See here for Part 1.

It has never been easier to create and scale a software company. Young entrepreneurs no longer have to buy a server as they did in the 90’s but can rent server space with just a credit card (‘Dude, the cloud’.) Freemium means a business may not even need a staff accountant to handle revenues, further reducing StartUp costs. The number of StartUps being formed in 2013 is at an all-time high, and continues to increase.

Freemium companies also grow faster than ever. Marketing has changed: all prospective customers and users are now online. Notably, there are a lot more people online today than during first generation of tech StartUps: an estimated increase from 100 million people in the late 90’s to 2-3 billion today. Social networks help good products and services spread faster than they ever have. Social and viral marketing have also eliminated the need for multi-million dollar marketing budgets, further reducing growth and StartUp costs, and further democratizing StartUp access.

New Companies with a $1B valuation, who arrived there in 2-4 years, with no real revenue, less than $10 million in funding, and 10 people under the age of 35 manning the ship, are becoming a lot more common.

Displacement by Freemium software has arrived. And the pace of Freemium usage is only growing. In hindsight, which dead Incumbent Companies should be our proverbial ‘canary in the coal mine’ here? Kodak, who refused to cannibalize its own hardware film revenues with Freemium software imaging in the 1990s? RIM, who watched its email-focused hardware device get whacked by Freemium mail software on more versatile iOS and Android phones? PDAs, which were dedicated hardware devices for planning, who were eradicated once their functionality became a free software app on all smartphones? Ectaco and dedicated language translation devices, which is also free via the software these days? The pile of dead canaries is becoming a mound. Put another way, in five years since Apple democratized software on mobile phones, Freemium software on Smartphones has devastated several industries, at least a dozen F500 companies, and hundreds of years of company growth when combined.

Welcome to the New World Order of Freemium software. As a consumer, this is great. Who doesn’t love free stuff? As a capitalist, it is dangerous to invest in a business that can be crushed when someone else gives a competing product or service away for free. As an economy, it is not good for companies to invest years of resources into pioneering a product, only to die quickly when a competitor gives a competing product away for free.

Patents as a Defense to Freemium

Which brings us to the fun part: what can an Incumbent Company do when their neutered patents cannot obtain injunctions, and damages are meaningless when a product has no revenues?

Hit below the belt! The easiest solution is to watch for small disruptive Freemium StartUps, and sue early, and hard. The defense costs alone will drown the fragile Freemium StartUp, who does not have enough money for a proper defense. Fighting 101 says to go after your opponent’s weaknesses. For a new StartUp, one weakness is a lack of battle experience. A bigger weakness is cash, or lack thereof. Worse still, the Freemium StartUp will not get new Round A or B of VC funding with the pending lawsuits soaking up most of the new Round A or B funds. This practice of big companies choking StartUps is not new. It has been happening for years. I will hereby label this tactic “Killing the Cub before it becomes a Lion” (A message to my beloved Silicon Valley StartUp Community: I will spend an entire blog post later on how to defend from Big Company patent lawsuits. In the meantime, suck it up, this is just business. Did you really expect the Incumbent Company in your space to roll over without a fight? Execs at these companies have a fiduciary duty to defend their turf.)

When attacking a Freemium StartUp, this proactive and aggressive cost-of-defense attack has to be done with certainty – Altera used four separate lawsuits to crush ClearLogic in defense fees, where the cost of each was projected to be $3-5M – and done quickly before the Freemium StartUp reaches $100M in valuation. There is the challenge: the Incumbent Company might not act in time. Freemium StartUps move faster than their predecessors with rapid consumer-driven product design and viral social marketing. Most do not come above the radar until a product hits the market. Some companies get to $100M in valuation in less than three years from company launch, and two years from product launch. After this, the Freemium StartUp can likely get the $10-20 million in funding, afford a decent defense for a single patent, or parry defense costs until another and larger funding event, and well, survive long enough to get the resources to fight back. In other words, the Incumbent has to kill ‘em before they grow strong.

If the product is truly just a Freemium knock-off, then the patent system is working just as it should: the knock-off has been denied and the incumbent has protected its turf. Some less informed people will pretend to be pro-consumer advocates and cry that the patent system is compromising innovation and consumer choice. I call bullshit on this defense: there is no innovation in giving someone else’s product away for free.

If the product is truly new, then the company becomes the villain. Incumbent Companies frequently crush StartUps whose products are not knock-offs as a frugal means of avoiding an expensive M&A or to keep an aging product from being displaced in the market. The StartUp will righteously cry foul, but large companies have much better press access and longevity to rewrite history.

Here’s the rub: very few assertions are so cleanly assessed in terms of whether the StartUp’s products are truly new or a knock-off. With so much subjectivity in the viewpoints, and so much money at stake, emotional bias takes over. It naturally leads to and name-calling. StartUps call anyone that sues them a patent troll. So do companies. This enables pseudo-informed professor-journalists and the mass media to start inflating the patent troll problem with bad data (Colleen got her data from RPX, who is incentivized to create the image of a large patent troll problem, duh.) Anyone who asserts a patent is now a patent troll. Adding the ample room for abuse, on both sides of the fight, to the skyrocketing number of StartUps, and one can see the growing Freemium chaos coming. Hidden in the chaos are the companies, who now use shell companies to attack StartUps, which prevents the bad press, and confuses those observers who lack the experience to see through the veiled attacks.

So let this be a heads up: the number of Freemium StartUp vs. Incumbent Company patent fights is about to go through the roof. Enjoy the fireworks.