[Fsfe-ie] Economist survey on intellectual property

teresahackett at eircom.net teresahackett at eircom.net
Tue Oct 25 12:42:39 CEST 2005

The current issue of the Economist carries an extensive survey of IP 
issues, focused on patents and the IT industry. Most of it is available 
to subscibers only. Here is the lead article.

A market for ideas*
Oct 20th 2005 The Economist

*Intellectual-property protection can be good for the technology
industry as well as for its customers, says Kenneth Cukier (interviewed
But it requires careful handling*

“The granting [of] patents ‘inflames cupidity’, excites fraud,
stimulates men to run after schemes that may enable them to levy a tax
on the public, begets disputes and quarrels betwixt inventors, provokes
endless lawsuits...The principle of the law from which such consequences
flow cannot be just.”

/The Economist /may have put it rather strongly in 1851, but its
disapproval of patents represented conventional wisdom at the time. A
century earlier, Adam Smith had described them as necessary evils, to be
handed out sparingly, and many other economists have since echoed his
reservations. Patents amount to temporary monopolies on useful new

In recent years intellectual property has received a lot more attention
because ideas and innovations have become the most important resource,
replacing land, energy and raw materials. As much as three-quarters of
the value of publicly traded companies in America comes from intangible
assets, up from around 40% in the early 1980s. “The economic product of
the United States”, says Alan Greenspan, the chairman of America's
Federal Reserve, has become “predominantly conceptual”. Intellectual
property forms part of those conceptual assets.

In information technology and telecoms in particular, the role of
intellectual property has changed radically. What used to be the
preserve of corporate lawyers and engineers in R&D labs has been
speedily embraced by the boardroom. “Intellectual-asset management” now
figures as a strategic business issue. In America alone, technology
licensing revenue accounts for an estimated $45 billion annually;
worldwide, the figure is around $100 billion and growing fast.

Technology firms are seeking more patents, expanding their scope,
licensing more, litigating more and overhauling their business models
around intellectual property. Yet paradoxically, as some companies
batten down the hatches, other firms have found ways of making money by
opening up their treasure-chest of innovation and sharing it with
others. The rise of open-source software is just one example. And a new
breed of companies has appeared on the periphery of today's tech firms,
acting as intellectual-property intermediaries and creating a market for

*Mind the keep-out signs*

At the same time, however, the legitimacy of many patents granted is in
question as patent offices struggle with the huge increase in demand.
Over the past decade the number of patent applications has nearly
doubled and continues to climb. Much of that growth has been in the IT
and telecoms field: in America alone, that sector's overall share of
patents has increased from around 30% in 1990 to almost 40% today. Also
climbing, alas, is the number of lawsuits over patent infringement, the
cost of litigation, and the amount of money plaintiffs are winning.

Meanwhile, emerging technology powerhouses such as China and India are
competing to move up from lower-end work such as hardware manufacturing
and software coding to more sophisticated projects requiring their own
innovation. This could pose serious challenges to today's incumbents.
The number of patents granted at China's patent office has trebled in
the past four years alone.

“Intellectual property has become more central to the industry,” says
Greg Papadopoulos, chief technology officer of Sun Microsystems. “I
don't know if that is a function of a mature industry, or simply a
confused one.”

*Licensed to make money*

The facts and figures speak for themselves. IBM alone now earns over $1
billion annually from its intellectual-property portfolio. HP's revenue
from licensing has quadrupled in less than three years, to over $200m
this year. Microsoft is on course to file 3,000 patents this year, when
in 1990 it received a mere five. Earlier this year it set up an entirely
new corporate division to exchange its technology for cash or equity in
start-up firms. Nokia has recently started licensing its technology to
other firms and plans to do more. And some companies, such as ARM, a
British firm that designs the blueprints for microchips used in wireless
devices, do little other than create and sell intellectual property.

According to a survey of business executives last year by McKinsey, a
consultancy, 54% of companies saw growth in licensing of 10-50% between
2000 and 2002. Almost 75% of executives say they expect to buy as well
as sell more licences over the next two to five years, and 43% expect a
dramatic increase in their licensing revenue. And they think the market
is still embryonic. “Many companies generate a lot of intellectual
property and do not capture the value from it,” says Jay Jubas of McKinsey.

The new predominance of intellectual property in technology industries
is fed by a number of broader industry trends. First, IT and telecoms
have become so complex that there is a greater willingness to accept the
innovations of others. Gone are the days when vertically integrated
firms handled every step of a product, from initial design to final
sale. Now, a small army of specialist firms focus on narrow portions of
technology, using intellectual-property rights to protect their
inventions when they are licensed out.

Second, as many new technologies quickly turn into commodities, firms
increasingly rely on innovation to remain competitive. Yet the return on
investment in R&D is short-lived because more people innovate at a far
faster pace than before. That means margins have shrivelled, explains
Ragu Gurumurthy of Adventis, an IT and telecoms consultancy. “How to
recoup the cost of innovation? By licensing the technology,” he says.

Third, customers are demanding “interoperability” and common standards
rather than proprietary systems, which means different firms'
technologies must work together smoothly. This often requires pooling
patents or cross-licensing agreements.

Fourth, generating intellectual property is less capital-intensive than
other aspects of the IT businesses because it relies mainly on people
rather than bricks, mortar and machinery. That makes it attractive to
many start-up firms. Venture capitalists often demand that firms patent
technology, both to block rivals and to have assets to sell in case the
firm flounders. This was particularly apparent during the internet boom
in 2000. “In addition to the dotcom bubble, we had a patent bubble,”
says Mark Webbink of Red Hat, a firm that sells Linux, an open-source
operating system.

Companies cannot simply turn their back on what is happening in
intellectual property. Even if they refuse to play the game, they may be
unwittingly infringing someone else's patents because there are so many
more of them around. Unless firms have patents of their own to assert so
they can reach a cross-licensing agreement (often with money changing
hands too), they will be in trouble. Thus many companies are acquiring
large numbers of patents for purely defensive reasons, for use only to
keep others' patent threats at bay.

Legally, the intellectual-property system covers four areas: copyrights
(used to protect artistic, musical or literary works); trademarks (for
things like brands); patents (for inventions); and an ill-defined
category of “trade secrets”, for practices that are kept confidential.
The system provides legal protection against counterfeiters and copiers
and is vital to many fields, such as biotechnology and nanotechnology.
And it matters not only to companies: universities, too, have recently
become big patent holders and licensers.

In IT and telecoms, the area of intellectual property that is creating
particular upheaval is patents (see article
This is because patents confer a “negative right” to exclude others from
using the same technique; yet information technology and
telecommunications rely on “network effects”, meaning that as more
people use a system, it becomes that much more useful. To make the most
of such network effects, interoperability between different technologies
is essential. This can be achieved either by a single standard set by a
dominant firm (which tends to generate resistance from customers and
competitors), or by using a mixture of different technologies, with the
patent system providing legal protection for inventions.

*The more the merrier*

As the system of intellectual property evolves, the ethos seems to be
that if a little is good, then more is better. That is to say, if some
property rights on inventions are beneficial, then increasing those
rights—in scope, strength or duration—will increase the benefits. But
that is a large assumption. There is even a body of evidence to suggest
it is flatly wrong.

The technology industry faces the question of whether today's abundance
of patents, rather than lubricating the gears of innovation, may be
clogging them up. Already, businesses are having to negotiate with other
firms in order to do basic things such as reading files from different
proprietary formats; and the design of new technology products now
involves lawyers as well as engineers. The proliferation of patents
might prove a serious encumbrance to businesses, just as travellers
along the Rhine in medieval Europe were slowed down by having to pay a
toll at every castle.

James Boyle, a legal scholar at Duke Law School in North Carolina,
claims that the current increase in intellectual-property rights
represents nothing less than a second “enclosure movement”. In the first
enclosures, in 18th- and 19th-century Britain, the commons—open fields
used by many, belonging to all, owned by none—were fenced in, and nearly
all land became private property. By analogy, the granting of property
rights on ideas, to the extent it is happening today, is plundering the
intellectual commons of our public domain.

Others see the expansion of intellectual-property rights as hugely
beneficial, leading not only to more innovation but to more openness.
The standard justification for the patent system is that it provides an
incentive for innovation, allowing the inventor to reap rewards by
protecting the work from imitators who would otherwise hitch a free ride
on the investment. But that is a simplification. The initial intention
was in fact to make inventions available to the public as well.

Before the 18th century, innovations were mainly kept secret through
trade guilds. Sometimes monarchs capriciously granted indefinite
exclusive rights to someone they favoured. Intellectual-property law was
meant to remedy this by requiring the invention to be vetted by experts,
limiting the right to a set period and making knowledge more widely
accessible through public disclosure. Its development was part of the
drive towards democracy and capitalism and the abolition of royal
privileges and monopolies.

In principle, patents open up innovations in two ways. First, they
confer only temporary rights; once patents expire or are abandoned, the
intellectual property they are designed to protect passes into the
public domain. Second, they require the details of the invention to be
disclosed so they can be replicated. This permits follow-on innovation,
which is essential for industrial progress.

More recently, as the patent system has evolved, it has been seen to
provide other benefits. It leads to a degree of economic specialisation
that makes business more efficient. Patents are transferable assets, and
by the early 20th century they had made it possible to separate the
person who makes an invention from the one who commercialises it. This
recognised the fact that someone who is good at coming up with ideas is
not necessarily the best person to bring those ideas to market.

Such specialisation is now so common that it is taken for granted.
Semiconductors, the silicon chips that power digital devices, are
typically designed by specialist firms that are good at engineering, but
physically produced by other firms whose expertise lies in
manufacturing. As the patent system has matured and licensing has become
much more widespread, these transfers are turning business relationships
on their head. Some economists argue that the growth of patent
transactions is establishing a proper “market for technology”. The
creation of any market takes time and trouble. When such an institution
develops, those outside the system feel threatened by it and condemn it.
Yet just as the banking system created a market for capital and the
insurance industry created a market for risk, the growth of the patent
system may be creating a market for innovation.

This provides a sort of “liquidity” to knowledge that did not previously
exist, argue Ashish Arora, Andrea Fosfuri and Alfonso Gambardella in
their 2001 book, “Markets for Technology, the Economics of Innovation
and Corporate Strategy”. Seen that way, the evolution of the patent
system in IT and telecoms is simply part of a broader movement to create
an institutional mechanism for the transfer of ideas to fuel economic

*Mutually assured destruction*

That is the context in which commercial battles are taking place in the
technology industry today. The convergence of IT and telecoms is forcing
companies to work together in new ways in order both to protect and
exchange their technology. “How do you create a marketplace for ideas in
that converged marketplace?” asks David Kaefer, director of
intellectual-property licensing at Microsoft. “That is really the big
question. In the past, two parties would haggle over a pound of wheat.
Today, they haggle over the patent of the week.”

These markets for technology are expanding. For instance, 60% of
technology and telecoms firms report an increase in licensing compared
with the previous decade, and 70% report fewer obstacles to reaching
such agreements, according to a survey by the Organisation for Economic
Co-operation and Development in 2004. “Intellectual property is the next
asset class. Companies are creating a market,” says Eric Gillespie, the
co-founder of ipIQ, one of the new crop of firms that are fuelling
patent transactions.

But when talking to executives in the technology firms themselves, the
language you hear most often is that of “the arms race” and “mutually
assured destruction”. Companies amass patents as much to defend
themselves against attacks by their competitors as to protect their
inventions. Many technology companies have recently championed reform of
the patent system to deal with spuriously awarded patents, licensing
extortion and massive lawsuits. “There is a broad recognition in the US
that the patent system, if not reformed, will...begin to impede American
competitiveness around the world,” says Bruce Sewell, general counsel of
Intel, the world's biggest chipmaker.

This survey will argue that, despite such adjustment problems, the huge
changes in intellectual property currently taking place in the IT sector
will in time produce more efficient markets. But what do the IT firms
themselves make of it all?

More information about the FSFE-IE mailing list