Global Business 3rd Edition by Mike Peng

Exercise 39

Should Huawei adopt an alternative intellectual property (IP) strategy when facing a series of IPR hurdles in the United States?
It was a warm fall day as Yi Zhao entered his office in Plano, Texas (a Dallas suburb). Still reeling from the morning news of Google's $12.5 billion bid for Motorola Mobility, Yi contemplated the implications of Google's potential acquisition of Motorola Mobility and its expansive patent portfolio. Yi, Vice President of Strategy for Huawei USA, had been in the United States since Huawei's entry into the US market in 2001 and had dealt with the challenges of entering a new market. Over the last few months, intellectual property rights (IPR) had been on Yi's mind, as Huawei had entered negotiations with InterDigital (ID) for alleged 2G and 3G patent infringements. ID, a non-practicing entity known in the marketplace as a "patent troll," had filed infringement allegations against Huawei and many of its competitors, including Nokia, ZTE, and ITC. These unexpected lawsuits were rumored to have been gamesmanship on the part of ID, with ID's true intent to increase the value of its patent portfolio in preparation of a potential sale.
Huawei, a Chinese multinational, has struggled since its entry in the United States with regard to patent and IPR issues. Yi had observed that as markets became more competitive, many firms in the industry increased their licensing fees and developed aggressive IPR strategies, similar to those of ID. As Yi faced this challenge, he wondered if Huawei's harmonious IPR approach made the company vulnerable to attacks. "Should Huawei consider changing its IP strategy?" Yi thought.
Brief History of Huawei
Founded in 1987 by Ren Zhengfei, Huawei is a privately held firm that has become a multinational information and communication technology (ICT) equipment and services company. Specifically, Huawei is involved in the development, production, and marketing of ICT equipment through the provision of mobile networks, broadband networks, IP-based optical networks, telecom value-added services, and terminals. Despite consolidation in the industry, Huawei has remained strong with a corporate compound annual growth rate (CAGR) of 29% since 2006 (see Exhibit 1). The company has grown into the largest China-based ICT equipment supplier and the world's second-largest supplier of mobile telecommunications infrastructure equipment behind Ericsson. However, Huawei's US division has not fared as well.
Huawei firmly believed in the natural selection of the marketplace. Embodying the competitive spirit of the lone wolf, Huawei "incorporated three components of the wolf spirit as part of its indispensable corporate culture: (1) a sensitive nose to opportunity, (2) aggressiveness, and (3) persistence on attack." However, Huawei's strategy failed to consider the complexity of the host nation's formal institutions (i.e., the US patent system). In January 2003, Cisco sued Huawei for IPR infringement. The suit, which was later settled out of court, forced Huawei to remove the majority of its products and leave the US.
Determined to build upon its previous experience and apply its knowledge of the patent process, Huawei returned in 2009. Focusing on linkage, leverage, and learning (LLL), Huawei emphasized cooperation and partnership with suppliers in the marketplace.2 This strategy was a success in general, yet was still ineffective in addressing the US IPR issue. Some of this gap appears to arise from cultural distance. Western culture maintains an "ownership of ideas" concept, whereas traditional Chinese culture maintains a belief that knowledge and ideas are an artistic expression that should be shared, not owned and exploited. Therefore, Huawei must not only overcome the cumbersome US patent system, but it must also overcome the distance between the two cultures. The US Patent System Once a driving force of innovation because of its ability to properly protect an individual's IP, the US patent system has more recently become a hindrance to the ICT industry. Unlike other industries where one patent can protect an entire product line, the ICT industry is

quite interconnected and interdependent. Each product or service embodies many patents.3 The complexity of modern telecommunications devices, along with many other issues, has resulted in a patent system that can no longer serve the needs of modern technology.
The problem originates from an outdated and underfunded US patent system. The current system is laden with inadequate review procedures, gamesmanship, and a volume of applications that has increased the difficulty for users to properly navigate the system. Regulations and attempts at reform have struggled to address the issues that result from a young and fastpaced sector. Furthermore, years of "first to invent" US patent procedures,4 key plaintiff-friendly rulings,5 and the rise of plaintiff-friendly courts (especially the Eastern District of Texas6) have created two recent trends: (1) the rise of infringement litigation designed to damage a defendant (which we call stifling litigation) and (2) patent trolls.
Stifling Litigation
The original intent of IPR was to encourage innovation by allowing the inventor to profit from his or her labors. However recently, many companies, particularly those in the ICT and software industries, have used patents as a way to curb a rival's growth and stifle the overall innovation of the industry (even if this stagnation is detrimental to the plaintiff firm). Furthermore, the patents these firms call into question represent a small part of the overall product. Two key examples of stifling litigation against Huawei have been the recent Motorola Solutions (MSI) infringement settlement in April 2011 and Microsoft's allegations of Android patent infringements in September 2011.
After MSI's courtship and intended merger with Nokia Siemens Networks (NSN), MSI filed suit against Huawei for patent infringement. The suit was seen as a way for NSN to divert Huawei's resources, as it swooped in to acquire one of Huawei's major customers. In a counterattack, Huawei sued MSI for illegally transferring Huawei's IP to NSN. After Huawei won a preliminary injunction and the NSN deal fizzled, Huawei and MSI settled for an undisclosed amount and formed a cross-licensing agreement, enabling Huawei to maintain its roughly $880 million business partnership.
More recently, Microsoft demanded a patent licensing agreement (with fees) for Huawei's use of the open-sourced Android operating system (OS) within its mobile devices. Microsoft, which takes home an estimated $444 million annually from Android royalties and is currently struggling in the mobile market, has already navigated similar agreements with Samsung, HTC, ViewSonic, and other Android device vendors in order to generate revenue. Interestingly enough, these licensing fees may generate more revenue for Microsoft than its Windows 7 OS. According to a Bloomberg News report, "Microsoft generated approximately $21 million from its Windows OS phones, whereas it received over $60 million from merely one Android manufacturer (HTC) in patent licensing fees."
Given Huawei's strong reputation regarding IPR and its expansive patent portfolio, containing more than 65,000 patents worldwide, critics view the allegations as a tactical move by Microsoft. The thinking in this case is that Microsoft wants either to destroy Android (and ease its stranglehold on the mobile OS market) or to make it more attractive for mobile phone hardware makers, such as Huawei, to switch its OS to Windows. If either scenario fails, the success of Android could still lead to Microsoft's next billion-dollar revenue stream.
Cross-licensing agreements are the most frequent and cost effective strategy used to combat infringement allegations. They typically occur between firms within the same value chain or product line. The process consists of negotiating licensing fees based on the value of the patents used within the product. The firms swap away the bulk of licensing fees in negotiations, leaving smaller amounts of actual costs to be recognized by each firm within the negotiation. However, some companies are changing their approach, with firms such as IBM, Texas Instruments, and AT T leveraging their patent portfolios to simply generate additional revenue. Additionally, many firms have found that generating revenue through licensing and patent litigation often produces a higher rate of return than its core business activities. As the ICT market continues to evolve, many firms are eschewing cross-licensing agreements in favor of revenue-generating strategies.
Patent Trolls
Patent trolls are a product of this evolution. Trolls typically are non-practicing entities consisting of lawyers, PhDs, and patent experts. Trolls are concerned with acquiring essential patents in industry standard technology (such as the 4G platform). They do not actually produce any products, but instead they hoard patents and wait for other companies to make the patents profitable. Since no one in the industry can use the standard technology without using the troll's patent, the troll stands to profit, either through the collection of licensing fees or by bringing an infringement lawsuit.8 Further, because trolls do not produce anything, they have no need to cross-license, thus having a robust patent portfolio provides no solution to the companies targeted by trolls.
ID is a known patent troll. According to its 2011 annual report, ID generated 94% of its total revenue from patent licensing with approximately 26% and 15% of total revenues from Samsung and LG, respectively (see Exhibits 2, 3, and 4). Based on that ratio, ID is estimated to have generated $214.79 million, $279.55 million, and $370.83 million in revenue from licensing fees and litigation awards and settlements from 2008, 2009, and 2010, respectively. That means that such vendors as Samsung and LG are paying fees upwards of $96.4 million and $55.62 million, respectively, to ID annually.
Huawei's Patent Strategy
According to Yi Zhao, Huawei has embraced a harmonious IP strategy in the United States and believes that patents should only be utilized as a defensive mechanism, not as an offensive one. As Yi stated in his softly spoken tone, "Huawei's patents are free to use within the technology community, unless Huawei is attacked." Under that condition, Huawei would revoke its agreements and retaliate with great force through either litigation or aggressive crosslicensing negotiations. Additionally, Huawei takes patent trolls very seriously. According to Yi, "If Huawei is attacked [by a patent troll], we will not consider a settlement and we are prepared to take them to court... and win."
Huawei has spent the last few years attempting to work closely with industry leaders to ensure compliance with licensing agreements and proper distribution of compensation. According to Yi, in every cross-licensing agreement so far, Huawei has made every effort to negotiate a fair price for licensing fees. To mitigate the growing trend of patent litigation, Yi and his staff have attempted to build a strong patent portfolio by leveraging Huawei's R D and by acquiring other innovative companies.
Research and Development
Yi knows that many firms are increasing their R D expenditures in the hope of expanding their patent portfolios. Huawei has been no exception. It has remained highly focused on R D: 10% of the annual budget and 43% of the company's workforce is allocated to R D. Huawei has effectively leveraged its highly skilled and inexpensive labor force to drive innovation cost considerably lower than that of its Western competitors, namely, Ericsson and Nortel. With this approach, and in just a few short years, Huawei has been able to secure more than 65,000 patents worldwide.
In addition, Huawei has focused on becoming a major player in setting international standards. By the end of 2010, Huawei was a member of 123 standards organizations and served in over 180 leadership positions. Huawei has accumulatively submitted more than 23,000 proposals. Specifically in the LTE/EPC field, Huawei possesses about 8% of patents (see Exhibit 5). It has submitted more than 6,400 proposals to 3GPP. In 2010, the number of proposals submitted by Huawei on LTE Radio Communication Core Specification passed by 3GPP accounted for approximately 20% of the world's overall accepted proposals.
Despite these achievements, Huawei has continued to struggle in the US market, leading Yi to wonder whether Huawei's defensive IP approach was the right strategy for Huawei to fend off competitors and establish itself within the US market.
Acquisitions
Traditionally, acquisitions have been a quick and effective solution to acquire expertise and amass a patent portfolio (along with market share) that would have otherwise been unattainable in the short term. However, Huawei has been unable to use this approach successfully. Due to the sensitivity of US national security concerns, Huawei has been blocked from potential purchases of 3Com, 3Leaf, and, most recently, Motorola. This inability to purchase US-based companies, and IPR for that matter, has become a major stumbling block for Huawei.


The situation has been so disconcerting that in February 2011, Huawei requested that the US government launch a formal investigation of the company in order to expunge any national security concerns that the US might have regarding the company's activities


and affiliations. The US government has yet to provide a positive response. Moreover, William Plummer, Huawei's government-relations point man, has been meeting with anyone in Washington willing to listen to Huawei's side of the story. As Plummer has pointed out often (including after the unraveling of the 3Leaf acquisition), "Huawei is Huawei, not the Chinese government."
However, the US government's skepticism continues to run deep as Huawei has balked at any suggestions to create a publicly owned US subsidiary. According to Huawei (which remains private and is not listed in China), this is not possible because Chinese law prevents companies with large employee ownership from going public. Additionally, if an IPO were issued, Huawei was concerned that it would generate billions of dollars for top management, giving many of them, along with their decades of experience and expertise, an incentive to leave the organization.
Conclusion
ID presented a growing problem for Huawei. As Huawei continued to battle in the US IP war-with competitors that were becoming more aggressive in their licensing fees and litigation attacks-Yi considered if Huawei should revise its IP strategy in the United States. He knew that R D is necessary for longterm success, but it provided little short-term relief. He knew that acquisitions would fix the short-terms problems, but a successful acquisition was unlikely without a change in attitude from the US government. He also knew that part of the rules of the game in the US meant having a lobbying presence in Washington, but Huawei's lobbying efforts had proven ineffective. Facing failure at every turn, Yi wondered if Huawei should embrace a Western attitude toward IPR and begin aggressively capitalizing on its robust patent portfolio in a similar manner as ID. The alternative was to embrace Washington's stance on transparency and form a publicly traded US subsidiary. Finally, Yi considered the worst-case scenario: Huawei would once again have to retreat to China and dwell upon its failures in the US.
Case Discussion Questions
From a resource-based view, does Huawei have the necessary resources to change its IP strategy?