HOW TO INCORPORATE

A Business Model of One's Own

A recent decision by the U.S. Patent and Trademark Office has allowed an Internet-based company to patent its own business model. Will this be a barrier to new businesses on the Web?
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Can you actually patent a business model? A recent decision from the patent and trademark office says you can. And that isn't good news for entrepreneurs

We have met the enemy and he is us.com. That was the conclusion of a number of CEOs last August, when two Web-based companies unveiled a couple of big hairy patents: not on their products, not on their technologies, but on their business models. Claiming that they had created fundamentally new ways of doing business, priceline.com and CyberGold Inc. attempted to cordon off their market niches from anyone not willing to pay licensing fees. The CEOs of both companies insisted that their actions were--and that their terms would be--reasonable. Still, if the patents represent a trend rather than an aberration, some entrepreneurs, particularly those panting after the Internet, may ultimately have to buy or fight their way into commercial spaces.

The patent announcements, unprecedented in the on-line realm, and with only a couple of antecedents among terra-firma companies, have at least had the welcome effect of putting to rest one of the most irritating clichÉs about the Internet: that it is a place where upstart Davids routinely fell bloated, convention-bound Goliaths. Priceline.com, a sort of "reverse auction" for airline tickets that launched in April, and three-year-old CyberGold Inc., which pays consumers to eyeball advertising, bear no resemblance to the Barnes & Nobles and Toys 'R' Us's that trailed start-ups to the Web and now stand accused of spoiling the party with their powerful brands and bounteous marketing and technology budgets. No, priceline.com and CyberGold are small entrepreneurial companies, the kind lauded by electronic-commerce boosters for blazing trails, not digging moats. When their patents were announced, many Internet purists began rummaging through their closets for "The End Is Nigh" signs. "If more such patents are awarded and upheld, business on the Internet could suffer," warned The Economist.

Within hours of the announcements, Web-company lawyers were all over the situation like transistors on a microchip. But it soon became clear that the doomsayers had wasted a lot of really good dudgeon on what is, for now anyway, a minor annoyance to a handful of businesses. Even as they awaited their attorneys' judgment, company owners were guardedly dismissive of the patent strategy. "First, we're skeptical that these broad patents are really valid," says Glen Meakem, whose three-year-old, $8-million FreeMarkets OnLine is an electronic marketplace for industrial supplies. "Second, we're skeptical that these kinds of claims can survive in court. And third, we're skeptical that there's value to be derived from these kinds of patents."

That skepticism notwithstanding, Meakem says that FreeMarkets has been pursuing its own parcel of patents for some time. The strategy may be chiefly defensive--Meakem concedes it is--but it suggests that even if the war is still won on execution, some company owners also anticipate fighting a battle or two in court. "Our focus has been on creating real achievement in the marketplace, not legal-paper-trail achievement," Meakem says. "But we'll play the game however it's structured."

What surprised people most about the priceline.com patent (announced nearly two weeks before CyberGold's) was that it was, in fact, possible to assert ownership of a business model. The terms just seemed so...broad. Of course the U.S. Patent Office has long suffered from a sort of "Ado Annie" reputation among technology companies, especially after the dark day in 1993 when it awarded Compton's NewMedia of Carlsbad, Calif., a patent that essentially covered a huge chunk of multimedia. (The patent was later revoked.) "If no one has any objections," read a typical entry posted to a newsgroup at the time, "I would like to patent the book (a vertical stack of equal-sized rectangular laminae of compressed wood pulp or other flexible media, bound along one edge so as to open exposing the laminae a pair at a time)."

Well, it turns out that you can patent a business model, so long as it meets the "new and useful" criteria spelled out by the Patent Office and the courts. But in the history of American business there have been few attempts to do so, and most of those--including efforts by Horn and Hardart to patent the automat business model and by a beverage company to patent something similar to the focus group--died in the courts (where, some observers predict, the current crop may also meet their Waterloo).

In July a federal appellate court upheld a patent issued to mutual-fund company Signature Financial Group for a computer-based investment model--largely because it was computer-based. Using that logic, many financial instruments--as well as other business mechanisms both on and off the Internet--would become fair game for patents. "The question raised in this case is how generic and abstract can a concept be, and still be patented?" says Richard Stern of the Washington, D.C., law firm Ablondi, Foster, Sobin, & Davidow, and a former chief of intellectual property in the Department of Justice. "The claims in these cases are so general that they amount to the use of a computer to do 'X'--and there isn't any other way to do 'X."

Although Signature is a flesh-and-blood company, the decision in its favor would seem at first blush to apply to many first-of-their-kind-on-the-Web ventures. But inventions that win patents must also be unique and nonobvious, and even when the cockles of entrepreneurial hearts were first being warmed by the Internet, most on-line commerce wasn't radically different from what had come before it. Buy a book. Bid on cattle. Check your account balance.

Jay Walker, vice-chairman of priceline.com and chairman and chief executive of Walker Digital, the R&D lab from whose loins priceline.com sprang, thinks that imitation is about to be overwhelmed by innovation. In his view, genuinely new business models develop from genuinely new technologies or applications of technologies. Walker Digital and companies like it, he says, are in the business of inventing the "genetic code" of Internet commerce: the business models created from that code will be unique and, therefore, patentable. "I think most people would agree that the future of commerce on the Internet will not be taking what was on the radio and putting it on television, or taking bricks and mortar and putting them on-line," says Walker. "I think we all know that the Internet is going to give rise to its own forms of doing things."

Of course, the Internet's first form of doing things was the give-it-away-and-lo!-more-will-come-back-to-you philosophy, which is clearly antithetical to the lock-it-up-and-wring-out-every-last-penny approach implied by patenting. That prelapsarian (i.e., before-commerce) mentality lives on, even among those using the Web for business, and is probably partly responsible for the loud hissing sound that went up following the patent announcements. Joseph Iandiorio, a partner in the Waltham, Mass., law firm Iandiorio & Teska, compares such arguments with the criticism that still swirls around Internet censorship. "There are people who say that everything on the Net ought to be open and free," says Iandiorio. "What they don't understand is that these guys have spent a lot of money devising these business models. They want to recoup something from it, and they think a patent is a very honest and forthright way to go."

But there are economic as well as social reasons for the Internet to remain the home of the free. As companies like Netscape Communications have proved, "if you have a great idea, the thing to do is get it out as fast as possible to as many people as possible, and by that have a chance to have your revenue coming in," says Kevin Kelly, the executive editor of Wired and the author of New Rules for the New Economy. "Wealth comes through ubiquity, and the fastest way to ubiquity is to give something away. The old model of the patent is scarcity."

Scarcity, in other words, also works against rapid adoption: if you want to familiarize people with something entirely new, make it part of the landscape. And while both priceline.com and CyberGold say they're not erecting barriers to entry ("We don't want to discourage people from offering incentives....But we want them to pay us royalties," CyberGold CEO Nat Goldhaber was quoted on Wired News's Web site at the time of the announcement), preexisting patents may dampen the enthusiasm of some entrepreneurs, to the detriment of commerce in general. "I think we've seen some of the best growth in the Internet industry come as a result of competition," says Ken Smith, director of on-line retailing for electronic-commerce consultancy Mainspring. "I think of AOL in the early days going up against Prodigy and Compuserve. I don't think AOL would have moved as fast or as smartly if they did not have competition nipping at their heels."

Smith says that while the immediate fallout from the patents will include court challenges and thousands of new applicants swarming around the Patent Office door, the longer-term result may be--sadly--the growing lawyerization of start-ups. "If you're a smart entrepreneur, you'll need a patent attorney to make sure you're not entering a space that someone else has patented and, if you are, whether you'll need to defend."

Conversely, entrepreneurs with patents in their pockets could be in gravy, a fact likely to set innovation synapses tingling. "When a person gets a patent they have to fully disclose the way their processes work," says Andrew Whinston, a professor of economics and computer science at the University of Texas at Austin. "Entrepreneurs can look at that patent, and if they don't want to pay the toll, they can work to find a better way of doing it."

Larry Schwartz, president and CEO of Auction Universe, based in Yalesville, Conn., isn't worried, even though his company is in the process of launching a "buyers auction" that has some elements in common with priceline.com's model. "We've got lots of lawyers," says Schwartz. "But when we ask for an opinion, they say, 'On the Internet, it's the Wild West. Go ahead and do it. If it sticks, great. If it doesn't, then we'll deal with it.' I think a lot of people have that attitude."

Schwartz says the patents may even have their bright side, signifying that the Web, as a vehicle for commerce, is starting to seem a little less dewey. "Rules make it better in the long run because they legitimize our businesses," he says. "Look at what I call the Web-enues that people are making right now; look at the valuations. Entrepreneurs aren't too unhappy."

Leigh Buchanan is a senior editor at Inc.


What The Patent Covers
Priceline.com's patent covers "bilateral buyer-driven commerce," in which a consumer names the price at which he or she is willing to buy a product, lists acceptable substitutes for that product, guarantees the intention to buy with a credit card, and then transfers to a "controller" the authority to conclude the transaction. The controller then alerts sellers, who may accept the offer and charge the buyer's credit card.

The model has fairly limited applications, most experts agree, and is unlikely to affect even companies that already operate Web-based auctions. But Walker Digital has 200 more patents in the works and could, potentially, trample on a lot more toes.

CyberGold's protection of what it pithily calls "attention brokerage" and "orthogonal sponsorship" is more likely to draw immediate challenges than priceline.com's. The company rewards consumers (with frequent-flyer miles, money, or various forms of cyberloot) for spending quality time with its advertisers' messages. Netcentives, BonusMail, and several other small companies have similar business models. Let the games begin.


Face-To-Face: Walker Digital's Jay Walker
Four years ago Jay Walker founded Walker Digital, an intellectual-property laboratory where 25 people--inventors, marketers, and lawyers--labor to create patentable business models that they can license, spin off into new companies, or exploit in ways as yet unfathomed. The company, which recently received $20 million in venture capital from General Atlantic Partners, has filed close to 200 patents since 1995. (The priceline.com patent, which the company spent more than $2.5 million pursuing, is the first to be issued.)

In August, Walker signaled his intent to spend more time in the idea kitchens of Walker Digital when he handed the reins of priceline.com over to Richard Braddock, former president of Citicorp. (Walker will remain as priceline.com's vice-chairman.) "I don't believe for a minute that I am an operator of a company, although I have built many," Walker explains. "I think the invention part is the thing I may be good at."

Inc. senior editor Leigh Buchanan spoke with Walker about the company's business strategy.

Inc.: Why is Walker Digital pursuing patents so aggressively?

Walker: Because we believe we can benefit our shareholders by building a portfolio of protectable intellectual property that other companies can use to grow their businesses. Fundamentally, our business model is no different than any business model that says, "Hey, I can create ideas that others can use that will be profitable for both of us."

We're like a person who says, "I know theater owners all across the country are going to need movies to show in their theaters. I'll go out and make a movie and we'll both do well because they'll get people into their theaters and I'll make money by renting a movie to them."

Inc.: So the primary goal is licensing?

Walker: We have two goals. First, we want to prevent others from ripping off our property. The Internet is known for its copying capability, and we have no objection to people copying other people when things are in the public domain. But we have invested and raised a total of $50 million in capital to build and launch priceline.com, and we don't think it's fair or reasonable for others to copy us because they felt like it.

Our second goal is to create a licensing revenue stream from companies that want to use the buyer-driven commerce model that we build in their businesses. We have absolutely no objection to finding smart partners.

Inc.: Would you license to a direct competitor?

Walker: Under the right circumstances, if we felt that having a smaller piece of a larger pie was significantly better than having a bigger piece of a smaller pie. If a big player comes along and says, "Look, we'd like to license," then we're faced with this wonderful opportunity of saying, "You know, this guy could probably triple the size of this market, and I'd rather own a smaller piece of a much bigger market." Generally speaking, cooperation is almost always going to work better than competition when your opponent is very large.

Inc.: What do you say to the argument that issuing patents on business models could eventually have a chilling effect on start-up companies?

Walker: You're going to have a hard time finding cases in the history of innovation in the United States where patent holders actually slowed things down. When inventors realize they can be rewarded for their risk, the consumer is always the winner. Someone invented the microprocessor and patented it. Someone invented the laser and patented it. And those people led to enormous rounds of innovation, as opposed to someone who said, "Wow, imagine if we gave a patent to the guy who invented the laser! What next?"

Inc.: But doesn't patenting a business model potentially close off more avenues than patenting a technology?

Walker: That potential exists, but patenting a fundamental technology is a big deal. If you had invented the laser--lasers are everywhere. There's a laser in every CD player. There's a laser assisting every telephone call. Business methods aren't broader than fundamental technologies.

If we chose to sit on our business model and practice it ourselves, we would be suboptimizing returns to our shareholders, because the law of increasing returns tells you that in the Internet age you're way better off licensing and getting a penny from everybody than you are holding it to yourself and building a proprietary model. A proprietary platform isn't a winner in this day and age. You want the biggest number of people adopting your platform.

Are there abuses in the process? There could be. There are people who might get patents on things they aren't entitled to, or who want to be parasites and see how much money they can extort from other companies that had no idea these guys had "invented it first." But I wouldn't look at abuses first when I looked at the whole patent debate.

I think the point Nat [Goldhaber, CEO of CyberGold] made is a good one, which is "Hey, what are you, crazy? I'm not going to charge a lot of money. I'm going to do well because I invented this thing and everybody's going to pay a very small tax and let's move on."

Market forces are very powerfully aligned not only to prevent monopolization but to encourage rapid investment, innovation, and risk by real inventors who develop new things and know that they can't simply be ripped off. But if they choose to be piggish they're going to get very little.

Last updated: Nov 1, 1998

LEIGH BUCHANAN | Staff Writer | Editor-at-large, Inc. Magazine

Leigh Buchanan is an editor-at-large for Inc. magazine. A former editor at Harvard Business Review and founding editor of WebMaster magazine, she writes regular columns on leadership and workplace culture.




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