Carrot or stick case study. Licensing strategy at Tessera. Carles Debart
Case study: Carrot and stick - Getting paid for innovation at Tessera Technologies Carles Gonzalez Debart Innovation Management, University of Strathclyde, Glasgow, UKIntroductionTessera is an innovative developer of micro technologies that are widely adopted by theconsumer electronic industry. Their solutions can be found in mobile phones, notebookcomputers and in general in many integrated circuit manufactures. Tessera doesn’tmanufacture by itself, it implements what is known as “carrot licensing”, which consist inpatenting and licensing those innovations to third parties in order to manufacture them.Tessera makes use of trade secrets and know-how to help those third parties to reach thecapabilities needed to manufacture their inventions. Contrary, what was so-called “sticklicensing”, which stands for the use of litigation as a way to extract license agreements fromthose companies using other’s technology without the payment of royalties, had been lately amore used approach for Tessera, as was exposed by Hank Nothhaft (CEO of TesseraTechnologies). In this case study we will analyse the situation of the company highlighting therisks, threats and opportunities of their particular approach to innovation. First we will providean analysis of Tessera’s licensing model. Secondly, we will review the patent environment andfinally, we will deliver a set of recommendations for Tessera’s new innovationcommercialization.Licensing modelTessera had been applying its approach to innovation with success (carrot licensing) throughthe 90s and early 2000s, having major clients in the semiconductor industry. Tessera licensingmodel was based on selling its intellectual property, patens, know-how and trade secrets toother companies willing to improve their technology. The selling cycle usually takes quite longtime, up to 18 months or more. Often the step were numerous and involved transfer of thetechnology, pilot productions at Tessera’s facilities and in-house training. Once the productionstarted successfully at the client site, the revenue was not yet secured. It depended on thenumber of electrical connections within the packages, the volume of the production and thecommercial success of the final assembled product. All of these facts were clearly out ofcontrol from Tessera and often the revenue was not reached until many years after licensing.
The way that Tessera developed, and later on licensed their innovations can be easilyunderstood in the next example. When the Tessera Compliant Chip (TCC) technology, whichwas a new approach to chip flexible packaging, was ready to manufacture it encountered someproblems. Although the product was promising and it really appealed the semiconductorindustry, they didn’t want to adopt such a radical change until Tessera would be able todemonstrate reliability and manufacturability at high volume. Larger firms were concernedabout the fact of introducing other’s parts on its circuits and its impact in the selling as well.Tessera had to commit plenty of resources in seven years of continuous R&D, not only todevelop the TCC technology, but mostly to convert it in a successful commercial product.Several manufacture processes were created and improved, implying a vast portfolio ofadditional patents, manufacturing know–how and trade secrets. With this, a couple oflicensees were obtained, but the big players were still resilient to adopt it. Tessera had toinvest in internal manufacturing to show them enough capacity. That contradicted with theaim of licensing as a way of securing turnover; as the technology matured and more licenseswere sold to other manufacturers, they found themselves in the tricky situation of competingwith their own licensees.But those were not the only challenges that Tessera had to face. In a very competitive industrylike the semiconductor is, where extremely high investments in manufacture capacity have tobe made in order to make profits out of low margin products, manufacturers were notinterested in quitting their assets to produce the new technology.Some other problems faced by Tessera with this model were that revenues were directlydependant from the ability to audit, monitor and collect royalties from the licensee, whichwere expensive and time consuming. Furthermore, a high pressure for auditing was indetriment with its licensee relationship. All taken into account, made Tessera not to fullydeploy its rights, at least initially in the licensor-licensee relationship. That was a clear threat,and entailed some firms to infringe the patents after some time. When this was detected,Tessera engineers had to first analyse the competing product and then report all infringementsdetected in detail. This was expensive and time consuming as well. If no agreement wasreached, litigation process was to be held in a court, normally favourable to the infringer. Thewhole procedure could take several years for each single case, in which the infringer was likelyto keep on producing and selling the litigated product.Tessera realised that the best strategy for TCC technology was to focus on customers in needof small size, higher performance and high density, in other words, they targeted the high-endsector. Potential customers were found in companies like Intel, Texas Instruments, DRAMmakers, etc.Changes in patent environmentTo understand infringements in patents we should first understand how patents work. Patentsare a legal formula which allows the inventor to exclusively make use of the invention for alimited period of time instead of keeping them in secret. In that way, the everybody could
benefit from it, increasing the welfare of the society. Others different from the inventor couldmake use of the invention, in such a case, a compensation should be given. Theoretically.The patent environment in the US in the 90s and early 2000s was concise. When a patent wasinfringed, injunctions were more or less automatic. Although the slow procedure of thesystem, infringers generally paid finally the royalties or some kind of compensation instead ofdropping the product of the market.However in 2006, there was a sue that set a precedent. NTP, a holding company for patents,sued RIM (the company behind Blackberry) for infringing patents. RIM lost the lawsuit andoffered a compensation of 450$ to be able to keep on using the Blackberry service. Butunlikely other cases were the compensation was the end of the lawsuit, NTP decided to keepon and tried to enforce the injunction. The possibility of a shut down in the Blackberry servicewas so critical that the U.S Supreme Court intervened to stop the injunction. That was the firsttime that legal regulations were “bypassed” in the interest of the whole society. But that wasnot an isolated case in which an injunction was refused for the public interest. MercExchangewas unsuccessful in the lawsuit with eBay. The reasons were that the court manifested theintention of not stopping the growth of the business electronic payments. But what was evenmore surprising was the fact that the court argued that MercExchange didn’t have anyintention of using their patent as they were willing to license it. From then on, if these kind ofsentences had to be the norm, Tessera’s business model based in licensing was seriouslythreatened. Tessera didn’t want to fall into that group of organizations named “non-practicingentities” or so-called “patent trolls”, they argued that they didn’t only invent, but produce,invest and even in some cases they took products into the manufacturability point. Theydidn’t see in themselves any similarity with patent trolls but, would courts think the same?And even more, what about other countries with a lack of proper patent regime? Nothhaftexpressed then the fear of investing money in projects with high risk of monetization. Hepointed out as well that an increase of litigation cases would force Tessera to spend more timeand money in courts defending its innovations. This was especially critical on its latestinnovation, the fanless cooling system that amalgamated a total of 76 patents.Recommendations for fanless cooling system commercialisationIn this section we will perform an analysis of Tessera’s new challenges for the fanless coolingsystem commercialisation that will lead into a set of recommendations.First of all, we need to make a review of the environment that Tessera is facing with its newinnovation. When the innovative fanless cooling system developed in-house was introduced tothe board of directors, they quickly realised that they were entering into a new kind ofcostumer. The companies targeted were not big players in the semiconductor industry likeIntel, Toshiba or Samsung were, but a number of white-box manufacturers mainly establishedin China, focused in the battle of price and not very prone to pay for intellectual property. Thatwas a new challenge for Tessera in his aim of getting paid for their innovations. Tessera wasconfident that this new cooling system would be implemented in all laptops in a few years. Onthe contrary, the confidence on whether it would be a profitable invention or not was stillunknown. Should Tessera modify its strategy for this new upcoming product?
To better foresee the attractiveness of the new market Tessera was entering with its newproduct, Porter five forces analysis will be conducted and discussed:1. Level of competition: despite being the IC industry very competitive, as we are analysing theenvironment for a particular product (fanless cooling system), the competitiveness is low. Theproduct is very innovative and it didn’t have rivals yet. The only rival that Tessera could havefaced was a small private company (Kronos), that had made significant advances in electro-hydrodynamics but was experiencing funding problems. Tessera took advantage from it andacquired rights to their portfolio of patents.2. Threats of substitutes: Thermal management was becoming a bigger issue in electronics.The only substitute was the traditional fan cooling system, adopted by many manufacturers inthe laptop industry. We could say that an old technology such as the fan could not be asubstitute for future miniaturized laptops, thus we could make the mistake of considering it alow threat of substitutes. Nevertheless, low cost manufacturers are not usually interested inquitting their assets to produce a new technology, thus the tradition fan system could still be asubstitute for many years.3. Threat of new entrants: The threat of new entrants is relatively low. The technologicalcapacity needed to develop a project like this is high, so are the barriers of entrance in thismarket.4. Bargaining power of buyers: Moderate. Due to the particular business model of Tessera, thebuyers are the licensers, which can hesitate in adopting the new technology and acquiring thenew capabilities to manufacture. Some buyers thought as well that introducing other’selectronics in their own products could imply problems on its own marketing. This could leadinto tight conditions that can put Tessera in a delicate situation.5. Bargaining power of suppliers: As Tessera is licensing their product and not fullymanufacturing them, this force has low impact in the analysis.6. Value chain analysis: value analysis tries to identify actions developed by the company inorder to add competitive advantage over its rivals. Some of them are inbound logistics,operations, marketing and sales, services, etc. Tessera’s licensing model implies that the valuechain is deployed not in whole lifecycle of the product (this is a task for the licenser) but in theprocess of licensing. Tessera revenues are directly dependant from the ability to audit, monitorand collect royalties. In the first years though, and to improve sells and costumer relationship,Tessera’s strategy was often to not fully deploy its rights. Other values adopted by Tesserawhere in house training and know-how transfer for a better manufacturability.
In that point, we need to evaluate the viability of the fanless cooling project and identifying internal and external factors that could lead into success or failure. SWOT analysis is provided: Strengths Weaknesses manufacturing know-how Heavy investments to support R&DInternal factors High technology expertise High risk-adjusted rate on return Financial position Extremely long payback period for Acquired knowledge by buying investments Kronos Litigation expenses High qualified HR Diversified portfolio of technologies Opportunities Threats High financial and technical Patent legislation changes in USExternal factors barriers for entry Absence of strong legislation in other Absence of direct competitors countries (weak appropiability regime) Size and perspective of the new Resilience of the market to adopt new market technology Technology could be developed for New costumers prone to avoid to pay for other industries licenses Be seen as a “patent troll” Taking both analysis into account and supported by the methodology exposed by David. J Teece in his paper “Profiting from technological innovation: Implications for integration, collaboration and licensing and public policy” we will deliver a set of conclusions for Tessera challenge. As the thread of new entrances is low, we can say that the preparadigmatic stage (when it is not still clear which innovative product will establish the new “standards”) will be easier to tackle in comparison to the hypothetical scenarios of multiple players in the game of fanless cooling system. Thus, the transition from preparadgimantic to paradgmantic (when new product is consolidated as the new “standard”) cannot be considered as a thread for Tessera and it is likely that their system would be the dominant, at least in the first stages of manufacturing and sales. The real thread that Tessera will have to face is when manufactures will start producing their system in large quantities, it is to say, when licensers will seek for lower unit costs through exploiting economies of scale and learning. Manufactures will be in a stronger position then, as they will already have acquired the capabilities of manufacture and they will be intensively using the know-how provided by Tessera in the early stages of the contract. In that scenario, licensers, as they often have their own R&D departments, could start developing parallel products to avoid or bypass the license, incurring into infringements.
Due to the weak appropiability regime in China (where most of the white-box manufacturersare settled), the persecution of those infringements could be tremendously resourceconsuming, putting Tessera in a tight position. Manufactures could even take advantage of thecospecialized assets such as distribution channels, advanced manufacturability, etc. Even in thecase that Tessera would enhance their “stick licensing” capacities, it is not clear that theoutcome of this innovation would transform into profits.It could be interesting to argue whether Tessera should change their “contractual” mode to an“integration” mode in this new product launch. Integration is seen as a way of ownership,where the innovator owns rather than rents the assets need to produce and commercialize theproduct. It is a way to control spill overs in general, but for Tessera could be the way ofavoiding being copied and not taking any profit out of it. Adopting this new approach would bea radical change, as contracting has always been the rule. Certainly in the past, contracting hadbeen beneficial for Tessera as it allowed to avoid the upfront capital expenditures need to buythe assets to produce, distribute etc. But in this new environment of weak appropiabilityseems a quite risky approach. Following the rules proposed by David J. Teece we obtain that:The analysis in the left-hand chart above shows us that when the success is critical and theinvestment is major for the project in question, internalize could be the position if cash is notconstrained. We can discuss whether the fanless cooling system is critical or not for Tessera,but as it has been reviewed, there has been put a lot of effort, many years of R&D, and theacquisition of a portfolio of patents form another company.In the chart at the right-hand side, shows us that if the investment required is major and timerequired to position relative to competitors (we have argued before the thread of entrance islow) is short, integration can be the right solution to choose.
Another tool developed by David J. Teece that can help use to make the decision is shownbelow:When the innovators and imitators are disadvantageously positions versus the owners of thecomplementary assets (in our case licensed manufacturers) and innovator excellentlypositioned versus imitators respect to commissioning complementary assets, the rule to followwould be integration. This supports the outcome of the previous analysis and establishes achange on Tessera business model as the right way of procedure in this particular project.Even if the integration being the best option, can Tessera implement such a big organizationalchange? Financial position is not shown in the case study, but assuming that it allows to buythe capacity to produce in-house, there are still other facts to be discussed. One of thestrengths that Tessera can use to reinforce the strategy of integration is its previousexperience of manufacturing. As it has been seen before in the introduction, Tessera has hadto produce sometimes batches of new products to show to its potential costumers thefeasibility of manufacturing. Tessera could capitalise this manufacturing know-how in this newproduct to avoid all the threats involved in licensing. Perhaps a total integration could be risky,but a mixed mode where Tessera manufactures in house (protecting more efficiently in thatway its creations) but externalises the distribution, marketing and sales can be the right pathto follow.