E-Commerce: Here Come the Lawyers

While most pundits were riveted by the growth of e-tailing during the holiday season, the real action may have been elsewhere. In the past three months, a series of lawsuits and legal decisions were filed that could change the contours of e-commerce for years to come.

At issue is a relatively new section of the patent law that has allowed selected companies to claim broad patent protection for the business that is conducted on the Internet. In 1994, Congress passed a law that extended patent protection to "whoever invents or discovers any new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement." In 1998, a U.S. Federal Circuit Court of Appeals upheld the validity of the law as it applied to business processes. In that case, the Signature Financial Group, a custodial agent for mutual funds, had patented a data processing system it used as an administrator and accounting agent for mutual funds.

Briefly, their so-called "Hub and Spoke" approach, called for different mutual funds (the spokes) to pool their assets in a central portfolio (the hub) organized as a partnership. The system allows for the allocation among the spokes of the hub’s daily income, expenses, and net realized and unrealized gain or loss, calculating each day’s total investments based on the concept of a book capital account. The system enables the determination of a true asset value of each spoke and the accurate calculation of allocation ratios between or among the spokes.

While the approach doesn’t seem very revolutionary, it does provide economies of scale in administering investments and certain tax advantages. The State Street Bank liked it enough to try to license the process. When negotiations broke down, State Street sued to invalidate the patent, claiming that lower courts had exempted "business methods" from patent protection. The Court of Appeals disagreed. Not only did it strike down the notion of an exemption in patent law for "business methods," it held out the possibility that if current law had been in place when the procedures of bookkeeping were created, bookkeeping could have been patented.

Since Internet-based e-commerce did not even exist five years ago, virtually all the business processes associated with it could be thought of as new. Some farsighted entrepreneurs patented many of the processes associated with e-commerce and now are fighting to protect those patents.

The first high-profile blow was struck last October by Priceline.com, which sued Microsoft for violating its patent on letting buyers name the price they are willing to pay for goods and services. In December, Amazon.com won an injunction against Barnesandnoble.com, claiming that its arch rival had violated Amazon’s patented "1-Click" express checkout service. It was not a trivial victory. Research shows the percentage of online sales actually completed rises dramatically with one-click systems.

The Priceline and Amazon salvos promise to be just the first in what could be a long, drawn-out, many-sided legal war. Several companies have business process patents on commonly used elements in Internet-based e-commerce. For example, in early December, LinkShare announced that it had been granted a patent for the affiliate network marketing model. On the same day, online marketer Be Free.com announced that it had received a patent for "determining behavioral profiles of computer users," in other words, tracking how people move through Web sites.

And there are many more patent holders of what are generally seen as basic e-commerce building blocks. Open Market holds a patent on a business process for online "shopping carts" which consists of a network that connects a computer of a buyer with a computer of a seller and a computer that handles payment.

The potential enforcement of these patents could throw the business-to-consumer e-commerce arena into uncharted territory in the courts. One observer opined that, given the current rules, the founders of HotWired, a pioneering online magazine, could probably have patented the concept of banner ads.

The protection of intellectual property is an essential safeguard in creating an environment in which innovation can flourish. People should be richly rewarded for new ideas that win acceptance in the marketplace. And protecting intellectual property has been a vexing issue, as applied to technology, for decades.

But, in my opinion, common business practices should not be protected simply because somebody thought to implement them on the Web. With all due respect to Priceline, the idea of a buyer naming a price for a good or service is about as old as commerce itself. In fact, it is fixed pricing that is a relatively new development. If Microsoft copied Priceline’s algorithms, that is one thing. But if Microsoft created its own technology to accomplish the same result, in my opinion they should not have to pay a royalty to Priceline.

Looking back, I don’t think that it would have helped economic development if a single company could have patented the idea of a checking account, a credit card or consumer advertising. If business process patents are too broadly applied, they could stifle innovation rather than foster it.

About the Author: Elliot King is an Associate Professor of Communications at Loyola College in Baltimore, Md. He can be reached at (410) 356-3943, or via e-mail at eking2@prodigy.net.