Brad Smith Keynote: Open Source Business Conference

Remarks by Brad Smith, Senior Vice President, General Counsel, Corporate Secretary, Legal & Corporate Affairs, Microsoft
March 25, 2008
San Francisco, Calif.

BRAD SMITH: Thank you. I really do appreciate the opportunity to be with you here this afternoon.

There are a few things I wanted to talk about, but before I say anything else, I do want to say this: We at Microsoft respect and appreciate the important role that open source software plays in our industry. We respect and we appreciate the passion and the great contribution that open source developers make in our industry. We respect and we appreciate the important role that open source software plays for our customers, customers who almost always have heterogeneous computer networks with software and hardware and services that, as you all well know, come from multiple vendors.

That is not what you have always heard from us, and I recognize that. But I did want to start by saying that. And what I wanted to do in the 30 minutes that I have is talk a little bit about three things. One is to talk a little bit about where I and where we and Microsoft see the industry going and where we have the opportunity to go. And then I want to talk about two things that I think are important for all of us as we try to go there. One is interoperability, and the other is intellectual property.

Let me start with where I think we are as an industry. It is a big world, and it is a diverse world. In a lot of ways when I think back to where we started as a company and where I am sure many of you started when you first got involved in this industry, some of the great dreams that we had have started to come true. We dreamed of a diversity of computer devices, and today we have them. There are small computers that are in our pockets. There are computers in our living room and on our desktop. There are computers that make up servers and there are still important mainframe computers as well. Devices have become more diverse.

Services have become more diverse. Nothing can underscore this the way the whole Web 2.0 phenomena has as well.

And I also think that, frankly, business models have become more diverse. And I think it is really hard for us to think together, to talk together, about where our industry might go without thinking a little bit about the diversity of business models we now have.

There are all sorts of ways to categorize business models, and there are probably several people here who can do a better job than me in doing this. But from where I sit, I think that we really have three fundamental business models in the industry today, and a lot of variance or subroutines, if you will, on those three.

I will start with the one that we obviously have at the heart of the biggest part of our business, which is the business model that I will call direct monetization. We invest money, we hire engineers, we do R&D, we create products, and we license those products for revenue, revenue that exceeds the cost of creating them. We directly monetize our investment in that way. It has been very successful for us and many other companies in our industry.

It is important, I think, for even those of us who rely heavily on it to keep in mind that it wasn’t the first business model for software. Maybe it was the second. It definitely wasn’t the first.

The first business model was indirect monetization. If you look back at mainframe computers in the ’60s and the ’70s, IBM, Burroughs, the others, they gave away the software for free, and then they monetized it through sales of hardware and services.

At that time, quite differently from today, the software that the mainframe companies provided ran only on their own hardware. So they had a clear vision on how to monetize it, but they did it in an indirect way. And even though people like Bill Gates and a lot of others created a direct monetization model in the ’80s, the indirect model never went away. We at Microsoft used it in many ways at many times in our history, sometimes in small ways. We sell hardware. If you need another copy of the software for your keyboard, no problem: it is free. That is a small example.

But we have done bigger things as well. We have used indirect monetization also. We have done it with things like the Messenger product or the media player product. There are lots of software products that people today use that companies may provide for free. They may provide them at a loss, and they indirectly monetize their investment, sometimes through hardware, sometimes through software, sometimes through services. Indirect monetization is alive and well.

And then this decade we have seen the third business model emerge, and I think it’s really been one of the most impressive business model innovations of this decade for our industry. That is ad-funded software. Obviously in this model companies provide the software and they don’t expect the user to pay them anything. But they expect to sell ads to someone else that their users will see. And they use ad-funded software as their way to monetize and recoup their investment.

So we have evolved into a world where we have three business models. What will the future hold? At bottom, I don’t think any of us has a crystal ball that can look so far into the future that we can safely predict what the future is going to look like three or four decades ahead. I will venture to guess, however, that we are going to continue to see multiple business models. And just as the world is big enough for diverse models for developing software and diverse models for distributing it, it is big enough for diverse business models as well.

The interesting thing to me about these different business models is something that we never really talk about. And it is interesting to step back and ask oneself why. At a time when we talk about open source this and proprietary that, you know what? We all do software. We all do software. We are all part of the same industry. We are all part of one industry that today has many diverse parts to it.

And regardless of who you talk to or in which part of the industry, one thing that I think people quite rightly have in common is some pride about what we have done for the world. I have had the pleasure and I have had the privilege of spending almost two decades being a lawyer working within this industry, and there is no other industry I would have wanted to work with. I think we have delivered more great things for the world in the last two decades than most people have the opportunity to deliver in a lifetime. And there is so much more ahead of us. And I think the interesting thing to ask ourselves is how much more we could do if we found more ways to collaborate across the borders that all too often seem to divide us.

When we ask ourselves what can we do for education, where I think computing has just scratched the surface, or healthcare where information technology maybe hasn’t even really scratched the surface, there is really much more opportunity ahead of us. And it is worth our thinking both about what divides us and about the things that we share in common.

Now, Matt said on his blog, “I hope Brad Smith doesn’t come down here and give us a bunch of platitudes.” And in keeping with that spirit, I think it is important to talk about what it would take. What are the things we have in common? What are the things that are different about us? How do we address them?

I would like to focus on two. The first is interoperability. The truth is if you look at interoperability in our industry I don’t think you will ever find an example where the market leader was the leader in pushing interoperability forward. That is not the way it has tended to be. And we’ve been on both sides of that fence many times.

Yet it is also clear that one of the big information technology trends of this decade is interoperability. It is interoperability that is being driven by customers. I was sort of excited when I walked into the hotel this morning because I had forgotten and then I remembered that the last time I was in this particular room was almost exactly four years ago to the day, when Steve Ballmer and Scott McNealy stood up and said, “We are moving beyond the past. Because fundamentally we both get the same thing: customers are in charge. And customers want us all to work better together.”

We have certainly done a number of different things at a number of different times, and personally I feel that one of the important things was done about six weeks ago. It was on February 21st. We articulated principles around interoperability, principles that we decided we want to use to guide where we go in the future. And believe me, I absolutely get it that ultimately what the world wants to see are not just words but deeds. People measure you by what you do. People will measure us by what we do.

And yet I’ll say that words also matter, especially when you are prepared to stand up and say, here are some things by which you can judge us. And this is what we did.

Now, one of the key pieces in my view was the step we took with respect to communication protocols, the protocols in our high share products. Now, from where we sit  and I know there are many of you who may have a different view — we think that there is an important role for protocols that are based in industry standards, and we want to do a better job in that area, and we believe that there is a role for proprietary innovation in protocols as well. But we also recognize that when it comes to proprietary communications protocols there were some new steps that were important for us to take. So we took them.

We said the specifications that we have created will no longer be secret. You will no longer need to get a license to get them. You will no longer need to pay us to see them. They will be free. They will be posted on the Web. And everybody can look at them and evaluate them and use them if they wish, a big change compared to where we had been before.

And I think sometimes people underestimate the magnitude of that kind of step. It was a big step.

We also recognize that there are some patent issues that need to be thought through with the proprietary protocols that we have. And we described in these principles what we were doing in that area and, to be honest, most of what I read in the press — in fact, almost everything that I read – in the 72 hours after we announced it was just confused. It is a complicated subject. So I did want to spend a minute on it here. If you have more questions I would be happy to try to answer them in the Q and A.

We said, look, we have got to find a way to make this work from a patent perspective, so this is what we will do. We will create this promise. It is a promise that came out of our discussions with the European Commission in October and it had its roots earlier than that in a variety of other places. We said, look, if you are an open source developer, it doesn’t matter if you are developing the software for free. It doesn’t matter if you are getting paid. It doesn’t matter if you are a company and you are doing commercial open source development. You don’t need a patent license for the development work for these protocols. You don’t need to think about our patents with respect to the development work.

If you distribute your software that has our implementation on a noncommercial basis when you are done, that doesn’t require you to think about our patents either. If, however, you are a commercial company and you start to distribute the software on a commercial basis  and there is a precise definition of it which basically comes down to making money directly or indirectly from the distribution of software  then once you take that step, then we ask you to ask yourself whether you need a patent license. And if so we are prepared to talk and provide information on which protocols have patents that apply to them, and we’ll make it cheap, with very low royalties.

So we are trying to find a way to do what we still believe in, which is having proprietary innovation in this space, and yet create ways to work together across the industry in a manner that might not have been there before.

And we took other steps that we have talked about in these principles as well. There are steps related to file formats and data portability and commitments about our own creation of open formats – new technology in Microsoft Office so that any format could go plugged in now or in the future with a default and a variety of other steps.

And we also tried to underscore the message that we get it: we know that when it comes to interoperability, sometimes the last 2 percent is the hardest 2 percent. Even if you have the best technical documents in the world, there is no substitute for getting good engineers in a room, in a lab, or some other setting, and just giving them the opportunity to work together. If there is one thing I have learned from my work over the last decade, it is that two engineers can solve a problem a lot faster than a thousand lawyers. So let’s create opportunities for engineers to work together.

We’re hoping that these steps move us forward. And we do so understanding that this is an ongoing process that needs dialogue. We don’t claim to know everything. We don’t even claim to be the smartest folks who happen to live in Redmond, Washington, but we do want to make strides forward. And that does require conversation and dialogue, and that is the kind of discussion we hope we can have.

We also recognize that if we are going to make progress on interoperability and if we are going to really realize the potential we have as an industry, we do need to have a direct conversation about hard issues. And let’s face it, one of the harder issues has been intellectual property or, more particularly, patents. Patents have been a much harder topic than copyrights or trademarks, for example.

So I wanted to spend a couple of minutes before concluding to share some thoughts on the patent topic. We have tried to move forward over the last two years with really four principles in mind. And I thought I would share these principles with you, or concepts, if you will. And I know there are some of you that are going to have a different view on some of them. And that is okay. It is a big world. But I wanted at least to give you the benefit of having a broader understanding of what we are thinking about.

Number one, we believe in the benefits that a well functioning patent system creates when we are all able to adhere to it. I recognize that there are a variety of views about patents for software. Some people think that they are not valuable; some people think that they are. We can all probably agree that having higher quality standards for patents would be a desirable thing.

We have been a voice  I personally have been a voice—for patent reform in Washington, D.C. We live on both sides of the patent fence every day. We have more patent lawsuits pending against us than any other company in our industry. We spend more money defending patent lawsuits than any company in our industry. We see first-hand many of the problems that exist in our patent system.

And yet I will say we still believe in the benefits and the value that a well functioning patent system creates. That is the first concept that guides us.

The second is this: we believe in the importance of building a bridge that makes it possible for the different parts of our industry to work together. We believe it needs to be a bridge that respects the diversity of different business models. We believe in a bridge that is scalable, that is affordable, that is workable, and that doesn’t try to move people from one island over the bridge to another but let’s everybody do what they love to do and respects that.

That is a hard bridge to build, and yet I will say I believe today more than ever that it is a bridge we need to build. And I very much value the work and the conversations we were able to have at Novell when we started to build that bridge in November of 2006. And I am pleased with the bridges we have been able to add with other companies in our industry. I am pleased with the conversations that we have had with regulators, even in Europe, about how to build that bridge.

Is the bridge finished? Is the perfect bridge already among us? There is a lot of room for more dialogue, more opportunities to learn from each other. But we do believe in this second concept: that a bridge that can span different development, distribution, and business models is fundamentally in the interest of our industry.

The third concept that has really guided us is a point of view that we heard loudly and clearly when we talked to others in the industry, especially customers. And that concept is this: we believe that patents are best sorted out by industry leaders so that developers and customers don’t have to deal with these issues themselves. We as industry leaders should take it upon ourselves to sort these things out.

When we worked things out with Novell, we did it with an eye towards succeeding in ensuring that the developers who were creating the software for Novell would not have to worry about this set of things, nor would their customers. And the same thing was true for Microsoft and its customers. They wouldn’t have to worry about Novell’s patent or portfolio, and our employees would not either. I think that there is a role and an opportunity and I will even say a responsibility for industry leaders to continue to focus on how best to address this issue.

The last thing that I think is applicable here is a concept that I have found applicable everywhere we have had differences in our industry—and I am the one who negotiated with Sun Microsystems, with RealNetworks, at times with IBM, with Novell, with lots of companies where we haven’t necessarily started by seeing eye to eye. If we are really going to make progress, everybody needs to be prepared to make some compromises along the way. It is just not realistic for anybody to think that if only the other side will see everything my way, life will be good. We have the opportunity to do more together, but that does require that we go forward in a real spirit of not just talking with each other but listening to each other and finding ways to make things work.

If we are going to get to a point where I believe we have the opportunity to get by, say, the end of this decade, and really make some substantial progress in addressing patent issues, it requires that kind of spirit for us to move forward. We have tried to bring that spirit to the discussions that we have had with other companies. And it is that kind of spirit that I hope we will have the opportunity to bring to more discussions with more people in the future.

The last thing I would like to leave you in concluding is this: I found myself, a week ago, in one of our internal meetings, frankly thinking a little bit about this meeting and who the heck had signed me up for 60 minutes of Q and A, but at the same time I was listening to a presentation by Bill Gates. And I saw Bill show a slide with a title that I have seen Bill show many times in my fourteen-and-a-half years at Microsoft. It is a title I will miss, at least from Bill, once we get to July.

It was called “The Magic of Software.” It wasn’t the magic of Windows software, it wasn’t the magic of Microsoft software, and it wasn’t the magic of proprietary software. It was “The Magic of Software.” And he talked about all of the things he had seen software accomplish to make the world what I think we all believe is a better place over the last three and a half decades. And then he talked about all of the opportunities we had not yet begun to realize.

I hope if nothing else unites us across this diverse and sometimes passionate and contentious industry, there is this: we all believe in the magic of software. It is what gets us up in the morning. It is what keeps us up at the office or in front of a computer somewhere else late at night. We have a lot more we can do together. If we look our problems squarely in the headlights and talk to each other honestly about how we might build some more bridges to address them, I think we have a lot more magic that we can unleash.

Thank you very much.

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