and theoretical concept. The 25% rule failed to provide any basis for the hypothetical negotiation between the two parties regarding the level of the royalty or offer any evidence regarding usual royalty rates for a particular technology, industry or party. In other words - the CAFC was not prepared to accept a royalty rate which it considered purely arbitrary and wanted to see comparative figures produced.

The implications for litigation are tremendous. Calculation of damages will rely on the ability to produce comparable figures from other sources - such as stock exchange filings or the annual LES royalty surveys. Licensing executives may not need to be so worried. The concept of the reasonable royalty based on a negotiation between parties is generally one that is practiced in reality. The 25% rule is often used as a starting point for the negotiation and is just one data point. Other data points include similar licensing agreements made with other companies and also publicly available data from sources such as SEC filings. It is unlikely that a court would attempt to change royalty rates in an agreement made entered into freely by two parties, merely because the royalty rate calculation was based on the (unapproved) 25% rule. Only in the unlikely event that one of the parties was put under duress to accept the royalty rate based on the 25% rule would a court be likely to overrule the calculation.

Copy of Goldscheider's article is available here.

Description of Route 25 here

Technorati Tags:
Royalty, Microsoft, Uniloc

Pre and Pixi smartphones to go to HP

Another challenge seems to come up for Microsoft with the news this week that Hewlett-Packard intends to acquire Palm for US$1.2 billion - a decision for Palm's operating system WebOS as the basis for new generation consumer smartphones and against Microsoft’s Windows.

The deal is expected to provide a lifeline to struggling Palm - their share price went down over 53% this year - and gives HP the chance to concentrate on the smartphone consumer market owning the end product.

According to the New York Times, Palm has 452 patents and another 406 applications on file. Research firm MDB Capital was reported to value Palm’s portfolio of patents at approximately US$1.4 billion; they believe the value of Palm’s IP alone is worth between US$8 and US$9 per share.

More information can be found here and here.

Microsoft reduces provision for damages in Alcatel-Lucent suit

Bloomberg is reporting that Microsoft has apparently reduced its provisions for a potential damages claim in its long-running suit with Alcatel-Lucent concerning patents relating to audio file compression. The story in Bloomberg is not complete, but reading between the lines it seems that the story refers to the recent judgment issued against Microsoft by a jury in San Diego which awarded USD 1.52 Billion against Microsoft [Bloomberg says USD 2 Billion]. Had Microsoft been found guilty of "willful infringement" then these damage claims could have been increased by up to three times. In other words, Microsoft needed to make provision for a maximum claim of USD 4.5 Billion.

However, a decision by the US Court of Appeals for the Federal Circuit last summer revised the standard for establishing willful patent infringement. In re Seagate Technology the Court of Appeal decided that triple damages would only be awarded if there was clear evdience of objective recklessness in infringing the patent.

Clearly Microsoft do not think that they have been reckless in infringing the Alcatel-Lucent patent - and indeed are defending themselves in the San Diego trial. So instead of making a provision of USD 4,5 Billion in their accounts, they only need to make a provision of USD 1,5 Billion. A massive saving of USD 3 Billion (which Bloomberg states is USD 4 Billion and points out is 41c a share).

Microsoft have already issued a statement stating that they will be appealing and pointing out that they have already taken a licence to the German Fraunhofer Institute's MP3 patent portfolio.