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I strongly believe that the recent trend to patenting algorithms is of benefit only to a very small number of attorneys and inventors, while it is seriously harmful to the vast majority of people who want to do useful things with computers. When I think of the computer programs I require daily to get my own work done, I cannot help but realize that none of them would exist today if software patents had been prevalent in the 1960s and 1970s. Changing the rules now will have the effect of freezing progress at essentially its current level.

Donald Knuth, letter to the Commissioner of Patents & Trademarks, USPTO, February 1994

Inventions must be tied to a particular machine or transform something. Useful, concrete, and tangible result of State Street is inadequate.

David Kappos, Federal Circuit, in re Bilski, 30 October 2008

Patents aren’t bad. They’re an essential element of our economic system. The patent system and the 1952 shift to the protection of a process is the problem.

The 1952 Patent Act expanded coverage to include industrial processes. With the increasing importance of manufacturing to the economy, Congress had been successfully lobbied to provide a layer of protection around industrial manufacturing processes. With the Act, however, it introduced the framework by which to patent business processes – patents such as one click buy. The patents have muddied the water and introduced an expensive and chilling sense of uncertainty to business and information-oriented innovation.

Patents start with a basic tension. Economies benefit from the dispersion of ideas accompanied by sharing the details of inventions. Inventors, however, have little incentive to share the details if it results in no more than a roadmap for competitors to follow. Patents offer inventors a simple trade-off. Make public the details of your invention, and the government will in exchange grant the exclusive right to exploit it.

The 1952 Patent Act was designed to advance manufacturing quickly. Industrial processes, without the protection of a patent, might remain trade secrets, and these trade secrets were perhaps too valuable to the economy to be kept private. A patent system designed to protect them would open them up and accelerate growth. Or maybe it was more facile than that. Patents would provide legal protection and accrue enterprise to those that developed them. Either way, the patent system shifted from one organized around physical designs to one accommodating of processes. Read the rest of this entry »

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While the Nobel Prize for Economics is a significant recognition, the Royal Swedish Academy of Sciences does not determine who is qualified to serve on the Board of Governors of the Federal Reserve System.
Richard Shelby, (R-AL)

The Nobel Prize for economics was recently announced. It went to three economists who provided the theoretical foundation for understanding search markets. Each had found themselves fascinated by the difficulty that buyers and suppliers sometimes have in finding one another. Together, they found that search markets belie commonly held beliefs of classical economics. They have search costs. They’re often inefficient. They provide multiple outcomes. They’re messy.

Messy markets dumbfound classical economics. Markets are supposed to provide unique and efficient outcomes. Search markets don’t, but they don’t resist analysis. The recipients, Peter Diamond, Dale Mortenson, and Christopher Pissarides, demonstrated this with the DMP model for unemployment. But the model also demonstrates the importance of regulation and policy to affect market structure and improve outcomes. This is far from a laissez-faire point of view so commonly held. Though the recipients focused their efforts on the labor markets, the common features they identified in search markets provide a metaphor for understanding other conventional economic markets and, perhaps, non-traditional markets: the process of finding a spouse or even the marketplace for ideas – a concept still reeling from the controversial Supreme Court opinion on Citizens United v FEC.

Diamond, Mortenson and Pissarides, articulated a handful of common traits associated with search markets. Search markets are typically associated with non-exchange-based transactions, such as labor markets. Unlike on an exchange, it’s typically difficult to find the right buyers or sellers, so search and matching costs, for example, are associated with high real costs. Movement in the labor market, for example, requires individuals to quit or be fired, search for a job and be evaluated, and question accepting a position on the basis of the difficulty of and compensation for the work.

Search markets are also inefficient and may include several outcomes. Though only one outcome can be the best, these markets do not yield unique and efficient outcomes associated with classical economics. Instead, they can lead to imbalances, such as resource utilization, which can skew either too high or too low.

The activity within a search market also affects the search market. When a job-seeker, for example, increases their search activity, the overall market becomes more challenging for other job-seekers and easier for recruiting firms. These are called external effects and are not taken into consideration among market participants. It yielded a relationship between job creation and the intensity of workers seeking jobs. If workers increase the intensity with which they look for jobs, the marginal improvement in a company’s ability to fill a position will encourage employers to open searches for more jobs. It also explains why job openings have increased recently, but the unemployment rate has not changed substantially. These may be attributed to structural issues within the labor market, such as uncertainty about regulation and taxes, a reduced ability to sell one’s house and move to where the jobs are, among other reasons. Perhaps we might also see option-taking by employers. For example, many people are looking for work with intensity, firms can easily fill positions. With low search costs, posting additional vacancies allows them an inexpensive option to hire, should they find someone.

Diamond, Mortenson, and Pissarides, initially working independently, soon found one another in perhaps an example of their own theory of search markets. The realization of one another’s interests galvanized their efforts, and they organized the Diamond-Mortenson-Pissarides (DMP) model to explain the Beveridge Curve. The Beveridge Curve denotes an empirical pattern of high unemployment and low vacancies or low unemployment and high vacancies. The DMP model broke new ground by providing an explanation for the relationship between the underlying economy, various regulations, and the position on the curve.

Rigidities in the labor market can contribute to unemployment. Participants seek to optimize both compensation and the quality of the work required. One’s inclination to compromise before finding the optimal combination might be determined by jobless benefits, the performance of one’s portfolio, or the condition of the overall economy. Similarly, employers might delay listing vacancies or hiring in general if they find it more difficult to fire employees when they feel necessary. India, for example, maintains a rule pertaining to industrial establishments of 100 workers or more. Rather than require the customary one-month notice on termination, industrial establishments require a three month written notice to employees and prior authorization from the appropriate government authority.

The DMP model, however, does not deny the benefits of regulation. Indeed, some regulations may introduce rigidities that impede the market, but properly applied, they may improve the functioning of the market. Though higher unemployment benefits predictably lead to higher unemployment and a higher search time for the unemployed, the DMP model suggests that it nonetheless has its place. Some job searches are complicated by the rarity of an individual’s skills. Without unemployment benefits, they might not have the time to conduct a thorough search. Circumstances will require that they take a position that does not capitalize on their abilities, and the mismatch between an individual and their job will result in a net loss in welfare for the economy overall. If a skilled machinist has to stock shelves at Walmart, the economy does not benefit from the investment required to cultivate those skills in the first place and may pay a price in a company’s inability to fill a vacancy. Without a proper match, the economy will function below its capacity.

Though the recipients’ work centered on the labor markets, search markets have also been applied to many areas where buyers and sellers find it difficult or expensive to find one another. Among them, the process of finding a suitable spouse, identifying and negotiating with strategic suppliers, used car shopping, and perhaps expert networks. Some of these have been explored, others may benefit from analysis through the lens of a search market. Expert networks, a relatively new phenomenon, connect those in need of expertise with those who have expertise through a costly and fitful process of collecting, profiling and delivering independent consultants, former executives, former government officials, and others for paid phone consultations and other engagements.

The metaphor of the market has even been used to understand the freedom of speech guaranteed by the Constitution. Viewing the marketplace of ideas as a search market might be just the metaphor Stevens was looking for when he dissented to the Supreme Court’s decision in Citizens United vs. FEC earlier this year. Indeed, it’s an elaboration of Professor George Stigler’s precursor to search markets discussed the search costs associated with information in his 1961 paper, The Economics of Information. Perhaps it was what Stevens had been struggling with when he wrote:

All of the majority’s theoretical arguments turn on a proposition with undeniable surface appeal but little grounding in evidence or experience, “that there is no such thing as too much speech,”

The marketplace of ideas is a search market. It’s messy. It yields multiple and inefficient outcomes. The Nobel Committee’s reward of Diamond, Mortenson, and Pissarides’ work on Monday helped us understand that better and laid bare the insufficiency of the laissez-faire perspective so often taken.

The facts do not owe their origin to an act of authorship.
Justice Sandra Day O’Connor (Feist v Rural Telephone, 1991)

But does the hunt, the research, the interviews? Or perhaps its organization into a story for the dissemination to a reading public? And can these be made exclusive? These questions have bubbled up as the newspaper industry wrestles with what the internet is doing to their business.

The Cleveland Plain Dealer’s Connie Schultz has argued fervently about the rights of authors and their newspapers to capitalize on their product. She came out against “the aggregators” as though they were a malfeasant band of marauders bent on destroying the institution of journalism and by extension democracy. Citing Daniel and David Marburger, she claimed, “parasitic aggregators reprint or rewrite newspaper stories, making the originator redundant and drawing ad revenue away from newspapers at rates the publishers can’t match.”

James Moroney, publisher and CEO of the Dallas Morning News takes a similar approach. He invokes the ‘hot news’ doctrine and asks congress to apply it to the internet. Says Moroney, “perhaps it is time for congress to establish a principle of ‘consent for content’ for breaking news–similar to the ‘hot news’ doctrine recognized by a few states.”

Copyright law sufficed to protect the written word, fixed in a medium, but these claims demand remedy for a larger issue. They aim to protect the investment required to collect the facts and write a story, when it might easily be re-written and distributed by another. But they ask for monopoly control of the story itself — indeed, ownership of the collection of facts and ideas that might make up a breaking story on government corruption, for example. Justice O’Connor, however, finishes with little support for these views: “The distinction is between one of creation and one of discovery.” And discovery is not subject to property rights.

The viewpoints of Moroney, Schultz and the Marburgers have their origin in the nature of print. Print leads to a confusion between controlling the medium and controlling the content – that is, the mistaken idea that breaking a story equates to owning it. The Supreme Court compounded the confusion in 1918 with its decision to augment copyright protection with “quasi-property rights” for the facts and events that make up a news story — the hot news doctrine. It was a legal solution for the disruptive impact of a new technology: newswires. News was paper, and these rights formalized the metaphor. They derived from the physical qualities of the paper, attached property rights to the news and would provide a legal basis from which to make, in this case, the AP’s news exclusive. Theoretically, the AP could then exclude people from learning of it or reprinting it without permission. They wouldn’t just report the news, they would own the news. Read the rest of this entry »

The PEW Project for excellence in journalism recently published its annual survey on the state of the news media. The report framed readers of online news media as mysterious strangers with dubious habits and few loyalties. They read promiscuously. They spend little time with the news online. And they are quick to abandon any site that might ask for compensation. Online journalism is in trouble.

The business of connectivity, however, is thriving. Both video and internet access, whether it’s through Verizon or Comcast or another, continue to increase penetration and, seemingly, price, and the FCC’s 100 Squared initiative will spread access wider and push it deeper than before. But the PEW project pits an underfunded online news media against the mysterious stranger who doesn’t seem to recognize or care for their impact on or the consequences for the media or perhaps the higher goals of journalism itself.

How can the fate of internet access and online media be so divergent? They’re actually intertwined. It’s not that we’re not paying for news. We are. Internet access bundles the full array of sites, services, and entertainment online with the physical connection, just like cable. But unlike cable, it doesn’t pay for the privilege.

Cable and the internet are a lot a like. Both are networks. Both distribute entertaining and educational programs and services. Both are actually bundles. But unlike the cable bill, which must pay out to the various networks, the internet bill doesn’t pay the panoply of sites across the internet. It pays only the ISP.

Cable bundles content in a way that’s immediately obvious. The guide shows a raft of networks, and with digital cable, many of these programs are available on-demand. Cable permissions the content, pays the rights-holders, and distributes it over a proprietary network — all for a monthly fee. These networks and programs are the complement to the cable network.

The internet portion of the bill, whether it’s from the telecom company or the cable company, appears to do none of that. It’s billed as pure connectivity that terminates in an ethernet connection. The ISP may market tiered levels of access, so an online gamer can experience a faster connection and lower latency than someone who only needs to check their email and stream The Daily Show. Everything about how it’s billed, marketed and promoted would suggest it has only priced connectivity, but it’s not just selling connectivity. It’s selling a bundle, just like the cable side of the bill, and that bundle includes the manifold benefits of all the sites, services, and entertainment of the internet.

Bundles solve one very important problem for companies – pricing. Not every customer will value any one product or service in the same way. A price for one customer might be too high; for another, too low. One could price each good or service to suit each customer, but price discrimination on this order is inefficient and becomes costly with each transaction. Over an entire portfolio of products or services, however, variances in customer perception begin to even out. No customer may value any one product or service, but taken as a the whole, the bundle may be valued similarly by all. Erik Brynjolfsson argues that bundles provide greater pricing efficiency and higher profits, and with digital information goods — the internet — the bigger the bundle the better. This is the power of the bundle.

The ISP bundles connectivity and its network of complements in the form of sites, services, and entertainment available online. The internet bundle, however, is distinguished in one important way – market power. The ISP wields market power in two ways. It’s not only a means to maintain and perhaps increase pricing with the consumer. It is also through the lack of market power inherent in the network of complements that constitute the sites, services and entertainment available online.

Market power starts with an explanation. Economists assume that within a perfectly competitive market no one competitor would have the power to raise prices for a particular good or service. If they did, customers would switch to a ready substitute at a lower price. These are the conditions of pure competition, in which a particular good or service is a commodity. Experience would suggest, however, that markets aren’t always perfectly competitive. What characterizes this divergence? Market power. In those cases, the company has the power to raise prices without losing customers to competition. At the extreme, market power may manifest as monopoly.

The market power of an ISP that has captured most of our attention faces the customer. It starts with the high barriers to entry associated with having laid the local loop in the form of copper lines, cable plant, and now fiber. These barriers limit competition, often to a maximum of two players in any particular area: a telco, such as Verizon, and a cable company, such as Comcast. Indeed, the FCC’s 100 Squared initiative admits 85% of markets have only one player, and in the remaining 15% markets much of the legacy telco infrastructure has not kept pace with the cable offering, so there is effectively one player. As the Berkman Center’s Next Generation Connectivity report suggests, these are regional monopolies and duopolies that have enormous market power over the consumer. Yochai Benkler’s recent op-ed in the New York Times, for example, drew stark parallels between the generous service offerings driven by regulated markets internationally than the relatively stingy offerings in the US.

What has drawn less attention is the effective market power ISPs have over the sites, services, and entertainment online. It’s this condition that allows ISPs to sell the bundle but keep the money.

The ISP operates as a broker and bundler between the user and the Internet. While selling the connection to the customer, the ISP also effectively provides access to the sites, services and entertainment available on the internet. Similar to a cable package, these are the complement to internet access, but unlike a cable package, the ISP doesn’t have to pay retransmission rights. Access is free, ostensibly. Who set the price? Who has market power? The ISP.

The Pew Project for Excellence in Journalism follows the thread all the way to the end customer and dismal results. Some 82% of customers are likely to go somewhere else if their favorite news site were to begin charging for access, and only 35% even have a favorite news site. To customers on the internet, substitutes may be so pervasive and available that it often does not even merit a respondent’s identifying a single one. Taken literally, only 7% of online readers would pay for access to their favorite news site.

Does that mean that customers aren’t paying for news? No. Customers are paying for news. The internet bill isn’t just for connectivity. They’re paying for the bundle – news, among other sites, services and entertainment online. The service would hardly be a worthwhile transaction for as many people as it is at $40 a month without youtube, The New York Times, Amazon. But the ISP’s market power conveys the proceeds of the internet access bill to the ISP, not the media.

Intellectual Ventures wants to define itself before someone else does. It’s been called a troll, a renegade, just another stop on shakedown street. Now, however, Nathan Myhrvold has launched a round of publicity that includes batteries from the New York Times (blogarticle) and a single shot from the Harvard Business Review. Myrhvold would have his readers believe that we are standing on the edge of a capital market for invention that will unleash and remunerate the full creative power of our economy, and Intelligent Ventures is just the firm to launch it.

Sometimes, however, a troll is just a troll. But Myhrvold is right. He’s not just a troll. Myhrvold’s ambition is greater than that. He’s planning an intellectual property cartel, and policy makers would be well-advised to monitor his project.

Myhrvold had the good fortune to work closely with Steve Lohr of the New York Times to publicize his manifesto in the HBR and share his vision. Lohr provides a patient and adulating witness to the quirky polymath. With an enterprise so shrouded in secrecy, Lohr understands that Myhrvold won’t just speak with anyone and chooses to reserve judgment and ingratiate himself with him: “white hat or black hat, Intellectual Ventures is growing rapidly and becoming a major force in the marketplace.” Lohr goes further, however, and instills the underdog spirit in Myhrvold, who exclaims, “We have to be successful,” following which Lohr warns us that the “issues surrounding Intellectual Ventures, viewed broadly, are the ground rules and incentives for innovation.” Josh Lerner, an HBS economist and patent expert, speaks up in the next sentence and says, “how this plays out will be crucial to the American economy.” Could Myrhvold’s success possibly be tied to answering crucial questions about the ground rules and incentives for innovation in the American economy? Lohr’s thoughtful organization might have you think so, and Lerner’s quote would seemingly substantiate it.

Maybe Lohr was uncomfortable with the persona he had attributed to Myhrvold, for he would couple his article with an early-morning blog post on Bits. While his print subscribers drank deeply of his David & Goliath – styled allegory on patent-law, he quietly published a clarification of the patent litigation dilemma. Lohr frames the next phase of IV in terms of solving the free-rider problem. The label is interesting for two reasons. First, it implicitly says what it is not. For example, it is not greenmail, as Jim Huston, a former licensing and patent executive at Intel, suggested in a 2006 Business Week interview: “If you don’t invest, you’re our No. 1 target.” Second, it suggests that there must be a simple solution to an unacceptable practice. Afterall, we’ve all heard about free-riders.

Intellectual Venture’s limited partners invested to protect themselves from trolls. If Intellectual Ventures can buy up loose patents, then the LPs have a quasi-insurance policy against trolls, who could just as easily, though more threateningly, buy those patents. Myrhvold initially called it a defense fund, almost a patent poolMore money means more insurance, but there’s a quirk. It may require litigation to work.

Though litigation may make Intellectual Ventures look like a troll, be assured, it’s not. Myhrvold claims to have only a reluctant interest in litigation. “It’s a stupid and inefficient way to resolve disputes, but in a polarized world, there will be litigation,” claims Myhrvold. It’s necessary, however, to solve the free rider problem. Some people have paid into the defense fund, others haven’t. IV’s hands are tied. They have to sue, so they can protect the interests of their initial investors. It’s their fiduciary duty.

The solution: bring new members into the Intellectual Ventures project. Litigation, or the threat of litigation, Myhrvold believes, will encourage others to join. As they join, he can manage the free rider problem and assure appropriate and legal access to the trove of intellectual property already collected, thus demonstrating the value of their initial investors’ decision to work with them, while creating a market for invention capital – a market for eureka.  “Our licensing task is to go from dozens of companies to thousands,” says Myhrvold.

Myhrvold’s vision would solve the free-rider problem, but it does not mean Intellectual Ventures is not a troll. Lohr mistakenly considers the free-rider problem in isolation. Intellectual Ventures does not have a free-rider problem in the vein of a public good. It’s not the case of a shipping association that has financed and constructed a lighthouse for their benefit, but may inadvertently serve that of the brigands, castaways and competitors who happen along. Lohr’s free-rider problem exists only because Intellectual Ventures has organized a Non-Practicing Entity to collect intellectual property with the intention of monetizing it for their limited partners. The free-rider problem in this case is that which is exploited by a troll.

It wouldn’t be wrong to just say troll, but Intellectual Ventures seems to be more than that. Myhrvold’s proposal would create a troll quite unlike anything that we have seen before – a troll with a cartel-twist: an intellectual property cartel. With “thousands of members” Myrhvold would have an agreement among competing firms to coordinate prices on a vast holding of intellectual property to the disadvantage of non-members. Patents are monopolies, so non-members will have no substitutes. Its alarming size would give it substantial reach in the intellectual property market and engender a network-effect, which would cultivate market power and make membership more valuable on a per-patent-basis as it grows. The problem with this isn’t the idea of patents. The problem is the power that an intellectual property cartel would have.

Intellectual Ventures would increasingly intersect with the interests and inventions of others. When it would, it would find itself better capitalized and equipped to pursue a claim. With growing resources, Intellectual Ventures would be able to take more risks with litigation, actual or threatened. A claim, for example, may be weak, but their credible ability to marshal legal action may force concessions and settlements where none may be merited. Because of the network-effect and the lack of substitutes, settlements and membership will become more costly on a per-patent basis. Moreover, with imperfect information on the scope and character of Intellectual Ventures’ holdings, it may only take a well-phrased bluff to induce a target into membership.

What happens in this model? What is the consequence of an intellectual property cartel? It raises the price of innovation. It puts smaller firms at a disadvantage. And it places us in a world where Non-Practicing Entities can lay in wait, as a hunter in a blind, lash out without warning and stifle the work of companies that may actually be organized to accomplish something, such as provide goods or services, with their efforts. Patents aren’t bad, but these outcomes are.

—part of the quotestream around IV

If I appear to be a total milquetoast and I say I’ll never [sue], then people will rip me off totally…I say, ‘I can’t afford to sue you on all of these, and you can’t afford to defend on all these.’

Nathan Myhrvold: WSJ 2008

You have a set of people who are used to getting something for free, and they are some of the wealthiest companies on earth. I was there. I was in the meetings. This is they way this business thinks about it.

Today invention is an area that people view as too illiquid, too uncertain, and too risky, so that nobody wants to invest in it. The world has shown that if you provide capital and expertise to an area that is starved for capital and expertise.

Nathan Myhrvold, on corporate respect for patents, BW 2006. Izhar Armony, a partner at Charles River Ventures, would say, “I think that Nathan is on to something really good and important. We share a common vision of thinking of [intellectual property] as an emerging asset class.”

The appeal is twofold: the opportunity to interact with a diverse group of thinkers purely for the sake of invention, and the efficiency with which IV translates imagination into intellectual capital.

Dennis Rivet, on working at Nathan Myhrvold’s Intellectual Ventures, which started as aPatent Defense Fund against trolls: BW 2006.

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