Brian Kahin

On September 24, the European Parliament passed the Directive on the Patentability of Computer-Implemented Inventions proposed by the European Commission, but not before passing a large number of amendments. Some members of parliament remarked that they had never before endured lobbying as intensive as that preceding the vote. Frits Bolkestein, European Commissioner for Internal Market, warned that failure to adopt the Commission's version would result in intergovernmental action that bypassed the Parliament. Taking up the challenge to its relevance, the Parliament voted dozens of amendments, producing a Directive that would drastically curtail the reach of software patents. It now awaits a vote by the Council of EU Ministers.

The pressure surrounding the vote is a measure of both how far patent practice has evolved and how prominent patent policy has become. Patents are no longer just a legal matter for legal specialists, but an economic matter of wide interest. The new mission statement of the European Patent Office puts it clearly - to support innovation, competitiveness and economic growth for the benefit of the citizens of Europe. The theme of the recent European Commission conference "Industrial Property - Quo Vadis?" was on the future role of IP in creating wealth and employment and stimulating innovation and competition.

Clearly an economic question, although no economists were invited. In fact, a number of prominent economists had sent a letter to the European Parliament on August 25 critical of the analysis behind the Commission's version of the Directive. While patent lawyers frequently testify from personal experience about the economic benefits of patents, economists are more modulated and nuanced in their views. In certain discrete technologies, notably pharmaceuticals and chemicals, the evidence shows that patents are essential. In complex technologies, especially in the information and communication technology (ICT) sector where there are many patentable functions in each product, the name of the game is not patents but portfolios of patents.

Strength in numbers

Large companies amass portfolios for strategic purposes: cross-licensing, blocking, deterrence, and revenue generation. This phenomenon has been studied in depth in the semiconductor industry, and the recently released Federal Trade Commission (FTC) report on IP and antitrust shows it to be endemic to digital technologies. The hearings held last year to gather information for the report convey in graphic terms the consequences of strategic patenting and low standards of patentability: patent thickets, widespread uncertainty, inadvertent infringement, and wholesale failure of the disclosure function.

While patents facilitate niche entry by small companies, patent portfolios disadvantage small companies seeking to enter markets for complex products. They have little to trade, but they need a lot of licences. But how many, and from whom? As Robert Barr of Cisco testified at a FTC roundtable: "There are too many patents to be able to even locate which ones are problematic. I used to say only IBM does clearance ... but IBM tells me even they don't do clearance searches anymore."

How can a SME do business in this environment? One option is to sell out to companies whose large portfolios give them freedom of action. Rather than making and selling products, the SME may do much better focusing on the patent business. In fact, testimony from the hearings suggests that the highest and best private use of a patent or two may be demanding royalties from companies that have inadvertently incorporated patented functions in products that are already on the market. This can be a profitable model for small companies or individuals with no need for cross-licences.

A question of utility

What's so bad about these "trolls" (as they were described at the hearings; the FTC prefers the term "non-practising entity")? After all, the large companies are exploiting their portfolios with their own softer and gentler form of "stick licensing". As last month's Managing Intellectual Property interview with Marshall Phelps, the architect of IBM's licensing programme, shows, Microsoft wants to start earning returns from its massive portfolio. After all, why shouldn't users pay innovators? Why shouldn't today's developers pay tribute to the R&D investments of the past 20 years? Why should European developers, small, medium, open source, or otherwise, get a free ride on Microsoft and IBM?

This might be a reasonable argument if developers actually learned anything from these massive portfolios, but from most accounts nobody reads software patents. Programmers don't use reference manuals, patents are not written to convey knowledge beyond the bare minimum needed to fulfil legal requirements, and lawyers advise against reading patents because of the risk of wilful infringement. Judging by comments at the hearings, this problem pervades the whole ICT sector, but pharmaceuticals and biotech patents apparently convey useful information in a reasonably efficient manner.

Public disclosure in exchange for exclusivity is the essential bargain underlying the patent system. It fails when there is too much information of indeterminate quality and value. In this environment, strategic portfolio development results in a kind of shadow IP system that rewards on the basis of aggregate past investment rather than specific ingenuity. Advantage goes to those who are best able to manage risk, uncertainty, and transaction costs. Scale is a great advantage, and companies that have successfully mastered strategic portfolio building have a built-in constituency for expanding the scope and reach of patenting and licensing.

Freedom of action

Advantage also goes to those that are focused and specialized, the "non-practising entities" that do not have the risks and liabilities attendant to developing and marketing products. Thus, in the US there are a growing number of licensing firms that are very skilled at gaining maximum returns from patents, and a liberalized legal system allows law firms to assert patents on a contingency basis. But of course contingency arrangements do nothing to help small firms facing patents - they just make life more dangerous. Small defendants pay retail. According to an AIPLA economic report, when the amount in a controversy is under $1 million the average cost per side is half a million (2003), not including staff time and opportunity costs. Licence fees of $10,000 look pretty good compared to the costs of contesting patents.

On the other hand, licence fees of $10,000 or even $100 kill the open source model of software distribution. This is why the World Wide Web Consortium adopted a patent policy precluding the incorporation of royalty-bearing patents in core web standards. This hard-fought decision to create a royalty-free zone at the heart of the web parallels the decision of the European Parliament to keep the uncertainties and overheads of the patent systems out of pure software. One might disagree about where and how the line is drawn, but the political principle is clear: there must be some defined area where the patent does not apply. Some may remember that Microsoft tried to create a zone around Windows free of patent claims through provisions in its licences - until the US Department of Justice put a stop to the practice.

While it was argued by Commissioner Bolkestein and others that the Commission's draft would effectively draw a strong line against further expansion of patentable subject matter, they were never able to explain how this newly formulated standard of technicality would be stronger than others. It did not convince the prestigious Institute for Information Law, which was commissioned to do a study on the Directive for the Parliament.

Concrete analysis

Meanwhile, the US government, flanked by every US patent organization, threatened to walk out of the WIPO negotiations on harmonization if the other delegates do not agree that patents should be available in all fields of activity, including business methods not just fields of technology. Patent lawyers, including Phelps, are fond of noting that logic can be implemented in hardware as well as software. Well, methods of doing business can also be implemented in hardware; shouldn't that make them patentable?

Ultimately, what should concern the Parliament is not one question but a series of questions about the patent system that cannot be effectively addressed in the limited bandwidth of parliamentary politics. Given the incomplete, contradictory information before them, the members of the European Parliament correctly intuited that something was seriously deficient about the work of the Commission.

The Commission owes it to the Parliament to ask the right questions and seek some clear answers before endorsing tens of thousands of patents with little understanding of their aggregate economic impact. There should be a record with concrete policy analysis rather than flat assertions that the Commission has considered everything. While the FTC conducted no empirical research, many of the questions that should be asked and analyzed are laid out in the FTC report.

Learn from mistakes

Europe has good reason to dig deeper. It lags in software. Its patent system is already skewed by heavy transaction costs. It should be learning from the mistakes of the US. It should be deeply concerned about how the patent practice aligns with the flow and utilization of knowledge, how it interacts with different business models and practices, and how it works within different industries and sectors. Unlike hardware, software is not manufactured. History demonstrates spectacular growth without patents. A recent study by James Bessen and Robert Hunt shows that patents actually substitute for R&D in the software.

More importantly, software is by nature exceptionally open - to new entrants, to distributed innovation, to independent thinking and invention, to customization, and to the widest dissemination of its value and benefits. The success of open source vividly demonstrates its uniqueness.

The fact that open source has been successful despite the patent-intensive environment in the US is no guarantee of the future. Dot-com failures have slowly unleashed thousands of patents to seek their highest and best use. The SCO case shows IP practice at a new extreme - and demonstrates the vulnerability of hundreds of millions of end users. Microsoft, a company that has not yet filed suit on any of its many patents, announces that it is entering the licensing business. I note that Phelps on behalf of Microsoft has offered Europe advice on patent policy, and of course he should be taken very seriously.

© Brian Kahin 2003. The author is a visiting professor in the School of Information, Ford School of Public Policy, and Department of Communication Studies, at the University of Michigan. He was formerly Senior Policy Analyst at the White House Office of Science and Technology Policy where he was responsible for the intellectual property and digital economy issues