Business Method Patents and Software Patents A comparative review Andrea Maurizio Gnerre (0917849), andrea.gnerre@itcom.

it Igor Mićić (1587591), Universita’ Commerciale Luigi Bocconi, Milan, Italy

A patent can be defined as a set of exclusive rights which are granted to the holder by a state in order to protect an invention from imitation for a limited time. It is a right to exclude others from making or using a particular invention, granted by the general public, in exchange for disclosing the invention and allowing others to build more easily on the knowledge contained within it in the future. However, software patents as well as business method patents are relatively new and as such they still do not have a universally accepted definition. Different countries are having different standards for granting these types of patents and the legal procedures and practices tend to change rapidly over time, making it even more difficult to conduct an comprehensive research regarding real social benefits of these rights. In this paper we try to summarize some of the contemporary research done on the topic by other scholars, with particular emphasis on important juridical decisions and perceived differences and similarities between these two closely related types of patents. We also touch briefly upon the empirical evidence of strategic patenting among firms and some of the actual controversies in patent policy.

An inevitable consequence of the growth of the modern ‘knowledge’ or ‘information’ economy is the increased importance of instruments designed to protect the property rights associated with these intangibles [13]. The main formal tool of such protection is a patent, broadly defined as a right of an inventor to exclude others from exploiting particular invention for a limited period of time, in exchange for the public disclosure of the knowledge contained within the invention. Patents are considered one of the best economic instruments for inventors to keep control of their novelties and ensure a return on their investments in research and development [1]. Recent analysis shows that although competition may suffer when we grant a monopoly right to an inventor, at the same time it will benefit if this right facilitates entry into the industry by new and innovative firms. Second, innovation will benefit from the incentives created by a patent but may suffer if patents discourage the combining and recombining of inventions to make new products and processes [2]. There are several reasons to think that both facilitating entry and discouraging recombination of elements may be particularly salient factors when considering the effects of patentability on the software industry, since this sector is one which is perhaps the most characterized by the high proportion of intangible assets, so strong methods of appropriation, among which intellectual property rights, are extremely important in order to secure protection for the investment. Additionally, software itself is usually composed of many different components that might be coming from different sources, so interoperability standards are the key element of a cumulative software design. Having all this in mind, we can say that evaluating the tradeoff between the benefits and costs of the introduction of software patents is a formidable task, at its best. Another important peculiarity of software is its logical nature and orientation towards abstraction and generalization which is quite often inconsistent with the required properties for patent claims i.e. concreteness, specificity and physical substance [12]. These peculiarities apply somewhat also to business method

patents and lie at the core of strong legal debates regarding the boundaries of patent protection and overall appropriateness of patenting business methods as such. From the origins of the industry in the 1950s until now, computer software was mostly protected through copyright [1]. In the 1980s, due to legislative changes in the US [13], patents started being used more extensively to protect software along with copyrights. This period was also the one when the well-known Bayh-Dole Act passed into the law, leading to the emergence of new players, such as universities and public research centers [13]. Federal Circuit court was created in 1982 to hear patent cases. At this time there was also a marked evolution in the area of competition policy and the attitude of the US Antitrust Division and Federal trade Commission changed towards much more nuanced and pro-patent position [13]. Similarly, new licensing guidelines were issued also by the European Commission in 2004 and similar regulation changes followed also in Japan and Korea. Taken together, these changes strengthened the position of patent holders and the response of private firms in terms of propensity to patent has been dramatic. The annual number of software patents in the US passed from 200 in 1975 to over 7000 in 1995 and over 10000 in 2001 [1] (Fig. 1). Practically similar trends can be observed also in Europe (see Fig. 2 for details about number of software patent applications at EPO) and Japan, but with some reluctance to still formally ratify software protection. The rise of software patents has raised also some concerns. Some time ago, Paul David [15] expressed the apprehension that proprietary platforms might create barriers to the development of the industry. Concerns about so called “strategic patenting” and the creation of wide patent thickets by some of the incumbents have been extensively discussed by scholars [16]. Similarly, the National Research Council of the United States (NRC, 2000) has expressed alarm about the new patenting trends, suggesting that the United States Patent and Trademark Office (USPTO) might have insufficient skills and resources to judge the novelty of software patents and evaluate prior art. Another peculiar problem may be a short product life-cycle in software industry (18 months on average). Business method patents (hereafter BMPs) have a long history too, they existed since the establishment of much of the modern patent system. The first business method patent has been granted in 1778 in the UK, BMPs have been present also in the US patent system since its creation, in 1790 [5][6]. In the beginning the USPTO approach to BMP was largely unregulated and relied on subjectivity of examiners [7], raising a lot of concerns about the quality of the patents issued that were addressed for the first time with the major USPTO reform of March 2000, where they increased the number of examiners, emphasized the hiring of them with both software and business experience and provided additional business training and established “Electronic Information Center”, having as a result an immediate decline of the grant rate for BM patents from 56% to 36% which later stabilized at 35-40% by October 2002 [7]. Even with this reform and after conflicting decisions in the reported breakthrough cases, it is still unclear what the Federal Circuit has learned about effective means of inducing innovation in the ten years after State Street [10] and the line that divides these patents from the software ones is continuously fading. At the present time, business methods are patentable in the US, Australia, Japan and Korea but not in Europe including UK and Canada [9].

In the next sections we will first review some of the breakthrough cases that are considered roadblocks of software and business method patents history, after that we will review some of the pros and cons brought by scholars regarding these patents and finally conclude with some empiric evidences in this domain while considering geographical, legal, and economic and policy issues.

Breakthrough software patent cases
Diamond vs. Diehr Diamond v. Diehr is a 1981 U.S. Supreme Court decision which, for the first time, held that the execution of a physical process, controlled by running a computer program was patentable. In this particular case, the invention related to a method for determining how rubber should be heated in order to be molded and a computer was used to calculate and control the heating times for the rubber. However, the invention included not only the computer program, but also included steps relating to heating rubber, and removing the rubber from the heat [4]. The court reiterated its earlier holdings that mathematical formulas in the abstract could not be patented, but it held that the mere presence of a software element did not make an otherwise patent-eligible machine or process (in this case for molding rubber) as a whole un-patentable. These shifts were later implemented in 1995, as the USPTO released the Final Computer Related Examination Guidelines, but many observers suggested that these guidelines only codified a change that had already been put into practice by Diamond vs. Diehr, which was perhaps the most important case in a so called patent-eligibility trilogy1. In re Alappat In 1988, Alappat filed an application for a patent on a means of smoothing the appearance of a waveform displayed by a digital oscilloscope. The USPTO rejected the claims as a nonpatentable subject matter. Alappat appealed the decision to the Board of Patent Appeals, which reversed the PTO’s decision on June 26, 1991. [2] The patent examiner then requested a reconsideration of the decision by an expanded panel of the Board of Appeals, which on April 22, 1992 reversed the decision of the original panel. [2] On July 29, 1994, the Federal Circuit Court of Appeals handed down a decision stating that the invention was not an “abstract idea”, but rather, “a specific machine to produce a useful, concrete, and tangible result” and that as such was patentable. [2] This decision was interpreted as a clear expansion of the patentability of software, but also demonstrated some weaknesses of the existing patent system, namely long processing times and a great amount of volatility and “personal opinion” factor when such matters are involved. It is clear that these types of patents were judged according to individual perception and without a widely considered methodology, and unfortunately, even with changes in legislation that came later, PTOs around the world still lack in competencies to duly evaluate these types of patents.

Lotus vs. Borland Lotus Development Corporation v. Borland International, Inc. is a 1996 United States Supreme Court case that tested the extent of software copyright. This case established that copyright does not extend to the text or layout of a program's menus. Borland released a product which had a menu that imitated the one of Lotus 1-2-3, a competing product. [4] None of the source code or object code that generated the menus was copied, but the names of the commands and the organization of those commands into a hierarchy were virtually identical. Lotus claimed that Borland was infringing their copyright-protected product by implementing a similar look-and-feel [4]. Borland appealed and the court ruled that the menu system of Lotus was a “method of operation” and so not protected by copyright [4]. This decision was later affirmed by the US Supreme Court. For the first time a distinction between the interface of a software product and its implementation was established. The implementation is subject to copyright and the public interface may also be subject to copyright but only to the extent that it contains expression (for example, the appearance of a graphical element). However, the set of available operations and the mechanics of how they are activated are not copyrightable. The value of copyrights for protecting software was dramatically revised downward as a means of protecting computer interfaces after the Lotus v. Borland decision, as stated by some contemporary scholars “ever since Lotus lost protection for look and feel, copyright has not seemed valuable in the industry” [4].

Debating the pros and cons of software patents
A large number of companies operating in the Information and Communication Technology industries (ICTs) are now patenting software [1]. There are basically two opposing points of view when it comes to patenting software. For some authors, mostly academics, the software should not be patented ([1], see Merges, 1996; David, 2001). The principal reasoning is that if future innovators have to pay royalties to the previous ones, it may hamper new entries, leading to a monopolistic market. Software industry is characterized by high level of cumulativeness and short product life-cycles, which are both inherently opposed to the logic of patent protection. There is also a concern that software patents may endanger the viability of many different manufacturing and service industries by denying access to more efficient technologies based on ICTs [1] and that ensuing litigations due to dubious legal framework and low quality of such patents might be socially and economically costly. Such disputes increase transaction costs and discourage combining and recombining of inventions. It is inherently difficult for PTOs to perform adequate novelty checks due to the huge size of existing prior-art and the time and budget constraints. Besides, some critics argue that disclosure function is particularly badly served by this type of patents and that in fact it is not an important mean of acquiring information for competitors. As expected, software patents were highly criticized also by the open source community, because of the obvious fact that coexistence of open source with patented software is problematical [2]. On the other side, the arguments in favor of software patents are also relatively strong. The entry of smaller firms on the other side might be encouraged by existence of

appropriability mechanisms to protect from counterfeiters and create license revenue streams which account considerably into the total revenue. Large companies argue that R&D and marketing costs are escalating as the complexity of modern systems increase, requiring hundreds of millions of dollars in sunk investments. Having in mind that 4 out of 10 software programs are pirated worldwide, without patent protection these software investments would be prohibitive [1]. There is no statutory reason to exclude patents for software, especially since the software components are highly reusable in many different applications, increasing benefits from disclosure. Patents are also quite often used “strategically” to prevent other firms in patenting a related invention (“patent blocking”) or to strengthen the firm’s position in negotiations with other players (as in “cross-licensing”) [16]. Some scholars argued that possibility of such a use of patents should be observed actually as a disadvantage, since in that way patenting can become a vehicle for impeding entry and related innovation, however other researchers argue that patent portfolio races actually help prevent breakdowns of negotiations over intellectual property (in a case when a potential downstream inventor might be overwhelmed too much by royalty obligations to upstream right holders and thus discouraged to develop the invention in the first place). Races of this kind encourage firms to disclose more inventions, because failure to do so creates the risk of being excluded from the industry and this greater disclosure presumably accelerate the pace of innovation [16]. However, other scholars further questioned the importance and social benefits of such overproduction of incremental innovations, arguing the “too much (unnecessary) innovation” actually reduces social welfare. Minority of firms also use patents as an internal performance measure or to enhance their reputation.

Empiric evidences on software patenting
The value of copyrights as a means of protecting computer interfaces was drastically reduced after the Lotus v. Borland decision. Firms affected by the diminution of copyright protection disproportionately accelerated their patenting in subsequent years [4]. The impact of the policy shift on firms’ performance was examined by researchers and little evidence can be found for any harmful effects in a number of performance indicators. In fact, the increased reliance on patent protection appears to be correlated with significant growth in a few measures, such as sales and R&D expenditures [4]. However, we always should have in mind that the environment is a complex one and many other changes (such as for example dissemination of the Internet) might have affected the result. Previous studies have also used somewhat different approach to identify software patents (using keyword search to construct the dataset instead of patent classification) so the results may be further influenced by this as well as the decision to which extent the large multinationals should be included in the dataset. Having all said in mind, we can still safely conclude that there is little evidence of harm at the firm level from the increased reliance on software patenting [4], although the benefits remain somewhat unclear. Another research [1] used software patent data to conclude that geographical concentration of high-tech firms is an important factor which fosters innovation, since flow of people inside the regional clusters is much more prominent. They also conclude that the number of software patents increase significantly with the size of the firms, since

larger firms patent more because they have more resources and more complex R&D strategy [1] and tend also to use the acquired patents strategically. The same research also shows that service-oriented software firms tend to patent less, bigger the percentage of products in the total revenues, higher the propensity to patent. However still the propensity to patent (13% for publicly quoted companies, as in [1]) in the software industry is not particularly high when compared to other high-tech industries, such as the pharmaceutical or chemical. Another research which confirms that copyrights are still preferred over patent protection, especially for smaller sized pure software firms, is detailed by D. Suh, J.Hwang (2010) [11]. They show that, at least in South Korea, software patenting failed to show positive impact on revenues and that copyrights seem more beneficial in contrast to a prevailing consensus that the software industry now prefers patents. The intuition is that a software copyright is generated from a software product or service, which is directly linked to software revenue and total revenue of the firm. However, unlike pharmaceutical patent, software patents do not necessarily map to a software product or service. Besides, most innovative software products comprise several software patents, which render the effect of a specific patent small and vague in the overall picture. [11] Another explanation why software firms generally prefer copyright over patents is that an average software firm is small in size and cannot bear the burden of administrative costs and the time involved in obtaining patents. These results have important implications for the industry and legal policy as a whole. [11] In order to encourage software innovations, policy makers should build different software policies for different industries, since as we saw the software and manufacturing industries show quite different attitudes when it comes to the choice of preferred IPRs. Its interesting to note how these findings nicely fit with T. Tamai’s (1998) [12] observations that the current practice of issuing software-related patents only if the claims are combined with hardware and written concretely and specifically is essentially against the nature of software i.e. its orientation towards abstraction and generalization. Even more concerning are the results of B.H. Hall, M. MacGarvie (2010) [2] which show that expanding the patentability of software was initially negative for firms in the software industry, especially for those with no prior patenting experience at the time of the decisions [2]. When we talk about the market value of software firms, it is worth noticing the finding that important (high-cited) inventions tend to be clearly positively correlated with market value overall, but filing additional patents that do not increase the total stock of citations (i.e. not increasing the invention quality) is negatively associated with market value [2]. Said empirical findings clearly paint a picture of firms adjusting to a new environment and set of rules, which were initially perceived by the market as negative for the software sector, and have resulted in yet uncertain benefits, despite the large increases in the share of firms filing patents in this sector (see Fig. 3 for the US data).

Breakthrough business method patent cases State Street v. Signature
This case revolutionized the approach of the US patent system not only regarding BMP, but also to SP.

In 1998, State Street claimed that a patent granted to Signature should be invalidated because it described a business method based on a mathematical algorithm and so clearly falling in the category of the unpatentable subject matters [8]. The court rejected the claim stating that the invention patented by Signature “produces a useful, concrete and tangible result”, consequently opening to patentability this kind of "methods of doing business” and introducing a completely new criteria of evaluation instead of the old machine-or-transformation test2 [8]. After this ruling, patent issuing about software-embodied business methods exploded (see Fig. 4) [7] putting the whole patent system under pressure and creating also some issues related to “prior art”, forcing the USPTO and the US Congress to pass the First Inventor Defense Act in 1999 in order to create a new defense to an accusation of patent infringement for a prior inventor of a business method which was later patented by another entity because of the State Street decision [7].

In re Bilski
In 1997, Bilski filed a patent application for a method of hedging risks in commodities trading [9] and the examiners rejected all the claims stating that “the invention is not implemented on a specific apparatus and merely manipulates an abstract idea and solves a purely mathematical problem without any limitation to a practical application, therefore, the invention is not directed to the technological arts” [9]. The applicant appealed and had the rejection confirmed because, at least for the examiners, the invention did not produce a “useful, concrete and tangible result”, as required by the new criteria imposed by the court after the State Street/Signature case. Then, the applicant appealed to the Federal Circuit and had another rejection of the claims with the argument that “the useful, concrete and tangible result test is insufficient to determine whether a claim is patent-eligible under Art. 101 and it’s inadequate and should not longer be relied on”, reverting the whole patent system to the classic machineor-transformation test for business patents claims [9]. The Bilski court left the discussion about the machine-or-transformation test to future cases. At the moment, it is therefore unclear whether tying a process to a general purpose computer is sufficient to pass the machine-or-transformation test [10] and a lot of concerns arise about how the Supreme Court will accord to the rights of those who for ten years relied on State Street and now find themselves with patent rights of uncertain value [10]. Moreover, few scholars have already highlighted the possibility that the machine prong could result in a resurrection of what Cohen and Lemley in 2001 referred to as “the doctrine of the magic words3 [10].

Debating the pros and cons of business method patents
About the pros, the most important point of BMPs is that they overcome drawbacks of copyright in protecting the idea behind the original work; this is the main reason why companies search for business method and software patents after all [4]. These patents can also be used as a strategic weapon in order to fight competitors [9], as a form of security in order to prevent spillovers and as a warranty to secure financing [9]. On the other side, about the cons, they share a lot of points with software patents, such as concerns about low quality [7], novelty [7], non-obviousness [7] and prior art citation [7],

but there are other arguments that are specifically bound to this kind of patents such as concerns about the subject matter, since they open the door for patenting developments in a wide range of human experience, which is far from the general requirement for patentability that requires an invention to be grounded in science and engineering, while “they are into the realm of thought and abstraction” [7] in addition to concerns about the possible monopolization and generation of a reward which greatly exceeds the cost of the invention [7].

Empiric evidences on business method patenting
According to some scholars, from a qualitative point of view, internet business method patents appear to have been no worse than the average patent, and possibly even better than most, also possibly even better than patents in most individual technology areas [7] but we have some concerns about the dimensions and the criteria used for reaching this conclusions. Generally, internet business methods probably require much less capital investment and start-up time to reach the marketplace than many other inventions and, as a result, by the time a business method patent issues, the product may be quite familiar to the public, contributing to widespread perceptions that the method is obvious [7]. To some scholars, it’s still unclear whether they are likely to contribute to social welfare over the long term, but claiming that efforts to treat them differently upon entry to the patent system will be ineffective at best and counterproductive at worst [7].

A common side of software patents and business method patents
A common issue using patent law to protect software and business methods is that innovation in these fields are usually accomplished in increments too small to be viewed as inventive steps [1][7]. For a long time the PTOs lacked the competencies to correctly evaluate these types of patents which were historically judged according to individual perception and without a widely considered methodology [1][7]. The big shifts in patent requests have always been triggered by changes in the approach of the USPTO and/or by court rulings [1][4][7]. Looking at the pros and cons of these two kind of patents, we can state that software patents and business method patents share a lot of common points: about the pros, they both are a method of appropriation [2][4][9], help develop competitive advantage [1], if found potentially valuable or interesting, help secure financing [2][9] and provide an incentive to innovate because they protect the idea behind the original work [1][4]. However, SPs and BMPs both raise concerns about low quality, about novelty and nonobviousness [2][7], about prior art citation [2][7], both generate patent disputes [2][7] and increased transaction costs [2][7] and both potentially lead to increasing monopoly power that eventually discourage the combining and recombining of inventions [1][7]. Also, we can evidence some main differences between these two kind of patents: we’ve drawn a comparative table that highlights the diverse characteristics of these technologies in respect of the most relevant dimensions of patentability: tangibility, novelty and priorart, economic justification of the reward, possible harmful effects, nature of the inventive step, market impact and common practices adopted by the PTOs (Table 1). Software More tangible [1] Difficulty to organize and cite the prior art Business methods More intangible [7] Too abstract, too many non-technical

and ensure novelty [12] Usually significant investment is necessary to realize the invention First mover advantage not crucial [2] Extreme cummulative innovation [2] Facilitates entry into the industry by new and innovative firms [2] Software not patentable “as such” but as part of a technical system or business method [1]

features, lack of prior art [7] Better Cost/Reward ratio [7] Harmful first mover advantage due to less long business cycles [7] Moderate cummulative innovation [9] Deter entry into the industry by new and innovative firms [7] Business methods not patentable “as such” but as implemented through a computer software or other similar apparatus [7]

Table 1. Main differences between software and business method patents measured on the most relevant dimensions of patentability.

The last dimension highlighted in Table 1 proves that there is a strong connection between these two kind of patents. De facto, software is patentable if it’s part of a business method and business methods are generally patentable if they’re implemented through software. This also explains why the normative in this domain is so unclear and why there are so many different treatments among filings.

Empirical data shows that patent protection for software and business methods has positive influences on the sales and R&D expenditure dimensions of the firms, however, our opinion is that it might also raise entry barriers. The economic welfare is highly dependable on patent quality, which in turn can be observed in two dimensions: the formal and the substantial quality. The formal relates to the compliance of a patent to the criteria of patentability and it can be a meager measure, not only because even if empiric evidences brought by some researchers demonstrate that the overall quality of these patents is even higher than average there might be some concerns regarding the importance of dimensions employed in quantitative analysis, but also because the criteria are still evolving and there is still a component of subjectivity in the evaluation process. What is of real interest is the substantial qualitative dimension, that means evaluating the invention to the extent to which it brings an effective technological advance that contributes to the increase of social welfare. Software patents and business method patents are strongly connected; basically software is something that implements a business method and this explains why there are so strong connections between them and why they face the same regulatory challenges. However, they also share some peculiar differences that we pointed in this paper. This topic also raises the question about the benefits that patenting business methods as such brings; since business methods can actually be embedded in software and covered by software patents, it’s unclear whether the PTOs should allow their patenting. Today, as assets become increasingly intangible, the regulation in IP field becomes even more important and the traditional criterias regarding patenting are questioned: Should the evaluation of patents really be based on tangible tests for intangible products?

[1] Chabchoub N., Niosi J. (2005), “Explaining the propensity to patent computer software”, Technovation 25 (2005) 971–978 [2] Hall B., MacGarvie M. (2010), “The private value of software patents”, Research Policy 39 (2010) 994–1009 [3] Diamond v. Diehr, 450 U.S. 175 (1981), Retrived 2011-12-20. [4] Lerner J., Zhu F. (2007), “What is the impact of software patent shifts? Evidence from Lotus v. Borland” [5] Bilski v. Kappos, USPTO Brief for the Respondent (2009) [6] Patent 2301X: Bank note printing, Retrived 2011-12-20. [7] By Allison J. R., Tiller E. H. (2003), “The business method patent myth” [8] Business Method Exception - Mathematical Algorithm Exception - "Freeman-WalterAbele Test", Retrived 201112-21. [9] Hall Bronwyn H. (2003), “Business method patents, innovation and policy”, Department of Economics, University of California, Berkeley [10] Fusco S. (2009), “Is In re Bilski a Déjà Vu?”, Stanford Technology Law Review [11] Dukrok Suh, Junseok Hwang (2010), “An analysis of the effect of software intellectual property rights on the performance of software firms in South Korea”, College of Engineering, Seoul National University, 599 Gwanak-ro, Gwanak-gu, Seoul 151-742, Republic of Korea [12] T. Tamai (1997), “Abstraction orientated property of software and its relation to patentability”, Information and Software Technology 40 (1998) 253-257 [13] Bronwyn H. Hall (2007), “Patents and patent policy”, Oxford Review of Economic Policy, Volume 23, Nr. 4, 2007, pp. 568-587 [14] "Defining a Software Patent". Public Patent Foundation. Retrieved 2007-05-30. [15] David, P., 2001. “Will building good fences really make good neighbours in science?”, Stanford Institute for Economic Policy Research, SIEPR Discussion Paper, 00–33. [16] Cohen W., Nelson R., Walsh J. (2000), “Protecting their intellectual assets: Appropriability conditions and why US manufacturing firms patent (or not)”, National Bureau of Economic Research, Cambridge, MA [17] Brian T. Yeh (2010), “The Jurisprudence of Justice John Paul Stevens: Selected Opinions on Intellectual Property Law”, Congressional Research Center, FAS

Fig. 1 Number of computer software related patents (US). [1]

Fig. 2 European software patent applications, 1979–2002. [1]

Fig. 3 Share of publicly traded US firms with granted software patents (by date of application) [2]

Fig. 4 US Patent Classes with Software/Business Method Patents Granted 1966-2002 [8]

1 2

The other two cases were: Gottschalk v. Benson, 409 U.S. 63 (1972), and Diamond v. Diehr, 450 U.S. 175 (1981).

An applicant may show that a process claim satisfies §101 either by showing that his claim is tied to a particular machine, or by showing that his claim transforms an article [10]. 3 Whereby the applicant could obtain a patent on software inventions “only if the applicant recited the magic words and pretended that she was patenting something else entirely,” such as hardware devices, some sort of apparatus, or other machines [17].

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