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Tim Watts

"Boom a Troubling Test of Patents"

BRW

May 5, 2000

One of the most frightening things about e-commerce is that almost anyone, anywhere, can copy what a company is doing and set up business virtually right next door. Low barriers to entry bring about ultra-competitive markets. The problem afflicts everyone, from Amazon.com to the smallest start-up.

If an internet business manages to attract customers and build market share, what is to stop competitors coming along, replicating its Web site down to the last click, offering lower prices and eradicating profits?

The answer that many e-commerce pioneers, including Amazon.com, Priceline.com and Netscape, have turned to is the patent system. Applications for patents for Web site features and e-commerce business methods have skyrocketed in the United States in recent years. Businesses are hoping to protect their investments in e-commerce technology by patenting their Web site "inventions" and forcing competitors to pay licence fees if they want to copy business methods.

In 1998-99, the US Patent and Trademark Office issued 12,779 computer-related and data-processing patents, an increase of 45% over the previous year; 1595 were related to the internet, an increase of 230%. Overall, patents in the US are now being issued at a staggering 10,000 every three weeks.

The commissioner for patents in Australia, Vivienne Thom, says her office is also receiving many applications for internet-related patents, but nothing like the volume in the US. Patents are territorial, and an application must be filed in every country in which the applicant wants protection.

John Swinson, a partner specialising in e-commerce issues and intellectual property with the law firm Mallesons Stephen Jaques, says the booming information economy is putting pressure on the patent system as never before.

"We are seeing a huge increase in patent applications, and the system is struggling," he says. "The quality has gone down. The patent examiners don't keep up with developments in the area."

Thom says that hiring patent examiners with backgrounds in information technology is increasingly difficult. A patent examiner earns about $50,000 a year in Australia.

Swinson says the stresses on the patent system in the US are a sign of things to come in Australia. "A new patent must be ... inventive or non-obvious. If you have under-pressure, under-qualified examiners awarding patents that don't meet the criteria, it is a major problem."

Swinson says bad patents lead to more research costs for innovative companies, which need to determine whether they are infringing an existing patent. In short, more patent attorney fees and litigation fees. "Already we are seeing people trusting patents less."

Patents are big money-spinners. IBM, one of the most aggressive patent-seeking information technology companies, had licensing revenue of more than $US1 billion in 1998-99. It was also issued 2756 new patents. Microsoft recently lost a patent- centred court case with a company called Stac Software. The damages payout was $US100 million.

One of the best examples of the high stakes involved in internet patents is the lawsuit involving Amazon.com and one of its main competitors, the US book retailer Barnes & Noble.

In the heat of the 1999 Christmas holiday shopping season, Amazon.com won an injunction forcing Barnes & Noble to add extra mouse clicks to the checkout section of its e-commerce Web site. A court ruled that Amazon.com's patent number 5,960,411, "Method and system for placing a purchase order via a communications network", had possibly been infringed.

Barnes & Noble's Express Lane buying feature was similar to Amazon.com's OneClick. The patent office ruled that Amazon.com was the inventor of the "single mouse click" buying method and granted it ownership of this concept. Barnes & Noble's customers then faced the absurd situation of having to click a meaningless extra button to confirm their orders.

The OneClick litigation led to an array of new lawsuits and encouraged hundreds of US companies to apply to patent their Web site features.

Some internet industry executives have suggested that the Amazon.com case shows that the patent system is on the verge of collapse. Harvard University law professor and cyberspace expert Lawrence Lessig was quoted in The New York Times as saying: "This is a disaster. This is a major change that occurred without anybody thinking through the consequences. In my view, it is the single greatest threat to innovation in cyberspace, and I'm extremely sceptical that anybody's going to get it in time."

The decision to grant Amazon.com and other companies patents for their e-commerce business methods seems to be part of a redefinition of what a new invention actually is. Abstract ideas and theories have never been patentable. Thom says: "You cannot register a patent on a general idea. There must be a concrete mechanism for putting it into effect."

Patent applications originally had to include a physical model of the invention. That is no longer a requirement, and questions are being raised about how appropriate it is to allow companies and individuals to "own" abstract processes such as Amazon.com's OneClick feature.

"The argument that these kinds of patents are ridiculous has been around for decades," Swinson says. "If you look back in history, people always criticise the patent system at periods like this. They said you couldn't patent the telephone. In the 1980s, patents on software were criticised."

He says the patent system has been effective in protecting the rights of inventors and fostering innovation. "Say you had developed an amazing new security application for the internet, an absolutely great concept that enabled huge advances in e-commerce. You should be entitled to protect that. Just because other people are patenting frivolous things is not a reason that genuine innovations should not get patent protection."

One of the strongest voices calling for reform of the patent system is Amazon.com chief executive Jeff Bezos. In an open letter published in March, Bezos proposed: a change to patent laws to recognise that business-method and software patents are fundamentally different from other kinds of patents; the creation of a new patent category with a life span of three to five years, not the current 17 years; and the establishment of a one-month public comment period before any patent in the new category was granted.

Bezos also outlined a plan to fund an online patent database so that e-commerce innovators could have accurate information on the ownership and coverage of existing patents.

If the pressure from Bezos and others leads to changes in patent laws, the consequences will be profound. Patent protection is already an integral part of the process of founding e-commerce companies. A start-up company that holds patents on its key Web site features is in a superior position to attract investors.

Patents prevent competitors using the same technology, and they are often an important defence if a business sues for infringement of its patents. If the patent rules change, the dynamics of this process will change as well.

Patents are also central to the debate on the appropriate valuation method for intellectual capital. As more companies move on to the internet, intangibles such as Web site features will become a key part of total assets. Patents may become a crucial means of converting knowledge resources into book value.

James Guthrie, a professor at the Macquarie Graduate School of Management, says: "The issue is not just legal property rights ... investors and other stakeholders are trying to understand the complexity of valuing the contribution of these new systems.

"For instance, financial reporting is still caught up in the old world of mining and the manufacturing era. It is time for accounting practice to adapt to the new terrain. If not, accounting will rapidly lose relevance as a discipline in support of the development of business."

Guthrie says some Swedish companies now use non-financial metrics in their accounting reports to record the value attributable to knowledge in the organisation. "Intellectual capital, in one form or another, is instrumental in the determination of enterprise value and national economic performance."