INTEROFFICE MEMORAND UM

TO: FROM: DATE:

SIM WONG HOO, FOUNDER AND CEO CREATIVE TECHNOLOGY NICK TIMMONS, IP ANALYST AND STRATEGIC CONSULTANT 6/22/2012

SUBJECT: CHOOSING THE BEST WAY FORWARD TO LEVERAGE OUR MP3 TECH. IP A. EXECUTIVE SUMMARY In todays environment of evermore efficient markets, enhanced information transparency, and reduced information asymmetry, the bottom line is that simply doing things faster, better, and cheaper no longer is a sustainable form of competitive advantage. So, many companies need to transition from competitive advantage to sustaining advantage, thereby extracting real value from assets for a long period of time. Apple does nearly ten times the revenue of Creative, and is gaining share at an incredible pace in the industry as a result of their iPod growth that is as spectacular as anything weve ever seen in business. It is a spectacular product, made possible by the coordination of a great many moving parts, one of which is the wonderful user interface. Out of the myriad options at our disposal, I strongly believe that given the nature of the aforementioned, the best thing to do is to litigate this patent. Creative, whether Apple likes it or not, has core IP that covers something that has helped the iPod become the incredible success it has become. Creative fully deserves to have its pioneering effort appropriated properly, so my unequivocal recommendation is to sue for damages and a licensing fee for each widget that Apple decides to make in this space. B. RATIONALE First, in order to understand exactly the way forward, we must understand the context in which our decision is occurring. If there is anything I know about culture in America, is that Americans love their movies and their music. The rest of the world, too, to be sure. But Americans have a special taste for spending lots of money on Hollywood flicks or the new Madonna single. However, especially with music, the way in which customers have consumed their media has been fundamentally disrupted (see Exhibit 1). What the Exhibit shows is that with disruptive technologies, the new entrants almost always win. So, the companies that ennoble this new methodology of music consumption on into the future are going to make an incredible amount of money. Apple, for their part, was able to create a product that does this very well. By making a device that leverages the convergence of the many technologies in a good MP3 player, they have disrupted the market, and have seen 1000s of percent growth in this new category. For our purposes here, the technology allows people to store an incredibly large catalog of music in the palm of their hands. So it stands to reason that being able to efficiently search through that catalog, to be able to easily find the song or group of songs that I want at the moment; this idea is going to be very important. Chris Anderson, the editor of Wired, wrote a game changing book just recently, called The Long Tail. With ever more bits of information out there, the key to using that information effectively is being able search for it. Before Creative came along, in your own words Mr. Hoo, there was no intuitive and efficient way to deal with the large number of tracks that could be stored on a high-capacity player. This is the importance of the simple and effective user interface that you created. And you should not take that lightly. Google would vigorously enforce any willful infringement on your, and I would expect that the company in charge of the organization technology in a different sphere of information, music, would do the same. The granting of this patent was a Godsend. This company has hit a speed bump, to be sure. We have not been profitable for the first time in a long time. Our core Sound Blaster business is fantastic, but it cannot sustain us forever. We need to be reinvigorated by moving into software. You have done that by creating this wonderful piece of technology, melding the hardware capabilities brought on by the solid state drive and the necessity for simple search and

play functions to deal with the ensuing ability to store data. We should absolutely press the advantage the patent has granted us. So, now that we know where we are at, and how we have gotten here, and what we should do, let me briefly run down our options, so that we can arrive at an understanding of why exactly vigorous enforcement is the best path to go down. We can simply let things go, and try to outcompete Apple. This is a pretty awful option, and pretty much the worst of the bunch. Apple has become one of the best companies in the world over the years 1998-2006, since Steve Jobs came back to the firm. There is no reason to think that as this digital revolution wont continue to drive spectacular growth from them, for years. One of the keys to success in the technology space, from a strategic point of view, is to get some great core technology and embed it in an ecosystem. With iTunes, the iPod, a rumored phone in the works, etc., Apple has done well to be leverage their position in this new digital world. Their unique design influence, product performance, and marketing ability has them riding a wave that I simply do not see stopping. Thus, as this point, keeping as is simply will not work. Something must be done. Our patent case is nearly unassailable. We will win the priority debate and Apple must come to terms with that fact. Now, which action to execute? We can sue to seek an injunction from allowing Apple to make their product. We must remember that the core benefit of a patent is that it does not confer on us a right to make or build something. What it does is provide us with the ability to undertake a negative action. That is, we can force other people not to do something, namely, making a product which infringes on our IP. This, on its face, actually seems like a fantastic option. But it is not. You see, most people would look at suing for injunction as an opportunity for us to get rid of a potential competitor for a time. Apple wouldnt be able to manufacture its iPod whilst we litigate our claims. This is a strong option, but we cannot forget the wave that Apple is in the midst of creating and riding. Lets not kid ourselves, if faced with the option to exit the MP3 market, Apple will redesign their software, have users dock their existing devices to iTunes and download a software upgrade. And in process manufacturing goods can simply have their systems swapped out. Now, certainly this is a not inconsiderable cost that is likely in the hundreds of millions of dollars. Especially given the nature of their vaunted circle track pad, which integrates with the interface, and so might have to be redesigned a bit. However, this pales in comparison to the future profits on offer by staying with the business. Apple will come back, with a vengeance. We wouldnt be gaining on a major competitor. We would be putting one to sleep that is ten times our size. When it wakes up, eating us will be the only thing on the bears mind. I just dont think, if we going the adversarial route with Apple by suing, that it does us no good to not sue for damages. We can sue for willful infringement and seek to recover damages, as well as an ongoing licensing fee. For years, people have wondered if Apple would ever build a TV. The response from Steve Jobs has always been the same: that Apple has not gone into the TV business because it they could not find a user interface simple enough to allow them to design the kind of product that they want to design. My point is that this gives an indication of the kind of connection that needs to exist between hardware and software in order for a product to function well out of the box in the minds of consumers. We have seen above what kind of power our police rights are. We can threaten Apple with injunction. But that is like a nuclear option. They dont want to stop producing, and as I reasoned above. We dont want that. Because we can make FAR MORE money by suing and getting damages, than by staying in the manufacturing game ourselves. This is why we must sue for infringement. But this presents the same kind of adversarial tone that the injunction options brings about. We can take the above decision, but with the fundamental stratagem that we are seeking settlement, rather than litigating this out to its end. What this twist in the tactic of suing for infringement is a very important psychological point. We dont want Apple to feel like we are skewering them. Keep your friends close, but your enemies closer, as they say. We want Apple to feel as though we want to partner with them, as we seek proper and just payment for the work that we have done to this point, as embodied in the Zen patent. There are many subtle legal maneuvers that can make this point. The reason why I am parsing out this seemingly

minor detail is that its very important. The instructions we give to our legal time that will actually argue in court matter a great deal. If we instruct them to litigate with a hard line, Apples lawyers will take note of that an respond accordingly. However, if we instruct them to be willing to play ball, then Apples lawyers will understand that we are amenable to making a deal, and then the two teams of lawyers will begin doing their settlement dances. So, we want Apple to know that we are suing for infringement, but dont want to litigate this forever. We can take this strategy because Apple wants the same thing as us: to get this resolved fast. We can seek settlement, and then choose to ourselves exit the MP3 manufacturing business. The last major option comes as a wrinkle of the sue and settle option. If we do sue and settle, then we will in a sense be competing against ourselves. We will have obtained damages, yes. But we will also have obtained an interest in Apples manufacturing, by virtue of the per product licensing fee we will receive for every iPod produced. We also make MP3 players with our NOMAD, obviously. So, to further entice Apple to settle, we can let them know that we elect to divest our hardware business in this category. We are only at a small 5%, and steadily declining, share. We can still get good money by selling off our manufacturing operations whilst it still has legs. And then we can get Apple to pay us an ungodly sum of money. Because not only will our injunction threat serve as a motivating factor for them to pay us, as opposed to fight us to the end, and then pay us only after they lose the casewe can position our strategy as good for them because they are essentially paying to eliminate another competitor from the MP3 market. Lastly, we can elect to take the above strategy, with all its resultant tactics, and then decide whether or not to be able to license our technology to other competitors than Apple. In some cases, like with the founding of Microsoft, getting an ongoing royalty fee from a company (in their case, IBM), but retaining the right to license the software to other people/companies, makes all the difference. However, this case is not quite the same thing. Again the fundamental strategy here is to sue, seek settlement, and maximize the size of the royalty payment as much as possibility. We are basically creating an annuity, owned by us and paid by Apple. We want the size of those ongoing cash flows to be as big as possible. And again, to do this means showing ourselves to Apple as willing to be their partner going forward, as opposed to an ongoing foe. Apple likes to keep things in house, and tightly wrapped, so I think that forgoing the option to take our software to others is the best play here. So, with that, we see basically what we are doing. We will be exiting the hardware business on our own, in order to sign a kind of partnership in perpetuity with the king of the space, and then we get paid hundreds of millions of dollars for the privilege. That kind of a payoff is the kind of thing that could sustain this companys push into the future, without a doubt!

C. EXHIBITS Exhibit 1