Business Method Patents, Innovation, and Policy Bronwyn H. Hall Abstract The trickle of business method patents issued by the United States Patent Office became a flood after the State Street Bank decision in 1998. Many scholars, both legal and economic, have critiqued both the quality of these patents and the decision itself. This paper discusses the likely impact of these patents on innovation. It first reviews the facts about business method and internet patents briefly and then explores what economists know about the relationship between the patent system and innovation. It concludes by finding some consensus in the literature about the problems associated with this particular expansion of patentable subject matter, highlighting remaining areas of disagreement, and suggesting where there are major gaps in our understanding of the impact of these patents. JEL No. K3, O0, L4 Keywords: intellectual property, State Street, software, internet; business methods, patents, innovation Bronwyn H. Hall Department of Economics 549 Evans Hall University of California at Berkeley Berkeley, CA 94720-3880 [email protected] H. Hall May 2003 1Business Method Patents, Innovation, and Policy Bronwyn H. Hall1 1 Introduction The explosion in business method patent applications and grants that occurred in 1999-2001 has abated somewhat, but the many policy questions raised by the response of the financial, e-commerce, and software industries to the well-known State Street Bank decision on the patentability of business methods remain. Many scholars, both legal and economic, have written on this topic and to a great extent it is possible to discern some points of agreement in their arguments.2 Although much of this literature provides a fairly thorough analysis of individual cases and what they signify, there is relatively little literature on the impact of business method patents that is based on a more broad-based or empirical approach. The current paper does what it can using available sources to fill the gap by reviewing some of the literature on patents in general in an attempt to infer the implications of this literature for business method patents. The focus is on two issues: the role of patents in encouraging innovation and the consequences of low patent quality. I begin by reviewing the facts about business method patents briefly, and then survey what economists know about the general relationship between patent systems and innovation, in order to draw some implications for the likely impact of business method patents on innovation in industry. A discussion of the patent quality issue is followed by a summary of the policy recommendations made by those who have followed the evolution of legal standards as both software and business methods have 1 University of California at Berkeley and NBER. Paper prepared for the Atlanta Federal Reserve Bank Conference on Business Method Patents, Sea Island, Georgia, April 3-5, 2003 and the EPIP Network Conference on New Challenges to the Patent System, Munich Germany, April 24-25, 2003. Comments from participants in those conferences are gratefully acknowledged. Thanks to Stuart Graham for giving me patent data updated to the end of 2002 in a very timely mannyer. 2 See, for example, Bakels and Hugenholtz (2002), Bessen and Maskin (1997), Blind et al (2001), Cockburn (2001), Cohen and Lemley (2001), Davis (2002a,b), Dreyfuss (1999), Hart et al (1999), Hunt (2001), Kasdan (1999), and Lerner (2001).Bronwyn H. Hall May 2003 2become acceptable subject matter. The paper concludes with a brief discussion of the one of the chief recommendations, an enhanced post-examination patent review system. Most economists view the patent system as a necessary evil: with a patent grant we trade off short term exclusive (monopoly) rights to the use of an invention in return for two things: 1) an incentive to create the innovation; and 2) early publication of information about the innovation and its enablement. The argument is that without the patent system, fewer innovations would be produced, and those that were produced would be kept secret as much as possible to protect the returns from misappropriation. Mazzoleni and Nelson (1998) expand on this analysis and provide two further related arguments for the existence of a patent system: it serves as an inducement for the needed investments to develop and commercialize inventions, and it enables the “orderly exploration of the broad prospects” opened up by particularly novel inventions. In considering the economic impacts of the implicit subject matter extension implied by the increased use of patents to protect business methods, the tradeoff between these benefits and the welfare cost of the grant of a monopoly right are at least as important as they are in any other technological arena. Economic analysis says first that competition may suffer when we grant a monopoly right to the inventor of a business method but it will benefit if this right facilitates entry into the industry by new and innovative firms. Second, innovation in business methods will benefit from the incentive created by a patent but may suffer if patents discourage the combining and recombining of inventions to make new products and processes. Thus the relationship between patents, competition, and innovation is guaranteed to be a complex one, and one that may vary over time and across industries. Table 1 summarizes these trade-offs. 2 Background and history There is no precise definition of a business method patents, and in reading the literature it becomes clear that many scholars make little distinction between business method patents, internet patents, and software patents more broadly, at least when making policy recommendations. This is inevitable in the present day, because many business method patents are in fact patents on the transfer of a known business method to a software and/or web-based implementation, so the distinction is hard to maintain. The USPTO defines a business method patent narrowly, as a patent classified in US patent class 705, defined as “data processing:Bronwyn H. Hall May 2003 3financial, business practice, management, or cost/price determination.” Such patents are on methods used for a variety of purposes in business such as the following:3 • Financial - credit and loan processing, point of sale systems, billing, funds transfer, banking clearinghouses, tax processing, and
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