Information Process Patents in the U.S. and Europe: Policy Avoidance and Policy Divergence

Information process patents in the U.S. and Europe: Policy avoidance and policy divergence by Brian Kahin
Patents on software and business methods appear to have a pivotal position in today's economy, yet they have remained a policy backwater in which scope of patentable subject matter has expanded without legislative input. This is changing as Europe struggles with patent reform. A push by the European Commission to validate and promote software patents has been opposed by many companies and professionals, and especially the open source community. In this process, it has become clear that Europe opposes the broad non-technical patents on business methods that are now available in the U.S., signaling a major rift in international standards of patentability.

Recent hearings held by competition agencies in the U.S. show severe problems of overpatenting that extend beyond software to much of the ICT sector. These problems have been ignored by the Commission, which despite a pro forma effort to address economic issues, clearly feels more comfortable framing the issue in legal terms. In outlining what a properly developed policy framework would look like, the paper stresses the need to understand why software is different from other technologies, why the disclosure function of the patent system is failing, the build-up of risk and uncertainty and its effect on industry structure, and the international political economy of information process patents.

Contents

Introduction
Overview: Policy development in the U.S. and Europe
The insularity of the State Street decision
Software patents in the U.S.
The debate in Europe
Developments in the U.S.
Why software is different
Disciplinary perspectives on patent policy
Conclusion

Introduction

There is a growing debate about the value and implications of information process patents, i.e., process patents that do not involve physical transformation. This includes two widely discussed categories, software patents and business method patents, but also patents on the presentation and use of information, movements of the human body, educational methods, and social processes.

The debate is framed very differently on the two sides of the Atlantic. In the U.S., the specialized appellate court for patents, the Court of Appeals for the Federal Circuit, has eliminated virtually all limits on patentable subject matter. In Europe, the European Commission's plan to develop a uniform Community Patent has triggered intense public debate about the desirability of software patents and how to limit the scope of the patent system by drawing a line based on technical contributions or effects.

There is continued discontent and skepticism about the patent system among software developers in the U.S., but the legal issue appears settled, and the debate in Washington is centered on quality rather than subject matter. It is cast as an administrative issue rather than a matter of substantive policy. As such, it is not limited to patents on software and business methods, although those are the areas where the quality problem has been most conspicuous.

The U.S. Patent and Trademark Office (USPTO) recently issued a strategic plan that attempts to address the problem through reengineering internal processes and allowing for the outsourcing of searches [1]. Yet while USPTO is attempting to reform its operations, the U.S. Government is urging the rest of the world to do away with limits on patentable subject matter in a proposed World Intellectual Property Organization (WIPO) treaty on substantive patent law. In May, the U.S. threatened to walk out of negotiations if the treat does not mandate patents for all fields of activity, whether or not they fall within common notions of "technology" [2]. This confrontation over the proper scope of the patent system has gone unreported, at least in the U.S. There is nothing on the USPTO Web site to indicate that the U.S. has asserted this position or is even currently engaged in these negotiations.

Given the relationship to common economic concerns, robust international debate on information patents should be front and center in the international policy agenda. On paper, the subject stands at the convergence of the major themes of the knowledge economy:

·  innovation;

·  intangible assets;

·  information technology and the Internet; and,

·  globalization.

Innovation

Promoting technological innovation is the principal rationale for the patent system, enshrined in the clause of the U.S. Constitution that enables federal patent legislation [3]. In principle, patents encourage invention by innovative small entrants by affording protection against large competitors. Without patent protection, large incumbents might copy the small firm's invention and use superior financial resources and marketing clout against the small firm.

The 1994 case Stac v. Microsoft is the poster child for this argument. Microsoft had sought to acquire rights to use Stac's compression technology, but negotiations broke down; Microsoft developed a compression program as part of its operating system, and Stac sued and won a jury verdict for US$120 million. Whatever the merits of this case, the case is frequently to show that software patents can protect small firms against big firms.

However, in the case of complex technologies, the patent system also allows large firms to accumulate portfolios of patents that can discourage entry by new firms or at least limit them to upstream niches. These portfolio effects reward firms for the scope of their investment in R&D by reducing the threat of future competition within the area of the portfolio. To the extent that innovation is sequential or cumulative, this may hold technological advance hostage to past investments. Entrants may be able to use patents to develop and occupy new niches, but their ability to develop and market complex products is likely to be limited by the patents of others, especially large competitors that are better able to bear the costs and distraction of litigation.

These portfolio effects are not necessarily a bad thing. A case can be made that firms which provide the lion's share of the R&D for their industry should be able to "tax" the companies that take advantage of it. However, an incentive based on the scope of investment goes beyond established patent jurisprudence and if desirable should be considered on its own merits. But it appears that patents are not a useful source of knowledge and if knowledge does not flow smoothly and transparently within the system, patents may encourage opportunistic, even parasitic, behavior rather than meaningful innovation.

If Stac v. Microsoft is the poster child for software patents, the case of BT v. Prodigy is the anecdotal problem child. BT discovered that it held an old patent on hyperlinks that predated the World Wide Web, announced that it would assert the patent, and sued Prodigy, a company that successfully pioneered an online service and then became a conventional Internet service provider. BT presents the picture of a large regulated company (a former state monopoly) with little reputation for innovation belatedly laying claim to a public standard to which it did not contribute and upon which others invested hundreds of billions of dollars on the assumption that it was open and non-proprietary.

Intangible assets

Intangible assets, sometimes described as "intellectual capital," are the principal source of value and competitive advantage in advanced economies [4]. The growing significance of intangible assets is reflected in the substantial disparity between market valuation and the tangible assets carried on corporate books. Since book value may of little use in evaluating firms offering services or intangible products, especially in fast-moving areas, academics and practitioners have looked for new objective measures that would be of help to investors [5]. Similar challenges arise in trying to measure economic value at the national level in terms of measuring capital stock, improvements in quality and choice, and consumer surplus.

"Intangibles" encompass human capital, R&D, business relationships, reputation, organizational strengths, and the different forms of intellectual property. In some respects, patents seem the most tangible of intangibles, because they appear well defined, can be readily traded, and give the patentee a nearly absolute right to exclude others from producing, using, or selling the invention.

At the same time, the patent system has expanded to embrace intangible processes and products as protectable subject matter. The argument for this expansion is often made on the basis of the economic importance of software and (Internet) business methods. In principle, patents can help firms rationalize investment in a broad range of intangible assets — making them easier to exploit and trade.

However, accounting for intangibles is asset-centric just as patent literature tends to be patent-centric. It is very difficult to figure in external circumstances and conditions that add or subtract value, such as standardization, technological opportunities, expanding markets, complementary products and services, and the competitive advantages or disadvantages of rivals. While a firm may know with reasonable certainty what patents it holds or has applied for, its knowledge of the patent positions of its adversaries will be much less complete. Yet if one is going to measure intangible assets, one must also consider intangible liabilities, including the risk and uncertainty created by the patents of others.

The 2002 Federal Trade Commission and Department of Justice hearings on "Competition and Intellectual Property Law and Policy in the Knowledge-Based Economy" shed light the high degree of uncertainty caused by patents in the ICT sector [6]. Presumably patent-related uncertainty is less of a problem for well-documented, slow-moving technologies where independent invention is rare and patent quality is high. However, it may be significant in fast-moving technologies, especially if the standard of inventiveness (non-obviousness) is low and reading patents is not considered a productive use of time.

Large firms with knowledge management capabilities and in-house patent counsel are able to minimize uncertainty better than small firms. Scale should make both licensing revenue and exposure to liability more predictable in the aggregate. Large firms in ICT also use cross-licensing to lower risk and transaction costs but cross-licensing increasingly is accompanied by side payments which reflect the perceived superiority of one side's portfolio and perhaps the needs and vulnerability of the other side.

How can one begin to put a value on these cross-licenses? [7] What is the value of the freedom of action that they buy? Even without explicit cross-licensing, there may be a tacit understanding that firms will not sue for patent infringement unless another company sues them first. This seems to be a reasonable response where inadvertent mutual infringement creates the potential for "mutually assured destruction."

Information Technology

During the 1990s, information technology played a leading role in transforming business in all sectors of the economy [8], especially as the Internet brought computing, communications, and information together in a common multifunctional infrastructure. Much has been made of how the unique economic characteristics of information products and services can be exploited them for business advantage [9]. Yet there has been little effort to link this literature to patent policy [10]. Instead, the case for software and electronic commerce patents has been made in conventional terms, citing the importance of software and Internet commerce, the value of the patents to venture financing, and protection for small companies against large competitors.

Although software patents are issued in ever greater numbers and the U.S. Court of Appeals for the Federal Circuit has endorsed them unequivocally, there is continuing controversy in the U.S. as well as Europe as to whether software patents are good policy. The 1999 National Research Council report, Digital Dilemma, describes developments as worrisome and argues the need for systematic study [11]. Even while endorsing the European Patent Office's (EPO) standards and practice on software patents, the draft European directive argues for monitoring the effects of software patents.

Software seems as different from pharmaceuticals, the industry that most clearly benefits from patents, as one might imagine. Software can be written by individuals without special equipment or resources. There is no need for clinical trials or regulatory approval. Unlike drug patents, software patents do not correlate to finished products; instead, a single program may have thousands of patentable functions [12]. Unlike other technologies, copyright is available to protect against wholesale reproduction of computer code.

In software, the granularity of innovation ranges from code-level algorithms to interface features — even the purpose of the program [13]. The internal structure is not only extremely complex, but interdependent in ways that require debugging and maintenance. Innovation is cumulative or sequential, so that patents favor early innovators at the expense of later ones. Economies of scale combined with network effects make first-mover advantages exceptionally powerful. Instead of reading patents, developers work from scratch, i.e., from tacit knowledge without resort to codified knowledge. Tacit knowledge is embedded in software, and if the software is well-designed, there is little need to explain how it works.

The open source phenomenon is the clearest sign that software is fundamentally different from other technologies. While open source development may be compared to open science and open standards, it results in finished products with immediate economic value. Open source software can be exchanged, tested, implemented, and distributed on the Internet, drawing on volunteer expertise from anywhere in the world.

Globalization

International trade promotes economic specialization, and economic specialization promotes trade. Under liberalized trade, developed economies with high costs of labor and natural resources must rely increasingly on intangible assets as a source of competitive advantage. Unlike other intangible assets, intellectual property can be projected remotely, indeed globally, without significant diminishment and with little remote investment — as long as other countries adopt and enforce similar rules [14].

The U.S. and other developed economies successfully tied intellectual property to trade liberalization in the negotiations that culminated in the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) [15]. TRIPS was part of the General Agreement on Trade and Tariffs that formed the charter of the World Trade Organization (WTO) in 1994 and is administered by the WTO. Thus TRIPS operates apart from and in addition to the regime-specific treaties administered by the World Intellectual Property Organization (WIPO), addressing the different forms of intellectual property in terms of minimum substantive standards and enforcement obligations. This includes a provision that national patent laws be technology-neutral with respect to patents: "[P]atents shall be available and patent rights enjoyable without discrimination as to the place of invention, the field of technology and whether products are imported or locally produced" [16].