Facebook vs. Yahoo: Who's shaking down whom?

Suddenly, the winner of this fierce patent war between two of Silicon Valley's biggest names has become a lot less obvious.

Paul Sloan Former Editor
Paul Sloan is editor in chief of CNET News. Before joining CNET, he had been a San Francisco-based correspondent for Fortune magazine, an editor at large for Business 2.0 magazine, and a senior producer for CNN. When his fingers aren't on a keyboard, they're usually on a guitar. Email him here.
Paul Sloan
4 min read

Before Tuesday, the outcome of the patent offensive that Yahoo opened against Facebook last month seemed a foregone conclusion: Facebook would pony up a giant pile of cash so it would be free to get on with the more important business of going public and striving for world domination.

Now, the end game has become as clear as mud.

Facebook's countersuit, which it just filed, is more than a defensive move. In its lawsuit a couple of weeks ago, Yahoo claimed that Facebook violated 10 of its patents. Now it's Facebook that insists Yahoo violated 10 of its patents -- many of which, coincidentally, touch a huge swath of Yahoo's business.

A negotiating tactic? Most definitely, and it's a really strong one that likely has the top brass at Yahoo -- a company already beaten down and widely disliked across Silicon Valley for picking this battle -- nervous.

"Yahoo has clumsily picked a fight with an opponent who is a lot fiercer than they realized," said Paul Graham, the Y Combinator co-founder who sold his company, Viaweb, to Yahoo in 1998. "I'm impressed that Facebook is fighting back instead of settling to make the IPO easier, as companies so often do, and as Yahoo probably expected them to."

Erin-Michael Gill, the chief intellectual property office for MDB Capital, an investment bank that specializes in analyzing and valuing IP, said that Facebook's countersuit shrewdly goes after a broad swatch of technology.

"This is dead-on, exactly what Facebook is supposed to do," said Gill, who became deeply familiar with Yahoo's patent portfolio after assessing it for hedge fund manager Daniel Loeb last November. "They're responded really aggressively by filing a diversified complaint that covers a whole host of product and features. Facebook is not coming back with 10 patents around one technology -- it's 10 patents around a number of technologies."

He's someone worth listening to. When I spoke to Gill after Yahoo filed its suit, he laid out a case in which Facebook might actually try to buy outright a big chunk of Yahoo's patent portfolio outright -- a multibillion purchase that would arm Facebook against others that might make patent claims against Facebook while helping an ever-more-desperate Yahoo.

That hasn't happened, obviously, but Facebook did buy 750 patents from IBM last month -- and Gill says the belief among the IP community is that that was aimed squarely at its battle with Yahoo.

The assumption is that a number of those IBM patents are already tied-up in cross-licensing deals with Yahoo. Late last month, the Law360 newsletter fueled the rumor mill with a report that many of those newly acquired patents were licensed to Yahoo, offering Facebook some very large bargaining chips to press for an amicable settlement.

And if that's the case, Facebook's position is now even stronger as it goes into talks with Yahoo over this mess. Eventually, like a lease to an apartment, those deals expire and Yahoo knows full well that the new landlord isn't a friendly Big Blue but a ticked off Mark Zuckerberg and team.

Even so, Gill said Yahoo's patent portfolio is so deep and strong that he fully expects Facebook to end up cutting a deal in which it ends up paying Yahoo and directly licensing some of its patents. For its part, Yahoo today said that it has tried to negotiate with Facebook to no avail.

"Other leading companies license these technologies, and Facebook must do the same or change the way it operates," Yahoo said in a statement that shed no further light on any contact it has had with Facebook.

In Silicon Valley, patent battles are common. Often, patent infringement lawsuits turn out to be the opening stage of a negotiation between companies. In this case, Yahoo may be trying to extract some tribute, especially since the United States Patent Office has a widespread reputation for granting nearly everything that comes across its desk, noted Larry Downes, a consultant and adjunct fellow with the policy think tank TechFreedom.

"It's easier for them to say yes than no," he said. "Especially on software and business method patents where they have no expertise. They are measured on output. They expect the affected parties to work it out in court."

Easier said than done -- especially when one of the parties is armed with a lot of valuable patents. That represents potential value if it can make a credible case. But the reason lawsuits against successful companies aren't filed more frequently is that the litigation ends up costing a ton and diverting a company's attention.

"The reason we don't see many patent suits like Yahoo's is precisely that they are followed by countersuits like Facebook's," said Mark Lemley, a patent lawyer on the faculty at Stanford Law School. "Each side has plenty of patents, and each side can do damage to the other. Most of the time the result is a settlement with a cross-license, though once in a while it turns into a free-for-all like the smart phone patent wars.

The opportunity for Facebook to find itself embroiled in a lot of patent fights is high, especially considering its ambitions with mobile and seemingly every part of the Web.

"Nothing is off the table with these guys," said Gill. "They have said nothing less than they want to own the Internet."

Which, of course, wouldn't be a terrible thing for all those clamoring to get a piece of Facebook's upcoming IPO.

CNET's Rafe Needleman, Daniel Terdiman and Charles Cooper contributed reporting to this report.