U.S. Markets open in 1 hr 24 mins

Why Microsoft may be relinquishing billions in Android patent royalties

Today marks the end of an era.

Microsoft is announcing that it has made peace with the free world. Specifically, the world of free and open source software (FOSS).

Unlike proprietary software, like Microsoft Windows, FOSS is made collaboratively by developers all over the world, costs nothing, and its users are permitted to alter, copy, and redistribute it at will.  

In the early 2000s, Microsoft executives decried FOSS as a “cancer” and “intellectual property destroyer.” Then, in 2007, it declared war on FOSS, alleging that many of its most important commercial manifestations—the Linux operating system, OpenOffice, and, later, Google Android—infringed hundreds of its patents. As recently as 2013 a Nomura analyst estimated that Microsoft was extracting patent royalty streams of around $2 billion a year from makers of Android-running smartphones.  

That chapter is now over. Peace was secured when Microsoft signed a license this month with an obscure organization called the Open Invention Network.

‘Today Microsoft is a very different company’

OIN is an alliance founded in 2005 by IBM, Red Hat, and three other corporate Linux patrons to shield Linux developers and users from patent suits and licensing demands. Today the group has expanded to eight funding members, including Google and Toyota, which joined in 2013 and 2016, respectively. But it also now embraces a community of more than 2,650 “licensees,” of which about 150 are public companies. They include the likes of AT&T, Broadcom, Cisco, Facebook, Ford, General Motors, LG Electronics, SpaceX, Twitter, and Yahoo Finance parent company Verizon.

OIN community members agree to give each other free licenses to use one another’s patent portfolios with respect to any inventions that might implicate Linux, Android, and other key open-source software packages. At the same time, OIN’s eight funding members amass and maintain a defensive patent portfolio to protect the whole community from outside aggressors. They attempt to create, as its CEO Keith Bergelt has put it, a patent “no-fly zone” over Linux.

The dreaded aggressor that, more than any other, prompted this whole elaborate, anti-ballistic missile system was Microsoft. Today, the lion lays down with the lamb—or with the Linux Penguin, in this case.

A Microsoft store is pictured in New York City, New York, U.S., August 21, 2018. REUTERS/Carlo Allegri

“Ten to 15 years ago we were very focused on the competition between Linux and Windows,” says Microsoft’s chief IP counsel, Erich Andersen, in an interview with Yahoo Finance. “But today Microsoft is a very different company. With the rise of our Azure [cloud services] business, Microsoft has become one of the largest contributors to open source in the world. . . . We’re in a position where, as [CEO] Satya [Nadella] says, we love Linux. We love open source. That’s a big part of the future of our business.”

“Through its participation in OIN, Microsoft is explicitly acknowledging the importance of open source software to its future growth,” comments OIN’s Bergelt in a press release. “Microsoft’s participation in OIN adds to our strong community, which through its breadth and depth has reduced patent risk in core technologies. [It] unequivocally signals for all companies who are using open-source software but have yet to join OIN that the litmus test for authentic behavior in the open-source community includes OIN participation.”

Microsoft puts its money where its mouth is

For years, Microsoft has made significant contributions to Linux code—ensuring interoperability with its products—and in recent years it has frequently professed benign, good intentions with respect to open-source code. But with today’s step, Microsoft earns deep, open-source street cred by putting its money where its mouth is. Though Andersen declines to comment on it, joining OIN means that Microsoft will have to begin foregoing much of the lucrative revenue stream it has enjoyed for years from Android-related patent royalties—money going straight to its bottom line.

In 2013, for instance, Microsoft said that Samsung alone owed the company more than $1 billion in Android licensing royalties. The company boasted then that it was receiving royalties from more than 80 percent of Android phones sold in the U.S. and more than half worldwide. These were flowing from such manufacturers as HTC, Hon Hai (Foxconn’s parent), LG Electronics, and ZTE.

But under the OIN license Microsoft just signed, it agrees to no longer use its mighty patent portfolio—59,000 issued U.S. patents and 29,000 pending, according to its latest securities filing—to seek royalties from OIN community members on Android related software. (HTC and LG are already OIN members, while other Android manufacturers can join for free.)

Why is Microsoft doing this? In part, Android royalty revenues have been steadily declining over the past three years, according to its securities filings. That may be because some Indian and Chinese smartphone manufacturers, which don’t pay royalties, have been gaining market share.

More important, however, the company’s burgeoning Azure cloud services business has become its strategic priority for the future. Azure revenues were up 89 percent year-over-year for the latest quarter, and the company reported $23 billion in income from its “commercial cloud” category for fiscal 2018.

“By coming to the table at OIN,” says Eben Moglen, a professor at Columbia Law School and the executive director of the Software Freedom Law Center, “Microsoft has acknowledged that the royalties it can acquire by squeezing Android manufacturers are no longer worth the maintenance of patent tension which interferes with the growth of the services business.”

To build its Azure business, Moglen explains, Microsoft first enticed existing customers to transfer work from their on-premises Windows servers to Microsoft’s cloud services. But to keep growing that business, it also had to lure customers who were using Linux on-premises into transferring their workloads to Azure, too. Since those customers wanted to continue running Linux—so they could integrate all their data, on-premises and off—Microsoft accommodated them. As a result, “about half” of all Azure workloads today are running on Linux, Microsoft’s cloud group chief told ZDNet last month.

A number of steps leading up to today’s news

Against the backdrop of this radically changing landscape, we have seen Microsoft take a series of steps foreshadowing today’s news, all since Nadella took over the reins in February 2014.

In November 2015, for instance, the company reached a “patent standstill agreement” with Red Hat, a major distributor of commercial-grade Linux (and charter OIN member). With no exchange of money, each agreed not to bring patent suits against each other’s customers. This provided comfort to Red Hat customers who wanted to run Red Hat Linux programs on Azure.

About a year later Microsoft began reassuring all Azure customers, through a program called Azure IP Advantage, that it would indemnify them against any patent claims that might be leveled against them for using open-source software on Azure’s cloud. That made it unthinkable that Microsoft would itself level such claims.

Shortly thereafter the company joined the board of the Linux Foundation as a platinum-level member, meaning that it contributed about $500,000. The foundation is a consortium that provides tools, training and events to foster open-source projects.

This past April the company launched its first Linux-based product—Azure Sphere for Internet of Things applications.

Then, in June, it announced that it would pony up $7.5 billion—about what it paid for Nokia five years ago—to acquire GitHub, the leading open-source software development platform. The purchase underlined the extent to which the company was no longer just a proprietary software maker but, rather, in very large part, a services company.

“When you’re Microsoft as a service company, what you want is all the best software in the world to be available to you,” says Moglen, of the Software Freedom Law Center. “GitHub is a place where cool FOSS programmers hang out and put all their stuff. It’s the great meeting place of the technorati who make software in the world. . . . It’s a contemporary fulfillment of Bill Gates’s doctrine that ‘software is an IQ business.’ It’s a way of owning the brains in the head.” 

‘There’s no excuse for not joining OIN’

What does today’s news mean for OIN, the other party to the transaction? Is it a Mission Accomplished moment?

No, explains Bergelt in an interview. Though this is clearly an inflection point for the organization, he sees the news in the context of a broader mission, where there is still much left to do.  

Bergelt joined OIN as its CEO in 2008, when its community numbered just 32 licensees. Before that he led the IP hedge fund Paradox Capital; advised the private equity fund Texas Pacific Group; and headed Motorola’s intellectual asset management group. Earlier still, he spent 13 years in the U.S. State Department, with the Foreign Service. (He speaks French and Japanese.)

With Microsoft entering the fold, he says, OIN’s “point of focus” may shift some from defending against threats to the community posed by operating companies to defending against those posed by so-called patent assertion entities—i.e., patent trolls.

Still, even at the operating-company level, there are remaining concerns. Microsoft, Bergelt hopes, will now serve as an example to those remaining corporate contributors to open-source code who have held out so far, refusing to take an OIN license. These include such players as Intel, Oracle (an early OIN member who withdrew in 2012), Qualcomm, and VMWare.

“There’s no excuse for not joining OIN,” asserts Bergelt, “unless you want to reserve the right to sue on core Linux functionality.” These companies remain threats in his eyes.

“If they’re not willing to disarm vis-à-vis that core code,” says Bergelt, “it creates questions around their authenticity as members of the open-source community.”

Roger Parloff is Editor-in-Chief of Opioid Watch, a nonprofit news service of The Opioid Research Institute. Parloff is a former editor-at-large at Fortune Magazine, and has been published in Yahoo Finance, Yahoo News, The New York Times, ProPublica, New York Magazine, and NewYorker.com, among others.