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Business Review

Q1 2001 5

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rising incomes. Between 1996 and1999, labor productivity grew at anaverage rate of 2.6 percent a year,much faster than the 1.6 percentaverage annual increase experiencedover the previous two decades.

Thisallowed the U.S. economy to growmore rapidly, and with less inflation,than most economists dared to predictfive years ago.Economists Stephen Olinerand Daniel Sichel estimate that atleast two-thirds of the increase in thegrowth rate of labor productivity since1995 is due to heavy investment incomputer hardware, software, andcommunication technologies, and therapid improvement of those technolo-gies. Their study shows that, since1990, investment in computer softwarealone has contributed more to growthin labor productivity (in fact twice asmuch) than all investment in capitalexcluding information technology.Advances in computersoftware, combined with large invest-ments in computing and communica-tions hardware, are enabling the rapidexpansion of an entirely new mediumof commerce — the Internet. Whilee-commerce accounts for only a smallshare of economic activity today, it isgrowing many times faster than thebricks-and-mortar economy. One of its most important applications is infinancial services. Already a signifi-cant volume of securities trading isinitiated by orders placed at a web site.Internet banking and electronic billpayment are predicted to grow rapidlyover the next decade.

Y Y Y Y You Can Patent That?ou Can Patent That?ou Can Patent That?ou Can Patent That?ou Can Patent That?

Are Patents on Computer Programs andAre Patents on Computer Programs andAre Patents on Computer Programs andAre Patents on Computer Programs andAre Patents on Computer Programs andBusiness Methods Good for the New Economy?Business Methods Good for the New Economy?Business Methods Good for the New Economy?Business Methods Good for the New Economy?Business Methods Good for the New Economy?

he United States is in the midst of an economic boom sustained inpart by rapid technological innovation.Firms are always looking for ways to en-hance or protect their market position.

Bob Hunt

is aneconomist in theResearch Depart-ment of thePhiladelphia Fed.

This calculation is based on the Bureau of Labor Statistics index of labor productivity inthe nonfarm business sector of the economy forthe periods 1976-95 and 1996-99.

the potential economic benefits andcosts of these new patents.While it is too soon toquantify these effects, there are goodreasons for concern and a number of things we can do to address thoseconcerns. At a minimum, we mustreserve patents for inventions thatrepresent more than an obviouscombination of existing technologies.We should be willing to increase theresources and expertise available to thepatent office to ensure it knows whathas already been invented. And whenpatent disputes reach the courts,decisions of the patent office shouldcarry no more weight than is war-ranted by the quality of its examina-tions. Over time, we may find thatmore radical measures are required.Or we may find that the patent systemwill adapt to this latest in a series of technological revolutions.

ENGINES OF GROWTH

In our economy, rising laborproductivity is a prerequisite forsustainable economic growth and

BY ROBERT M. HUNT

Increasingly, they are turning to patentsto protect not just physical inventions,but more abstract ones such as computerprograms and even ways of doing busi-ness. Two decades ago, many of thesepatents would have been impossible toobtain, let alone enforce. But almost ev-ery day now, another example of thesepatents is described in the press.Are these patents really anew phenomenon? Are they good forthe economy? This article describeshow changes in patent law made itpossible for inventors to obtain patentson discoveries as abstract as lines of computer code or simply a way of conducting business. It also examines

6 Q1 2001

Business Review

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Competition in this newmedium is intense. Naturally, compa-nies are looking for ways to enhance orprotect their market position. Increas-ingly, they are turning to patents toprotect their investments in computersoftware and even their businessmodels. According to the U.S. Patentand Trademark Office, fewer than 100Internet-related patents were issuedprior to 1992. Over the next five years, the patent office granted 750Internet-related patents. In 1999alone, it granted nearly 4000 Internet-related patents.

Only a decade agovirtually none of these patents wouldhave been granted, and few companieswould have bothered to file anapplication. What happened?

PATENTS ARE NOT FOR ALL INVENTIONS

The American patent systemis designed to reward inventors thatmake new and useful discoveries (see

Patent Basics

). But our patent lawsinclude certain limitations thatpreclude the patenting of someinventions.

Patent BasicsPatent BasicsPatent BasicsPatent BasicsPatent Basics

or over 200 years, the U.S. government has used patents to reward inven-tors for their discoveries.

The reward is a grant of the legal right toexclude others from making, using, or selling the patented invention for alimited period of time. But monopolies imply higher prices and, thus, lessconsumption of patented products or processes, which is socially waste-ful. A golden rule, then, is that patents should be granted only for dis-coveries that are really new.While economists favor the establishment of well-defined propertyrights, they also recognize that doing so entails some cost—at a minimum, the cost of resolving any disputes that may arise. That is one reason most countries go a little further,granting patents only for inventions that are not trivial extensions of what is already known(the legal concept is called nonobviousness). What’s more, the monopoly granted ought tocover only what the inventor discovered and no more. But to do so, the inventor mustdescribe the invention in sufficiently precise terms. If that description is made available tothe public, granting patents can assist in the more rapid dissemination of technologicalknowledge.Each of these features is embodied in the American patent system, which in-volves inventors, specially trained attorneys, the U.S. Patent and Trademark Office, andthe federal courts. An inventor typically obtains the services of a patent attorney to under-take the process of applying to the patent office for a patent on his or her invention. Thepatent application will contain a description of the invention, a discussion of any relatedinventions or techniques known to the inventor (what is called the

prior art

), and a set of proposed claims that will define the property rights he or she is seeking. Examiners at thepatent office review the application, conduct their own search of the prior art, decidewhether to grant a patent, and if so, specify the precise language of the patent’s claims. Inessence, the inventor and the patent office negotiate a custom-designed property righttailored to reflect what was invented.

But a patent can be granted only when an inven-tion satisfies the requirements set out in the patent statute, as interpreted by federal courts.An inventor who disagrees with a patent examiner’s decision may choose torefile the application and have it reconsidered, or appeal the decision to an administrativepanel and, from there, to a federal appeals court. If a patent is granted, and the owner feelsthe patent is being infringed, he or she can sue the offending party in a federal court. Thepatent holder can seek a court order prohibiting any further infringement (an injunction)and compensation in the form of lost profits or a reasonable royalty. Defendants in a patentsuit typically argue they did not infringe the patent and that the patent is invalid, that is,the patent office made a mistake when it decided to grant the patent. The federal courtsdecide these cases on the basis of their precedents and the language of the patent statute.Some infringement cases are settled before a verdict is reached. This typically involves alicensing agreement whereby the defendant agrees to pay for the right to use the inventionor to license some of its own patented technologies to the other party.

The first U.S. patent was granted in 1790 to Samuel Hopkins of Philadelphia, who invented a newway of making potash (used in soap, glass, and gun powder).

The patent office’s online database of patents can be found at its web site: http://www.uspto.gov.

So far, growth in these services has beendisappointing. In an article in the

BusinessReview,

Loretta Mester examined a number of factors that explain why adoption of these newpayment methods is likely to be initially slow.These include large up-front costs for deployers;network effects, which limit consumer interestin a payment method until its widespreadadoption; and the balance of risk and benefits of a new payment method as compared to existingones.

Computer and telecommunication equipmentmanufacturers and software developers ownmost of these patents. But here are just a few of the interesting exceptions to the rule: WalkerAsset Management (owners of the Pricelinepatent and 24 others), Citibank (15), IncytePharmaceuticals (the firm responsible formapping a significant part of the humangenome, 9 Internet patents), Merrill Lynch (9),Amazon.com (7), VISA International (7),Chase Manhattan (6), Andersen Consulting(5), E-Stamp Corp. (4), and Cybercash (one of the first developers of e-cash, with 3 patents).

The U.S. law of patents can be found in Title35 of the U.S. Code (http://uscode.house.gov/ usc.htm), which incorporates all of the variouspatent statutes enacted over the years.

Patentable Subject Matter.

Assuming the criteria described in thenext section are also satisfied, any newand useful process, machine, manufac-ture, or composition of matter, or anynew and useful improvement of thesethings, can be patented. These cate-gories are quite broad, but the courtshave identified certain types of subjectmatter that cannot be patented,including laws of nature, physicalphenomena, and abstract ideas. Priorto 1980, most patent attorneysbelieved these exceptions precludedthe possibility of patenting computersoftware or methods of doing business.

Business Review

Q1 2001 7

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Patentability Criteria.

Toqualify for patent protection, aninvention must satisfy the require-ments of

utility, novelty,

and

nonobviousness.

Utility simply meansthat the invention is useful. Noveltymeans the invention is truly somethingnew. An invention fails the test of novelty if before the inventor appliedfor a patent something very much likeit already existed or was described inprint. Existing products or processes,existing patents, or articles on thesubject in technical publications arecalled the “prior art.”The requirement of nonobviousness goes a bit further thanthe requirement of novelty. Apatentable invention must be some-thing more significant than a trivialextension of the prior art. In hind-sight, an invention may seem prettyobvious, but that is not the standardused in patent law. Patent law asks,would the invention have beenobvious, at the time it was made, to aperson with ordinary skill in the fieldand with knowledge of the relevantprior art? If the answer is yes, theinvention is obvious and a patent willnot be granted.

CAN I PATENT THAT?WELL, NOW YOU CAN

Over the last two decades,the American patent system haschanged in many ways. The definitionof patentable subject matter hasgradually been expanded, reversing thetraditional view that computerprograms and methods of doingbusiness were unpatentable. Inaddition, patentability criteria havebecome less strict. These trends arosefrom a series of court decisionsbeginning in the early 1980s. Theireffect has been amplified by certainother changes, described below. Theresult is a patent system that operatesvery differently than it did 20 yearsago.

The Early Years.

In the1960s and early 1970s, computerprograms enjoyed very limited intellec-tual property protection. And it waswidely believed that patent protectionfor computer programs was unavail-able. This impression was bolstered bya 1972 Supreme Court decision(Gottschalk v. Benson) involving anapplication to patent a computerprogram that translated decimalnumbers into binary numbers. Thecourt concluded the program was acomputer programs would run on moremachines. Firms began to purchasemore software “off the shelf,” and morefirms began to develop software withthe intention of selling it to as manycustomers as possible. But when acompany widely distributes a computerprogram, protecting it as a trade secretbecomes more difficult.As trade secret protectionbecame less effective, a number of firms began to seek other legalprotections. After many years of studyand debate, Congress modified theCopyright Act in 1980 to explicitlyextend copyright protection tocomputer programs. But by the early1990s, it was clear that copyrightafforded relatively narrow protectionfor software, allowing rivals to offervery similar products without infring-ing the copyright. Some firms soughtbroader forms of protection fromimitation. What they eventually gotwas patent protection for computerprograms.

Computer Programs Become Patentable Subject Matter.

Long before the meaning of copyrightprotection for computer programs waswell defined, the Supreme Courtopened the door to the possibility thatcomputer programs could be pat-ented.

In a 1981 decision (Diamondv. Diehr), it ruled that an inventionusing temperature sensors and acomputer program to calculate thecorrect curing time in an otherwiseconventional process of moldingrubber goods could be patented. Thepatent office had rejected the patentapplication, arguing the only newaspect of the invention was thecomputer program, which repeatedlysolved a well-known chemical equa-tion using the temperature dataprovided by the sensors. The SupremeCourt disagreed, arguing that theinvention was an improved process formaking rubber goods that happened touse a computer program. Thus, the

A more detailed discussion of thenonobviousness requirement can be found inmy previous article in the

Business Review.

The key to asserting trade secret protection isdemonstrating that substantial precautions weretaken to prevent the secret from beingdisclosed. See the article by Friedman, Landes,and Posner. Since that article was written, theEconomic Espionage Act of 1996 (18 U.S.C.831-9) created new federal criminal penaltiesfor certain instances of misappropriation of trade secrets.

In the 1960s and early1970s, computer programs enjoyed verylimited intellectualproperty protection.

mathematical algorithm, which, likelaws of nature or an abstract idea, doesnot fall into one of the categories of patentable subject matter.This lack of protection didnot matter as much then as it doestoday. At the time, most computersand computer programs were custom-designed. As a result, most computerprograms would not work on anothermachine without significant modifica-tion. Also, companies developed moreof their own computer programs andlimited outsiders’ access to their code.In this environment, firms couldprotect their programs as

trade secrets,

using state law to prosecute those whostole the code or disclosed it to thepublic.

When the computer industrybegan moving away from custom-designed machines, toward standard-ization and mass production, more

The Supreme Court later argued it had neverruled that all computer programs wereunpatentable, only that the computer programsinvolved in the early cases were not patentable.