of airline customers make a decision based solely on price and flight availability. Because none of the major national airlines con- sistently has better prices or flight schedules than its competition, virtually all customers shop around.
Companies like Southwest Airlines are an exception. South- west has been able to corner its segment of the market because it has a true cost advantage. Because Southwest utilizes ticketless travel and unassigned seats, there is no need for computerized seating. The cost of selling physical tickets (both in materials and employees) is eliminated, and the time it takes to check someone in is reduced, so Southwest has less overhead and requires fewer employees. Even more important, the airline is able to load and unload its planes so rapidly that it gets more flights per plane per day, another boon to its bottom line.
For all of these reasons, Southwest has an inherent cost advan- tage, and it passes the savings on to the customers, offering fares consistently lower than the competition’s. This further strength- ens its foothold.
A PRODUCT THAT CAN’T
Drug companies aren’t the only ones that have made a killing thanks to patent protection. Several high-tech companies haven’t done too badly, either. Texas Instruments, for example, holds many of the original patents on computer memory chips. Believe it or not, Texas Instruments gets a royalty for almost every memory chip that hits the market. Those royalties have been a rich source of revenue for the company, and despite a plethora of lawsuits, its patents have held strong.
Gemstar is another entity that owes its bank balance to patent protection. The company’s brainchild was the first electronic pro- gram guide for television. You’ve probably seen it; the guide is bundled with most television sets and many cable subscriptions.
For each customer, Gemstar gets a kickback—a few dollars a pop.
Not only does it get the royalties, but it owns the advertising space, as well.
How tight are the patents? Very. Microsoft recently wanted to create its own electronic program guide for WebTV and was forced to pay Gemstar royalties on it. Let me tell you, Microsoft would go to the ends of the earth to avoid paying a royalty to anyone. If it agreed to that deal, I’d bet good money that those patents were unbreakable. Anyone who knew Microsoft and was reading the progress of all this in the papers would have known the same.
One of the most famous instances of patent protection is the Intel–AMD battle. Throughout the PC revolution, Intel provided the chips that fueled most desktop computers. At a certain junc- ture, though, its stranglehold started making hardware vendors (like Compaq, Hewlett-Packard, and IBM) nervous. They were worried that if something went wrong at Intel, they’d have no other source for computer processors, and their bottom lines would be at risk. Under pressure from these vendors, Intel agreed to license its technology to another chip manufacturer, AMD.
Under the terms of the deal, AMD was legally allowed to make an Intel-compatible processor without doing nearly as much R&D itself. This was a huge economic advantage for AMD, but all good things must come to an end. Eventually, Intel decided that AMD wasn’t pulling its share of the load and wanted to cut it out of the loop.
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Lawsuits followed. Intel won. The company had legal rights to its intellectual property, and once permission was pulled, AMD was no longer privy to the specs it needed to easily replicate Intel’s product.
What AMD was permitted to do, however, was what is called a clean roomreplication. The courts ruled that while AMD couldn’t have access to Intel’s R&D without its permission, AMD could reverse-engineer Intel’s products.
Under clean room guidelines, AMD is allowed to use publicly published information (for example, how the Intel chip interacts with an operating system like Windows) and then create the prod- uct from scratch. Legally, it is not allowed to use any person who has ever worked for Intel or had access to Intel R&D; that would violate Intel’s copyrights, trade secrets, or patents. Reverse engineering has allowed AMD to stay in the game, but the lag time between when Intel first creates a new chip and when AMD is finally able to get a replication on the market has hurt the company.
In technology, patents are emerging as a key weapon in the fight to remain unique and retain a stranglehold on one’s piece of the market. As an investor, it’s important to determine not only how good a technology is, but how easily it can be copied. Investors should determine what products a company has attempted to pro- tect by filing patents, and also see who has licensed those technolo- gies. When significant potential competitors license a technology, it usually means that they realize it would be far too difficult or expensive to try to replicate it.
A good example of this phenomenon is Sun’s software prod- uct, Java. This product has been licensed to players as diverse as Microsoft, IBM, Apple, and Netscape. Java is a new-generation development tool for software that works across multiple plat- forms (like Windows, Unix, and Mac). It is also a piece of code that can be sent through the Web (or put right on the desktop) to make it possible for any machine to run an application, regardless of what operating system is on that hardware.
In short, Java is a cross-platform enabler. It functions as middleware—in other words, it sits between the hardware and the operating system.
It’s precisely this intermediary position that has led to trouble.
Microsoft, which acquired its dominant position in the PC space through its operating systems, doesn’t like having a middleman like Java in the mix. Java threatens Microsoft’s power by removing the need for developers to create software solely for Windows, because software created for Java can be shared by all platforms. To combat
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C O M P E T I T I V E A D V A N T A G E : W I N , L O S E , D R A W
Win: Corning. Corning is an old-world company, for- merly known for its casserole dishes, with a patented technology that suddenly has a new application. Corn- ing holds patents and trademarks on optical fiber, which it invented in 1970. The Internet, which uses fiber as a means of transport, has opened up a whole new market for the company. Corning’s sales in 1999, much owing to these patents, were $4.3 billion.
Lose: Xerox. Many of the most important technological inventions of this decade were developed at the Xerox Research Center—the mouse, the graphical user inter- face (GUI), Ethernet, and the laser printer. Unfortu- nately, Xerox didn’t patent anything. These technologies have generated billions of dollars in revenue for other companies, but Xerox hasn’t seen any of it.
Draw: University of Illinois. The first Web browser, Mosaic, was invented at UI and was properly protected legally. Marc Andreessen, who worked at the university as a grad student and went on to help found Netscape, lifted some of Mosaic’s technology for Netscape Naviga- tor. He had no permission from the university, and it eventually sued Netscape and won in an out-of-court settlement. The good news for the university was that the patents held; the bad news was that, unlike Netscape, it never made much money from the browser technology it had invented.
this cross-platform colonization, Microsoft licensed Java and devel- oped its own version of the product—one that is optimized for Win- dows, but doesn’t work very well on other platforms. Sun’s Java works on all platforms, but not optimally on any specific one.
Because Microsoft’s version makes Java so much smoother on Win- dows machines, and most PC owners use Windows, a number of software developers began creating software on Microsoft Java.
As Microsoft Java began picking up momentum, Sun threw a curveball and sued Microsoft. According to Sun, Microsoft had violated their licensing agreement by creating a version of Java that wasn’t Javaesque. After a visit to the courtroom, Sun won the case. The judge agreed that the patents had been violated and ordered Microsoft to stop abusing them. At this writing, Microsoft has appealed the decision, but has also stopped selling Java tools.