Thursday, May 27, 2010

Fitting Open Source Pieces Into the Inbound Licensing Puzzle

The decision to bring outside technology inhouse is an important one for technology companies big and small.  It requires a clear strategy that provides the greatest benefits at minimum risk exposure. Though open source issues are often singled out as a unique case, they should be treated as but one facet of a company's broader inbound technology strategy.

Companies are founded for the express purpose of pursuing a specific vision, and technology companies do this by creating intellectual property. Inevitably, technology companies reach a point in which their in-house development resources cannot achieve company goals at a reasonable cost. That is when they consider bringing in outside technology either through an acquisition or a licensing arrangement. The benefit of an acquisition is that the acquired intellectual property can be treated as internally developed technology (with some important caveats, of course).

Inbound Licensing Risks
The other option is inbound licensing. While inbound licensing can be used to quickly achieve technology development goals, it can also introduce significant risks. Some important risks to consider in designing an inbound licensing strategy include:

  • Third-party dependency - By choosing to license technology rather than build or acquire it, a company risks being dependent on the technical knowledge and intellectual property rights of the licensor. This means the company must rely on the licensor's assessment and representations as to intellectual property rights. The company also might not have the expertise to support the licensed technology, which would require an additional expense.
  • Usage Limitations - A company's strategy for inbound licensing should always include obtaining rights as close to ownership as possible, including regarding use of source code. Unfortunately, few licensors are willing to grant such broad rights and the real difficulty for the licensee is to determine what restrictions are acceptable. Term limits and termination rights might also be considered usage limitations in that ending the right to use outside technology can be detrimental to a company's product plans. It can be difficult to create a one-size-fits-all policy on usage limitation because each use case will likely be different.

  • Lack of differentiation - Unless a company obtains an exclusive license, any technology it licenses could also be licensed (or even acquired) by others, including by competitors. As a result, a company should consider whether to develop different inbound licensing strategies for technology based on whether it is a critical feature for customers.

  • Sales compensation complexity - A company that licenses technology might distribute it as embedded in one of its own technologies, or as a separate standalone technology. The latter case in particular can create difficulty in setting sales compensation. Sales incentives designed to encourage complete solutions that include outside technology can easily and unintentionally be perverted to drive sales of the outside technology to the detriment of the company's own products.

  • Intellectual property infringement - An inbound licensing strategy should be built on a license agreement template that includes broad warranties and indemnification rights for intellectual property infringement claims along with uncapped liability on such claims. This eliminates much of the additional risk inbound licensing introduces as compared to internal development. However, indemnification rights and uncapped liability are only as good as the solvency of the licensor.

  • Fees - The most tangible impact of licensing outside technology is the cost of doing so. A one-time fee is clearly better than less predictable royalty fees. However, companies should not underestimate the cost of maintaining a development team to create similar technology inhouse or assume that inhouse development always provides a cost advantage.

Adopting the wrong strategy could have a serious negative impact. Not only could it result in significant monetary loss, but it could also impede internal innovation, reduce product quality, slow time to market, or impact other matters that might hurt customer satisfaction. Smaller companies might even lower their attractiveness as a target in an acquisition, their value as a target, or their value in an initial public offering. Companies should also remember that a strategy's deficiencies might not be evident for years. They often show up at critical times, such as when a company changes its business models, or achieves mass adoption of a product that depends on a third-party technology.

Open Source

You'll note that I haven't mentioned open source. Many of the widely used open source technologies present minimal inbound license risks. For example, they are typically free, embedded components without license limitations. In addition, third-party dependency is often not an issue because one of the primary purposes of open source technology is freedom from vendor lock-in. On the other hand, the broad availability of open source technology means that it often is better suited for basic, foundational features rather than differentiating features. Open source licenses also lack any guarantees or protections regarding intellectual property rights and infringement claims. In many cases, a commercial technology provider will offer support or a commercial license to open source technology, which subjects it to the same type of analysis with regard to the risks above. In short, though the mix of benefits and risks might be different with open source components, a single inbound license strategy can easily accommodate use of open source.

Role of Legal Advisor
While an inbound license strategy is not necessarily the domain of a company's legal advisers, lawyers can play a significant role in designing and implementing the strategy. In large companies, a business development function might own the inbound license strategy, which would leave the lawyers drafting inbound license agreements with the role of ensuring consistent implementation on a deal level.

By contrast, small companies might not have separate resources for these types of business development activities. In fact, small companies might be so focused on chasing revenue that they might not factor in the long term risks of an inconsistent inbound license strategy. In those scenarios, lawyers can play a critical role in implementing a rational approach by reminding their clients of the long term risks inherent in inbound licensing.


Companies of all sizes should develop and frequently review their inbound license strategy to ensure it aligns with their short- and long-term development needs. The strategy should evolve as a company grows and its development and business priorities change. Companies should also ensure that at least one functional group within the organization is tasked with implementing or enforcing that strategy. This could either be a dedicated internal deal team like a business development department, or the lawyers that work on inbound licensing deals. While open source might have a unique mix of benefits of risks, it should still fit neatly within the chosen inbound license strategy.