Why Google And Android Must Deal With The Mobile Protection Racket

It’s kind of amazing to consider that in just three short years, Google (NSDQ: GOOG) found its answer to critics fond of the “one-trick pony” slur with Android, currently the world’s most popular mobile operating system and the vehicle for Google’s ambitions in mobile advertising and application development. But now that Android is on top of the world it is faced with the greatest crisis of its short life as barbarians armed with patents mill at the gates.

Forbes this week revisited an amazing anecdote from Gary Reback, the attorney best known for hunting down Microsoft (NSDQ: MSFT) in the 1990s and harassing Google at present, from his days at Sun as a young attorney. When confronted by lawyers from IBM seeking licenses for patents that Sun believed didn’t apply to any of its products, an IBM lawyer referenced its horde of around 10,000 patents and supposedly said: “Do you really want us to go back to Armonk [IBM headquarters in New York] and find seven patents you do infringe? Or do you want to make this easy and just pay us $20 million?” Sun paid.

Following Google’s inability to secure perhaps the biggest block of mobile patents ever put up for auction last week, the Android partners who have been key to its success are going to start seeing the mobile-computing equivalent of IBM–Microsoft–more and more frequently. Even before the Nortel patents were put in play Microsoft had launched a mobile strategy aimed at convincing Android partners that Android wasn’t really free: there was a patent-licensing toll that just hadn’t yet been collected.

But now that Microsoft, Apple (NSDQ: AAPL), Sony (NYSE: SNE), Research in Motion (NSDQ: RIMM), Ericsson (NSDQ: ERIC), and EMC control the 6,000 patents auctioned off by Nortel for $4.5 billion, Google is scrambling to figure out what to do next. The company declined multiple interview requests about the aftermath of the auction and the plan going forward, but a few interesting details emerged this week regarding the auction and its impact on Android.

Class War–Google has a way of stirring resentment among its peers, sort of like the know-it-all kid in high school who was also quarterback of the football team and just biding his time before waltzing into Harvard. That was evident in the aftermath of the auction, when *Reuters* posted an account of the bidding process fueled by anonymous quotes designed to make Google look as silly as possible, claiming that Google was “either supremely confident or bored” in making bids equal to famous mathematical constants and was unwilling to go above $4 billion.

While a source familiar with Google’s auction strategy confirmed that the company showed its irreverent side in the auction process, the source also said there’s no way Google took the auction lightly. It’s not like Google submitted three bids equal to mathematically significant numbers and hit the bar: contrary to the Reuters (NYSE: TRI) report, Google and Apple exchanged bids in $100 million increments until Apple (backed by the consortium) set the high-water mark at $4.5 billion during the 19th round of bidding. That account was verified in a report (click for PDF) filed by a monitor from the Canadian court system that was made public on Wednesday.

High in the mountains of Idaho, Google Chairman Eric Schmidt told reporters at the Allen & Co. conference this week that “the price exceeded our value threshold,” which is a little curious considering Google was reportedly ready to pay $6 billion for Groupon, a dubiously profitable company slated for an initial public offering at some point later this year.

The same source said that Google walked away when the bidding reached a point where it no longer made sense, sort of how buying real estate in the Bay Area can become a game of chicken when even the starting price far exceeds any sensible number. That may have been a mistake: without the patents, Google and its Android partners are back to square one, besieged on all sides by deep-pocketed and well-patented competitors who want a piece of its success for their own. Sometimes coveted objects are worth what people are willing to pay for, not necessarily what the algorithm says they are worth.

Division in the Ranks?–There’s no question that Android was a lifeline to a smartphone industry caught flat-footed by the debut of the iPhone in 2007. Companies like Motorola (NYSE: MMI) and Samsung, which had tried and failed to create their own mobile software for years, found themselves with the option of a good-enough mobile operating system that would allow them to design their own hardware, software, and services without having to do the heavy lifting. And lower-cost handset makers and wireless carriers were excited to be able to offer smartphones at competitive prices.

But the life of an Android partner isn’t necessarily easy. Application developers are in love with iOS and tend to treat Android as a necessary second-class citizen. Handset makers find themselves in the shoes of the Dells, HPs, and Gateways of the world a decade ago, who were dependent on Microsoft and Intel (NSDQ: INTC) to come up with breakthroughs to which they could add their own twists. Their attempts to set themselves apart from the pack can cause problems as Google tries to maintain compatibility, causing tension. And for all that, they’re not making much money.

And now those partners also have to deal with advances from Microsoft, Apple, Oracle, and perhaps the other members of the Rockstar Bidco consortium that won Nortel’s patents. HTC was derided by some for capitulating to Microsoft and signing a license deal a few years ago when this strategy first emerged and others, like Motorola, chose to fight. But now it looks smart, as Microsoft moves from town to town pointing toward its treasure chest of patents and asking for larger and larger checks made out to Steve Ballmer.

If Samsung cuts a deal, it will be hard for companies like Motorola and Barnes & Noble (NYSE: BKS) to argue that the patents are invalid or that their products don’t infringe when so many similar companies have endorsed the patents by signing a license. And even if Samsung does reach an agreement with Microsoft, it has another huge challenge in fending off Apple’s aggressive legal maneuvering.

So at a certain point, an Android partner must think very carefully about their operating system options if they’re going to have to pay something per handset one way or another. Both Microsoft and Hewlett-Packard (NYSE: HPQ) are shopping mobile operating systems these days, two companies backed by decades of patents, while Google offers basically no cover for its partners when it comes to patents. Companies that have made large investments in Android are not going to switch abruptly now that Android is the world’s leading mobile operating system, but they may start building Windows Phone 7 or WebOS businesses on the side, which could arrest future growth potential for Android and deny Google a chance to influence the development of mobile computing as much as it would like.

Plan B–It’s perhaps a bit of a stretch to call this a “plan,” but Google is essentially throwing open its arms to the intellectual property community, willing to listen to just about anyone with mobile patents for sale or rent. It’s going to have to get patent coverage somehow, and it doesn’t seem to care if that’s through one-off deals with small companies, large acquisitions, or even patent licensing deals with its foes. It’s also hoping that federal regulators change the terms of the deal while they review it, similar to how a patent sale involving Novell was altered by the Department of Justice following complaints, and has a pipe dream that Congress may stop playing chicken with the debt ceiling and embrace real patent reform.

This is a crucial summer for Android. It rose to prominence as the anti-iPhone, but has managed to unite Apple, Microsoft, and Research in Motion in a consortium of competitors who are trying to hit Google in its most vulnerable spot.

As Reback related years ago, modern patent litigation isn’t really all that different from a protection racket: you pay, or you get hurt. If Google wants to keep the Android miracle rolling, it’s going to have to find a way to offer its own brand of protection before its partners opt for peace of mind over loyalty.