nventors, tinkerers, and entrepreneurs have long been laboring in their houses in the woods (and in their garages in the suburbs) to create the proverbial better mousetrap. For more than two centuries, the desks of clerks at the U.S. Patent and Trademark Office (USPTO) have been cluttered with patent applications for wondrous new devices: a light bulb (Thomas Edison, 1880), a flotation device (Abraham Lincoln, 1849), a new self-guidance system for torpedoes (actress Hedy Lamarr, 1942), and a compound to help sufferers of depression (Eli Lilly, Inc. The drug Prozac is covered by six chemical patents granted between 1974 and 1986). In recent years, patents have assumed an important role in the burgeoning field of e-commerce. But not all patents are created equal: consider U.S. Patent No. 5,443,036, granted in 1995, which is shown below.

This is not a joke. The patent is held by Messrs. Kevin Amiss and Martin Abbott, who managed to demonstrate both the utility and novelty of using a laser pointer to play with a cat. Now, it is possible the applicants and the USPTO were just having fun. But the patent nonetheless illustrates an important trend. It was not granted for a device, or a thing. Instead, it is a patent for how to do something. Other intrepid inventors have been awarded patents for methods of completing quotidian activities, like finding the right bra size (No. 5,965,809) and hitting a tennis stroke while wearing a knee pad (No. 5,993,366). While these patents may seem like novelties, this trend is not entirely new. The USPTO has been awarding so-called “methods” patents for decades. But in recent years, the numbers have risen dramatically. And patenting “business methods,” some of them stunningly obvious – such as using a single mouse click to complete an online book order – has become a hallmark of entrepreneurship in the digital economy.

The Background of Patents

The patent law of 1790 created an office that was empowered by the Constitution to “Promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries” (Article One, Section 8). In 211 years, the USPTO has established a proud tradition of rewarding the development of technologies of all sorts (though often for things that might seem at a distance to be trivial, or obvious, or both). The objective has always been to draw out of the collective genius inventions that would promote the good of the nation. But granting patents can be a Faustian bargain. On the one hand, by commercially rewarding the efforts of inventors, we call forth their creative efforts. On the other hand, we create monopolies and all the evils that attend them.

The patent laws grant inventors a 20-year window during which they – and only they – may exploit the commercial potential of their work as they see fit. The philosophy of the USPTO seems to embrace the ‘solitary genius’ model of innovation, wherein the lone innovator receives protection from competition while he or she perfects the reaper, or the cotton gin, or the cellular phone. But other elements of our government have expressed ambivalence about the granting of exclusive monopolies. “It was never the object of patent laws to grant a monopoly for every trifling device, every shadow of a shade of an idea, which would naturally and spontaneously occur to any skilled mechanic or operator in the ordinary progress of manufactures,” the Supreme Court ruled in an 1882 case (Atlantic Works vs. Brady). “Such an indiscriminate creation of exclusive privileges tends rather to obstruct than to stimulate invention. It creates a class of speculative schemers who make it their business to watch the advancing wave of improvements, and gather its foam in the form of patented monopolies, which enable them to lay a heavy tax on the industry of the country, without contributing anything to the real advancement of the arts.” Six-score years later, these words resonate with those who view some contemporary business model patents as little more than sand thrown into the gears of the digital economy by “speculative schemers.”

Patenting Business Methods

The idea of patenting a method of doing business is as old as the Internet is brand new. Todd Dickinson, director of the USPTO, offers as evidence a patent awarded in 1867 for a method of registering hotel guests in a book with advertisements in the margins that “looks suspiciously like a commercial (web)site.” But even those completely comfortable with the idea of patenting a “how to” might still be puzzled by Patent No. 4,744,028, awarded in 1988 to Narendra Karmakar, then at Bell Laboratories, for the solution to a mathematical problem – the linear programming problem with large numbers of activities. After all, haven’t we been taught that equations are laws of nature? Apparently not all are, since dozens of patents have been awarded for equations, including, Pierre Duhamel’s Patent No. 4,797,847 for the Discrete Cosine Transform, a mathematical result that is used in designing compact storage for video data. (For readers who may suddenly feel inspired to patent Einstein’s E=mc , save your energy. This one is viewed as a law of nature, and is regrettably not patentable.)

In order to be patented, an equation must be new, and must have some commercial potential. Karmakar’s solution was new, and it has proved very useful to the airlines in assigning planes to routes and flights. But here, again, the government has created something of a muddle. The Supreme Court has singled out mathematical algorithms for exclusion from patentability. They are unpatentable if they merely represent an abstract idea – abstract ideas can’t be patented. But, in a 1981 case, Diamond v. Diehr, the court left the door ajar; noting that “certain types of mathematical subject matter standing alone, represent nothing more than abstract ideas until reduced to some type of practical application.” Of course, any business model is an idea, an abstract expression. But, one can certainly argue that a business model has a practical application, especially when it is put into use.

When an Internet entrepreneur tries to gain a patent on a business method, she is not just patenting the idea – she is patenting the software that runs the transaction. And in order to obtain a patent on software, one has to be able to patent an algorithm, which is essentially an equation. In the mid-1990s, when dealing with such a question, the USPTO seemed to turn a corner that led to the current flood of business method patents.

The ‘Hub and Spoke’

In 1993, designer/inventor Todd Boes created a “Hub and Spoke” data-processing system for Signature Financial Services Corp. The system was designed to keep track of individual mutual fund investments that had been pooled into a single portfolio. Boes created a computer algorithm for doing the computations. At the time, computer programs could be copyrighted but not patented. (The distinction between a copyright and a patent is subtle. Superficially, a copyright gives the holder protection only against physical reproduction for commercial gain of their idea or creation whereas the patent literally protects the use of the idea. Thus, for example, two people could both copyright the same dramatic photograph or painting – assuming they had created them independently.) The patent holder, say to an equation, can prevent all others from using their idea for commercial gain without their permission. Boes, however, did obtain a patent for the underlying idea, which was assigned to Signature Financial Services in 1993.

State Street Bank and Trust attempted to negotiate a license to use Signature’s technology. When the negotiations broke down, State Street sued, arguing that the patent was invalid since it covered a mathematical algorithm. The district court agreed, and granted a summary judgment in State Street’s favor, with the judge noting that “as established by a series of older cases, business methods are unpatentable abstract ideas.” However, the Federal Circuit Court disagreed and overturned, and the patent held.

This case, which forms the foundation of the current environment of business model patenting, opened the floodgates. Individuals and groups such as Walker Digital, the Stamford, Ct.-based idea factory run by Priceline.com founder Jay Walker, have been emboldened to comb the intellectual landscape for patentable ideas great and small. The number of applications for business model patents jumped from roughly 700 to 2,600 from 1996 to 1999. The number of patents granted for business methods jumped from less than 100 to over 500 in the same period. In general, applications for Internet-related business-method patents seem to have been warmly received at USPTO, though sometimes the agency makes obvious mistakes. In 1993, it awarded a patent to Compton’s New Media (Compton’s Encyclopedia) which apparently laid a basis for the company’s claim to multimedia itself. The patent was as ridiculous as it seems, and at the instruction of USPTO Director Dickinson, Compton’s claims were ultimately overturned.

Walker Digital has applied for hundreds of business model patents. One of them which was granted is for “shopping up,” a system in which a customer at a store, such as a Kentucky Fried Chicken outlet, takes their change “in kind,” in the form of an additional food product. Even more striking, and perhaps better known, is Walker’s patent on the pricing method used by Priceline.com, which looks like a patent on the English Auction, a device which has been in the public stock of knowledge for decades. The poster child for this entire debate is Amazon.com’s famous “1 click” method and system for placing a purchase order via a communications network (U.S. Patent No. 5,960,411, granted in September, 1999).

The Rationale for Digital Commerce Patents

Why should we have business model patents such as these? By his own account, Jeff Bezos of Amazon.com has been besieged with correspondence about Patent No. 5,960,411. In an open letter on this subject he argues that business model patents should be treated differently by the USPTO. And while he suggests a shorter track from application to award and a shorter lifespan for the patent (five years instead of 20), he nonetheless enthusiastically endorses them as good for both his shareholders and his customers. After all, he writes, “online, the balance of power shifts away from the merchant and toward the consumer.” What one takes away from Bezos’ missive is the sense that online entrepreneurs need patents for business methods because the heat of competition on the web is greater than in the “old economy.” Entry is easy, and customers are fickle – branding is difficult and customer loyalty is hard to come by. Amazon.com’s mantra, “Get Big Fast,” should more appropriately read “get it as fast as you can, while you can.” First-movers like Bezos obviously believe a little sand in the gears to slow down the competition can't hurt. But I’m not sure this justifies a fast track to quick monopoly profits before they evaporate.

One could argue that patent protection provides a crucial role in allowing developers of “things” such as pharmaceuticals to recoup the huge, sunk research and development costs. Obviously, it costs a substantial sum of money to design and build a truly effective website. But, as a general proposition, this hardly seems a compelling case for patenting methods of conducting business such as shopping up, or a system for providing expertise online – as AskJeeves.com, another Walker Digital creation, did in Patent No. 5,862,223.

One of the challenges facing patent-granting bureaucrats is that the amount of prior art (existing knowledge) which must be verified for business model applications is vast and the art, itself, is often ambiguous and diffuse. And the lingo and newness of the Internet sometimes aggravates the situation. American University law professor James Boyle believes, “the Patent Office is issuing patents for blindingly obvious things just because they are being done with software or on the Internet,” and that such patents are causing a “chilling effect on electronic commerce.” New York University Law School’s Rochelle Dreyfuss argues forcefully that business model patents “undermine the very basis on which the anti-monopoly argument depends.”

There has been very little proof offered in the literature to support the notion that monopolies on business methods are a good thing. And the prodigious volume of entry (and, of late, exit) of new businesses on the Internet makes it hard to accept the argument that these temporary monopolies are really necessary to give entrepreneurs incentive to try their newly invented hand at business on the Web.

Even so, some patent professionals embrace the notion of granting business-method patents. USPTO Director David Dickinson states that business model patents represent “a very logical extension of the patent system” that has served America so well. Dean Alderucci, head legal counsel for Walker Digital, suggests, “If you have a new and useful business method, a patent can force the money out of it and benefit the public.”

The challenge for the USPTO – and for those who would apply for such patents – is that the criterion of new and useful are subjective. And the conundrum for those who would challenge such patents is that the definitions of ridiculous and obvious are equally in the eye of the beholder.

Courting Controversy

In the end, many of these questions may be settled in the courts. Amazon.com’s “1 click” feature was made available to its customers in September, 1997, and the company received a patent for it on September 28, 1999. Three weeks later, on October 20, Amazon sued rival bookseller Barnes & Noble – and its online subsidiary, barnesandnoble.com – for infringement. U.S. District Court Judge Marcha Pechman granted an injunction on December 14, 2000. But, on February 14, 2001, a federal appeals court overturned the injunction.

For the time being at least, “1 click” is public domain. The trial at which the issue is supposed to be resolved will convene in Seattle on September 10, 2001. Until then, this case suggests that at least some are reconsidering the wisdom of a trend toward ubiquitous patenting of every mechanical aspect of Internet commerce. But even as it prepares for trial, Amazon.com has also served notice that it will defend its recently obtained patent on “affiliate programs,” which are widely used on the Web. These programs are used by many Internet retailers to link their sites to other retailers’ catalogues. This is a far-reaching and potentially very disruptive patent that is certain to evoke a cornucopia of lawsuits and countersuits.

But perhaps there is justice (and a touch of irony) in cyberspace. As part of its expansion efforts, Amazon.com in the late 1990s began offering CDs for sale, and it used new technology to let potential customers listen to a snippet of a Frank Sinatra song before buying the whole disc. It turns out another company already had that idea. On April 12, 2000, San Francisco-based Intouch Group Inc. sued Amazon.com for infringing patented methods for consumers to preview music samples over the Internet.

It may not be entirely original, but what goes around, comes around.

William Greene is professor of economics at NYU Stern.