THE PERFORMANCE OF THE IPR SYSTEM IN THE NEW ECONOMY: IMPLICATIONS FOR DIGITAL INVENTIONS AND BUSINESS METHODS

Paper to be presented at the DRUID Summer Conference on "Industrial Dynamics of the New
and Old Economy - who is embracing whom?" Copenhagen/Elsinore 6-8 June 2002
Theme E: New Competition Policies and Intellectual Property Rights

THE PERFORMANCE OF THE IPR SYSTEM IN THE NEW ECONOMY:
IMPLICATIONS FOR DIGITAL INVENTIONS AND BUSINESS METHODS1

Birgitte Andersen2

Department of Management - Birkbeck - University of London
Malet Street - Bloomsbury - LONDON, WC1E 7HX
Tel: +44 (0) 207 631 6848 / Fax: +44 (0) 207 631 6769 / EMAIL: b.andersen@bbk.ac.uk

8th May 2002

Abstract: The aim of this paper is to evaluate the relationship between property rights
on business methods and computer implemented inventions on the one hand, and the
social and economic effects of such on the other hand. Although the rationales for IPR
regimes (i.e. why we have them) have been greatly discussed, the existing socio-legal
or economic literature on IPRs has largely ignored the dynamic effects (economic or
social) of the exploitation of IPRs on the general profile of corporate power, or the
accountability of that power. First when we understand this relationship, we will be
able to design the most appropriate intellectual property right regime in relation to
such ideas.
The European Union (EU)’s hearing on IPR protection of business methods and
computer implemented inventions has been overshadowed by defining alternative
classifications of business methods for patent protection. This paper argues we should
instead focus on the nature and form of such legislation. It is here the challenge for
IPR policy resides, and such discussion has been largely ignored. It is argued in the
paper how policy must use IPR legislation very cautiously in the new economy of
‘increasing returns to scale and adaptation’. Also, a weaker IPR protection is
suggested, including an IPR system enforcing (by law) collaboration around an open
source architecture on digital inventions and business methods.

Key words: Intellectual property rights (IPRs) and IPR policy, Business methods and
computer implemented inventions, Forms of competition, IPR strategy, New
economy.

JEL: Will be provided


1 A report version of this paper was prepared for “Round Table on the Patentability of Computer
Implemented Inventions” organized by The Standing Committee of Research and Industrial
Development of the Danish Parliament, Christiansborg, Copenhagen, February 20th 2002. The research
in this paper also draws upon interviews for the EU fifth framework ‘Patents and Services’ project in
which I participate.
2 Dr Birgitte Andersen is Senior Lecturer in the Department of Management at Birkbeck – University
of London, and she is Director for the E-commerce Programme that runs across School of Management
and Organizational Psychology, School of Economics, Mathematics and Statistics, and School of
Computer Science and Information Systems.

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1. AIM OF PAPER

The Commission of the European Union (EU) has recently made a hearing across the
Member States, to get their opinions regarding policy on intellectual property
protection of business methods and computer implemented inventions (EU 2002). The
problem formulation is essentially about if the EU should be confined to harmonising
the relevant laws of the Member States on the patentability of business methods on
the basis of the status quo as defined by the jurisprudence (i.e. as it is now in most
member states of the EU) or if the EU should extent the scope of application of the
Directive as in the US or beyond. The specific formulation of the different options are
listed in Section 2.

However, I would argue that before we can design any appropriate policy on such
matters we need to know the institutional issues regarding how IPRs on business
methods and computer implemented inventions change the ‘rules of the game’ for,
especially, many knowledge based service sectors. Here, I refer in particular to how
IPRs change the nature of competition to which corporate strategy and royalty
management have to respond. There are many important issues to address in this
respect. Also, we cannot just assume that an IPR system is the best way of organising
inventive activity at the macro economic level. Hence, the rationale of the IPR system
and its’ relationship with corporate strategy is a central area which requires
illumination.

The existing socio-legal or economic literature on IPRs has largely ignored the
dynamic (e.g. social and economic) effects of the exploitation of IPRs on the general
profile of corporate power, or the accountability of that power, nationally or
internationally (Andersen and Macmillan, forthcoming). The industry concentration
around IPR based industries is notable (see e.g. pharmaceuticals, software and music),
but it is not entirely understood to what extent the IPRs are responsible for such
concentration. More information is needed for policy makers regarding an
understanding of the dynamics and the performance of IPR systems. What are the
socio-economic effects of such IPR power-bases?

The aim of this paper is to discuss the relationship between property rights on
business methods and computer implemented inventions on the one hand, and the
social and economic effects of such on the other hand. First when we understand this
relationship, we will be able to design the most appropriate intellectual property right
regime in relation to such ideas.

I believe that in order to understand the relationship between IPR legislation and the
social and economic effects of such, we need to understand how IPRs on business
methods and digital ideas interact with forms of competition as well as corporate
incentives and strategies surrounding such intangible ideas when protected by IPRs.
Also, as IPR systems are not neutral but set ‘the rules of the game’ in which players
interact, it is essential to address the economic and social effects of IPRs on business
methods and digital ideas in relation to the rationales of IPR systems.



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1.1. Outline and contribution of paper

Section 2 sketches the problem in a historical context. It provides some background
information regarding the increasing importance of intellectual capital as well as
outlines the problems regarding IPR policy on business methods and computer
implemented inventions.

In Section 3, the paper sets out to explain how IPR regimes are extremely complex
systems, with strong moral and ethical rationales (including human rights, business
and consumer ethics) and strong economic rationales (including incentives to
creativity, increased competition and more formal organisation of science and
technology at the national level). The problem of the rationales of the IPR system is
also discussed in the context of the performance of the IPR system in real life,
including the social and economic effects of such.

In the subsequent sections it is illustrated how IPR systems are not neutral but set ‘the
rules of the game’ in which individuals and organisations interact, and in which
corporate leaders and stakeholders are shaped and technological trajectories selected
or reinforced. The paper therefore argues and concludes in Section 5 that the
rationales of the IPR system become very vital and should be addressed at the
political level.

With respect to the un-neutral nature of IPR systems, we need to gain a better
understanding of the dynamics of such an innovation system and its interaction with
the competitive forces in its socio-economic surroundings. What difference does it
make? In Section 4, the paper illustrates how the new form of competition in the new
intangible knowledge based service economy is faced by increasing returns to scale
and adaptation and lock-in, due to (i) the intangible nature of knowledge, digital ideas
and business methods, (ii) large set-up of fixed costs, (iii) learning effects, (iv)
network externalities, (v) technological webs and (vi) adaptive expectations
imprisoning informational increasing returns. Thus, the paper stresses that it is the
creation of institutions and infrastructures from social interaction that is central to
why some technologies win the competitive game and why some corporations
become leading. (Such characteristics are very different from the nature of dynamics
in the old manufacturing and agricultural economy faced by decreasing return to
scale.). Thus, the new economy of increasing returns to scale and adaptation has
found a new source of profitability or value in IPRs.

Section 4 also illustrates how the IPRs regime can encourage corporate strategies to
create fast log-in into technological and institutional frameworks in order to control or
protect market advantages in stead of searching for optimal solutions and thereby
increase overall welfare. That is, IPR in ‘increasing return’-induced lock-in situations
can (i) enforce creation of sub-optical technological and economic solutions, (ii)
provide a platform for unfair exploitation of individuals and sectors of the economy,
that subsequently have to adapt to established technological trajectories or paradigms,
and (iii) create major corporate concentration in industries rather than competition
with many players.

In this context, the paper concludes in Section 5 that that since the ‘increasing return
to scale and adaptation’-nature of the new economy is very different from the

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‘diminishing return to scale’ of the old economy, a ‘weaker IPR protection policy’
might be essential.

Section 4 also discusses the practical aspects of enforcing intellectual property rights
on computer implemented inventions and business methods. A basic argument is that
although a rationale or an objective of IPRs might be to (i) strengthen the sectoral
innovation system, (ii) improve financial corporate performance, (iii) enhance
competition and corporate competitiveness, (iv) protect market advantages; the
ownership of an IPR portfolio is only worth something if it is ‘managed properly’ at
both the firm, sectoral and national level. The problem is not merely that unused IPRs
are not worth anything or that we need to develop IPRs in ‘promising’ fast growing
technological areas (which was constantly stressed in the old economy), - but that, - as
IPRs have become important as an income generator through licensing, we need to
understand and be able to manage the complex mechanism regarding the way rent is
generated and captured from value-driven intellectual capital. It must be recognized
that while the IPR regime may underpin an industry, the enforcement of the system of
royalty flows between IPR providers, users and right-holders is by no means
automatic, but needs to be monitored and administered through a complex
institutional machinery. Such practical considerations are even more complex with
IPRs on business methods and digital inventions where it has become almost
impossible to control copying and flow.

The paper also concludes in Section 5 that the IPR regime, for all its flaws, is vital to
modern IPR-based industries specialising in value driven intellectual capital,
especially as new information technology is associated with radically reduced costs of
reproduction and distribution. However, unless firms or society develop institutions to
match and manage the new technological and business opportunities, we may be
unable to fully realise the benefits from the creativity and talents of people.


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2. BACKGROUND

2.1 The increasing importance of Intellectual Capital (IC) as a competitive asset

With the emergence of the knowledge based intangible service economy a new form
of competition has emerged in which intellectual assets rather than physical assets are
the principal sources for wealth creation and competitive advantages. The battles are
not for control of raw materials but for property rights to new ideas and innovations.

Even the asset-bases of the manufacturing firms have also shifted dramatically during
the last 20 years. 20 years ago physical assets-bases constituted about 60% of
companies’ market value. Today, they constitute about 30%. About 70% of
companies’ biggest assets today are intangibles such as Intellectual Capital (IC) like
patents, copyrights and trademarks. Using the ‘market to book value’ of intellectual
capital in which everything left in the market value after accounting for fixed assets is
regarded as Intellectual Capital [IC = Market value – Book Value], we see how
Microsoft is worth 85.5 bill£ on the market but has a book value on 6.9bill£: Hence,
IC for Microsoft = 85.5 – 6.9 = 78.6£. (Stewart 1998).3

Patents have been used by companies to communicate their asset picture and earnings
potential to investors and the financial community. Even Wall Street is slowly waking
up to the asset value of patents. It has been identified how companies whose patents
were more frequently cited in the patents of other companies saw their stock prices
rise far more rapidly than those of companies with less frequently cited patents. Stock
analysts have begun looking at companies’ IP capabilities when evaluating earnings
potential and competitive prospects. Furthermore, patent infringement suits can even
change the stock value prices of firms overnight. (Rivette and Kline, 2000)

Whereas IPRs in the old manufacturing paradigm were used to protect or monopolise
innovations embodied in products and production lines (machines and process
innovations), they are in the new service paradigm mainly used as an aggressive mean
for revenue generation through licensing. This way of doing business has become
extremely topical for digital ideas such as software, music, some and business
methods etc., which are easily digitally produced, exchanged and consumed.
However, this new way of capturing rent is also adapted by established knowledge
driven or science based manufacturing firms that are currently diffusing their
production lines in order to specialise in value driven intellectual capital, which is
where the money is to be made in the future.

Also, in the new knowledge based service economy the true source of a company’s
competitive advantage lies not merely in its products or services, but in its innovative
way of doing business (which is a typical scope of a dot.com firm). Hence, the
patentability of business methods patents has become a central area of attention for e-

3 Although very useful, it should be mentioned that the ‘market to book value’ is a very rough and not
perfect measure: MARKET VALUE PROBLEM: Stock market is volatile and responds to factors
entirely outside control of management: E.g. macro-economic instability is reflected in the market
value of the firm, and hence also the IC value. BOOK VALUE PROBLEM: Assets are deliberate
‘depreciated’ faster than the ‘true depreciation’: Reason is tax advantages and in order to encourage
investment. An under-evaluation of book value will over evaluate the IC value given, IC = Market
value – Book Value

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business sectors. In this context, it is important to stress that although the operation of
business methods sometimes might be software based, the idea of the method itself
may not be software based. Hence, in a conceptual context we have to distinguish
between a software patent and a patent on a business method in the narrow sense.

In this respect, a very central subject of debate when it comes to the patentability of
business methods emerges. That is, the opportunities for obtaining business method
patents are greater in the US than in either Europe and Japan. This is due to (i)
different classifications / definitions of business methods and (ii) different
requirements of degree of novelty (EU and Japan: has to be novel and non-obvious vs.
US apparently allows patents on trivial inventions as long as they are ‘useful’.).

In this connection, the European Commission is currently assessing their policy on
IPR protection of ‘business methods’ which is currently in most member states
protected in the same way as computer programmes / software. That is, a business
method in most European countries can (as software / computer programming) only
obtain patent protection if it involves a technical progress idea. Otherwise, the
software or the computer programme codes are protected via copyright law.

For illustration of this I first list how computer programmes are protected and then list
the different options the European Commission (EC) faces regarding protection of
business methods ideas.

2.1.1 Protection of computer programmes

To give an example of when computer programmes are protected via patent or
copyright law, let us focus on a software programme developed to operate a machine
painting cars. Let us first imagine that a programme was developed from analysing
the movements of a real person painting a car, and that the software programme now
can operate a machine doing the same job. As the programme idea was regarded a
technical progress it could obtain a patent, and the written source codes in the
programme could be protected by copyright law. Then someone invented a new
programme which from analysing the surface of the car could calculate an optimal
way of painting it (which was more optimal than the programme developed from
simulated human movements as humans do not calculate as computers). Subsequently
a more optimal software programme operating the machine painting the car was
developed. Also here the idea was of technical progress and could obtain a patent, and
the written source codes could be protected by copyright law. Now let us imagine that
someone could write a programme that is different from the one just invented but that
it can do the same job. However, unless the new programme is more efficient (e.g. in
terms of speed and quality) it will not be able to be protected by patent law, as the
technical progress idea is the same (i.e. not novel and non-obvious). Yet, the new
programme can still obtain a copyright on the written source codes as they are
different from the other computer implemented ideas. Hence, a software patent
protects the technical progress idea, whereas the source codes within the programme
are protected by copyright law.

However, this way of protecting computer programmes has not always been like the
current legislation. At first, in the 1960s-1980s, software programmes were mainly
protected via copyright law. However, as reverse engineering is easy for digital

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products, and as copyright law has a very weak or no criteria for novelty on an idea in
comparison to patent law (see Andersen and Howells 2000), information technology
(IT) firms like IBM experienced that copyright law was not enough to protect their
inventions or ideas. E.g. if IBM invested 300 human-years to develop an idea in the
form of a digital product it could be ‘reversed engineered’ by the Japanese in 10
minutes and such type of behaviour happened (IBM 2002). Therefore the patent
protection on the idea was considered as essential for both large and small IT firms
who are willing to invest in ideas.

2.1.2 Protection of business methods

As we are well aware, companies must focus on protecting the technologies (e.g.
software) that give their products and services an advantage over their competitors.
But what if the true source of a company’s competitive advantage lies not in its
products or services but in its innovative way of doing business (i.e. its business-
method)? This is the particular problem faced by e-commerce and many firms going
on-line.

Examples (Rivette and Kline, 2000):
• Dell’s computer’s advantages lie not in its computers, but in its system for
selling (“build to order”-direct sales business model), distributing and
providing after sale support. Dell has secured 42 issued and pending patents
on its innovative business model. The patents cover not only the customer on-
line ordering system, but also the way the ordering system is integrated with
Dell’s manufacturing, inventory, distribution and customer service operation.
• Amazon.com received a patent for their “one-click” system for processing
customer orders. (Competition against Barnes and Noble)
• Priceline.com got the “name your own price” auction patent

Patents on business methods are not only a source for royalty generation, but also a
way of protecting online market advantages. Business methods are becoming
important for service firms, especially in e-commerce, and we have to understand
their role in the new form for competition in the new economy.

However, although the operation of business methods may be software based, the idea
of the method itself is not software based. Hence, conceptually, we have to distinguish
between a software patent and a patent on a business method.

The EU has made a hearing across the Member States, to get their opinions regarding
policy on intellectual property protection of business methods and computer
implemented inventions. The problem formulation is essentially about if the EU
should be confined to harmonising the relevant laws of the Member States on the
patentability of business methods on the basis of the status quo as defined by the
jurisprudence (as it is now in most member states of the EU) or if the EU should
extent the scope of application of the Directive as in the US or beyond. That is, we got
three way in which business methods can patented:

• Option 1: As currently in most European countries and Japan: A business
process can be patented if it reflects a technical advancement. In this sense, it
is protected as software and computer programs (Criteria: The digital idea

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embedded in the business method has to be new and inventive; - i.e. novel and
non-obvious)
• Option 2: As currently in the US: Business methods can be patented as long as
they are in ‘the technological arts’; - that is, the business methods may not
necessarily be of technical character, but it needs to be implemented via
computers/software to get the protection. (This meets UN’s definition of
technology: ‘a combination of equipment and knowledge’ and so to be in line
with the basic patent law principle (EU 2002). (Criteria: The business method
idea has to be useful, concrete and tangible results has to be provided)
• Option 3: There should be no technical or technological restrictions on the
patentability of business methods: Any new idea of doing business (i.e.
business method) should be able to be patented (Criteria: The business method
idea has to be useful and concrete).

It follows that Amazon.com could not have obtained their patent for their ‘one-click
system’ in Europe under current legislation in most member states, as this invention
based upon a new way of doing business does not involve technical progress,
although it is implemented via computers and software.

Which definition is best for harmonization of intellectual property protection is
difficult to say. The European Commission is clearly concerned with the legal
matters.

Most experts would say that Option 3 goes beyond the basic principles of patent law,
which is based upon a science based principle of technical or technological character.
However, when discussing the different options there is ‘no conceptual reason’ for
that a business methods need to be technical or technological implemented. Why
should there? The technical or technological criteria are very manufacturing and
tangible economy based and do not match the new intangible economy. Also, - should
the IPR system only protect science based technical or technological knowledge? Isn’t
that ancient in the new knowledge based service economy embracing a variety of new
types of knowledge?

However, many independent experts as well as the software industry (IBM 2002) are
totally against a broad definition of business methods (i.e. Option 3). That is, a too
broad definition will not be operational in practice. Without any technical criteria it is
very difficult to judge an eligible criteria for granting a patents (that it, when is it
novel and un-obvious). These are indeed also the problems often raised against
Option 2. That is; - even, if in principle we would support the US definition – is it
practical possible? – What are the novelty criteria, and would we end up patenting too
many trivial inventions – so the system becomes inefficient? These are the concerns
often raised over the US system.

However, many knowledge based firms (from finance, insurance, other business
services, etc.) operating in the EU would certainly argue for implementing the US
system in the EU. As argued by Navision (Navision 2002), many of their inventions
regarding new ways of doing business are very resource demanding and therefore
need protection. Also, the competitive advantages from many of their inventions is in
the form the way they do their business (their business methods), and there is no
reason way such ideas should result in a technical progress, although they are

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implemented via technology. A different matter is that with the technical progress
constraint on the legal protection of business methods, this place many knowledge
based business services in unfair competition against software firms. Finally, in
reality, there is not a clear line between, (i) when a business method is a technical
advancement in itself, and when (ii) the method is of non-technical character but still
an invention in technological art as it uses computers/software to be implemented.
Hence, many computer-implemented business methods inventions implemented via
computers and software and patented in the US can be argued to be of a sufficient
technical character to be patented in Europe and in Japan. (EU 2002).

What is evident is that we are dealing with many complex issues. However, I believe
that the European Commission (EC) is too focused on the definitions of the business
process with respect to when it is eligible for a patent. As mentioned in the
introduction, it is difficult to discuss or design any appropriate policy on such matters
with out understanding how IPRs change the nature of competition to which corporate
strategy and royalty management have to respond.

Also, we cannot just assume that an IPR system is the best way of organising
inventive activity at the macro economic level, and the socio-legal literature have not
really dealt with the social and economic effects of such. In this respect, the rationales
of an IPR system are central and should be revisited. Why do we an IPR regime (see
Section 3)? Does it make the difference to which it has been designed (Questioned /
listed reservations about in Section 3). Or, does other economic and technological
effects and social constraints come into play (see Sections 4 and 5)?




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3. THE IPR CONTEXT

3.1. Definitions of IPRs

IPRs came about as a natural evolution from property rights on land, capital and
labour. Intellectual property rights are extremely important because they present the
legal mechanism for protecting (or enhancing monopoly over) many corporate assets.

Intellectual property is intangible as opposed to tangible property (property of land,
labour, capital etc.). It includes a protection of exploitation of knowledge embodied in
• new ideas (mainly patents, trade secrets and copyrights)
• product and process innovations (mainly patents, trade secrets and copyrights)
or related to
• symbolic material (mainly copyrights and trademarks)
• creative effort (mainly copyrights)

That is, the exploitation of knowledge embodied in product and process innovations,
new ideas, or related to intangible assets and symbolic material, is in most mature
economies protected through the use of IPRs. IPR instruments differ considerably in
history and precise intent, and in mode of operation. The main IPR measures used, in
studies of innovation for example, are patents designed to protect the inventor from
exploitation of his or her knowledge embodied in, mainly industrial, product and
process inventions. In the new economy patents are also obtained in order for firms to
control and capture rent from the way in which their intellectual ideas may be
exploited through licensing and other agreements (see Section 2.1).

Another IPR instrument is copyright, which provides rights to the creators of certain
kinds of mainly symbolic material, enabling them to control the various ways in
which their symbolic ideas may be exploited. At an early stage of intellectual
property protection of software and computer programmes, copyrights were the
preferred form for protection. However, as we discussed in the above Section ? this
way of protection was not sufficient due to the weak novelty criteria of copyrights on
ideas (compared to patents) combined with the easy reversed engineering on digital
ideas.

Among the several other instruments that are in use, I should mention in particular
trademarks, which relate to any word, name, symbol or device that is used in trade
with goods to indicate the source or origin of the goods and to distinguish them from
the goods of others. The use of brands has experienced new break-through with the
emergence of the Internet. For newly established artists, the Internet represents the
opportunity to ‘speak’ directly to consumers through personal branding.

Finally, Internet domain names have become a matter for concern. “A variation of the
use of trademarks that has arisen specifically with the Internet is the Domain Name
System, which enables users at different addresses to connect with each other.
Internet domain names are today registered by a number of organizations certified by
ICANN (Internet Corporation for Assigned Names and Numbers). Only one name can
be registered under each top-level domain (.com, .org, .net, and so forth)” (Davis
2002). In interview with Carlton PLC in London (the largest English language movie
producer outside Hollywood and owner to ITV) they highlighted that one of the

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