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Mind
Over Matter: In the information economy, intellectual
property is bringing huge returns. But just how will
society split up the bounty?
REASON, June 1998
By
James V. DeLong
Wherever
you turn, every medium of communication is saturated
with the terms information revolution and intellectual
property. The root cause of the fascination is simple:
Lots of money is involved. Both individuals and business
organizations have become aware that their rewards depend
increasingly on mental products--in the form of education,
patents, copyrights, trade secrets, databases, computer-assisted
employee cooperation, and general know-how--and less
on machines, buildings, and raw muscle.
The
size of the stakes would itself be enough to generate
an explosion of interest, but another factor also counts:
a high degree of uncertainty over who, exactly, will
collect this loot. Will it be the individual inventors
who generate the ideas? Teams of innovators? Entrepreneurs
who translate concepts into commercially viable products?
Venture capitalists? Long-term stockholders? Consumers?
The obvious answer is that all these groups will share
in the bounty, but this answer leaves a lot of latitude
about the precise details of the split--and billions
of dollars hinge on the answers.
Wall
Street seems to assume that a huge share will go to
the stockholders. When Nervous Nellies fret that current
stock price levels are extraordinary by all historic
measures, and hence ripe for correction, the bulls point
to the growing importance of intellectual property and
information. The familiar yardsticks of companies' value,
they say, are based on old industrial models in which
the most important assets were plant and equipment,
plus some allowance for the value of an ongoing business.
But, continue the bulls, as value becomes more dependent
on a firm's mental assets and less on its physical embodiments,
those old measuring rods lose cogency. From this perspective,
current market levels reflect the future earning power
of mental assets that are not reflected in old-style
balance sheets.
Take,
for example, Microsoft, the flagship of the armada of
new companies whose value is almost entirely mind-based.
Microsoft has 2.4 billion shares of stock outstanding
and, at press time, is valued by the market at about
$220 billion. The company's physical existence is minimal:
It has about $12 billion in cash, investments in other
companies, plant, and equipment. That leaves $208 billion
as the value of its patents, copyrights, trade secrets,
brand name, presence on Rolodexes of customers, and
the brains of its 25,000 employees. You can pare the
physical component of value down even further. Microsoft's
existing products are worth almost nothing in the sense
that if the company announced it was freezing its designs
and planning no further improvements, its products would
be obsolete in a couple of years--and the company's
value would drop precipitously. Clearly, no analysis
based on physical assets captures the essence of this
company or others like it.
So
you can make a serious case that almost all of Microsoft's
value lies in the new-style form of information and
intellectual property, and mostly in the brains of its
staff. But while Wall Street bulls may be right about
that, it's far from clear that stockholders will snag
those brain-based earnings in the long run. Consider
that, in 1997, Microsoft produced earnings of $3.5 billion.
Of this, zero dividends were paid to the stockholders--the
same payout they have gotten every year since the company
produced its first earnings of a penny per share back
in 1982. Employees, on the other hand, not only got
their salaries, they also got 96 million shares of Microsoft
stock, which they were entitled to buy at bargain prices
under various option plans. The company spent $2.4 billion
buying shares to meet this commitment, and if this sum
were added to the company's wage bill, Microsoft's 1997
earnings would drop by two-thirds.
Roger
Lowenstein, a columnist for The Wall Street Journal,
cited these figures as an example of a general phenomenon
that companies are "transferring ever-appreciating
portions of their profits to workers...motivated not
by warm-hearted charity but by cold-hearted reality.
Capital is in surplus; skilled geeks are at a premium.
No surprise that labor is grabbing a bigger share of
the capitalists' pie." Indeed, Microsoft looks
a lot like a cooperative venture of its employees. At
the end of 1997, the officers and directors, the people
defined as "insiders" by the Securities and
Exchange Commission, owned 35 percent of the company's
stock. Many lower-level employees also own shares. While
the company will not say how much stock is held by employees
other than the "insiders," it is commonly
reported that at least 6,000 of them own enough to be
millionaires. In addition, it is known, again through
SEC-required disclosures, that employees hold options
to buy another 22 percent of the stock, at an average
exercise price of $21. In sum, then, we know that the
employees have a claim on at least 57 percent of Microsoft's
value, plus an additional unknown percentage for the
shares already owned by the lower level-employees.
The
tug between stockholders and geeks within the information
companies is only one dimension of the coming struggle
over brain-created value. Another is even more basic:
How much will the information companies themselves keep,
as opposed to other players in the economic system,
and consumers? To repeat the obvious, we are talking
about massive gains here--very much a positive-sum game--and
all the players should wind up better off. But some
will be more better off than others, and the various
amounts that will be paid out are up for grabs.
As
a half-hour spent browsing through the new buzz-word-larded
books in the business section of any local bookstore
will demonstrate, discussion of information issues is
often muddied by a tacit assumption that "information"
is a free-standing entity that can be understood separately
from any physical embodiment. This is not so. The value
of most information is inextricably linked to its context.
For information to be significant it must be about something,
and to assess its value you must bring that about into
focus.
For
most information, the crucial question is how it increases
the efficiency with which we use physical assets, such
as capital equipment, labor, and energy. This is not
a novel phenomenon. Go back 1,000 years or so to one
of the great information revolutions of human history--the
invention of the horse collar. The Greeks and Romans
harnessed a horse by putting one strap around its belly,
another around its neck, and joining them on top of
the shoulders. The connection to the wagon or chariot
ran to this junction. Under a load, the neck strap pulled
tight and choked the horse, which cut its ability to
pull by about 80 percent. All heavy loads were pulled
instead at a slow pace by plodding oxen.
The
horse collar, which came to Europe sometime during the
Middle Ages, changed that: It still went around the
neck, but two connections to the load were used, placed
lower down and to the sides to take the strain on the
shoulders rather than the windpipe. This adjustment
multiplied a horse's pulling power by a factor of five,
and, since horses are faster than oxen, also increased
the speed with which goods could be hauled. The idea
of the horse collar, when incorporated into a cartage
system, was an extraordinarily valuable piece of intellectual
property.
Much
of the current information revolution is similar: Its
value lies in its ability to increase the power of other
factors of production. Consider the carrying capacity
of telephone wire fiber. In 1989 a strand of such fiber
carried 24,000 simultaneous calls. In 1997 it carried
516,000. The number will jump to 1.8 million calls this
year, and to 8 million in 1999. The increased capacity
is a result of changes in software--that is, in information
processing--not in the nature of the fiber itself.
Another
example comes from the oil industry. Improvements in
processing the complicated data generated by exploration
techniques has cut by a factor of three the number of
wells that must be drilled to figure out the size and
shape of a newly found oil field. Or take agriculture,
where reliance on global positioning satellites allows
farmers to micromanage the application of fertilizer
down to the square yard. In all these contexts, and
myriad others, information makes physical assets or
energy or human labor more productive.
The
horse collar was a great invention, but it is safe to
say that its inventor made no royalties on it. Medieval
Europe lacked a patent system, and a horse collar, once
seen, was easily duplicated. Besides, it would have
occurred to no one at that time and place that ideas
or inventions could or should be protected. The very
idea of a patent system that converts ideas into tangible,
profitable, marketable property was itself a milestone
invention in human history, a major contributor to the
great economic ascent that began in the 18th century.
It became economically rewarding for people to think
systematically about innovation, and they responded
with an outpouring of creativity.
The
problem that has bedeviled societies ever since is how
much to reward intellectual property, given that it
is inextricably intertwined with other things. Suppose
the inventor of the horse collar could have gotten a
patent. A cartage system that was collecting $1.00 in
freight charges for a particular trip can now haul five
times as much and can collect $5.00. Should the patent
on the horse collar entitle the inventor to the entire
increase? If so, which inventor, given that few innovations
appear in perfected form and an end result comes from
tinkering by many minds over a period of time?
The
owners of horses and wagons, not to mention the drivers,
will also stake a claim, pointing out that the collar
may be a fine thing, but without them it produces nothing.
So why should its inventor get so much? Consumers will
suggest that perhaps the freight charges should remain
at $1.00 while the price of goods is dropped. After
all, inventors draw heavily on the general stock of
knowledge that exists in a society, so why should either
they or the owners of the physical assets collect all
the rewards? Sure, we need to encourage innovation,
but we do not want to allow massive enclosures of the
intellectual commons. Nor do we want to tie the whole
economic system in knots by imposing transaction costs
on all the cross-fertilizations that occur in the interaction
of creative minds.
As
societies become more complex, ever-more-nuanced tensions
arise. The newspapers and the legal reporters are filling
up with stories showing the difficulty of drawing the
proper lines. Some involve lines between employers and
employees. Evan Brown, who works for DSC Communications,
a company that makes equipment for the telecommunications
industry, and who signed a complex contract governing
inventions, has an idea for updating old computer software.
He says it was 80 percent complete before he went to
work for DSC, and that it is unrelated to DSC's business
anyway, so it is his. DSC thinks the idea belongs to
the company: "If a janitor came up with a method
of cleaning a hardwood floor suggested...by work in
cleaning a DSC hardwood floor, technically the idea
belongs to DSC," it argues. A novel element in
the situation is that Brown has never put his idea on
paper and has refused two court orders to do so.
Other
stories look at the lines between scientists, as when
a biotechnology company claims that a key idea was stolen
from a scientific paper during peer review and used
to obtain a patent for a rival. Among its defenses,
the rival argues that the peer review process carries
no obligation of confidentiality. Yet other stories
turn on the lines between generators of intellectual
property and consumers. A couple of years ago, the American
Society of Composers, Authors, and Publishers, which
collects for the use of music that has been copyrighted
by its members, got into an embarrassing brawl with
the Girl Scouts over the use of songs at summer camps.
ASCAP claimed that the Scouts should be paying license
fees, and earned headlines such as "The Birds May
Sing, But Campers Can't Unless They Pay Up," "Campfire
Churls," and "Legal Sour Notes." In the
face of such negative publicity, ASCAP retreated.
No
perfect answers to the problems of dividing the fruits
of invention exist in the theory or practice of either
ethics or economics, but society has evolved a series
of rough-and-ready rules designed to reward and encourage
invention without slighting the interests of other players
on the economic system. Patents and copyrights are limited
in time. You can patent only an actual device, not a
general idea; if someone else invents another device
that performs the same function, that's too bad for
you. An inventor of a horse collar could patent his
particular design, but could not patent "the idea
of a collar that shifts the strain to a horse's shoulders."
As the U.S. law puts it, one cannot patent an "idea,
procedure, process, system, method of operation, concept,
principle, or discovery." Einstein, to the regret
of his heirs, could not patent the formula E = mc2.
Nor could Apple Computer, to the regret of its stockholders
and employees (and to the delight of Microsoft), patent
the idea of a mouse and a graphical user interface,
both of which originated elsewhere anyway. On the other
hand--and showing the considerable confusion over the
exact meaning of these formulas--a patent was issued
covering a way to swing a golf club.
Other
restrictions exist, such as the proviso that no one
can patent familiar or obvious devices or logical extensions
of current art. Because such a proviso can conceivably
undercut virtually any patent, this is precisely what
most patent litigation is about. We also retain our
fundamental faith in the virtues of competition and
impose some legal limits on the use of patents as mechanisms
of monopoly. The current government investigation of
Microsoft focuses on the charge that it is trying to
leverage its power over the intellectual property of
the Windows operating system into control of other areas.
It
may seem a long way from horse collars and cartage systems
to computer software and today's high-tech industries,
but the distance traveled is really not so far. One
of the great challenges over the next few decades will
be to evolve property rights in intellectual products
in a way that reconciles old concerns in these new contexts.
The
task will not be simple, because the stakes are large
and the conflicts are going to be fierce. Furthermore,
the sides are not obvious. The interests of investors,
managers, employees, consumers, and inventors are all
multi-dimensional, and sometimes counterintuitive. For
example, it is often assumed that large corporations
favor expansive rights in intellectual property so that
they can buy them up. But this is not necessarily so.
Those whose power is financial might be better off with
narrow definitions. That way, they can copy innovation
freely and rely on marketing muscle to squeeze out the
inventors. Small inventors worry about this possibility
in connection with pending legislation that would make
patents public 18 months after the application is filed
rather than when the patent is granted, as is the present
practice. Big companies, they fear, will steal the ideas
and wear down inventors through litigation.
Similarly,
how far should creative people go in demanding legal
protection for the fruit of their labor? Creators are
borrowers as well as lenders, and a requirement that
they get permission for every cross-reference would
be a heavy--even potentially crushing--burden. A healthy
intellectual commons is to the benefit of all, but precise
definitions of all the terms in that claim are elusive.
Hence, in the ongoing debate over possible reform of
the copyright laws, the boundaries of the concept called
"fair use" is one of the most contested topics.
Corporate
management will also be affected. In theory, managers
are the agents of the shareholders exclusively, bound
to promote their interests. But, as in the Microsoft
context, "capital is in surplus; skilled geeks
are at a premium." So the managers who do the best
job for their shareholders in the long term will be
those who are good at harnessing the mental energies
of their information workers. This requires a more subtle
balancing than exists at present between the interests
of investors and employees, especially when, as with
Microsoft, these categories have huge overlap. Since
1994, for example, Cisco Systems, a leading manufacturer
of Internet hardware, has purchased 19 companies, most
of them small software firms on the brink of product
launch. "In short," says The Wall Street Journal,
"Cisco is buying new product teams on the open
market...and it is paying lofty prices--sometimes as
much as $2 million an employee." When you pay that
much for mental machinery, you have to figure out how
to keep it in good working order, and, unlike metal
machinery, you cannot do this with an occasional squirt
of lubricant.
All
in all, it should be an interesting time.
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