EU Threatens to Fine Microsoft for Lack of Innovation

In what could be an historic first, the European Commission's new statement of objections to Microsoft for alleged non-compliance with its March 2004 antitrust ruling forwards a novel theory: not that the interoperability information the EC demanded is incomplete, but instead that the communications protocols it describes are not innovative enough for Microsoft to deserve charging royalties for its use.

In Microsoft's draft copy of the royalties it proposes to charge for licensing its interoperability protocols, as the EC has directed, it divides its intellectual property in categories based on the degree of confidentiality of IP information licensees would be receiving. Certain protocols which may fall outside the realm of patentability are given a separate classification, and for those, Microsoft wants to charge a flat fee; but for technologies for which it claims patent rights, the company proposes either US dollar rates per server or percentages of revenue.

Some individual technologies within the premium tier, such as Kerberos authentication, are actually free of charge; though others, such as Base Authentication Services (used to grant authentication to clients accessing Windows Server resources) are relatively expensive - as high as $17.50 per server seat. (The complete proposed rate table is available in this PDF document.)

EC Commissioner for Competitiveness Neelie Kroes stated today she believes Microsoft's proposal constitutes charging a premium for protocols based on their relative innovativeness, by virtue of their having been patented. However, the analysis she's received thus far, she said, indicates to her that those protocols aren't innovative enough to warrant the premium charge.

"Microsoft has agreed that the main basis for pricing should be whether its protocols are innovative," Commissioner Kroes' statement reads this morning. "The Commission's current view is that there is no significant innovation in these protocols. I am therefore again obliged to take formal measures to ensure that Microsoft complies with its obligations."

This morning's statement from the EC acknowledges that certain "third parties" are objecting to the notion that they must receive a license to Microsoft's patents in order to be able to use the communications protocols for their own software to be able to interoperate with technology covered by those patents. It's a new take on the old argument that you don't need a license to Ford's or GM's intellectual property to be able to drive one of their vehicles.

But the EC is arguing two points simultaneously: that Microsoft's patented tier doesn't deserve a premium because its patents aren't innovative enough, and also that its non-patented tier shouldn't require charges at all because, by virtue of their not being patented, they obviously cannot be innovative anyway.

"The Commission's preliminary view is that there is virtually no innovation in the 51 protocols in the 'No Patent Agreement' where Microsoft has claimed non-patented innovation, and that Microsoft's current royalty rates for this agreement are therefore unreasonable," reads the EC statement. It goes on to acknowledge the work of its designated trustee, Dr. Neil Barrett, in having examined 160 Microsoft claims to patented technologies, and having concluded that among those, only four may only deserve to claim "a limited degree of innovation."

The ramifications of this claim go far beyond whether the EC would impose new fines on Microsoft - which, incidentally, would be at a rate of 3 million euro per day (nearly $4 million USD) retroactive to August 1 of last year, or $842.6 million USD if the fines were imposed today. The EC now appears to be accumulating the interoperability information Microsoft has given it, to perhaps mount a challenge to the very originality of Windows itself, disputing the company's rights to exclusivity over its own operating system.

For its part, Microsoft's senior vice president and general counsel Brad Smith defends the validity of his company's patents, by saying not only that the US Government seems to back them well enough, but that partner companies appear willing enough to pay royalty fees to use the technologies they cover.

"Other government agencies in both the United States and Europe have already found considerable innovation in Microsoft's protocol technology," Smith said. "US and European patent offices have awarded Microsoft more than 36 patents for the technology in these protocols, which took millions of dollars to develop, and another 37 patents are pending, so it's hard to see how the Commission can argue that even patented innovation must be made available for free."

Smith then went on to cast doubt on Kroes' contention that Microsoft already agreed that, because royalties would be set based on relative innovativeness, non-innovative protocols would be free of charge. "The proposed findings suggest that unless our intellectual property is innovative and patentable, it has to be made available royalty free. That has never been the standard for software or other intellectual property, and it misstates the test agreed to by the Commission and Microsoft in June 2005, which has been available on Microsoft's website since that time."

From there, Smith contends that the EC may be overstepping its bounds, from a geographical standpoint. Microsoft's proposed royalty fees apply to all customers, not just those in Europe. A European agency may not have the authority, he argued, to determine the global efficacy of royalty rates - a subtle implication that the company may be willing to argue this case before a higher court, with US evidence to back it up. "If other authorities all took similar views of their power," Smith said, "companies would be unable to comply with contradictory rulings."

An FAQ on the European Union Web site voices the Commissioner's contention that Microsoft's proposed royalty fees are unreasonable because they fail to "reflect the market valuation of comparable technologies." The statement did not go on to list any other companies who provide interoperability protocols for Windows. In Microsoft's response this morning, Brad Smith cited a PricewaterhouseCoopers analysis that concluded Microsoft's proposed fees were 30% lower than market rates.

Update ribbon (small)

12:15 pm ET March 1, 2007 - In response to BetaNews' inquiry, European Commission Spokesman on Competition Jonathan Todd reassured us that the EC "is not challenging the validity of the patents" (emphasis his).

Todd cited a paragraph in this morning's EC press release which acknowledges Microsoft's existing patents. With regard to the royalty licensing tier Microsoft proposes called "All IP Agreement," which bundles technologies Microsoft claims are either patented or otherwise confidential, the press statement reads:

"The Commission has assumed that the existence of patents indicates some associated innovation, although third parties remain free to challenge Microsoft's patent claims before an appropriate court or to implement software that, in their view, does not infringe the patented technology. In any event, the Trustee's analysis is that most of the information relates only to solving problems specific to Windows, and will not improve the functionalities of the licensee's own operating systems. The Trustee has also provided evidence to the Commission that comparable technologies to these were provided royalty-free."

The reference to "the information" in the above paragraph appears to relate to information that monitoring trustee Dr. Neil Barrett has ascertained in his analysis of whether anyone could effectively argue the innovativeness or originality of Microsoft's protocols. "It is on this basis that the Commission considers that the current royalty rates are unreasonable," Todd told BetaNews.

However, a paragraph preceding the one Todd cites quotes Dr. Barrett specifically as having concluded "the information" indicates little or no innovation on Microsoft's part. "All of the described features [in Microsoft's 160 patent claims] were considered either to have been Microsoft implementations of prior developments by others, or to have been anticipated by prior developments and to be immediately obvious minor extensions to that prior work," Dr. Barrett stated.

That particular conclusion appears to be an open dispute of Microsoft's claims of originality. So if the EC doesn't plan to directly challenge Microsoft's patents, it appears willing nonetheless to support the efforts of others who may make that challenge privately.

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