“When Marshall Phelps took the job at Microsoft in 2003, many in the industry believed he was on a fool’s errand. The task of helping to transform the culture and business practices of Microsoft through the use of its intellectual property seemed impossible. Burning the Ships proves that Marshall is the unchallenged master in designing creative uses of intellectual property to enhance business performance. And through his collaboration with David Kline, they’ve accomplished something equally unique: a thoroughly entertaining and informative ‘can’t wait to get to the next page’ read.”

“Burning the Ships offers a dramatic insider’s account of how Microsoft used intellectual property to remake its business strategy and embrace the open source movement and the new open innovation world—with real-world benefits for large enterprise customers and chief information officers everywhere.”

“When Marshall Phelps talks about intellectual property strategy, business leaders would be wise to listen closely. More than anyone else in business today, Marshall understands how open innovation has changed the rules of the IP strategy game. It’s time we learned the new rules!”

“It’s easy to talk open innovation and collaboration but extremely difficult to actually implement it in any company. Phelps and Kline bring to life the painful realities and unexpected rewards of embracing this change in Microsoft. The important story, though, is not the challenge of changing course, but that other companies can reap similar benefits of accelerated innovation, stronger partnerships, and better corporate image by ‘burning the ships.’ Read it and ‘start a fire.’ ”

“Through the power of example and compelling firsthand accounts, the authors have conveyed many practical insights about how intellectual property can be harnessed in new and creative ways to achieve overall business objectives and enable new collaborations once considered unthinkable. This book is extremely readable and refreshingly devoid of the abstract jargon and theoretical frameworks plaguing many works on IP management.”

“Marshall Phelps is the internationally recognized leader in the use of intellectual property as a strategic corporate asset. He recognizes that long-term survival in the constantly evolving information technology industry requires a flexible and nuanced intellectual property policy. Burning the Ships shows business leaders how to develop one for today’s open innovation environment.”

“Marshall Phelps is the principal architect of two dramatically different but equally compelling examples—one at IBM and one at Microsoft—of how intellectual property can be a transformational business tool when thoughtfully used to drive business strategy. It is a critically important message that he and David Kline make understandable to any company seeking to learn how it is done.”

“Once again a book involving David Kline—this time in partnership with the formidable Marshall Phelps—has moved the IP revolution forward. The story of Microsoft’s open innovation efforts, led by Phelps, is fascinating and informative. But the book also provides a whole new level of understanding of the necessity of managing and fully leveraging intellectual property as a strategic class of business assets. Intelligent companies that follow this example will find that they can grow in ways not previously contemplated.”

Marshall Phelps is Microsoft’s corporate vice president for intellectual property policy and strategy and is responsible for setting the global intellectual property strategies and policies for the company. He also works with governments, other companies in the technology industry, and outside institutions to broaden awareness of intellectual property issues.

Before transitioning to his current position in 2006, Phelps served as the deputy general counsel for intellectual property in Microsoft’s Legal & Corporate Affairs group, where he supervised Microsoft’s intellectual property groups, including those responsible for trademarks, trade secrets, patents, licensing, standards, and copyrights. He oversaw the company’s management of its intellectual property portfolio, helping to grow the patent portfolio to approximately 55,000 issued and pending patents worldwide today.

Phelps joined Microsoft in June 2003 after a 28-year career at IBM Corp., where he served as vice president for intellectual property and licensing. Phelps was instrumental in IBM’s standards, telecommunications policy, industry relations, patent licensing program, and intellectual property portfolio development. Phelps also helped establish IBM’s Asia Pacific headquarters in Tokyo and served as the company’s director of government relations in Washington, D.C.

Marshall Phelps is also an advisor on intellectual property to the Japanese government, and executive in residence at Duke University’s Fuqua School of Business. He holds a bachelor of arts degree from Muskingum College, a master of science degree from Stanford Graduate School of Business, and a doctorate from Cornell Law School.

David Kline is a journalist, author, and intellectual property consultant who has earned a reputation for his unique ability to demystify complex IP issues and explain them in a clear and relevant manner to a broad business audience. His best-selling 2000 book, Rembrandts in the Attic from Harvard Business School Press, is considered a seminal work in the field of intellectual property strategy within corporate America.

As a journalist, Kline has covered some of the world’s most dramatic stories for the New York Times, Christian Science Monitor, NBC and CBS News, the Atlantic, Rolling Stone, Wired, and other major media. The first Western reporter to go behind the battle lines in Afghanistan in the 1979 to report on the developing anti-Soviet resistance war, Kline was nominated for a Pulitzer Prize in international reporting by the Christian Science Monitor that year and covered the war for a variety of major media over the next eight years. He was also the first reporter to uncover the 1983 famine in Ethiopia, as well as the first to document the failure of the U.S. drug war against the Bolivian “Coca Nostra” in the mid-1980s.

A highly regarded business writer, Kline has also written for the Harvard Business Review, Sloan Management Review, and Strategy + Business—three of the most prestigious U.S. management journals—as well as for Chief Executive, Business2.0, Wired, and other business and technology publications. He served as the “Market Forces” columnist for Wired’s early online magazine, HotWired, and the “NetProfits” columnist for the former Upside magazine. Kline has also been a commentator on public radio’s “Marketplace” business show as well as a frequent speaker before business audiences.

In addition to Rembrandts in the Attic, Kline is also the author of Road Warriors: Dreams and Nightmares Along the Information Highway (Dutton, 1995), and Blog! How the Newest Media Revolution Is Changing Politics, Business, and Culture (CDS, October, 2005). He may be reached at dkline@well.com.

This book was a bear to write. But thankfully, a great many people helped us to wrestle it into submission by sharing their thoughts and insights, brainstorming about the future, helping to explain what might otherwise have been inscrutable technological issues, digging deep into old files for critical facts or the dates of crucial events, and in general being forthright and often brilliant in their criticisms and suggestions.

Put another way, to even attempt to write a book about a subject as complex and multifaceted as the transformation of Microsoft requires more in the way of advice and counsel, criticism and support, than the casual reader might suppose. We are grateful for everyone’s help.

Brad Smith, Bill Gates, Nathan Myhrvold, Horacio Gutierrez, Lori Harnick, Mike Marinello, Susan Hauser, David Kaefer, Anne Kelley, Tanya Moore, Lisa Tanzi, Bart Eppenauer, John Weresh, Ken Lustig, Marty Shively, Tom Robertson, Tom Rubin, David Harnett, Dan’l Lewin, Jason Matusow, Atsushi “Yoshi” Yoshida, Susan Mann, George Zinn, Mark Murray, Mike Ensing, Tricia Payer, Tom Burt, Larry Cohen, Sanjay Sidhu, Rainer Kuehling, Jim Foster, Sam Medici, Dan McCurdy, Dick Gerstner, David Jones, Marti Murphy, Kathryn Foreman, Katie Carter, Georgia Barnes, and of course the amazingly resourceful Joyce Schnepp.

Additional thanks go to Masanobu Katoh of Fujitsu; Ruud Peters at Philips; Yoshihide Nakamura of Sony; Editor Joff Wild at Intellectual Asset Management magazine; Senior Associate Vice President for Development David Kennedy at Stanford University; and Professors Wesley Cowen and Ashish Arora at Duke University, Naomi Lamoreaux at UCLA, Iain Cockburn of Boston University, and Bo Heiden at Stockholm University.

We wish also to express our special gratitude to our editor at John Wiley & Sons, Susan McDermott, for her enthusiasm and insight; to our rock of an agent, the ever-supportive and highly prolific Jim Levine at the Levine/Greenberg Agency; to our friend and colleague Dan Burstein, for his perspective and wisdom about book writing and publishing; and to our tireless and masterful editorial assistant, Jennifer Powell.

Why should anyone care what happens at Microsoft? This was the first question my coauthor David Kline and I asked ourselves when we sat down to consider writing this book in the summer of 2007. Thankfully, among all the questions that we would face over the next year and a half, this one was the easiest to answer.

New technology, after all, is the beating heart of innovation and global economic growth. So when arguably the most powerful technology company on earth engineers a radical 180-degree change in its business strategy and practices—abandoning its single-minded strategy of go-it-alone market conquest in favor of industry collaboration, and opening up its vast technological treasure chest to other companies and individuals—it’s hardly surprising that this transformation should have effects far beyond the company itself.

Although Microsoft employs only 95,000 people directly, its influence stretches much deeper into the global economy. Nearly half of the 35 million people employed in the worldwide information technology (IT) sector depend upon Microsoft software or related services for their jobs. This includes 42 percent of information technology employment in the United States, 47 percent of Irish IT employment, and 44 percent of IT employment in Malaysia. And for every dollar of revenue that Microsoft earns, other companies in the global Microsoft “ecosystem” generate $7.79 for themselves. In 2007, in fact, they earned a staggering $400 billion from Microsoft-related products and services, and invested close to $100 billion in their local economies.

Given its huge footprint in the global economy, therefore, it’s no wonder that the recent goings-on at Microsoft should be the subject of speculation and debate among technologists, industry executives, regulators and policy makers, and of course the media.

Are the company’s new joint product development and other collaborative relationships with other firms boosting competition in the industry, spurring the rate of innovation, and speeding time to market for new products and services? Are the company’s new technology-sharing initiatives with local entrepreneurs all over the globe fueling the growth of national industries and economies? How was such an entrenched enterprise as Microsoft able to refashion its culture and business strategy in only a few years—and are there lessons here for others?

In one sense, though, all these questions can be distilled down to three key issues: For industry executives, has Microsoft become a good partner? For policy makers and antitrust regulators in the United States, Europe, and Japan, has this once-adjudicated monopolist become a good citizen? And for customers, is Microsoft’s new technical collaboration efforts with other companies producing better products and services that more effectively meet their needs?

Ultimately, these questions will be answered by whether Microsoft continues to be a successful and profitable enterprise. But perhaps a tentative answer may already be deduced from the fact that during the past six years more than 500 companies large and small around the world have chosen to sign technology-sharing and collaboration agreements with Microsoft, nearly all remaining antitrust issues with regulators worldwide have now been resolved, and new partners and customers are streaming into the global Microsoft “ecosystem” in record numbers.

The reader will naturally ask why Microsoft embarked upon what one analyst has called “the biggest change it has undergone since it became a multinational company.” Obviously, it was not because Microsoft had suddenly become some sort of high-tech Mother Teresa. To quote another analyst: “They’re not pulling lepers out of the gutter.”

No, the simple truth is that Microsoft was, is, and will forever remain an intensely competitive business whose primary goal is to make a profit for its shareholders by creating products and services that customers need. And it was for entirely business reasons that the company decided to change its approach.

Remember that at the start of this decade, Microsoft was on the defensive—beset on all sides by antitrust suits and costly litigation, and viewed by many in the technology industry as a monopolist and market bully. At the same time, the center of gravity of technology innovation was beginning to shift away from large corporate R&D centers to a more diverse array of companies, universities, and even individuals—with no company any longer able to accumulate by itself all the technologies and business competencies needed for success.

This was the challenge facing Bill Gates and other senior executives at Microsoft, and they correctly determined that the company’s old fortress mentality culture and go-it-alone market strategy were no longer suited to the emerging twenty-first-century business environment. A new culture and strategy would have to be created—one that relied to a much larger extent than ever before upon building mechanisms of collaboration with other firms so that Microsoft could add their technological strengths and market competencies to its own in order to achieve success.

Perhaps there is a parallel here in America’s abandonment of its unilateralist go-it-alone foreign policy of recent years in favor of a more collaborative and mutualist approach better suited to the fragmented, disorderly, and multipolar world in which we live. While the recent inauguration of a new U.S. president certainly gave new hope to people all over the world, the United States will ultimately be judged by its behavior, not just its words. The same is true of Microsoft as well.

To be sure, it would be a mistake to overstate the role that intellectual property played in the changes at Microsoft, or imply that other factors such as innovation policy or trends in technology development were not also important. But intellectual property did serve as the primary and surprisingly-sturdy scaffolding upon which Microsoft was able to construct a whole set of new business practices and relations with others in the industry.

In the pages that follow, the reader will gain extraordinary behind-the-scenes access to the dramatic struggle within Microsoft to find a new direction—to the high-level deliberations of the company’s senior-most executives, to the internal debates and conflicts among executives and rank-and-file employees alike over the company’s new collaborative direction, and to the company’s controversial top-secret partnership-building efforts with major open source companies and others around the world. Nothing was held back from this book save for information specifically prohibited from disclosure by confidentiality agreements that Microsoft signed with other companies. Indeed, the degree of access to Microsoft’s inner workings granted to us—and the honest self-criticism offered by Microsoft leaders and employees alike—was unprecedented in the company’s 34-year history.

But this is no authorized corporate biography. Microsoft paid not a penny for the writing or production of this book, nor did the company control the final content in any way. In fact, senior executives went out of their way to provide us with the information we requested.

Still, full disclosure by the authors is required. I am at this writing still a corporate officer of Microsoft, for which I obviously receive a salary. My coauthor David Kline, a noted journalist, author of the best-selling Rembrandts in the Attic, and an intellectual property consultant to a number of high-profile firms, has also worked for Microsoft. So we obviously cannot claim to have never benefited by our dealings with the company.

The book itself is the product of an unusually-symbiotic collaboration between the authors. For my part, I brought to the project the business and IP leadership experience of a 28-year career at IBM, as well as the lessons learned from my work in international business, public policy, and venture capital. David Kline contributed not only his deep knowledge of intellectual property’s dynamic role in business and the economy and his practical experience as an intellectual property consultant, but also his rare—indeed, unique—talent for demystifying complex IP issues and explaining them in a clear and relevant manner to a broad business audience. Many of the most important insights in this book are his, and I am grateful for his collaboration.

If there are lessons in this book for executives in every industry, we hope the one most taken to heart by readers is the role that intellectual property can play in liberating previously untapped value in a company and opening up powerful new business opportunities. Intellectual property is not just for the technologist or lawyer anymore, nor even simply an asset of high-tech companies alone. Now accounting for up to 80 percent of the market value of all publicly traded companies in the world, IP ought rightfully to command the interest and attention of all serious business leaders today. It is, after all, the single greatest wealth-creating asset of the modern corporation.

On Sunday, May 25, 2003, I was playing golf near my home in New Canaan, Connecticut, when I received an unexpected phone call. “Hi, Marshall, this is Bill Gates,“said the caller. “I know that Brad [Smith, Microsoft’s general counsel] spoke with you yesterday about the offer. But I just wanted to reinforce our hope that you’ll come to Microsoft and help us with this really big challenge that we’re facing.”

Bill and Brad had already outlined the nature of that challenge when I met with both of them nine days earlier at the company’s Redmond, Washington, headquarters: a limited patent portfolio that failed to protect Microsoft’s huge R&D investment or provide it with the new business opportunities created by today’s fast-changing technology environment. In short, they said, Microsoft needed a first-class patenting program and an intellectual property (IP) strategy that could facilitate the close collaboration with other firms that Microsoft needed to succeed in this new landscape of business competition.

It appeared that Bill had read some of the press reports on my work at IBM, which noted how (to quote one report) I had “put IP on the corporate map and made senior management and Wall Street sit up and take notice of IP as a revenue generator.” During my 28-year career at IBM, I had led the transformation of the company’s patent licensing program into an almost $2 billion per year profit machine—more profit just from IP licensing, it should be noted, than the total earnings of all but the top 40 largest companies in America at the time. As one of the first senior executives in corporate America to see profit and competitive advantage where others had seen only legal documents sitting in the filing cabinets of corporate law departments, I had helped to kick-start a revolution in the way that companies manage their intellectual property portfolios.

Three days after the phone call, I met with Bill and Brad again. And over the course of several more days of discussion, we reached agreement on the scope of my responsibilities and the company’s commitment to this effort. On June 5, 2003, Microsoft announced that I would become the company’s corporate vice president of intellectual property.

The announcement had a rather electrifying effect. As one IP trade journal put it, “When the world’s richest man hires the architect of the world’s most lucrative intellectual property program, the [business world] takes notice.” And when the world’s richest man happens to also be regarded in some circles as the world’s biggest monopolist, it’s no wonder that his hiring of a high-profile patent “warrior” might have caused some alarm.

“The fact that Microsoft hired Marshall Phelps tells you everything you need to know about their intentions,” insisted analyst Russell Parr in an interview with MSNBC at the time. According to Parr, I had been brought to Redmond to recreate the massive $2 billion-a-year IP royalty stream I had built for IBM in the 1990s.

Not for the first time, of course, the pundits were wrong. The idea that a significant industry force such as the open source movement could ever be hemmed in by me or anyone else was patently absurd. And in point of fact, a key objective of the licensing program we planned to launch was to build a cooperative bridge to the open source world in order to meet customer demands for greater interoperability between Windows and Linux software.

As for trying to recreate IBM’s $2 billion-a-year IP royalty stream, suffice it to say that for a company that generates a billion dollars in free cash flow every month, a mindless focus on maximizing licensing income made no business sense at all. In all my talks with Bill and Brad, both before and after I was hired, we never once discussed the idea of building an IBM-style revenue juggernaut from patent licensing. Instead, we merely hoped that licensing might generate sufficient revenue to cover some or all of the costs of maintaining the patent portfolio.

What none of these nervous analysts seemed to realize was that my hiring had come at a moment of profound change for the company. For years, Microsoft had been on the defensive, beset on all sides by antitrust suits and costly litigation, and viewed by many in the technology industry as a monopolist and market bully. At the same time, the dynamics of technology development and the software business had begun to change radically, requiring Microsoft to adapt to the emerging era of “open innovation,” in which collaboration between firms, rather than go-it-alone market conquest, would be the keystone of success.

Underlying Microsoft’s desire for change was its recognition that technology development had become too widely dispersed and heterogeneous, the pace of innovation too rapid, and the competition for markets and customers too multifaceted and demanding for any one firm to go it alone anymore. Indeed, it was becoming increasingly difficult for even the largest companies to hold all the pieces of even their own product technology in their own hands anymore. This was true even for Microsoft, which invested billions of dollars a year in research and development. In this new, decentralized technology environment, therefore, companies like Microsoft would simply have to collaborate if they wanted to succeed.

Bill, Brad, and I were hardly the only ones who had come to this conclusion. Indeed, in an era in which inventions were building upon each other with such rapidity as to quickly render obsolete even the most far-sighted company’s product development strategy, it was becoming clear to a growing number of business leaders that the only way to stay above the rushing waters of creative destruction was to stand on the firmament of alliances with other firms. Whereas some 80 percent of major innovations during the 1970s had come from inside a single company’s own R&D labs, by the dawn of the twenty-first century, studies now showed, more than two-thirds of major new innovations involved some sort of interorganizational collaboration—either between private firms, or between firms and federal laboratories or research universities. Recognizing that fact, 7 out of 10 senior executives surveyed by The Economist would conclude that their best strategy for accelerating innovation was to increase collaboration with other firms.

As my colleague Masanobu Katoh, then-corporate vice president for intellectual property at the Japanese giant Fujitsu, recently noted: “We are a $45 billion company. We are into consumer products, computers, consulting, and services, even manufacturing. We do it all. But alas, doing it all is no longer enough. We can no longer succeed unless we collaborate with other companies.”

This new “collaboration imperative,” as I called it, was reshaping business and redefining the sources of competitive advantage. And more to the point, it was rewriting the rules that businesses have always followed for how they leverage and deploy intellectual property.

First and foremost, it meant that intellectual property could no longer be viewed solely as a negative right—meaning, the right to either prevent someone from using your technology and competing in your market, or to tax them in the form of licensing fees for the right to do so. From now on, IP’s greatest value would lie not so much in being a weapon against competitors, but rather in serving as a bridge to collaboration with other firms that would enable companies to acquire the technologies and competencies they needed to compete successfully.

Indeed, intellectual property was becoming the sine qua non of open innovation itself. It provided the legal scaffolding upon which firms could share their most innovative research and partner together to create new products and services. Without IP rights, firms would resist sharing their ideas for fear that others would misappropriate their innovations. But with such rights, firms could share their innovations with others, secure in the knowledge that all were fully protected in deploying them to mutual advantage. Just as good fences made good neighbors, strong IP rights would make for strong and successful collaborations. And in the case of intellectual property, this so-called “fence” would turn out to be more of a bridge than a barrier between firms.

We Need Relationships

This was the vision that informed Microsoft’s new direction. Because collaboration now appeared to be the key to Microsoft’s future success, the company’s greatest need was to start building relationships with other firms—large firms, small firms, open source firms, venture capitalists, software developers, even independent inventors. In short, Microsoft needed relationships with anyone and everyone it could find in order to remain at the center of technology innovation and at the forefront of new markets and business opportunities. And intellectual property was quite simply the best available vehicle for constructing those collaborative relationships. As the legal embodiment of any company’s most precious resource—its innovation—Microsoft’s IP defined the arena of cooperation and established clear rights and obligations for both sides in any joint endeavor.

Commenting on my hiring, the industry trade journal eWeek noted that “Gates agreed with Phelps that Microsoft was at an inflexion point in its history” and needed to cooperate more with other firms. Newsweek magazine, meanwhile, reported that I took the job “only after Gates promised [me] he wanted to change the way Microsoft interfaced with the technology world.”