One of the first things I do every morning once I’ve grabbed my cup of coffee is review what is new and interesting involving IP in the press – as my direct reports know all too well from the links I forward to them. Over the past two weeks or so, I have followed with interest the coverage of Apple’s suit against HTC. Reactions to the suit run the gamut from those who defend Apple’s taking steps to protect its IP to those who claim that Apple’s suit will impede further development in the smartphone market.
I don’t agree with the latter viewpoint. There is a long history of IP litigation in the mobile phone market, and innovation has continued apace. As the New York Times noted, “Nearly every large mobile phone player . . . has recently been involved in some sort of patent litigation involving mobile technologies.” Whether it is Nokia v. Apple,RIM v. Motorola, or now Apple v. HTC, companies active in the smartphone space are taking steps to protect their inventions. To me, the interesting questions are, “Why is this? And what does it tell us about the evolution of the smartphone market going forward?”
The smartphone market is at an early stage of development. That may appear to be a surprising statement – after all, mobile phones have been around since the 1970s, and have been common devices since the 1990s, when so-called 2G mobile phones (small handheld phones with similar form factors to what we see today) came on the market. But the principal functionality of and value proposition for the phone has changed. With 2G and 2.5G mobile phones, the principal purpose of the device was to make and receive calls. Whether it was the Nokia candybar-style phones or the Motorola Razr, the value of the successful phones of this era was embodied primarily in the radio stack – the functionality that allowed users to make and receive calls. Not surprisingly, this was the portion of the phone that commanded – and still commands – the highest patent royalties, on the order of 5% of the price the device manufacturer charges the mobile phone operator.
Now, however, as a new category of ‘smart’ devices has emerged, the value proposition has moved to the software stack. As is clear from advertising by all of the major brands – Apple’s iPhone, RIM’s Blackberry, Palm’s PrÄ“, Motorola’s Droid, and Windows Phones – people buy smartphones because they are fully functional computers that fit in the palm of your hand. The radio stack is still valuable, as it allows the phone to connect to the Internet. But what is most valuable is not the connection per se, but the new things that users can do with it – find nearby restaurants and movie theaters, send and receive email, and watch video, just to name a few. The primary driver for adoption and sales in this market is the software on and available for the device.
The smartphone market is still in a nascent state; much innovation still lies ahead in this field. In all nascent technology markets, there is a period early where IP rights will be sorted out. This is particularly true in a market, such as smartphones, in which a number of different technologies previously offered on a standalone basis now converge into a single device. Indeed, smartphones are a product of the ‘open innovation’ paradigm – device manufacturers do not do all of their development in-house, but add their own innovations to those of others to create a product that users want. Open innovation is only possible through the licensing of third party IP rights, which ensures that those who develop the building blocks that make a new technology possible are properly compensated for their investments in research and development. After all, technology just doesn’t appear, fully-developed, from Zeus’s head. It requires lots of hard work and resources to create.
We see that in the radio stack. We also see it in the media stack, where royalties for codecs (which encode and decode digital media) and other technology represent 1-2% of the price to operators. And now the industry is in the process of sorting out what royalties will be for the software stack, which now represents the principal value proposition for smartphones. In the next few years, as the IP situation settles in this space and licensing takes off, we will see the patent royalties applicable to the smartphone software stack settle at a level that reflects the increasing importance software has as a portion of the overall value of the device. In the interim, though, we should expect continued activity. Apple v. HTC was not the beginning of this process, and it isn’t the end of the story either.