Microsoft, Foxconn locked in royalty feud & neither side wants to back down

'Microsoft should be going after Chinese smartphone brands including Huawei for royalties,' Foxconn Chairman Terry Gou said

A lot has changed at Microsoft Corp. in the five years since Satya Nadella took over as chief executive officer. But sometimes the past comes roaring back, this time in the form of a patent suit that has gotten nasty.

Microsoft last week sued Hon Hai Precision Industry Co. for failing to pay royalties on intellectual property owned by Microsoft as part of a 2013 deal. Microsoft says Hon Hai, which is also known as Foxconn Technology Group, owes it missed payments and interest. In its filing with a California court, Microsoft alleges that for the past three years, Hon Hai hasn’t submitted the royalty reports required by the 2013 agreement and has refused to submit to an independent audit, which the agreement stipulated in the event of a dispute. 

Foxconn’s billionaire chairman Terry Gou earlier this week accused Microsoft of a personal attack on him and his company, terming it a “wrongful” attempt to extract royalties on Android mobile operating software. While Hon Hai is the party named in the lawsuit, Hon Hai only makes iOS devices, and it is Foxconn's Hong Kong-listed unit FIH Mobile Ltd. that makes Android phones for Huawei Technologies Co., Xiaomi Corp. and other vendors, according to Gou and FIH CEO Calvin Chih. 

The amount in question is not significant, according to a person familiar with the dispute who asked not to be identified because the details aren’t public. But neither side wants to back down. Gou doesn’t want to pay and Microsoft wants to make a point that a deal is a deal. 

The whole kerfuffle is a vestige of an older Microsoft strategy to amass patents and intellectual property and generate a revenue stream by licensing various bits to other technology companies. The architect of that strategy, Marshall Phelps, even wrote a book about it in 2010, intended to help other tech companies profit from his experience. His successor Horacio Gutierrez took the practice one step further as he began to file suits against companies including TiVo Inc., Salesforce.com Inc. and Motorola Mobility Holdings Inc. alleging unauthorized use of Microsoft’s patents. (Gutierrez, now general counsel at Spotify Technology SA was also in the news this week for asking the European Union’s antitrust agency to probe Apple Inc.)

Back then, one of the most profitable areas for Microsoft was royalty agreements with makers of Android devices — it struck dozens of intellectual property licensing deals from 2010 to 2014 with companies such as Samsung Electronics Co. and HTC Corp. In 2012, Microsoft said that 70 percent of Android devices were covered by such agreements. The following year, analyst Rick Sherlund estimated the company made $2 billion a year from Android phone sales. This isn’t the first time such an agreement has led to open legal dispute with another tech firm. Microsoft sued Samsung for non-payment in 2014 and settled the suit the following year. 

Even Gou’s comments sounded like they dated from 2013 — “Microsoft is falling behind in the smartphone era faced with the rise of Android so now it is adopting such a bad strategy,” Gou told reporters Tuesday. “I really sympathize with them.” Microsoft three years ago admitted defeat in smartphones — at least in hardware and operating systems — and stopped making them.

Microsoft has also re-upped some of these deals more recently, including renewing one with Wistron Corp. in 2016. But under Nadella, Microsoft has largely taken a different approach, striking fewer intellectual property licensing deals. Then last year, the company made a library of 60,000 patents available to the open-source patent group Open Invention Network, which is a pool of patents from many companies that are designed to help open-source companies fend off lawsuits.

“Microsoft has always vigorously protected its IP, and this Foxconn suit is related to the Android strategy that Redmond enacted a decade ago,” said Dan Ives, an analyst at Wedbush Securities. “In this open-source world, Microsoft has to play nice in the sandbox but also defend its IP, which is why the Foxconn suit is important. We do not see Microsoft backing down on this one.”

Microsoft said the suit doesn’t indicate a shift in its commitment to open source, but it expects agreements to be upheld. The company declined to disclose terms of the deal saying they are currently sealed by the lawsuit process. Microsoft also contracts with Foxconn to make the Xbox gaming system.

“Microsoft takes its own contractual commitments seriously and we expect other companies to do the same. Today’s legal action is simply to exercise the reporting and audit terms of a contract we signed in 2013 with Hon Hai,” the company said in a statement when the suit was filed. “Our working relationship with Hon Hai is important and we are working to resolve our disagreement.”

Even if the deal doesn’t reflect Microsoft’s current focus, it still wants to get paid. And that’s where Gou has a problem. 

"Microsoft should be going after Chinese smartphone brands including Huawei for royalties," Gou wrote in a Facebook post shortly before his public outburst on Tuesday. Instead, he added, the U.S. company is pressuring Taiwanese contract manufacturers to pay for their customers so Microsoft can secure royalties without angering the Chinese public and companies.

Bloomberg