A Key to Making Big Profits in Wireless Investments
Revised December, 2004

Understanding the Standards-Setting Process

Introduction:

Investors who understand the way wireless communications standards are determined have a significant advantage in picking winning investments in the telecom industry.

This exclusive report explains how investors with this knowledge can benefit greatly by knowing when to invest.

The world is turning to mobile wireless communications. Worldwide, there are over 1.5 billion mobile subscribers today and the number is rapidly expanding. Over 688 million mobile handsets are sold each year.

Standards enable a subscriber with a Nokia cell phone to communicate with a Motorola cell phone user. Or an analog cell phone with a digital cell phone. A CDMA (g) based phone with a TDMA (g) or GSM-based device. As next generation 3G (g) phones are coming online, standards help ensure compatibility with current phones, no matter who manufactures them, or what country they are made in. The same base station/cell phone tower must communicate with phones from perhaps 20 different manufacturers.

Over the past two decades, the process for determining international standards (specifications) has changed remarkably.

Standards have been important for centuries. Harry Newton's Telecom Dictionary provides a fascinating insight:

"The U. S. Standard railroad gauge (distance between the rails) is 4 feet, 8.5 inches. That's an exceedingly odd number.

Why was that the gauge used? Because that's the way they built them in England, and the U.S. railroads were built by English expatriates.

Why did the English people build them like that? Because the first rail lines were built by the same people who built the pre-railroad tramways, and that's the gauge they used.

Why did "they" use that gauge then? Because the people who built the tramways used the same jigs and tools that they used for building wagons, which used that wheel spacing.

Okay!

Why did the wagons use that odd wheel spacing? Well, if they tried to use any other spacing the wagons would break on some of the old, long distance roads, because that's the spacing of the old wheel ruts.

So who built these old, rutted roads? The first long distance roads in Europe were built by Imperial Rome for the benefit of their legions. The roads have been used ever since.

And the ruts? The initial ruts, which everyone else had to match for fear of destroying their wagons, were first made by Roman war chariots. Since the first chariots were made for or by Imperial Rome, they were all alike in the matter of wheel spacing.

Thus we have the answer to the original question. The United States standard railroad gauge of 4 feet, 8.5 inches derives from the original specification for an Imperial Roman war chariot. Specs and bureaucracies live forever.

So, of the next time you are handed a specification and wonder what (expletive deleted) came up with it, you may be exactly right. Because the Imperial Roman chariots were made to be just wide enough to accommodate the back ends of two war horses." (Newton's Telecom Dictionary, page 835.)

The financial success of some wireless communications firms like Qualcomm (Nasdaq:QCOM) and InterDigital Communications Corp. (Nasdaq:IDCC) is directly related to their success in getting their patented technology (intellectual property) embedded in international standards. Motorola was particularly astute in using the digital cell phone standards process in the 1980s. Qualcomm made a fortune for its shareholders by deftly playing the standards game in the 1990s.

An understanding of the standards process demonstrates the strategic importance and profitability of intellectual property (g) (e.g. patents) in the wireless industry today.  It affects chipmakers like Texas Instruments (NYSE:TXN) and Infineon Technologies (NYSE:IFX) and could affect the survival of firms like Ericsson (Nasdaq:ERICY) and Motorola (NYSE:MOT).

The wireless standards-setting process has changed substantially since the mid-1990s. Because of problems associated with intellectual property claims for 2G (g) (current digital cell phones) as well as the immensely complex technology required for 3G (g) communications, the standards system has improved greatly.

What firms will benefit most from this major change in the standards setting process? You might be surprised. WirelessLedger.com has discovered one intellectual property think tank with substantial patented technology essential in the standards for next generation (3G) wireless communication. Recently revised forecasts suggest that 70 million 3G cell phones will be purchased in 2006, at an average cost to operators (who often discount them to get them to customers) of $400. A 1% royalty on these 2006 sales could yield $280 million to the think tank firm we have in mind. With 55 million shares outstanding, and assuming that $160 million goes directly to bottom line profits, that is $2.90 per share. At a conservative PE of 20, shares would be valued at $58 for 3G cell phones alone -   Add 2G & 2.5G sales - plus 3G infrastructures - and a share value of at least $70.00, maye be quite reasonable in 2006. This firm's shares were trading at $20 at the end of November, 2004. See the IDCC report on this think tank, that WirelessLedger.com believes is the most undervalued wireless communications stock today.

Standards Setting- The old way vs the new way (3G):

To understand the standards-setting process and its substantial influence on Nokia, Qualcomm, Ericsson, InterDigital, NEC, Siemens and many others in the wireless communications industry we will compare below the process that determined standards for current 2G digital cell phones to the process being used for establishing the internationally agreed-upon specifications (standards) for the next generation (3G) wireless devices. There are several 2G standards. We will focus primarily on the 2G standard used in most of the world's cell phones, GSM (g).

The best explanation of the 2 G. process is written by Bekkers, Dysters and Versagen in the excellent paper "Intellectual Property Rights, Strategic Technology Agreements and Market Structure. The Case of GSM." A very talented engineer who posts on the Raging Bull as "Infinite q" digested much of the Bekkers, Dysters and Versagen paper.

Below is Infinite q's excellent work, with update notes in December 2004, by WirelessLedger.com's editor. The material (in greater detail) originally appeared at TelecomTechStocks.com.

From the Bekkers, Dysters and Versagen paper we see that today there are five major players in GSM manufacturing - Motorola, Ericsson, Nokia, Siemens and Alcatel. In the paper, the authors studied the relationship between market domination, the ownership of essential intellectual property, and the position of a company relative to others in the overall network of strategic alliances. They provide a historical overview of the GSM industry as well as a glimpse into the importance of the standards-setting process. They also talk about which companies were able to establish essential intellectual property in the standard, and the time periods in which that intellectual property was established. I’ll try to hit some of the relevant highlights before moving on to 3G, because the same things that proved to be important for success in GSM will probably lead to success in 3G as well.

Intellectual property was important in the early days of the telecom industry. Companies like Bell Telephone (later AT&T) owed much of their market domination to their intellectual property. But after the early days the importance of intellectual property “waned”, according to the authors, as state-owned monopolistic network operators emerged. Much of the research and development was done in this period by operators, as well as by manufacturers. There was little incentive for manufacturers to apply for patents on their intellectual property because having the patents made little difference in their ability to drive sales and revenue. Nationalistic operators had procurement policies that dictated who would get orders for equipment, and had the leverage to force manufacturers to give up rights to their intellectual property. Nobody could benefit from protecting their research results. In fact, “a culture emerged in which it was considered to be improper for manufacturers to demand licensing fees from operators, and this applied to a certain extent also to other manufacturers.” (Bekkers, Dysters and Versagen)

But things changed in the 80’s, as wireless networks were being built, competition was increasing and the overall sector became liberalized and deregulated. Standards became increasingly important, for wireless operators who wanted to create interoperability between networks and economies of scale. But the authors point out that standards and intellectual property are at cross-purposes.

“While it is in the interest of any party that wants to promote a standard to have the technological knowledge that is needed to implement the standard diffused widely, the main aim of intellectual properties, on the contrary is to restrict diffusion. The conflict is most outspoken in cases of a (semi-)public standard, when the formal standardization body will aim to give all interested parties equal access to the standards they produce. Individual firms contributing to the standard and holding intellectual properties on their knowledge will, on the contrary, want to enforce their exclusive rights for parts of the technologies used. Still, although intellectual properties and standards are often at odds with each other, they need to be combined, as was the case for GSM.” (Bekkers, Dysters and Versagen)

The authors talk about the differences between essential and non-essential intellectual properties in standards, and point out that “essential intellectual properties for a certain standard has a great strategic value. During the phase when the standard is negotiated, such an intellectual property may be used as a means of blocking the standard.” (Reminds me of Qualcomm and Ericsson prior to their settlement.) “After the standard has been established, an essential intellectual property have great value in negotiations about the exchange of technology, or in licensing negotiations.”

InterDigital Communications Corp., which has had limited success so far in negotiating licensing deals for their TDMA (g) intellectual property “after the fact” found that it is a much better approach to be heavily involved within the standards-setting process. In fact they have been involved with the 3G IMT-2000 (g) international standards development since the beginning.

The value of IPR included in Standards:

Today, most 2g telecom standards are based on proposals that are developed by manufacturers, although some operators (owners of telephone companies) like NTT DoCoMo have significant R&D resources and are active in developing their own standards proposals. This R&D is expensive, and companies that make the investment need to protect their interests and ensure they get a return on the investment. So why bother? Why not just wait for someone else to develop the technology and the standard, and simply build to that standard after it has been approved? The answer has to do with the value of the intellectual property in those standards.

Companies realize that the most valuable intellectual properties are those that are essential to a worldwide standard where there is an obligation for other companies to use the standard, i.e., they cannot realistically opt for another alternative. IMT-2000 (the internatinal 3G standard) is the first attempt to create a unified, world-wide wireless standard, and thus any essential intellectual property in this standard can be considered to be of great value. That is why so many proposals were submitted to the ITU, (the international standards setting body) for 3G - everybody wanted to get as much of their intellectual property included as possible.

Just as was the case for GSM, a holder of essential intellectual property in IMT-2000 (g) can (a) command high royalties (like InterDigital and Qualcomm are claiming), (b) use the essential intellectual property to cross-license with other intellectual property holders to gain access to their intellectual property without having to pay high royalty rates (e.g. Nokia, Ericsson, NEC, Siemens, Motorola), or (c) demand that others license an entire bundle of patents, including many that are not essential to the standard (the Qualcomm approach).

Also, essential intellectual property holders could conceivably “selectively” grant licenses to a few in order to limit the sources of supply for equipment, thereby reducing competition for their products. Qualcomm, for example, has used their intellectual property in IS-95 to limit sources of supply for critical components, leaving them with a virtual monopoly on IS-95 (g) chips (narrowband CDMA).

The GSM story:

In the early 80’s in Europe there were a number of incompatible cell phone technologies being introduced. Unlike in the US, the Europeans realized the importance of having a single standard for a new wireless network. So they set out to create such a standard. It was tough getting all the companies behind the standard development, as they feared competition from companies outside Europe and weren’t sure how many operators would actually use the new standard. But when network operators pledged support for deployment of the new standard, manufacturers got behind it as well.

German and French operators lobbied for a digital standard using technology from companies in their countries, trying to get a jump on others. But in the end, Ericsson’s proposal formed the basis for the standard. One reason was the German and French proposals were considered “too proprietary,” and companies involved with the standards process started to realize the importance of using intellectual property from more than one source. Intellectual property became a hot topic. This, in fact, seems to be one of the main reasons for the refusal initially to adopt Qualcomm’s CDMA2000 (g) as part of the 3G IMT-2000(g) standard, until Qualcomm brought pressure to bear through political channels and by threatening to block the deployment of WCDMA (g), which they claimed infringed on their CDMA intellectual property.

Operators tried to get GSM intellectual property holders to contribute their technology to the public domain at no charge. Bekkers, Dysters and Versagen write, “These operators … produced a draft procurement procedure in which manufacturers were essentially forced to give up all their intellectual properties and to provide for free world-wide licenses for essential patents… This arrangement was found to be unacceptable by many manufacturers and resulted in a dispute that threatened the entire GSM program. Especially Motorola from the US, which was heavily involved in the development of GSM, stood up against the attempted imposition. Under pressure of the manufacturers, the intended provisions of the operators were dropped. However, in a Musketeer’s Oath approach, a number of operators required the suppliers of their network to sign a declaration in which they agreed to serve the whole GSM community, both suppliers and operators, on a fair, reasonable and non-discriminatory conditions.”

Note that this language is now part of ETSI’s (g) and the ITU’s (g) respective patent policies, and any holder of intellectual property that has been included in IMT-2000 has made a declaration to the ITU to make their intellectual property available on a fair and reasonable, non-discriminatory basis. We’ll see how that plays out over time.

Motorola out smarted it's 1980 competitors:

One of the most interesting parts of the Bekkers et.al. paper deals with Motorola’s approach to intellectual property. Motorola was one of the few non-European companies involved in the GSM standard-setting process. As reported to ETSI, Motorola ended up with the largest number of GSM patents (27), followed by Nokia, Alcatel, Philips and Telia. Ericsson got much of their intellectual property by buying Orbitel. Nokia and Philips also acquired intellectual property that was originally held by others.

(Editor's note: Although InterDigital shareholders believe that the Company owns intellectual property related to the fundamental technology of GSM, the Bekkers et. al. paper does not include references to InterDigital. The authors have indicated their paper is not primarily addressing the question of who owns the fundamental IPRs related to GSM, and their information about firms claiming GSM intellectual property comes from a European group, ETSI. InterDigital claims substantial IPRs in GSM, but has brought those claims directly to the ITU, which has worldwide jurisdiction rather than to regional bodies like ETSI.)

The authors grouped intellectual property into three categories, depending on when the patents were applied for. The first group of patents was applied for prior to the point in time when the choice of technology for the GSM standard was made. Companies who filed for patents prior to this point in time had no assurance that their technology would ever be part of a standard. Their research and development was not necessarily directed at the GSM standard, but was of a more general nature. Many technologies were considered for GSM, based on patents applied for beginning in 1977.

The second group of GSM patents were applied for from the point in time when the basic technology choice was made (1987) through 1991, when the exact implementation details were being determined. Technology development during this period was done in parallel with the standards process, so companies could really focus on patenting specific features of the standard. The third period includes patents that add new services and extend the basic standard.

Some companies were active early on in applying for patents. Others jumped on the patent bandwagon later in time. “Philips was initially strongly involved in the GSM development. But Philips did not patent with a very clear intention to exploit essential intellectual propertys once the standard was established, as is illustrated by the fact that it made the licenses for its most valuable patents (the GSM speech coder) available at no cost.” (Bekkers, Dysters and Versagen) Bad move on Philips part? Could be, but their decision was probably based on cultural factors. ("we believe in sharing")

But let’s focus on Motorola. The mean time when Motorola’s patents were issued coincides with the point in time when the GSM standard emerged. “Motorola had the advantage that it already had some of its work from the pre-standard period laid down in essential GSM patents. But unlike Philips … it turned this advantage into a strong position after the standard had been decided upon.

Where other firms refrained from patenting once the basic technical decisions were taken (i.e., during the early phases of the development period), Motorola intensified its patenting activities. In parallel with the gradual work of drawing up the standard and early product development, Motorola applied for numerous patents that turned out to be essential to the standard. It was even accused of stealing ideas of others and applying for patents on them subsequently… Others, in contrast, were also highly involved in the standardization work but did not apply for patents.

These others were still stuck to the traditional role of intellectual property in telecommunications, and believed there was a ‘gentlemen’s agreement’, in which ‘the developers were generous to each other when it came to potential patents…’ We thus conclude that in the period right after the decision for the basic GSM standard had been taken, Motorola was able to build up a strong position in essential patents, with other firms lagging behind considerably.”

For better or worse, Motorola seems to have changed the intellectual property landscape permanently, as they subsequently tried to use their patent portfolio to further their own corporate agenda. In spite of the declaration Motorola made to the GSM community, they effectively limited the number of cross-licenses they would enter into and even tried to limit geographically where licensees could sell their products.

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These others were still stuck to the traditional role of intellectual property in telecommunications, and believed there was a ‘gentlemen’s agreement’, in which ‘the developers were generous to each other when it came to potential patents…’ We thus conclude that in the period right after the decision for the basic GSM standard had been taken, Motorola was able to build up a strong position in essential patents, with other firms lagging behind considerably.”

For better or worse, Motorola seems to have changed the intellectual property landscape permanently, as they subsequently tried to use their patent portfolio to further their own corporate agenda. In spite of the declaration Motorola made to the GSM community, they effectively limited the number of cross-licenses they would enter into and even tried to limit geographically where licensees could sell their products.

Motorola, it seems to me, was trying to keep GSM out of countries where it planned to promote IS-95 narrowband CDMA networks, like in the US. Motorola succeeded in keeping many companies out of the GSM game, including many Japanese firms.

In the end, GSM succeeded and virtually all of the equipment supplied came from “companies that took part in the cross-licensing scheme: Ericsson, Nokia, Siemens, Alcatel, and Motorola.” Eventually Motorola was forced to remove their geographic restrictions, and other players entered the market, but one of the conclusions of the authors of this study was that having essential intellectual property in the standard had a direct correlation to success as a manufacturer of equipment for that standard. Motorola also generated a substantial amount of royalty revenue on their intellectual property.

Bekkers, Dysters and Versagen observed that “companies that do not succeed in securing all the necessary licenses simply cannot market products.” The authors continued, “Secondly, those firms that do succeed in getting all the necessary licenses, could be forced to pay a premium price for them. Sometimes, intellectual property holders are only prepared to sell a full bundle of patents that in fact only contain a few essential ones.” Does this sound familiar? Looks like Qualcomm has learned a lot from the GSM lessons. Finally, “… the cumulative fee paid for GSM handset licenses is very high… Such prices make competing very difficult for those companies that are not particpating in [cross-licensing].”

Now we see why the big manufacturers work so hard to make sure they have sufficent intellectual property in the standards to allow them to get access to others' intellectual property without paying for it. The twist, as I see it, is how non-manufacturers, like Interdigital and Qualcomm, fit into the picture.

It is important to note that of the top five GSM equipment manufacturers, only Motorola, Nokia and Alcatel have substantial intellectual property. The other two, Siemens and Ericsson, seem to have leveraged both their intellectual property in the GSM standard as well as strategic relationships they formed with other intellectual property holders - thus gaining access to the needed intellectual property through non-direct channels. Many companies entered into strategic relationships, forming a “network” of alliances through which one can trace access to specific intellectual properties. Ericsson, “because of its strategic position, is not dependent on other companies for its information flow, and it holds a position as a gatekeeper for the flow of information between other companies in the network. We attribute this exception to the fact that the basic GSM technology is based on an Ericsson proposal, as pointed out above. Consequently, this company had a technological head start… Although Ericsson did not emerge with very many essential intellectual properties, it definitely was a smart networker.”

As for Siemens, “Motorola had strong experience in developing base station products and mobile terminals, but did not have a switching platform on which GSM switching products could be based… This is how Siemens was able to enter the deal with Motorola… Siemens is specialized strongly in switching.” So it seems that it all comes down to what each company brings to the table.

Based on this article it seems clear to me that if you wanted to play in GSM you either needed some serious intellectual property in the standard, like Motorola, or you needed to be well-connected like Ericsson.

Bold New Insight - Patent or Perish:

It appears that the GSM standardization process showed a lot of companies that the rules in the industry were changing, and intellectual property was the new path to success. They could have used a new slogan, something like “patent or perish.”

Today many companies recognize the importance of having intellectual property in a worldwide standard. The new 3G international standard IMT-2000, is a good example, where many companies are trying to claim a piece of the intellectual property pie.

I've written above about the GSM standard and GSM intellectual property holders like Motorola. Motorola apparently caught the Europeans off guard, beating many of them at the standards game and securing rights to the majority of the intellectual property in the GSM standard. They used this intellectual property to their advantage, though some would argue they could have played the game better and would be in better shape today had they made some different decisions along the way (like, perhaps, not refusing to license with InterDigital for their TDMA intellectual property).

Qualcomm and InterDigital are two companies that have been around this industry for a long time (20 to 30 years), and have apparently learned a lot from Motorola. Today, Qualcomm and InterDigital represent a new breed of company (e.g. "IPR think tanks"), as they evolve toward pure, intellectual property companies which don’t manufacture any end products themselves,although they do sell chips which others manufacture for them.

New Entry - Intellectual Property Companies:

When the GSM standard was being developed in the 80’s, intellectual property companies really did not exist, at least in the telecom industry. This is only a recent development in the industry, and the new 3G standards-setting body, ITU, has even created a separate category for non-manufacturers in trying to help the industry reach agreements on royalty rates for 3G intellectual property. Non-manufacturers are supposedly entitled to a higher royalty rate than manufacturers. But they create some new issues in terms of cross-licensing between manufacturers.

In GSM, most of the intellectual property ended up in the hands of manufacturers. Manufacturers were able to leverage that intellectual property to create competitive advantages that effectively meant you had to have your own intellectual property to even get in the game. Those manufacturers with sizeable portfolios of essential patents could access all the intellectual property they needed without paying royalties to anyone. Those without essential intellectual property had to find other “value” to offer intellectual property holders or they were excluded.

But now that companies like InterDigital and Qualcomm are involved, manufacturers who hold signifcant intellectual property must also find a way to pay the non-manufacturers for their essential patents. Non-manufacturers have no need for cross-licensing, because they don’t produce anything that contains other companies’ essential intellectual property. They expect to get cash royalties to pay for their R&D investment. I assume the manufacturers view this change as a negative, as it complicates the way they do business.

This could also be one reason that InterDigital had trouble getting the big boys like Motorola, Ericsson and Nokia to license their TDMA intellectual property. Those manufacturers had come from a culture where telecom technology patents were never enforced, through an era of heavy patenting activity started by Motorola relative to the GSM standard, and now to a time where non-manufacturers like InterDigital are asking for royalties - not cross-licenses. Pretty hard to swallow all at once, IMO.

Qualcomm's Monopoly Play:

Qualcomm has taken Motorola’s tactics to an even higher level, though. Motorola found that it could restrict the number of producers with access to its intellectual property, and control geographic territories in which their patents could be used. They were able to shape the GSM market, limiting sources of supply. Qualcomm managed to get their cdmaOne technology adopted, and even standardized in the US and certain other countries. Their technology was strong, and their ability to use politics, among other things, to advance their technology was great. Qualcomm created a virtual monopoly in some areas (e.g. Korea) where their technology was the only 2G digital standard in commercial use. But their “patent one, patent all” bundling policy, with one, standard (arguably objectionable) rate was very irritating to some in the industry. This policy was unheard of in some circles, and the Europeans in particular were offended. IS-95 (cdmaOne), being a competitor to GSM, never saw any real adoption in Europe. But the Europeans knew the advantages of CDMA would one day force them to adopt some form of CDMA - even though they shuddered at the thought of licensing with Qualcomm under the terms Qualcomm was demanding. They had to find an alternative, as a matter of principle and pride. The Europeans and the Japanese banded together around wideband WCDMA, and began developing their own proposals, in addition to the North American proposal, for a WCDMA architecture. When the ITU called for proposals for a world-wide 3G standard Qualcomm’s CDMA2000 (g) proposal was not well-received. The Europeans, had clearly made a conscious attempt to design around Qualcomm’s technology where possible, with the ultimate goal of removing the need to license Qualcomm’s intellectual property, IMO. During the period when the 3G standards movement was getting underway, InterDigital was getting some attention for its wideband BCDMA (g) work. InterDigital just happened to be working on a technology similar to Qualcomm’s, but with fundamental differences.

InterDigital was involved in some of the early 3G proposal efforts, and some of their intellectual property was going to probably end up in the standard regardless of whose proposal (European, Japanese, North American or Qualcomm's) was accepted. But of course, InterDigital wanted to get as much of their intellectual property in the standard as they could, having learned from Motorola and Qualcomm that substantial royalty revenue could be generated.

Inter Digital's New Strategy - Co-operation not Domination:

Unlike Qualcomm, though, InterDigital was trying a new approach, one of being cooperatively involved in the standards-setting process from the beginning, rather than trying to collect royalties after the standard independently evolves. They had seen the reaction to Qualcomm’s patent licensing policy. They also saw the value of being a team player in that you can, over time, increase the amount of intellectual property you have in a standard when you have a good working relationship with the other participants (like Ericsson and Nokia). InterDigital saw an opening, if only they could get into the center of the 3G standards activities. Yet, InterDigital was fighting over GSM royalties with Ericsson and Nokia, and didn’t want to give up on that revenue, which it felt entitled to. And Ericsson and Nokia were clearly in control of the European ETSI UMTS (g) movement (3G in Europe).

The situation was a real conundrum for InterDigital. How to get back and future TDMA royalties from resistant manufacturers and at the same time develop close working relationships with those same manufacturers within the ITU? Not an easy problem to solve, even for the best of diplomats.

So how did Nokia and InterDigital suddenly end up settling the TDMA intellectual property issues and come away with an engineering services contract in 1999? Nokia’s handset sales were on the rise, and they knew their exposure was increasing every day they continued to infringe InterDigital’s TDMA-GSM intellectual property. They knew of InterDigital’s work on BCDMA, and of InterDigital’s inevitable involvement in the WCDMA standard. It seemed that at some point a settlement would have to be made, with either InterDigital or Qualcomm, or both. Did Nokia get creative, and find a way to reduce the dollar amount of back royalties? Did InterDigital have something more important to Nokia than simply clearing up a licensing issue with another intellectual property holder? I certainly think so.

How did these two companies come to join forces after so much reluctance on the part of Nokia to license InterDigital’s TDMA intellectual property?

Why Nokia partnered with Inter Digital:

I believe that Nokia knew it would have to begin licensing with InterDigital and/or Qualcomm. As much as the big GSM manufacturers tried to resist paying royalties to non-manufacturers it was becoming clear that eventually it would become necessary to do so. Too much of the advanced technology development had been driven by intellectual property companies who now owned the patent rights to the CDMA technology they needed. So why InterDigital? After all, didn’t Qualcomm own CDMA?

I’m not going to get into a lengthy discussion of Qualcomm’s intellectual property in WCDMA. Suffice it to say that they more than likely would win the argument in a court of law that at least one of their patents is infringed by products manufactured to the IMT-2000 WCDMA (FDD) specs.. Why did Nokia then agree to license InterDigital’s WCDMA intellectual property and establish a structure for future royalties on 2G TDMA/GSM phones? Was InterDigital’s intellectual property position in WCDMA actually stronger than Qualcomm’s? Was there more to the decision than that? I think so.

Here is my theory. In 1998, Nokia knew that InterDigital’s TDMA patents had been upheld in Germany and Sweden, and would likely be revalidated by the U. S. Patent Office. (They were revalidated a year later.) There was also heavy pressure from North American TDMA operators for an enhanced TDMA standard as part of 3G IMT-2000. They needed to settle and start paying licensing fees for TDMA. But how could they minimize the capital outlay for past infringement and achieve other goals as well?

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Nokia was backing WCDMA for 3G. They were strongly opposed to Qualcomm’s 3G CDMA2000 standard and WCDMA was their way around it. Harmonization efforts were underway to arrive at one WCDMA standard. InterDigital was involved, but was really trying to penetrate the industry’s inner circle and thereby get even more of their intellectual property introduced into that standard.

Much of InterDigital’s intellectual property offered improved alternatives to Qualcomm approaches in areas such as power control, handoff, and coding techniques, in addition to other valuable technology that would improve system operation. Nokia knew that they could help InterDigital get their intellectual property embedded into the WCDMA standard using their clout in the standards bodies, and at the same time help themselves get around most of Qualcomm’s infringement claims. Maybe not completely, but by the time the standards were would be finalized Qualcomm would be left with only a few legitimate claims of infringement, and Nokia could demand a more reasonable royalty arrangement with Qualcomm than the 5% it had been demanding. (Observors believe Nokia finally hammered out a 3% royalty agreement with Qualcomm in 2001. - editor)

But beyond this, there was one more aspect to the deal. Nokia wanted to increase its market share for infrastructure equipment. They were quickly gaining handset market share, but Ericsson still had the majority of the infrastructure market share. Now Nokia knew that InterDigital and Ericsson had been involved for years in their lawsuit over TDMA intellectual property, and Ericsson and InterDigital did not have a good working relationship.

This would make it difficult for InterDigital to get into the standards activities, but Nokia could help. And InterDigital could help Nokia cut into Ericsson’s infrastructure market share. How could they do this? With TDD (time division duplexing) (g). InterDigital had made a lot of progress with TDD and Nokia wanted to lock up access to InterDigital’s work in this area

TDD was the final catalyst in the formation of a strategic relationship between Nokia and InterDigital. InterDigital had apparently been doing some cutting-edge work with TDD, otherwise known as TD-CDMA (g), and Nokia was aware of the efficiencies TDD presented for data transmission in a picocellular (g) environment. Nokia knew that efficient data-handling capabilities would be a key mode in UMTS, the Europeans' term for WCDMA. Some of the WCDMA proposals included TDD (g) as well as the FDD mode, which is usually what WCDMA refers to. FDD (g), as we know, is better suited to longer coverage ranges and particularly suited for voice communications.

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Nokia wanted to create a competitive advantage that would allow it to expand its lead in the handset market and greatly increase its share in the infrastructure market. Nokia knew that InterDigital was one of the few companies in the world, other than Siemens, which had any real experience with TDD. If anybody could get TDD to work, and do it quickly, InterDigital could.

If Nokia could establish a relationship with InterDigital whereby the two companies focused their efforts on bringing TDD base stations and terminals to market quickly, and Nokia could be first to market with those capabilities, it could be just the advantage they needed over Ericsson. At the same time they could use InterDigital intellectual property to minimize the Qualcomm claims to the standard. I think this was foremost in their minds when they approached InterDigital in 1998.

Let’s take a look at the press release announcing the Nokia/InterDigital relationship.

February 1, 1999
INTERDIGITAL AND Nokia ANNOUNCE MULTI-YEAR DEVELOPMENT PROJECT FOR THIRD GENERATION TECHNOLOGY;
Estimated Value of Approximately $70 Million

King of Prussia, PA, and Helsinki, Finland, February 1, 1999 . . .
InterDigital Communications Corporation (ASE: IDC) and Nokia today announced a long-term cooperation agreement involving the development of new technology for third generation wireless telecommunications products designed for high data rate applications, such as Internet access.

Under the multi-year agreement, InterDigital will deliver technology building blocks for Nokia to use in third generation wireless products. The agreement, which includes paid up TDMA and CDMA patent licenses which generally extend through the project period, has an estimated value to InterDigital of approximately $70 million, including an initial payment of approximately $30 million. The companies have defined a framework for establishing licensing terms after the initial licensing period.

"Nokia is committed to furthering the development of third generation technologies, which will herald the era of a true Wireless Information Society. In addition to Nokia’s own core development of third generation, we place great emphasis on additional R&D, including co-operation with key industry players," said Ahti Väisänen, Vice President, Third Generation Technology, Nokia Mobile Phones. "Nokia believes that its work with InterDigital over the next several years will complement its own development of third generation products," he said.

Harry Campagna, Chairman of InterDigital, said: "Nokia has selected us to develop an important component of third generation wireless technology. In doing so, this global telecommunications leader recognizes our expertise in developing air interface technologies. This is an important relationship for us. The telecommunications industry is moving aggressively to address the demand for high-speed data capability and we are pleased to be particpating in that technology arena. Our work with Nokia will broaden our position as a developer of leading-edge technologies and enable us to grow as third generation technologies are commercialized.

"In working for Nokia, we will use our technical expertise to design advanced technology and we will retain ownership rights over the technology we develop. This will enable InterDigital to produce and sell products utilizing the new technology, as well as license other companies under the technology," he said.

Nokia’s in-depth know-how of wireless systems is acknowledged world-wide, and Nokia plays a central role in taking the future-proof GSM platform further into third-generation telecommunications systems with the UMTS (Universal Mobile Telecommunications System) and IMT-2000 (International Mobile Telecommunication System 2000) technology.

Nokia is the world's leading mobile phone supplier and a leading supplier of mobile and fixed telecom networks including related customer services. Nokia also supplies solutions and products for fixed and wireless datacom, as well as multimedia terminals and computer monitors. In 1998, net sales totaled FIM 79.2 billion (USD 15.7 billion, EUR 13.3 billion). Headquartered in Finland, Nokia is listed on five European Stock Exchanges and on the New York Stock Exchange (Nokia.A), has sales in over 130 countries and employs more than 44,000 people worldwide.

InterDigital develops and markets wireless telecommunications systems and components using both proprietary and standards compliant technologies for voice and data communications. In the past twelve months, InterDigital has developed relationships with a leading wireless access provider, and now, the number one mobile phone supplier in the industry, Nokia.

So we can see from this release (above) that Nokia is acknowledging InterDigital as a key industry player, and had agreed to terms whereby they will pay InterDigital royalties after their “project” is complete. The project, as we now know, was the development of Nokia’s entire TDD suite, including base station and handset sides of the air interface. Obviously Nokia and InterDigital recognized the importance of the high-speed data capabilities that TDD will provide. Were they also aware of Qualcomm’s plans to bring data upgrades to the IS-95 before WCDMA would be ready? Did they need something to counter the tactics they knew (Qualcom's Irwin Jacobs) would use against the WCDMA camp in the 2001 timeframe? Perhaps they were.

I have felt for some time that Nokia and InterDigital have a master plan that involves secret development of TDD blocks in parallel with the standards development.

This is much like DoCoMo’s decision to deploy WCDMA in 2001 - before anyone else could bring it to market - and in spite of the fact that specs were still being defined for the final version of the standard. Risky, but the payoff could be huge if successful. If Nokia can launch an end-to-end TDD solution that can be overlayed in a cost-effective manner, the operators will line up at their door to get their hands on the equipment. That is because data is apparently viewed as the brass-ring of 3G revenue opportunities.

Yeah, lots of manufacturers, including Ericsson, would have FDD features at about the same point in time, but who would bring the efficiencies of TDD to market first? Nokia seems to want to be the first mover here, and InterDigital had the ability to pull it off.

We learned later that although InterDigital retains patent rights on its technical contributions to the TDD standard, Nokia gets immediate access to the “building blocks” they are developing under the “project," plus Nokia pays no royalties on technology co-developed by InterDigital and Nokia during the project period, nor for InterDigital's basic TDD technology required to enable the TDD development for Nokia.

Did Nokia get a "Sweetheart Deal"?

Some investors have asked how can it possibly be a good deal for InterDigital to let Nokia settle up for past 2G (TDMA/GSM) infringement for a mere $30M, plus additional revenue for engineering services, when they don’t pay royalties on technology co-developed under the program? Since Nokia is the largest handset producer in the world (over 100 million units every year) didn’t InterDigital sacrifice a major revenue stream by agreeing to these terms?

OK, let’s start with the dollar amounts of the agreement.

Sure, InterDigital gave Nokia a break on past infringement. But they got a lot in return.

First, it sure is going to sound bad in that Texas courtroom in February 2003 when InterDigital attornies tell a jury that 23 other companies, including the world’s largest handset manufacturer, have agreed to license InterDigital’s TDMA intellectual property, but Ericsson refused. That should greatly influence jurors to side with InterDigital. Second, by agreeing to license InterDigital’s 3G CDMA intellectual property, it will be much more difficult for others like Ericsson to try to get off without licensing as well. Third, Nokia is doing a lot for InterDigital in terms of supporting their involvement in the standards process. More than we outsiders can comprehend.

Let’s look at that for a moment. Think about how the GSM standards process was conducted, and how the process was controlled by a few operators and key manufacturers. How does a company like InterDigital get taken seriously in that kind of a forum? You don’t just show up and say you want to participate. You have to have something to contribute, but even then you can still be shut out of the process. Just look at Qualcomm, for example. And InterDigital hadn’t developed very good relationships with Ericsson, Motorola and Nokia up until this point in time, due to the battle over TDMA intellectual property.

I think InterDigital realized they could leverage the relationship with Nokia to get much more of their intellectual property introduced into the standard than they ever would have been able to do on their own.

I think Nokia “greased the skids” and forced other players to seriously consider InterDigital techniques when determining the specifications. In addition, I think that Nokia and InterDigital together have shaped the TDD standard in such a way that major pieces of the TDD standard are actually InterDigital’s. I think that Nokia has helped InterDigital gain entrance into the standards bodies, and their technology was so strong that they quickly became a key contributor. In fact, InterDigital now has such a prominent position in the 3GPP (g) standards activities that their contributions are fully documented and undeniable. InterDigital representative now even chair or co-chair standards working groups defining 3G standards.

InterDigital management and engineers have or are currently serving in a number of leadership positions in key industry standards bodies including Chair of IEEE 802.16 Tga (Broadband Wireless Access, 2-11 GHz); Chair of the 802.16 Mobile Study Group; Vice Chair of the 3GPR RAN Working Group 3 (WG3); Vice Chair of T1P1.4 Wireless Wideband Internet Access; North American Rapporteur for ITU-R-IMT-2000 Deployment Handbook; Editor, 3GPP RAN WGI, Physical Layer Procedures (TDD) (R5) and Editor and Rapporteur, 3GPP RAN TDD Base Station Classification.

(I don’t know how many of you have read the reports and submittals from the 3GPP working group meetings, but I can tell you that nothing gets said without being recorded, and it is very clear who is contributing which ideas.) This sort of documentation within the minutes of standards bodies meetings can be very strong evidence to support one’s claims to inventions within the standard.

Basically, I think both Nokia and InterDigital got a fair deal to reduce the amount for past infringement in exchange for support within the standards organizations. But now let’s look at the terms surrounding the technology produced under the project.

Was it fair for Nokia to get royalty free use of TDD technology developed under the project? Sure, they are paying for the development of that technology. That is what the engineering services revenue is for.

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If you were to hire your own engineers directly and pay their salaries you, as a company, would have the rights to the technology your employees developed. Even if your employees patented their inventions you, the company, would retain ownership of those patents. Of course, in this case they are not your own engineers, they are InterDigital’s engineers acting as subcontractors. Usually if you hire a subcontractor you would still retain rights to the patents and technology they develop for you on your nickel. In this case, InterDigital didn’t sign up for the usual contract engineering terms - they retained rights to their engineers’ inventions. Nokia just gets to use the technology developed on their nickel without paying further royalties since they subsidized the development. It’s sort of like being an early investor in a startup company, you get a pretty good equity stake for your dollar compared to those who come along later. Nokia was willing to cover the development costs while InterDigital benefits from the additional patents and a solid position in the UMTS (g) standard. Even after the project is complete InterDigital will benefit from the support Nokia gave them during this period. Others will have to pay the going rate to get that technology.

Now I’m not talking about the actual contributions to the standards, necessarily.

Keep in mind that there is a difference between access to the intellectual property (patents) that applies to the TDD standard, and access to the building blocks InterDigital and Nokia are developing outside the standards process. The patents must be made available for licensing by others, per the ITU patent policy. So all the TDD patents that InterDigital is granted that apply to the TDD standard will be available for licensing by other manufacturers besides Nokia.

Nokia will not have to pay royalties if the patents cover inventions produced during the project period, and in addition Nokia will have immediate access to some “technology” produced under the project.

So I believe Nokia gets immediate access to design cores codeveloped by InterDigital during the project, and royalty-free use of InterDigital’s TDD patents. They still pay InterDigital royalties on FDD patents, and perhaps on some nonessential TDD patents that were applied for prior to the project period. In exchange InterDigital becomes the world's major intellectual property holder in TDD, knowing full well that Nokia will be working as hard as they can to get TDD deployed quickly and ubiquitously. Wow, talk about synergies! This is a real win-win for both companies. (Editor's note: But apparently Nokia has reneged on this part of the agreement. There is no evidence of Nokia's actively promoting TDD. -editor. (See "Nokia-InterDigital Partnership." TDD technology is at the core of TD-SCDMA (g) the 3G technology preferred by China- the worlds largest market.)

So let’s assume that Nokia really has helped InterDigital enter the inner circle and take on a leadership role in terms of TDD technology development. If that is true, and all the other manufacturers know InterDigital’s contributions are undeniable, then why have only some licensed with InterDigital by Fall 2002?

That is the big question, because one would assume that InterDigital has been pursuing licensing agreements for their 3G technology. And one would assume that the lack of licenses means there is a problem with my theory. But this is not necessarily a valid conclusion.

These licensing deals must be extremely complicated, and clearly take a long time, to negotiate. Every manufacturer is going to try to get the best deal they can, and they will try anything possible to reduce their royalties. As InterDigital's CEO Howard Goldberg pointed out, manufacturers are first going to try to cross-license in order to obtain access to the needed intellectual property.

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Since the TDD portion of the standard is still evolving in 2002 it is not yet clear how strong any single company’s patent portfolio is compared to others’. I would guess that until the TDD portion of the 3GPP (g) specifications is final, there are still some big variables in these intellectual property equations. Also, keep in mind that many of the patents that apply to the standards have probably been applied for but have not yet been granted. More on this key point in a moment.

We learned from the GSM experience that essential patents in a standard come in three phases: (1) those patents applied for before the basic technology choices have been made, (2) those patents applied for while the standards details are being hammered out, and (3) those patents applied for as additional services and functions are added over time.

Right now we are in phase 2. And considering it takes about 3 years for a patent to be issued it may still be a while before it is clear who has what essential patents. This, I believe, is the major obstacle for InterDigital to overcome in securing licenses at this time. On the other hand, when the commercial launching of 3G products begin in earnest in 2003, licenses will be required. Several Asian manufacturers have already worked out licensing terms and InterDigital is already receiving initial revenue.

InterDigital has been working on CDMA for a long time. They have several patents that fall into the first category for WCDMA - that is patents applied for before WCDMA was chosen as the technology for UMTS. But once they were admitted into the 3GPP specification development process new opportunities were presented for InterDigital to make contributions and apply for new essential patents.

This is very important to understand. It may very well be the case that InterDigital’s most valuable patents have not yet been granted, but were applied for during phase 2 (as details of the standard were being decided, i.e., at the time their contributions were being introduced to 3GPP). This, I believe, is particularly the case for TDD intellectual property.

The full definition of TDD was not completed in Release 1999. I believe Nokia and InterDigital tried to get the full TDD specs defined earlier, but it was just too much for that first release. TDD specs were put off until Release 2000, which has now been split into Release 4 and Release 5. InterDigital has been very active, as indicated by the many submittals to 3GPP, in the TDD specification development effort. InterDigital management has stated that hundreds of its contributions to the standards had already been accepted in early 2002.

I guess you can tell by now that I am really excited about the opportunity that InterDigital has for growth with TDD. I think InterDigital would have made a lot of money off of FDD royalties, even without a Nokia relationship. But with Nokia on their side, InterDigital is extremely well positioned. InterDigital knows what contributions they have made. They know the patents are coming. They know the stock price will take off one day. They are in no rush to play their hand. Only some investors are getting nervous and wishing there was much more news released about the Nokia-InterDigital partnership.

Regardless of how much we investors want to know more, we must understand that this is a very competitive industry and control of information is essential to the success of individual companies. If a company like Nokia was to show its hand now it would simply give the competition more time to change their product development plans and accelerate development in those areas that Nokia is attacking.

Also, if InterDigital makes too much noise about the extent of its contributions to the 3G standards it might impact its ability to make further contributions to the 3G standards, I believe. The standards-setting process involves many manufacturers who, on a daily basis, compete with one another. Within the standards bodies, they must leave their corporate affiliations at the door, to some degree, and work cooperatively to produce standards that use intellectual property from many sources. The goal is to produce the most efficient and cost-effective system possible, keeping the needs of operators and consumers in mind. But it must be difficult to ignore the source of the intellectual property that is being included, and companies surely approach this standards process with strategic agendas in mind.

If it becomes clear too soon that any firm is moving, by virtue of its intellectual property being embedded into the standard, into too powerful a position, then I suspect the pressure will increase to limit further contributions from that one source.

The industry seems determined to make sure that the standards produced are not based on intellectual property from just one company, like Qualcomm’s IS-95, for example. Rather, there is a conscious effort to balance the intellectual property contributions from many companies. It would not be wise for InterDigital to make too big a deal about the lead it is taking in TDD, in my opinion, until the TDD standards are finalized in 2002 or 2003.

The same reasoning applies to licensing, and cross-licensing. If the WCDMA specs had been more “complete” in Release 1999, then it would have been much more clear which companies own the essential patents. But key pieces of the standard, including TDD, were left to Release 2000, which has now slipped into 2002 or 2003. Work is still ongoing in key areas, and important contributions are still being made. It is evident, however, that InterDigital has made more contributions to the TDD portion of the 3G standard than anyone else.

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Until WCDMA equipment starts shipping in significant quantities in 2003, intellectual property holders may be content to wait until the intellectual property picture is clearer. They may have a stronger negotiating position in another six months. Further, since InterDigital requires substantial upfront, prepaid 3G licensing fees (NEC and Panasonic have paid $19 million each upfront). Licensees are not anxious to sign on until they are shipping product, especially in the difficult economic environment we are facing in 2002.

InterDigital can expect revenue from those patents to flow for many years, so a few months’ delay may be well worth it if it helps InterDigital get their fair royalties.

For current information on the Nokia-InterDigital partnership, see "The Nokia-InterDigital Partnership" and "Nokia Arbitration".

 

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