Tessera develops microtechnologies used in consumer electronics. It licenses its innovations to manufacturers through "carrot licensing" rather than litigating as a "stick". Tessera faces challenges monetizing its new fanless cooling system as potential customers in China are more prone to avoid paying licenses. Porter's five forces analysis shows moderate buyer power and a weak appropriability regime threaten profits. Recommendations include that Tessera may need to change from licensing to integrating manufacturing to control technology and avoid copying that does not generate revenue.

1. Case study: Carrot and stick - Getting
paid for innovation at Tessera
Technologies
Carles Gonzalez Debart
Innovation Management, University of Strathclyde, Glasgow, UK
Introduction
Tessera is an innovative developer of micro technologies that are widely adopted by the
consumer electronic industry. Their solutions can be found in mobile phones, notebook
computers and in general in many integrated circuit manufactures. Tessera doesn’t
manufacture by itself, it implements what is known as “carrot licensing”, which consist in
patenting 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 the
capabilities needed to manufacture their inventions. Contrary, what was so-called “stick
licensing”, which stands for the use of litigation as a way to extract license agreements from
those companies using other’s technology without the payment of royalties, had been lately a
more used approach for Tessera, as was exposed by Hank Nothhaft (CEO of Tessera
Technologies). In this case study we will analyse the situation of the company highlighting the
risks, threats and opportunities of their particular approach to innovation. First we will provide
an analysis of Tessera’s licensing model. Secondly, we will review the patent environment and
finally, we will deliver a set of recommendations for Tessera’s new innovation
commercialization.
Licensing model
Tessera had been applying its approach to innovation with success (carrot licensing) through
the 90s and early 2000s, having major clients in the semiconductor industry. Tessera licensing
model was based on selling its intellectual property, patens, know-how and trade secrets to
other companies willing to improve their technology. The selling cycle usually takes quite long
time, up to 18 months or more. Often the step were numerous and involved transfer of the
technology, pilot productions at Tessera’s facilities and in-house training. Once the production
started successfully at the client site, the revenue was not yet secured. It depended on the
number of electrical connections within the packages, the volume of the production and the
commercial success of the final assembled product. All of these facts were clearly out of
control from Tessera and often the revenue was not reached until many years after licensing.

2. The way that Tessera developed, and later on licensed their innovations can be easily
understood in the next example. When the Tessera Compliant Chip (TCC) technology, which
was a new approach to chip flexible packaging, was ready to manufacture it encountered some
problems. Although the product was promising and it really appealed the semiconductor
industry, they didn’t want to adopt such a radical change until Tessera would be able to
demonstrate reliability and manufacturability at high volume. Larger firms were concerned
about 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 to
develop the TCC technology, but mostly to convert it in a successful commercial product.
Several manufacture processes were created and improved, implying a vast portfolio of
additional patents, manufacturing know–how and trade secrets. With this, a couple of
licensees were obtained, but the big players were still resilient to adopt it. Tessera had to
invest in internal manufacturing to show them enough capacity. That contradicted with the
aim of licensing as a way of securing turnover; as the technology matured and more licenses
were sold to other manufacturers, they found themselves in the tricky situation of competing
with their own licensees.
But those were not the only challenges that Tessera had to face. In a very competitive industry
like the semiconductor is, where extremely high investments in manufacture capacity have to
be made in order to make profits out of low margin products, manufacturers were not
interested in quitting their assets to produce the new technology.
Some other problems faced by Tessera with this model were that revenues were directly
dependant from the ability to audit, monitor and collect royalties from the licensee, which
were expensive and time consuming. Furthermore, a high pressure for auditing was in
detriment with its licensee relationship. All taken into account, made Tessera not to fully
deploy 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 infringements
detected in detail. This was expensive and time consuming as well. If no agreement was
reached, litigation process was to be held in a court, normally favourable to the infringer. The
whole procedure could take several years for each single case, in which the infringer was likely
to keep on producing and selling the litigated product.
Tessera realised that the best strategy for TCC technology was to focus on customers in need
of small size, higher performance and high density, in other words, they targeted the high-end
sector. Potential customers were found in companies like Intel, Texas Instruments, DRAM
makers, etc.
Changes in patent environment
To understand infringements in patents we should first understand how patents work. Patents
are a legal formula which allows the inventor to exclusively make use of the invention for a
limited period of time instead of keeping them in secret. In that way, the everybody could

3. benefit from it, increasing the welfare of the society. Others different from the inventor could
make 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 was
infringed, injunctions were more or less automatic. Although the slow procedure of the
system, infringers generally paid finally the royalties or some kind of compensation instead of
dropping 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 and
offered a compensation of 450$ to be able to keep on using the Blackberry service. But
unlikely other cases were the compensation was the end of the lawsuit, NTP decided to keep
on and tried to enforce the injunction. The possibility of a shut down in the Blackberry service
was so critical that the U.S Supreme Court intervened to stop the injunction. That was the first
time that legal regulations were “bypassed” in the interest of the whole society. But that was
not an isolated case in which an injunction was refused for the public interest. MercExchange
was unsuccessful in the lawsuit with eBay. The reasons were that the court manifested the
intention of not stopping the growth of the business electronic payments. But what was even
more surprising was the fact that the court argued that MercExchange didn’t have any
intention of using their patent as they were willing to license it. From then on, if these kind of
sentences had to be the norm, Tessera’s business model based in licensing was seriously
threatened. Tessera didn’t want to fall into that group of organizations named “non-practicing
entities” 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. They
didn’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? Nothhaft
expressed then the fear of investing money in projects with high risk of monetization. He
pointed out as well that an increase of litigation cases would force Tessera to spend more time
and money in courts defending its innovations. This was especially critical on its latest
innovation, the fanless cooling system that amalgamated a total of 76 patents.
Recommendations for fanless cooling system commercialisation
In this section we will perform an analysis of Tessera’s new challenges for the fanless cooling
system 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 new
innovation. When the innovative fanless cooling system developed in-house was introduced to
the board of directors, they quickly realised that they were entering into a new kind of
costumer. The companies targeted were not big players in the semiconductor industry like
Intel, Toshiba or Samsung were, but a number of white-box manufacturers mainly established
in China, focused in the battle of price and not very prone to pay for intellectual property. That
was a new challenge for Tessera in his aim of getting paid for their innovations. Tessera was
confident that this new cooling system would be implemented in all laptops in a few years. On
the contrary, the confidence on whether it would be a profitable invention or not was still
unknown. Should Tessera modify its strategy for this new upcoming product?

4. To better foresee the attractiveness of the new market Tessera was entering with its new
product, Porter five forces analysis will be conducted and discussed:
1. Level of competition: despite being the IC industry very competitive, as we are analysing the
environment for a particular product (fanless cooling system), the competitiveness is low. The
product is very innovative and it didn’t have rivals yet. The only rival that Tessera could have
faced was a small private company (Kronos), that had made significant advances in electro-
hydrodynamics but was experiencing funding problems. Tessera took advantage from it and
acquired 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 in
the laptop industry. We could say that an old technology such as the fan could not be a
substitute for future miniaturized laptops, thus we could make the mistake of considering it a
low threat of substitutes. Nevertheless, low cost manufacturers are not usually interested in
quitting their assets to produce a new technology, thus the tradition fan system could still be a
substitute for many years.
3. Threat of new entrants: The threat of new entrants is relatively low. The technological
capacity needed to develop a project like this is high, so are the barriers of entrance in this
market.
4. Bargaining power of buyers: Moderate. Due to the particular business model of Tessera, the
buyers are the licensers, which can hesitate in adopting the new technology and acquiring the
new capabilities to manufacture. Some buyers thought as well that introducing other’s
electronics in their own products could imply problems on its own marketing. This could lead
into tight conditions that can put Tessera in a delicate situation.
5. Bargaining power of suppliers: As Tessera is licensing their product and not fully
manufacturing them, this force has low impact in the analysis.
6. Value chain analysis: value analysis tries to identify actions developed by the company in
order 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 value
chain is deployed not in whole lifecycle of the product (this is a task for the licenser) but in the
process of licensing. Tessera revenues are directly dependant from the ability to audit, monitor
and 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 Tessera
where in house training and know-how transfer for a better manufacturability.

5. 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&D
Internal 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 US
External 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.

6. Due to the weak appropiability regime in China (where most of the white-box manufacturers
are settled), the persecution of those infringements could be tremendously resource
consuming, putting Tessera in a tight position. Manufactures could even take advantage of the
cospecialized assets such as distribution channels, advanced manufacturability, etc. Even in the
case that Tessera would enhance their “stick licensing” capacities, it is not clear that the
outcome 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 the
product. It is a way to control spill overs in general, but for Tessera could be the way of
avoiding being copied and not taking any profit out of it. Adopting this new approach would be
a radical change, as contracting has always been the rule. Certainly in the past, contracting had
been beneficial for Tessera as it allowed to avoid the upfront capital expenditures need to buy
the assets to produce, distribute etc. But in this new environment of weak appropiability
seems 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 the
investment is major for the project in question, internalize could be the position if cash is not
constrained. 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 the
acquisition 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 time
required to position relative to competitors (we have argued before the thread of entrance is
low) is short, integration can be the right solution to choose.

7. Another tool developed by David J. Teece that can help use to make the decision is shown
below:
When the innovators and imitators are disadvantageously positions versus the owners of the
complementary assets (in our case licensed manufacturers) and innovator excellently
positioned versus imitators respect to commissioning complementary assets, the rule to follow
would be integration. This supports the outcome of the previous analysis and establishes a
change 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 organizational
change? Financial position is not shown in the case study, but assuming that it allows to buy
the capacity to produce in-house, there are still other facts to be discussed. One of the
strengths that Tessera can use to reinforce the strategy of integration is its previous
experience of manufacturing. As it has been seen before in the introduction, Tessera has had
to produce sometimes batches of new products to show to its potential costumers the
feasibility of manufacturing. Tessera could capitalise this manufacturing know-how in this new
product 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 that
way its creations) but externalises the distribution, marketing and sales can be the right path
to follow.