Time Warner vs Optical Recording Corporation

Optical Recording Corporation (ORC) was established in 1984 with the main purpose of capitalizing on the technological innovation of James T. Russell. Russell’s new technology was based on his recent invention that revolutionized recorded music storage devices. Although Russell was not the first to come up with the concept of the Compact Disk (CD), he was among the first people to patent this technology. By 1985, Russell held over 25 patents in 7 countries across the world to various technologies related to optical recording and playback. Russell’s intellectual property was purchased by ORC in Toronto in 1985, the firm then proceeded to notify a number of CD manufacturers that their CD technology was infringing on patents held by ORC. In 1987, ORC signed an agreement with Sony allowing them to license with other companies and use of ORCs CD technology in return for royalties and licensing fees. ORC continued negotiation process with other companies interested in or involved in CD/CD player production. A large CD manufacturer, now called Time Warner, objected to infringement claims presented, and was then sued by ORC in 1992.

The CD industry in late 1980’s to early 1990’s was comprised of a number of companies across the world. One of the major reasons that contributed to the development of rivalry among the CD manufacturers was high profitability of the market and projected growth. As a technological breakthroughs for many companies, CD technology was a very high yield and low risk investment. The following trend explains the high priority of CD technology during legal negotiations described later in the research. The main purpose of the following report is to analyze and discuss legal and managerial decisions of John Adamson in regards to securing ORC’s legal right to the CD technology. In addition, this paper will provide an overview of business and legal techniques that could have potentially improved business standing of ORC. Furthermore, this report will identify the courses of action for ORC leading up to the final legal proceedings with Time Warner in 1992. The situational analysis that identifies all external variables affecting the business and legal decisions of ORC in the period of 1984 to 1992 will be also provided in this report.

The collaborative effort for our team members will provide a contingency plan that evaluates negative and positive consequences of each of the ORC’s legal and business decisions and how they might affect development of the company in the future. The need for an initial revenue stream was the focal point of ORC’s efforts in obtaining licensing agreements with major players in the industry. Sony was the first firm to sign a licensing agreement with ORC, and while ORC expected to engage in licensing agreements with other similar firms it was found that most of these firms were infringing on the Russell Patents. It was discovered that a quick estimate of the royalties owed to ORC by infringing CD manufacturers totaled $200 million in the U.S. This patent infringement offered ORC a way to create a revenue stream to further their development in research, in which ORC had been falling behind. ORC owned the patents to this technology but would be gambling its resources to the point of bankruptcy if they were to fail.

However, they decided to pursue the patent infringement case starting with informing the infringing firms of ORC’s patents. In 1986 ORC had the first meeting with a suspected infringing firm, Phillips Corporation and the DuPont Corporation, which did not go as smoothly as ORC had hoped. Attorneys for Phillips and Dupont did not believe that the patents were infringed upon and questioned the legitimacy of Russell’s patents. It was clear that no further forward progress could be made with Phillips or DuPont without legal action taking place. ORC decided not to pursue legal action against Phillips and DuPont at this point. A critical decision considering ORC wouldn’t have been able to afford costly litigation to back up their patent claims. ORC chose to move its attention to Japanese firms as they were the only other firms using CD technology and the only other option for patent infringement.

ORC had no patents in Japan, but the Japanese firm’s main customer market was within the United States. ORC went to Japan in August of 1986 to meet with Japanese firms suspected of infringement. Throughout ORC’s travel to Japan the company maintained a high status symbol by spending large amounts of money; this was a risky move for a company with bankruptcy looming in their future, but a smart move in increasing their potential for success in Japan. With every trip to Japan, ORC presented its technology and patents to the Japanese firms. ORC was repeatedly challenged by Sony on the grounds of Prior Art Acquisitions, or the challenge that ORCs patents were not an original idea and therefore were to be considered null and void. ORC’s defense to each acquisition was a technical responses prepared in what was known as the “Blue Book.” The Blue Book consisted of technical responses to each reference to Prior Art claims against the Russell Patents. Working with ORCs legal team, the decision to compile the Blue Book and distribute it to each prospective licensee was a decision that upheld ORCs credibility.

From a strategic perspective, the decision to pursue infringement on the patents was very risky at this point for ORC. ORC had to balance between threatening legal action and coming to agreements over a licensing agreement. In ORCs case, if any of the major firms felt threatened by any infringement accusations, ORC would not have the financial backing to be successful in litigation. It was key for ORC to sign Sony to a licensing agreement. Agreeing to Sony’s terms was a strategic move which not only solidified a revenue stream but also paved the way for other firms to follow suit. Upon signing Sony to a licensing agreement, Phillips Dupont seemed to follow suit primarily to avoid costly litigation. Specifically, ORC managed to sign a licensing agreement with Phillips on moderate terms that did not fully utilize the legal leverage of ORC. In other words, ORC was not able to negotiate the license on their terms but more out of desperation of signing a licensing agreement. Despite having the upper hand, ORC was unable to capitalize on their strong position. During the Sony deliberations, ORC was experiencing financial troubles in Canada.

The Canadian government wished to immediately resend their tax credits which awarded ORC, as a research firm, $6.5 million Canadian dollars. Adamson refused to pay the $6.5 million which was primarily based on the fact that ORC could not afford to pay them. Nevertheless, the aforementioned decision of the Canadian government was a potential threat to ORC, and could have resulted in a different business development strategy employed by the company. To capitalize on the recently successful licensing program, ORC turned their attention towards the next largest manufacturer of CD media in the U.S. – WEA Manufacturing (Subsidiary of Time Warner). Initial talks to Time Warner resulted in stalemate between the licensing company, ORC, and the infringer Time Warner. By 1991, ORC decided to sue Time Warner to validate their patent infringement claims and bolster their revenue streams. However, ORC’s patent expired before the court could rule on an injunction to stop the infringer’s production lines; making the business decision to sue more complicated.

From a strategic perspective, the bar was set high for a leveraged battle between these two companies. With the expiration of the patent, ORC was left with a diminishing outlook on the collection of royalty payments. Based on the expensive nature of corporate lawsuits, the amount of money set aside to fight the case could have exceeded the amount of the court award. ORC wasn’t initially comfortable with betting that their reward would outweigh the costs. Considering this, ORC decided to make a settlement offer of $3 million to Time Warner; Luckily for ORC, Time Warner rejected the offer and both parties went through with the litigation process. The implications of settling would be a short-term gain with long-term repercussions. Aside from the positive dollar amount of settling with Time Warner, the strategic implications would be substantial. When the case was finally presented to the court, 30 attorneys representing the majority of the recording industry were in attendance.

The manufacturers of CDs were keenly interested in what the outcome would be as either one of two things would occur: 1.) If ORC won, the companies would be forced to sign a licensing agreement. 2.) If ORC lost, the companies would ignore ORC’s supposed patent violations. Furthermore, ORC was betting the entire future of their business on the outcome of this court case. If Time Warner won the suit, what would happen with the existing agreement between ORC and Sony? Essentially, Sony could simply stop making royalty payments which were the primary revenue stream of ORC. With the importance of the court decision in mind, ORC requested a royalty payment of 6 cents per disc sold in the U.S. Time Warner eventually had to reveal the unit volumes of the production of CDs from the infringement period between 1986 and 1992 (when the patent expired).

This amount totaled over 450 million discs making the potential court award over $27 million. This amount also could be increased for damages and interest on the earnings. Based on the business issues and subsequent managerial decisions, we believe that overall ORC made the correct business and legal decisions. Since the onset of the monumental task of licensing, ORC relied on consultation from professional lawyers. ORC ‘s priority consisted of establishing a revenue stream by signing a licensing agreement with Sony; this agreement made ORC profitable and made it possible for more forceful negotiations, and later litigation, with Time Warner. From a managerial perspective, Adamson also had some inaccuracies/mistakes. An example of his mistake is the settlement letter sent to Time Warner’s in-house counsel.

This decision might have led to potential loss of existing royalty agreements with Sony, Philips, and other competitive companies. As a result of legal negotiations with Sony, ORC had the financial backing to push negotiations with Phillips to more favorable terms. However, Phillips took advantage of ORC’s quickness in signing on terms that could have been better for ORC. Despite the strength of the European patent agreement, if ORC had been more aggressive with Phillips, this case could have affected its legitimacy in the American market. The decision to sue Phillips could have resulted in better terms in the American market and with Time Warner. In other words, the Philips litigation process could have given more credibility to ORC in negotiations with Time Warner. Lastly, this whole legal ordeal could’ve been circumvented if ORC would’ve focused their efforts on being bought out instead of going after licensing fees.

The buyout process would net them with considerably more money and the opportunity to retire or work for their parent company in some capacity. This worthwhile strategy was never discussed by ORC which revealed management’s ineptitude in planning for the long-term viability of the company. Through this entire process, ORC’s emphasis was more focused on short term goals rather than long-term goals. Despite making money in licensing, further development in the company’s research and products were all but abandoned while the company focused its efforts on litigation and licensing activities. According to further research on ORC and Time Warner, we have found that ORC won more than $30 million from Time Warner in a suit that gave ORC 6 cents for every CD the company manufactured from 1986 until 1992.