February 2007 Archives

Once again the stock market has reminded us of the fragility of intangibles - and the power of that market intangible which Keynes called "animal spirits." By that Keynes meant business confidence. But it equally applies to the loss of confidence. Roughly $600 billion of value (according to analyst Howard Silverblatt as quoted in the New York Times) evaporated yesterday on the US exchanges alone. As Steven Pearlstein, it was a situation when "unvarnished greed gives way to unadulterated fear."

It is hard to tell how much of those lost billions were simply speculative value (bubble) versus real intangible assets. I'm sure a great deal were bubble assets. When the market comes back and settles down at a new level, we will be able to judge the amount of froth. But not all the loss will be froth. Some may well be due to a post-drop reevaluation of risk and therefore a reassessment of the value of company intangibles. Unfortunately, it will be very difficult to sort out the two.

Federated Department Stores is changing its name to Macy's Group. The company owns Bloomingdale's, May's, Marshall Field's and Filene's. According to the WSJ.com:

As for the plans to change its name, the company is "focused on Macy's and Bloomingdale's, not a federation of department stores," Mr. Lundgren said. "That said, Bloomingdale's is -- and will remain -- a very important part of the company."

Such is the power of brands.

The big news on Wall Street this morning is the private equity buyout of energy giant TXU. But the real shocker is that the new owners wanted to improve the company's environmental image as part of the deal. According to A Buyout Deal That Has Many Shades of Green - New York Times:

Because private equity firms are unregulated and historically have valued their privacy, neither Kohlberg Kravis nor Texas Pacific were eager to become an "enemy combatant" of the environmental groups, people involved in the talks said.

I wonder if we could quantify what the end of the warfare between the company and the environmentalist might be worth in dollars and cents. The purchase price is already at a $15 premium over the current stock price. But the buyers are betting the deal will make future energy investments by the company a lot easier. This is one to keep an eye on.

While the US discusses how to measure innovation (and decides it is all about productivity), the EU has released its latest European Innovation Scorecard 2006. And based on their Summary Innovation Index (SII), the US is now an innovation follower:

• Sweden, Switzerland, Finland, Denmark, Japan and Germany are the innovation leaders, with SII scores well above that of the EU25 and the other countries. The lead of the innovation leaders has been declining compared to the average of the EU25, with the exception of Denmark.
• The US, UK, Iceland, France, Netherlands, Belgium, Austria and Ireland are the innovation followers, with SII scores below those of the innovation leaders but above that of the EU25 and the other countries. The above EU25 average innovation performance of the innovation followers has been declining. Also, the gap of the innovation followers with the innovation leaders has on average slightly increased.
• Slovenia, Czech Republic, Lithuania, Portugal, Poland, Latvia, Greece and Bulgaria make up the group of catching-up countries, with SII scores well below that of the EU25 and the innovation leaders, but with faster than average innovation performance improvement.
• Estonia, Spain, Italy, Malta, Hungary, Croatia and Slovakia seem to be trailing, with SII scores well below that of the EU25 and the innovation leaders, and innovation performance growth which is either below or only just above that of the EU25.

I have to quibble with the definition of "innovation follower" - since it means above average but not in the top 10%. This is especially confusing when they admit, "The US and Japan are still ahead of the EU25 in terms of innovation performance, but the innovation gap between the EU25 and Japan, and in particular with the US is decreasing."

I also have to question these comparison, as compete data is not available for all countries. For example, under the Innovation & Entrepreneurship category, there is no complete EU data or US data on 4 of the 6 elements: SMEs innovating in-house; Innovative SMEs co-operating with others; Innovation expenditures; and SMEs using organizational innovation. Nor was there complete EU or US data 2 of the 5 elements of the Applications category: Sales share of new-to-market products and Sales share of new-to-firm products. (As the accompanying report on individual countries admits, "Only four indicators are available for year 2005. The figure below shows the latest available data for United States, yet ten indicators are still missing.")

Still, it is a useful look at international innovation. There is also an extensive section on innovation in regions: Stockholm is the most innovative, London is 35th (out of 203 - and behind other areas of the UK) and Sicily is 177th.

The report also outlines a number of possible new innovation measures. As is well known, our innovation metrics leave a lot to be desired. The authors of this report -- the Maastricht Economic Research Institute on Innovation and Technology (MERIT) and the Joint Research Centre (Institute for the Protection and Security of the Citizen) -- are to be commended for their work.

Let us hope that the Secretary of Commerce's Advisory Committee on Measuring Innovation in the 21st Century Economy (see Friday's posting) can come up with something as useful.

Yesterday, a jury ruled that Microsoft was liable for $1.52 billion in damages for infringing on Alcatel-Lucent's MP3 patent. Turns out that Microsoft licensed the technology from the wrong company. As the Washington Post explains:

Alcatel-Lucent argued that it held the rights to the technology because it was developed at Bell Laboratories, which later became part of Lucent. Alcatel bought Lucent last year. The company successfully argued that Microsoft infringed on the patents by including the digital music technology in its Windows operating system starting in 1998. The same technology later was used in Microsoft's Windows Media Player and is included in the Windows Vista operating system, which was released to the public last month.

Microsoft countered that it had properly licensed the technology from Germany's Fraunhofer Institute, which was involved with Bell Labs in developing aspects of the MP3 format. Only after Microsoft and other companies made licensing agreements with Fraunhofer did Alcatel-Lucent raise its claim, Microsoft argued.

The jury said "wrong" and awarded the damages to Alcatel-Lucent.

That decision may have huge implications for the digital music industry. The Post story goes on:

About 400 companies have similar licensing agreements with Fraunhofer, according to Thomson Technology, a San Diego company that identifies itself as the "licensing representative of MP3 patents and software of the Fraunhofer Institute." Those companies include Apple, Creative Technology, Real Networks, Palm and Samsung.

To me, this raises a fundamental question about the patent system. If the electronics industry can't figure out who owns a basic patent (and whom they should be licensing it from), then how can there be any innovation? I don't know all the details of this patent or the licensing history. But how can Microsoft and 400 other companies simply guess wrong about who owned the patent?

Something is seriously wrong here.

Yesterday was the first meeting of the Commerce Department's new Advisory Committee on Measuring Innovation in the 21st Century Economy (see also my earlier posting). The meeting was generally a good start to the process, with a few disappointments. The good news is that the participants have a firm grasp of the complexity and diversity of innovation. Unlike most times when innovation gets talked about in Washington, the discussion was about new processes and new organizational models - not just new gadgets. Most of the CEO's present told great stories about new ways of doing things, which is the broad definition of innovation. Even my favorite topic of the importance of intangibles was mentioned.

The not so good news was when they came down from the 30,000 foot level of generalities to the specifics of measure. Too much of the discussion got stuck on utilizing macroeconomic measure of total factor productivity (TFP) as the ultimate measure of innovation on the one hand, and firm specific measures such as customer satisfaction and market share on the other hand. Little if any way said about measurement of the innovation process itself. While the old line about "what gets measured gets managed" was repeated often, there was almost no discussion of metrics for better managing innovation. Measuring ultimate outcomes (such as TFP) is great, but you need to understand the factors that influence how TFP rises or falls. That is where those innovation process measures come in -- the one's we don't yet have.
(See also the ACM summary of the meeting)

I was also surprised by the apparent lack of awareness of previous activities. When the question on cross-national comparisons was raised, EU projects on better measuring productivity were mentioned. But no one seemed to know about the 50 years of OECD work on comparative innovation statistics. I hope that will change as the staff gets to work on the process. The Commission's Executive Director has worked with OECD projects and should be able to bring that work to bear on the issue.

So a good beginning, but we will have to see where it goes. My biggest fear is that this group will either head off into macroeconomic never-never land (without ever looking at whether we are collecting the right data) or try to re-invent the wheel. If the final recommendation of the Commission was simply that the US should institute a periodic innovation survey based on the OECD Oslo Manual -- like every other advanced economy does -- I would be happy. As I've said before, that would be a major step forward.

And more on the patent front this morning . . .

The PTO revoked Genentech's so-called "Cabilly II" patent on techniques for making monoclonal antibodies (see New York Times. This is the patent that was the subject of the MedImmune v. Genentech case recently decided by the Supreme Court. In that ruling, the Court allowed MedImmune to challenge the validity of the patent even though it was paying royalties to license the patent. The request for a PTO reconsideration can from a lawyer representing an anonymous client.

The Verizon - Vonage patent suit went to court. As the WSJ.com explains:

Verizon is accusing Vonage of infringing five patents, some related to features such as call forwarding, fraud detection and other technologies. Vonage denies the accusations and argues that the actual goal of the Verizon suit is to eliminate the Internet company, a growing competitor to Verizon's landline phone business.

Here is another example of a government program that is coming to grip with the I-Cubed Economy - Job Corps Plans Makeover for a Changed Economy - New York Times:

Over the last four decades, even as failed experiments and partisan disputes took the luster off the war on poverty, the Job Corps, the government’s main effort to give poorly educated youths a second chance at a diploma and a trade, was widely seen as one of the few success stories.

But now, as the economy has turned against those with low skills and researchers have questioned the long-term impact of the Job Corps on the lives of its graduates, this remnant of the Great Society is facing an urgent need to reinvent itself.

According to the story, the new head of the Job Corps, Dr. Esther R. Johnson, wants to move the program toward higher value-added careers through "improving their reading, math and vocational skills. She also wants trade courses to connect more closely with college programs and emerging industries, and she thinks the corps must double the number of graduates, now just 10 percent, who go on to higher education."

The result will be individuals who qualified for those higher level jobs:

With better training, high school diplomas or, better, degrees from community colleges, many graduates of such programs, it is hoped, will become chefs instead of hamburger flippers; plumbers, electricians or carpenters instead of pickup laborers; nurses instead of health aides.

That is clearly the right direction. As more and more of the low skill jobs are either automated or shifted offshore, the skill level of the bottom portion needs to be significantly raised. The rising tide may lift all boats; but you have the skills to float - otherwise you drowned.

Revamping Job Corps is a good start at making sure those individuals at the bottom are ready when the tide comes in.

As a follow up to an earlier posting, Apple and Cisco have reached a settlement. According to WSJ.com:

Under their agreement, Cisco, of San Jose, Calif., and Apple, of Cupertino, Calif., are free to use the iPhone trademark on their respective products throughout the world. Cisco will drop a lawsuit it filed against Apple in federal court in San Francisco, accusing Apple of infringing on a Cisco trademark with a forthcoming cellphone called the iPhone, due out in June.

In a joint statement, Apple and Cisco said they will explore opportunities for making their products work better together "in the areas of security, and consumer and enterprise communications." The companies said other terms of the settlement are confidential, declining to comment further.

The agreement may be a win-win. As the AP reports (Cisco, Apple settle 'iPhone' dispute - Yahoo! News):

Analysts said the settlement announced late Wednesday in Cisco's trademark-infringement lawsuit could help both companies strengthen their positions in the increasingly fierce battle to deliver video and other applications directly to consumers' homes.

Zeus Kerravala, a network infrastructure analyst with Yankee Group, said there are ample opportunities for the companies to dream up collaborative projects to win over consumers.

One possibility, he said, could be a device from Cisco's Linksys division that users call into to record podcasts that are then automatically uploaded to iTunes. Such a product would make it easier to create and disseminate such programs.

Negotiations win out once again.

Today the Supreme Court hears oral arguments in Microsoft v. AT&T. At issue is generally framed as the extraterritorial application of U.S. patent law. As the FT explains:

AT&T won a claim that Microsoft infringed its ­patent by including its technology in the Windows operating systems installed in computers built in the US. This case tests whether Microsoft must also pay when it sends Windows versions including the AT&T technology overseas for installation in ­foreign-made computers.

The dispute centres on a law aimed at preventing companies from circumventing US patent law by shipping "components" overseas for assembly. The case tests whether software is such a "component" and whether creating copies of software overseas from a master disk shipped from the US is covered by that law.

I am less interested in the extraterritoriality of the case as with the definitions. One of Microsoft's claims (in their brief) is that they do not supply the infringing component:

The only things Microsoft furnishes from the United States are the golden master disks and encrypted transmissions containing master versions of the Windows object code. But those masters are never installed on a computer that is sold; rather, only the foreign-made copies of Windows are installed on foreign built computers.

Thus, the infringement takes place when the foreign copies are made from the master and installed on the computer. This is beyond the scope of US law (I won't get into all the details - for a good discussion of the case see the Patently-O: Patent Law Blog: Microsoft v. ATT: Unlicensed Export of Patented Software).

To argue this, Microsoft has to claim that the copying the software from a master disk (but not directly onto a computer) is foreign "manufacturing."

I worry about that assertion. Copying of the software from a master to individual disks does not involve a transformation, which what is required to define "manufacturing." The point of transformation is the process of installation on the computer (which transforms the computer and the software into a usable product). In the Microsoft case, the component is never transformed between the time it leaves the US and the time it is installed on the computer abroad. The software can in no way be considered foreign-manufactured by simple copying (no transformation).

I also find the case interesting in what it says about the US patent law. In their brief, Microsoft and the software industry essentially argue that US infringement penalties are so draconian that they would move software "manufacturing" (i.e. code writing and development) offshore rather than expose it to US infringement penalties on foreign sales. I don't know if that is just hyperbola rhetoric. But is it is a damning statement about the current state of patent law.

It may also come back to bite the software industry when they argue for tougher enforcement in other countries. On the one hand, Microsoft (and the software industry) admit infringement in the US but argue that US law should not be enforced abroad. They also seem to say that piracy is allowed. Microsoft and the software industry are defending the right of foreigners to pirate IP (and reverse engineer) in foreign countries (see p. 19 of the petition for writ of certiorari):

In foreign markets, a patentee’s competitor remains free to duplicate or reverse-engineer inventions patented in the United States, or to assemble such inventions from foreign-manufactured component parts.

It may be good legal argument to stress the limit the extraterritoriality of US law. But it runs counter to all public policy in this area, which is based on the assertion that foreign infringement on foreign sales (aka piracy) is bad. Thus Microsoft seems to be arguing that the sale of a computer with a pirated Windows operating system sold in China should be subject to US trade retaliation (trade law under special 301) but its infringement of AT&T’s patent in operating systems sold in Europe should not be subject to US law. Legal technicalities aside, it make no sense.

Interesting. We will see what the Court decides.

One of the underpinnings of any technologically advanced economy is the research infrastructure. That infrastructure is not just physical, but also intangible. One of those intangible pieces is our system of measurement. Accurate measurement is important for any technological innovation. With that in mind, the National Institute of Standards and Technology (NIST) is recently completed An Assessment of the United States Measurement System: Addressing Measurement Barriers to Accelerate Innovation:

The National Institute of Standards and Technology teamed with other organizations to assess the capacity of the nation’s scientific and technical measurement infrastructure – the U.S. Measurement System, or USMS -- to sustain U.S. innovation at a world-leading pace.

The USMS is the complex network of organizations that develop, supply, use, and ensure the validity of measurements. This system spans from university laboratories to commercial testing services and from manufacturers and service providers to regulators and standards bodies.

Involving more than 1,000 people in industry, academia, and government, the assessment included a survey of 11 industrial sectors and technology areas. This yielded more than 700 measurement-related challenges facing U.S. industry today or impeding its progress toward the technologies of tomorrow.

You may not think that this is a real problem, but it is. As the NIST report points out, "software errors due to ineffective testing cost the U.S. economy $60 billion annually." Likewise:

The United States spends more than $100 billion per year on measurements in health care, incurring
increased costs due to errors in measurement. For example, in a cancer screening trial participants
spent an extra $1,000 a year in medical expenses due to false-positive results.

The next steps will be to work with companies and universities to address those issues. Some of this work can be done as part of NIST's ongoing mission. Other government agencies and laboratories will need to be involved in other parts. Still other areas may require more action by academia and/or the private sector.

However it is done, this is a great example of public policy adjusting to the shifting nature of the economy. The I-Cubed Economy is very different from the old Industrial Age - and we need new measurements to better understand the differences. I applaud NIST For leading the way. Now, let's see if they get the resources to do the job.

The consulting firm Doblin has come up with a list of The Greatest Innovations of All Time:
1. Weapons
2. Mathematics and the number zero
3. Money
4. Printing
5. Free markets and capital markets
6. Domesticated animals and agriculture
7. Property ownership
8. Limited liability
9. Participatory democracy
10. Anesthetics and surgery
11. Vaccines and antibiotics
12. Semiconductors
13. The Internet
14. Genetic sequencing
15. Containerized shipping

Personally I think they missed some - including language. But it is an interesting idea.

It is especially an interesting idea because many of the innovations are essentially intangibles - not technologies. For example, mathematics, free markets, ownership, limited liability, democracy are all intangible social inventions. Money has a physical manifestation - but it is essentially an idea.

So, lesson for today: when you think about innovation and national innovation policy, think about the full range of innovations (not just the next gizmo).

This is Entrepreneurship Week - and a host of studies are out.

Yesterday, the Kaufman Foundation held a Public Policy Forum on U.S Entrepreneurship and Innovation at which they discussed their latest paper: On the Road to an Entrepreneurial Economy: A Research and Policy Guide.

As I said at the meeting, the paper is a refreshing look at the state of entrepreneurial policy - refreshing in that it attempts to break from what I call the same-old, same-old mentality that permeates our policy debates. The paper rationally discusses the problems with university technology transfer, with the patent system and with corporate governance (among other topics). It may be refreshing because the authors actually talked to entrepreneurs - who pared down a large volume to those areas that entrepreneurs believed were really important. By the way, Kauffman is encouraging comments at the report’s webpage.

Also of note is the Council on Competitiveness’' new report - Where American Stands: Entrepreneurship:

Building on the findings of its flagship Competitiveness Index, the Council on Competitiveness is releasing the first in a new series of reports on the high-impact drivers of U.S. innovation capacity and prosperity. Where America Stands: Entrepreneurship focuses on one of the most critical advantages for U.S. competitiveness. While U.S. entrepreneurial performance continues to lead the world by almost any measure, this report shows that other nations are catching up to the United States. The report also highlights that the U.S. environment for entrepreneurial activity faces its own challenges and opportunities in the 21st century.

Entrepreneurship Week runs through Friday with events all across the nation. For activities in your area, check their website.

From BusinessWeek - India's Designs on Innovation:

In India, design has never been a part of the business lexicon. Now, New Delhi wants to change that. This month, 40 years after setting up the National Institute of Design in Ahmedabad in the western state of Gujarat, the Indian government finally ratified a design policy to make the discipline a national priority.

To achieve this, the new policy envisages a "platform for creative design development, design promotion and partnerships across many sectors, states, and regions for integrating design with traditional and technological resources."

Not only has the NID been deemed a university, the government wants to set up four more NIDs and make design a part of the curriculum in engineering and other educational pursuits. Finer details are still scarce, but with education as the key issue, it will bank on public-private partnerships to foster design.

So far, India has only a dozen design programs, compared with 241 in China. There are 300 design colleges in Korea, in contrast to India's 10. While China churns out 30,000 design students annually, India produces just one-third of that number. And while Asia is increasingly becoming the hotbed of design, India is nowhere on the scene.

And where is the US national policy making design a priority for the American economy?

The New York Times is reporting the following “good news.”
Trade Deficit Peaks and Declines, but It Remains Huge - New York Times:

After years of deterioration, the United States trade deficit appears to have finally peaked and started to decline.

To be sure, the government reported this week that for all of 2006 the trade deficit in goods rose 7 percent, to a record $818 billion. But as a percentage of gross domestic product, the figure was virtually unchanged at 6.2 percent.

A sign of improvement is that exports of United States goods were up 14.5 percent in 2006, while imports rose 10.9 percent. It was the first time since 1997 that exports rose more rapidly than imports, and it was the biggest rise in exports since 1988.

However, if you look closely at the charts there is little to be optimistic about. Many have latched on to the fact that petroleum is a large part of the deficit. But as the chart shows, 2/3 of the deficit is non-petroleum. So even if we were completely in balance on oil, we would still be running about a $45 to $50 billion deficit every month -- roughly 4% of GDP. Likewise China. If we had a balance with China, our goods trade deficit would still be $600 billion.

Trade theorists tell us it is wrong to focus on any one bilateral deficit - such as US-China. The way multilateral trade works, we are told, is a deficit with one country can be made up with a surplus in our trade with another. But, there is no region of the world with whom we are running a surplus -- and very few countries.

Likewise, we are told that currency changes work. But look at our trade with the Euro zone (after a decline in the dollar versus the euro -- see Trade Deficit Stubbornly Defies the Dollar’s Slide - New York Times). With that decline, our deficit has stabilized at $91 billion. We had to have a major decline in the dollar just to stop the acceleration of the deficit. How much further does it have to decline in order to get back to balance?

Nor will our intangibles and services trade help very much. Our services trade surplus is about a tenth of the total deficit (even though services make up about a quarter of our exports).

I would like to remain optimistic about our international economic position. Any improvement in the deficit is good - and any sign of hope should be celebrated. But we also need to be realistic. These are marginal changes at best.

There are massive structural shifts going on that we are still trying to understand. As a consequence, we are altering our perceptions of the world to fit the disconcerting facts. The old theory of self-correcting markets through exchange rates has given way to the new theory that deficits are sustainable. Thus, the debate is between those who think the problem will go away versus those who say we just need to fix the exchange rate problem, especially with China. Neither of these theories is helpful. We need a new theory of international economics in the I-Cubed Economy.

Anyone out there have any ideas?

And from Marc Gobé - Why Advertisers Still Don't Get It - on the BusinessWeek Innovation blog:

It's the Product, Stupid

Understanding what the consumers want and bringing solutions that will inspire them is the most powerful way to support any business strategy. Putting consumers and the product at the center of the equation is fundamental to a brand's success. Design then becomes the message and the advertising, as it's proof of a company's commitment to people and to innovation.

A relevant and well-designed product will make its way into the world, will be spun across the blogosphere, will be sought after and endorsed in the most emotional fashion as a reward. Indeed, advertising needs brands more than the brands need advertising. When the commercial becomes more popular than the product, you really have a problem—not least that it doesn't serve your brand long-term.

In Apple's strategy, the product is the message and the only topic of the conversation. Similarly, the new Target drug packaging is the most talked about idea in the retail world at the moment, while Absolut Vodka is its own super-model. You buy a BMW because it's a great experience. You wear Crocs because they make your feet happy, and you relish the culturally colorful American Apparel brand—the approach is valid for small and big companies.

Sounds right to me.

From Seth's Blog: Sheepwalking

I define "sheepwalking" as the outcome of hiring people who have been raised to be obedient and giving them a braindead job and enough fear to keep them in line.

You've probably encountered someone who is sheepwalking.

The TSA 'screener' who forces a mom to drink from a bottle of breast milk because any other action is not in the manual. A 'customer service' rep who will happily reread a company policy six or seven times but never stop to actually consider what the policy means. A marketing executive who buys millions of dollars of TV time even though she knows it's not working--she does it because her boss told her to.

It's ironic but not surprising that in our age of increased reliance on new ideas, rapid change and innovation, sheepwalking is actually on the rise. That's because we can no longer rely on machines to do the brain-dead stuff.

We've mechanized what we could mechanize. What's left is to cost-reduce the manual labor that must be done by a human. So we write manuals and race to the bottom in our search for the cheapest possible labor. And it's not surprising that when we go to hire that labor, we search for people who have already been trained to be sheepish.

Interesting, but I think not inevitable. Sheepwalking is the end point of the Taylorist/Fordist era of "scientific management" where people are treated as parts of the machine. Others (managers, engineers, etc.) do the thinking for them.

But in the I-Cubed Economy, it is more and more important that the innovative and creative resources of workers are utilized. We used to call these "high-performance workplaces" (see my piece "Time to Get Serious About Workplace Change").

I also disagree that "we can no longer rely on machine to do the brain dead work." As Frank Levy has pointed out, if the job can be described in enough detail to be written down in a manual (a true brain-dead job), then it can either be automated or transferred offshore. Whether a company has brain dead jobs depends on how the workplace is designed. A well design workplace turns brain-dead in to brain-rich activities.

As I've argued before, the I-Cubed Economy is very different from the industrial economy's never ending quest for standardization and optimization of routine activities. Those companies who rely on sheepwalking will not survive. Nor should they.

However, we can not simply let the market take its course. The costs are too high and the outcome uncertain. We could just as easily end up in a race to the bottom as a journey to the peak. The public policy goal should be to help companies make the transition and ease the pain of the inevitable disruption. Expanding and transforming the Manufacturing Extension Partnership program is one example of what could be done. Tax credits for on-the-job worker training (to help keep they competitive rather than wait until they are unemployed) is another.

And there is more, much more. But first we need to get rid of our mind old industrial age mindset of workers as physical cogs in the machine and replace it with the view of workers as creative information contributors. Only then can we avoid sheepwalking.

In an op-ed earlier this month in the Washington Post, Joseph Fuller and Brock Reeve discuss the future of stem cell research (Will We Lose in the Stem Cell Race?). In the piece they contrast the current state of research to the past success in biotech. As part of that discussion of the reasons for that success, they highlight the contradictory role of patents:

Government actions and court decisions allowed the patenting of living organisms and made it possible for private researchers to commercialize discoveries funded by federal grants. Further, Stanford University, which controlled key patents, ensured their widespread and rapid adoption.

On the one hand, proprietary control over ideas as protected by patents was needed to provide commercial incentives. On the other hand, fundamental underlying ideas needed to be shared even if they were already patented. In other words, it was the right balance between proprietary and shared information. Had Stanford not made their patents widely available, the US biotech industry may have floundered. This is a point Fuller and Reeve unintentionally amplify later when they remark, "while Stanford granted 73 nonexclusive licenses in less than a year, WARF has awarded just 13 licenses in eight years under economic terms that many believe have slowed the sector's growth." [The Wisconsin Alumni Research Foundation (WARF) holds the fundamental patents underlying embryonic stem cell research.]

Biotech is not the only example of the need to share information as well as protect it. Radio technology was going nowhere until the government stepped in a created a patent pool (controlled by the newly created Radio Corporation of America - RCA). A patent pool between the Edison and Biograph companies ("the Trust") allowed the motion picture industry to gain a foothold (and ironically helped found Hollywood as independents move from New York to Los Angeles to escape the control of this Trust).

There is an inherent tension between control of information and sharing ideas -- a tension that makes the system work. Neither the "everything should be free" nor the "I own it completely; it's mine" side are completely right or completely wrong. It is a balance.

We need an intellectual property system that understands that balance. Right now, many feel that the system is out of balance. For example, Michael Crichton, in an op-ed in the New York Times - Patenting Life - takes a harder stance on gene patents:

Gene patents are now used to halt research, prevent medical testing and keep vital information from you and your doctor. Gene patents slow the pace of medical advance on deadly diseases. And they raise costs exorbitantly: a test for breast cancer that could be done for $1,000 now costs $3,000.

He would like to see gene patents done away with.

I'm not sure I agree. But I am sure that we need to look at what can and should be protected by patents. We also need to look at mechanisms for patent sharing.

So, it appears that there is a long list of items that should be on our patent reform agenda. I hope Congress is listening.

Hal Varian's latest New York Times column inadvertently hits upon a subject that is near and dear to my heart: how today's competitiveness challenges are different from the 1980's:

Remember when Japanese manufacturing techniques were all the rage? You could hardly read the business press without encountering mention of “lean manufacturing,” “just-in-time inventory systems” and “total quality management.”
You don’t hear much about these ideas anymore, but not because they are no longer in fashion. Quite the reverse is true: the practices have become so widely adopted that they are no longer newsworthy.

In other words, the world has absorbed these ideas and moved on. Those who keep talking about how the Japanese economic challenge was not real are missing the point. The US overcame the competitiveness challenges because we learned how to compete better. And government programs, from Semitech to the Manufacturing Extension Partnership, were part of that process.

But, Varian's subject is not really about the nature of the new competitiveness challenge. He argues that there is one element we can still build upon from that earlier time, especially for online businesses:

It is therefore a paradox that one of the most important drivers of online business success is taken directly from the pages of Japanese management techniques. I am referring to kaizen, the practice of continuous improvement.

Kaizen doesn’t just mean a business should keep trying new things. Rather, it refers to a disciplined process of systematic exploration, controlled experimentation and then painstaking adoption of the new procedures. In the original formulation, kaizen was applied to manufacturing, where experimentation could determine whether a new process resulted in quality improvements or cost savings in a matter of months.

It is much more difficult to apply kaizen to product design, since it can easily take years to design and market a new product. To take a recent example, the iPhone has been two and a half years in the making.

Product development can cost hundreds of millions of dollars, making it almost impossible to run a controlled experiment with a product introduction.

But it is simple to run a controlled experiment with a Web page. Amazon can show a different page layout to every hundredth visitor and determine in a few days whether the new design increases sales.

I have to disagree with Varian as to the application of Kaizen to product development. I think it is done all the time - minor improvements introduced in a quasi-experimental fashion. Likewise, the whole notion of user-driven innovation is very similar to Kaizen.

What we are talking about is really evolutionary innovation - a continuous process of change and adaptation. And speaking of evolutionary innovation, there is a new blog on the subject - Endless Innovation. Call it what you will – evolutionary innovation, continuous innovation, continuous improvement, endless innovation – it is basically the same. Managed change has been come the paramount task and the key to economic growth and competitiveness.

Just like we learned to compete in the 1980s and 90s by absorbing the new ideas of lean, JIT and TQM, we need to learn the new lessons of innovation. Once again, I believe government programs can help – from expanding MEP into an Innovation Extension Partnership, by funding cross-disciplinary design schools and research centers (like we funding engineering and cross-disciplinary research centers) and changing numerous policies that affect intangible assets. The sooner we understand that, the better.

Bruce Nussbaum warns about The Backlash Against Innovation And Design.

Given this headline today - Republican Romney calls for U.S. innovation - Yahoo! News, I'd say innovation is in danger of becoming a cliché. On the other hand, having a Presidential candidate talking about innovation in the American economy is a good thing - see Romney's remarks.

As Nussbaum points out:

The hard work of building an innovation culture is only just beginning in corporations. It will take a generation, just as the quality movement took a generation to build.

The same can be said for policy makers. I hope Romney keeps talking about innovation - even it is a cliché.

From today's Financial Times: US investor group unveils climate blacklist:

A group of US investors with more than $200bn in assets has accused 10 companies, including oil major ExxonMobil, financial services group Wells Fargo and utility TXU, of not doing enough to respond to global warming and climate change, in a sign of increasing shareholder activism on environmental issues.

The publication of the blacklist by Ceres, a coalition of state pension funds, institutional investors and environmental groups, coincided with the filing of shareholder motions at more than 35 companies, demanding action on a number of climate issues.

It also coincides with the opening of Congressional hearings on climate change and energy security.

The ten companies are:
* Banking and financial: Wells Fargo
* Electric power: TXU, Dominion Resources, Allegheny Energy
* Coal: Massey Energy and Consol Energy
* Insurance: ACE
* Oil & Gas: ExxonMobil and ConocoPhillips
* Retail: Bed Bath & Beyond

If reputation is really the strong intangible some claim (see earlier posting), then those 10 companies will be acting fact to get off that list.

The latest research prize has Sir Richard Branson and Al Gore teaming up in the Virgin Earth Challenge. The competition will give $25 million to "whoever can demonstrate to the judges' satisfaction a commercially viable design which results in the removal of anthropogenic, atmospheric greenhouse gases so as to contribute materially to the stability of Earth’s climate."

I'm becoming a big fan of R&D prizes (see earlier postings). As gizmag points out in their article The use of special prizes to fuel global innovation:

Two heads are better than one. Six billion are even better.

Putting 6 billion brains to work is a wonderful vision for the I-Cubed Economy

By the way, last summer, the British Conservative Party proposed the use of prizes to encourage innovation. That is an interesting turnaround from a traditional conservative (small "c") approach which favors the market forces over government incentives.

Our trade situation continues to look bad. The US ran another record trade deficit in 2006 of $763.6 billion, $46.9 billion more than the 2005 deficit of $716.7 billion, according to this morning's BEA trade data. In December the deficit was $61.2 billion-- an increase of $3.1 billion over the $58.1 billion in November.

Unfortunately, our intangibles trade does little to help. The intangibles surplus for the year increased by $7.2 billion to $99.6 billion. But that was a slow down from 2004 and 2005. The monthly increase in December was only $100 million. In December, royalty payments received (exports) grew while outgoing royalty payments (imports) were steady. Imports and exports of business services both grew, but exports outpaced imports. For the year, both exports and imports of royalties and business services all grew by healthy amounts. Total trade in intangibles grew by $42 billion.

While our annual intangibles surplus has more than doubled since 1992, the current rate of growth in export is slightly lower than the growth rate in imports. This means that we can not count on a rapidly growing surplus in intangibles to offset the rest of our trade deficit.

There was good news concerning the deficit in Advanced Technology Products, which declined by $5.5 billion in 2006 to $38.3 billion. In December, the deficit shrank an incredible $2.2 billion to $2.2 billion from $4.4 billion in November. Much of this change was due to a $1.4 billion drop in imports of information and communications technology (ICT) and a $500 million increase in ICT exports. The last monthly surplus in Advanced Technology Products was in June 2002 and the last sustained series of monthly surpluses were in the first half of 2001.

Clearly we need a new trade policy – one that addresses our all parts of our trade: intangibles, consumer goods, capital goods and energy.

Note: we define trade in intangibles as the sum of "royalties and license fees" and "other private services". The BEA/Census Bureau definitions of those categories are as follows:

Royalties and License Fees - Transactions with foreign residents involving intangible assets and proprietary rights, such as the use of patents, techniques, processes, formulas, designs, know-how, trademarks, copyrights, franchises, and manufacturing rights. The term "royalties" generally refers to payments for the utilization of copyrights or trademarks, and the term "license fees" generally refers to payments for the use of patents or industrial processes.

Other Private Services - Transactions with affiliated foreigners, for which no identification by type is available, and of transactions with unaffiliated foreigners. (The term "affiliated" refers to a direct investment relationship, which exists when a U.S. person has ownership or control, directly or indirectly, of 10 percent or more of a foreign business enterprise's voting securities or the equivalent, or when a foreign person has a similar interest in a U.S. enterprise.) Transactions with unaffiliated foreigners consist of education services; financial services (includes commissions and other transactions fees associated with the purchase and sale of securities and noninterest income of banks, and excludes investment income); insurance services; telecommunications services (includes transmission services and value-added services); and business, professional, and technical services. Included in the last group are advertising services; computer and data processing services; database and other information services; research, development, and testing services; management, consulting, and public relations services; legal services; construction, engineering, architectural, and mining services; industrial engineering services; installation, maintenance, and repair of equipment; and other services, including medical services and film and tape rentals.

Friday's Economist had an article on the rise of liquidity of money (A fluid concept). Part of the story dealt with the issue of how the "global willingness to save and lend is running ahead of investment."

Ben Bernanke, chairman of the Fed, has spoken of a savings glut. Then again, the real puzzle could be companies' “investment restraint”, according to Raghuram Rajan, of the University of Chicago's business school (and until recently chief economist at the IMF). Maybe, he suggests, investment is becoming more centred on people and less on physical capital; maybe physical investment is being switched to emerging economies; maybe uncertainty still holds back investment abroad—as it does not, say, investment in property at home.

That tantalizing statement illustrates how the changing nature of the I-Cubed Economy is changing the rules of the economic policy game. Rajan's full statement on the possible cause of underinvestment included this remark:

A second explanation is that the nature of investment may have changed — from hard physical assets like plant and equipment to items like training and research and development that are expensed and not as easily tracked.

In other words, we really don't know the implications for monetary policy of our investments because we don't really know what are our investment levels (and patterns). So, without knowing whether there is a savings glut (since we mis-measure investments in human capital), can we really make solid monetary policy?

I also have to raise an issue with the rest of the Economist quote: "Whatever the cause, a shortage of investment in fixed assets implies a shortage of debt collateralised on them." In part, this view may be based on another Rajan statement:

Indeed, if the "missing" investment is because individuals are investing in acquiring more human capital, then it is not clear that this investment can be as easily securitized. When an employee co-invests by acquiring firm-specific human capital — probably an increasing form of investment as the share of services increases the world over — she acquires a claim on the future revenues of the firm which will be paid out in the form of higher wages. The firm looks more profitable today, and invests less in hard assets, but will have to pay in the future for the soft assets its employees are acquiring. In the meantime, it is harder to create financial claims on these soft assets — how does a lender to an employee repossess specific investment in human capital given that slavery has been abolished?

Therefore, regardless of whether investment in physical assets is unnaturally low, whether it has been naturally displaced by investment in intangible assets, or whether physical goods have become cheaper so that less is spent on them, the point is that there is less in the way of incremental collateralizable assets being produced the world over. The collateral value is even lower if more of the assets are being created in emerging markets that, typically, are less well governed.

This is only partially right. It is very difficult to securitize investments in human capital. However, there is a growing trend to collateralization of intangible assets, such as intellectual property -- the subject of a forthcoming Athena Alliance report. The liquidity of those assets, however, is very different from traditional fixed assets. How that affects the operation of the financial markets remains to be seen.

And the proper measure of the shift to investments in intangibles may work the opposite way. By properly measuring investment in R&D and training, the US national rate of savings is approximately 2 percentage points higher (see earlier posting Underestimating savings).

All of this make policy making based on our old assumptions and models very suspect.

Thomas Palley (In Defense Of Sarbox) adds another reason to be skeptical of all the cries for looser regulation of the financial markets in the name of competitiveness:

The economics of regulation teaches that regulation only matters if it is binding and compels people to change their behavior. It also teaches that because binding regulation compels change, those subject to it oppose it. After all, they preferred doing what they were doing before the regulation was passed. That carries an important political lesson: those subject to binding regulation will want it repealed.

These academic musings have direct relevance to business’s attack on the Sarbanes-Oxley Act (Sarbox) regulating capital markets. The story being told is that Sarbox has raised the cost of doing business in America’s financial markets, thereby undermining America’s competitive position. However, close inspection reveals that there is little foundation for these charges. Instead, they provide a case study of business’s anti-regulation scare tactics.

Palley echoes and amplifies what many have been saying:

Foreign financial markets are catching up in quality of technology and regulatory governance.
With foreign stock markets becoming better, deeper and more liquid, there is less incentive to list in the usual places, including the U.S. Thus, since 2000 London’s main stock market has seen foreign listings decline 23 percent since 2000, the Deutsche Börse is down 58 percent and Tokyo is down 39 percent.
With regard to IPOs, these have fallen in part because comparison is made with 1999 when the market was in the throes of a speculative bubble. When the NASDAQ was at 5,000, firms had an incentive to bring offerings to market as quickly as possible. It also explains why the premium received by foreign companies for listing in U.S. markets has fallen. In 1999 U.S. investors were paying bubble prices, giving foreign companies a premium relative to what they could get in home country markets.

Preserving the competitiveness of US financial markets is a serious concern. But, we should not rush into a major redo (and possibly gutting) of regulations. We need a careful examination of the causes and cures of the problems. Palley and other continue to remind us that this examination is still an open inquiry.

The rhetorical war over publishing federally-funded research is heating up -- see this morning's Washington Post story Research-Result Battle Now Pits PR 'Pit Bull' Against Barbie Blenders. In this battle, I guess I come out on the side of greater access. But I did find especially amusing the suggestion of the publisher's PR guru, Eric Dezenhall. Accord to the Post story:

Dezenhall told publishers to simplify their message with lines such as "the government [is] seeking to nationalize science."

Nationalize science? Does this guy understand that science was nationalized over a hundred years ago with the land grant college? Does he know about all of those promenade researchers and others who are advocating increased federal funding for science (i.e. "nationalizing science")? Maybe he thinks that all of those researchers who publish in those scientific magazines he is advising should give back their federal grants?

Science has been a national government function for a long, long time. To sudden raise the specter of "nationalization" is to reveal a lack of basic understanding. And it serves no constructive purpose. Nor does raising the level of political theatre from the other side (as the Post story describes).

Too bad, because there are some serious issues here over the distribution of federally funded information and the important role of peer-reviewed journals. Unfortunately, it looks like we are well beyond the stage of rational debate. To paraphrase Shakespeare, cry havoc and like slip the dogs of rhetoric.

Some time ago, I posted a piece on how a town in New Hampshire wants to place a value on and tax the view from a house (treating it like any other building amenity that raises value). At that time I said, "The irony of this story is that someone else may be getting a tax benefit for providing Mr. Wilder his (taxable) view. If he owned the land he was looking at, he might have gotten a tax break or some other financial reward for leaving it as it is."

To follow up, here is a story from yesterday's Wall Street Journal about those scenic easements - Tax Break With a View. I support scenic and preservation easements. But the program does raise issues of valuation. As the Journal points out, "the value of the donation for income-tax purposes generally is the difference between the land's unrestricted value and its new value with limited development or usage rights." Determining that new value can be subjective - how much has the value of the land really declined was there any real development potential before hand, etc. In fact, was there any loss at all - if local jurisdictions are now taxing the view?

Just an example of some of the conundrums of valuing intangible assets. Like beauty, value may be in the eye of the beholder.

Is Steve Jobs announcementt that Apple would like to drop DRM the end of copy protection for songs? Daniel Altman (Managing Globalization) thinks so in his blog posting Is copy protection obsolete?. He also takes aim at Jobs logic:

There’s another motivation, though. The restrictions embedded in Apple’s iTunes (and some competitors’ tracks as well) have come under heavy attack by regulators in Europe. Jobs may have seen the offshore forecast and decided that it would be better to create the wave than be sucked into the undertow. Could it work? Well, some artists won’t sell their music to iTunes because of Apple’s restrictions. If Jobs can gain a market-dominating selection of songs to go with his market-dominating iPods, copy protection won’t seem like such a big deal. Right?

I have long argued that the success of iPod has as much to do with legal song availability, in a proprietary mode from iTunes, as with cool design. Altman may be right that the iPod/iTunes connection now has such a commanding lead that they can dominate without the DRM. He could be right.

And even Hungary gets it -- Hungary’s New National Design Center Takes Shape in a Former Bus Terminal

. . . and why don't we.

From Business Week - Innovation and the Prosperity of Nations:

In November 2005 the UK Treasury published the Cox Review of Creativity in Business, addressing “a question that is vital to the UK’s long-term economic success—namely, how to exploit the nation’s creative skills more fully” where the “emphasis is on the use made of creative skills by smaller businesses, with particular concern for manufacturing.”

This December the UK Design Council, of which report author Sir George Cox is Chairman, convened the Competitiveness Summit ’06 in London to brief people on progress with implementation of the report’s recommendations and ‘build momentum’ around it. Specifically the Summit was intended to showcase the role of creativity and design in UK competitiveness, discuss how they may be further embedded, and examine future trends; consider threats and opportunities from abroad; and examine the role of education and its relationship to industry.

Yesterday, the Educational Testing Service let loose a broadside on our economic future called America's Perfect Storm. The report highlights

the convergence of three powerful sociological and economical forces that are changing our nation's future:
* substantial disparities in skill levels (reading and math)
* seismic economic changes (widening wage gaps)
* sweeping demographic shifts (less education, lower skills)
There is little chance that economic opportunities will improve among key segments of our population if we follow our current path. To date, educational reform has not been sufficient to solve the problem. National test results show no evidence of improvement over the last 20 years. Scores are flat and achievement gaps persist. Hope for a better life — with decent jobs and livable wages — will vanish unless we act now.

We must raise our learning levels, increase our reading and math skills and narrow the existing achievement gaps, or these forces will turn the American Dream into an American Tragedy — putting our nation at risk.

What bothers me most about the report is the projected decline in literacy. As the Christian Science Monitor reported:

"There is no time that I can tell you in the last hundred years" where literacy and numeracy have declined, says Andrew Sum, director of the Center for Labor Market Studies at Northeastern University in Boston and one of the report's authors. "But if you don't change outcomes for a wide variety of groups, this is the future we face."

In other words, we are in danger of slipping backwards, not just failing to stay ahead.

I don't know if the report's conclusions are correct. But it is one more call for reforming our educational system -- a call that we have needed to heed for a long time.

Speaking of taxes on patents (see yesterday's posting), how about patents on tax strategies. Yes, the PTO has issued patents on tax shelters and the Subcommittee on Select Revenue Measures of the House Ways and Means Committee even held hearings on the patenting of tax advice last summer. Among the issues raised in the hearings were the scope of business process patents (which these computer--implemented tax strategies are a subset) and whether you can patent something that may be illegal. On the later point, the PTO has pointed out that a patent does not speak to the legality of the activity and the IRS has been very strong in stating that just because the process tax strategy has a patent, it may not necessarily be legal.

More telling is the discussion of business method patents. At the hearing, witnesses spoke against the idea of patenting tax strategies for a number of reasons, including that it would complicate general tax planning for fear of infringement on a patented technique and (as Professor Ellen Aprill put it) "whether the government monopoly granted to a patent holder is fundamentally inconsistent with the policies underlying our tax system."

In an op-ed last fall, the New York Times (Pay to Obey) raised a similar concern:

The broken American patent system has a knack for sanctioning the ridiculous. In the latest example, businesses are receiving patents for devising ways to obey the law — the tax code, to be more specific. What’s next, a patented murder defense?

The op-ed is a little over the top. But the concern over the scope of patentability is valid. Even those who defended tax patents admit that "while the issues surrounding patenting tax strategies are significant, the focus should be on the fundamental utility/novelty/nonobviousness requirements that have historically guided our patent system in receiving 'new technologies.' ” (see comments by Stephen T. Schreiner and George Y. Wang).

As far as I can tell, nothing ever came of the House hearings. The New York Times coverage a few month later produced some discussion, but little else. And the question of business process patents was not front and center in last year's debate over patent reform. As Congress once again takes up the issue maybe it is time to take a new look at the question of business process patents.

The Budget of the United States Government, as released today, does not contain a detailed or complete analysis of what we invest in intangibles assets. But it does contain a rudimentary analysis as part of the federal investment chapter (Chapter 6) of the Analytical Perspectives volume. The analysis includes investments in physical capital, R&D and education and training. Education and training expenditures include aid for higher education through student financial assistance, loan subsidies, the veterans GI bill, and health training programs, education programs for the disadvantaged and individuals with disabilities, training programs in the Department of Labor, and Head Start.

Taking out physical capital gives us a very rough estimate of the intangibles investment. As the chart below shows, our investments in intangibles peaking in 2006 in real terms. Real dollar investments in R&D and education and training grew slightly between 1968 and 2001 and then jumped dramatically. Estimated levels for 2007 and proposed levels for 2008 drop, mostly due to a sharp decline in investments in education and training, again in constant dollars. According to the budget documents, "the decline in spending from 2006 to 2007 reflects a significant decrease in estimates of Federal subsidies due to reduced student loan consolidation activity." Much of the increase in R&D was due to a steady rise in defense spending, although non-defense R&D also jumped significantly after 2001 to a new stable level.

Sunday's New York Times had an interesting story on how the Netherlands is becoming a tax haven for intangibles: The Netherlands, the New Tax Shelter Hot Spot:

But for earnings derived from intellectual property such as royalties, the Netherlands has become a tax shelter of choice. With celebrities lending their names and images to clothing lines, licensing their hit songs to corporate sponsors, seeking roles in Hollywood and engaging in other ventures that generate significant taxable income, the Dutch system, which does not tax royalties, offers a nifty shelter.

As they flock to Amsterdam, celebrities are taking a leaf out of the playbook of major corporations that also use Dutch tax shelters to help reduce or eliminate the royalty taxes on patents, another form of intellectual property.

Interestingly, there is a catch, at least when it comes to Americans:

Not everyone has access to Dutch shelters. Dutch tax benefits are typically available only to artists who are not citizens of the United States. While the Netherlands does not tax royalties going in or out of a Dutch company, the Treasury Department in the United States typically levies its standard corporate income tax rate of 35 percent on royalties coming into America from a Dutch entity.

Dutch holding companies set up to protect royalties often work in tandem with offshore Caribbean companies, shuffling money around to escape taxes, analysts say. For example, part of the Rolling Stones’ Dutch-run assets are funneled through the Netherlands Antilles, a Dutch protectorate and a classic Caribbean tax haven, according to company registration documents.

15 months ago, the Wall Street Journal ran a similar story about Ireland -- Irish Subsidiary Lets Microsoft Slash Taxes in U.S. and Europe:

Giant U.S. companies whose products are heavily based on their innovations, such as technology and pharmaceutical firms, increasingly are setting up units in Ireland that route intellectual property and its financial fruits to the low-tax haven -- at the expense of the U.S. Treasury.

The movement of intellectual property to Ireland has been good for the Irish economy. According to the Irish business information website, FinFacts Ireland, the lower tax rate on patent income has raised revenues that Ireland would not have raised:

Up to half of Irish corporate tax receipts may relate to taxes paid on profits transferred from other overseas units of US corporations, to its Irish subsidiaries.
In effect, the Irish tax exemption on patent income, could well fund over 5% of the Irish Government's planned total spending (current and capital) of €48.5 billion, in 2006.

The Irish would surely dispute that they are a tax shelter for IP. Rather, they see it as a tax incentive to locate R&D in Ireland. As the law firm of A&L Goodbody points out in their description, The Irish Patent Exemption:

The basic requirements for the patent exemption have always been that the work which went into developing and having a patent registered must have been carried out in Ireland, other than work which is ancillary to the main work carried out in Ireland. For a person or company to enjoy the exemption, that individual or company must be resident in Ireland for tax purposes. It is important to note that the patent itself does not need to an Irish registered patent. The determining factor for the grant of the relief is that the work in developing the patent is carried out in Ireland.

But, as the Wall Street Journal pointed out, there are ways to game the system:

A common device is to take successful, patented American ideas and then develop new generations of them -- with help from an offshore research division. The ownership of the new version (and profits on licensing it) can then legally be shared between the U.S. parent company and the offshore unit.

Suppose a U.S. company develops a new, easy-to-use computerized day planner, and it's a global hit. All the royalties must go to the U.S., where it was invented, and be taxed at the U.S. corporate income tax rate of 35%. But if the company builds a new and improved version, adding features created partly by its offshore R&D team, the intellectual property rights of day planner 2.0 can be shared between the U.S. and the foreign unit -- as can the profits. Day planner 1.0, of course, disappears.

U.S. law explicitly permits this practice. The controversy comes in valuing the contribution made by the offshore unit. Did it pay a fair share of the development cost? And did it pony up a reasonable price to the parent company to be able to share the rights to the original invention, a price an arm's-length party would pay?

U.S. companies seek to meet the test by creating "cost sharing arrangements" between them and the foreign unit. "R&D cost-sharing agreements within corporate structures can minimize the tax payable in the parent country," notes Ireland's government in a development paper.

In the I-Cubed Economy, we need to look carefully at factors that determine the creation and location of intangible assets. Intangible assets are both very localized (local tacit knowledge) and very foot-loose (IPR). Those that are foot-loose with flee to the most advantageous location. Every once and awhile there is a flurry of activity about offshore tax havens and the entire issue of international taxation of corporations. Maybe it is time for one of those flurries to re-examine the laws and regulations relating to the transfer and taxation of intangibles.

According to a recent Wall Street Journal story - How Boss's Deeds Buff A Firm's Reputation, Microsoft is the most respected company, with Johnson & Johnson coming in second. But it is not clear that the ranking is due to how people feel about the company's products or how they feel about other factors:

Even though it slipped to second place, Johnson & Johnson scored very highly and still benefited heavily from the emotional connection many consumers, particularly women, feel with the company after using its powder, shampoo and other products on their babies. That baby halo continues to protect J&J from negative perceptions of the pharmaceutical industry regarding the safety and price of drugs.

But it is clearly Microsoft's year, as Mr. Gates demonstrates how much the reputation of a corporate leader can rub off on his company. Formerly chief executive officer and now chairman of Microsoft, he contributed to a marked improvement in the company's emotional appeal. Jeanie Cummins, a survey respondent and homemaker in Olive Hill, Ky., says Mr. Gates's philanthropy made her a much bigger fan of Microsoft. "He showed he cared more for people than all the money he made building Microsoft from the ground up," she says. "I wish all the other big shots could do something like this."

This is where brand management gets very squishy. Are people going to run out and buy Microsoft's new Vista because they like how Bill Gates is giving away his billions? Probably not. On the other hand, people will probably continue to buy Johnson's baby powder because of an emotional attachment to the product.

It is important to understand which intangibles motivate consumer behavior. Liking a product is much more powerful than a general "feel good" approach toward a company. And while the "feel good" factor helps give a company a buffer during times of bad news, ultimately how people feel about the product will be determinate. Such is the real power of brands and reputation.

Don Tapscott and Anthony D. Williams tell a wonderful story about prizes and open source research in Innovation in the Age of Mass Collaboration on the Business Week website:

A few years back, Toronto-based gold mining company Goldcorp (GG) was in trouble. Besieged by strikes, lingering debts, and an exceedingly high cost of production, the company had terminated mining operations. Conditions in the marketplace were hardly favorable. The gold market was contracting, and most analysts assumed that the company's fifty-year old mine in Red Lake, Ontario, was dying. Without evidence of substantial new gold deposits, Goldcorp was likely to fold.

Chief Executive Officer Rob McEwen needed a miracle. Frustrated that his in-house geologists couldn't reliably estimate the value and location of the gold on his property, McEwen did something unheard of in his industry: He published his geological data on the Web for all to see and challenged the world to do the prospecting. The "Goldcorp Challenge" made a total of $575,000 in prize money available to participants who submitted the best methods and estimates.

Every scrap of information (some 400 megabytes worth) about the 55,000 acre property was revealed on Goldcorp's Web site. News of the contest spread quickly around the Internet and more than 1,000 virtual prospectors from 50 countries got busy crunching the data.

. . .

The contestants identified 110 targets on the Red Lake property, more than 80% of which yielded substantial quantities of gold. In fact, since the challenge was initiated, an astounding 8 million ounces of gold have been found—worth well over $3 billion. Not a bad return on a half million dollar investment.

The lesson they draw from this, and other examples is stark: the old concept of hoarding your information is dead. The new corporation is about peer-production:

A new breed of 21st-century enterprise is emerging—one that opens its doors to the world; co-innovates with everyone, especially customers; shares resources that were previously closely guarded; harnesses the power of mass collaboration; and behaves not as a multi-national, but as something new: a truly global business. These new modus operandi revolve around four powerful new ideas: openness, "peering," sharing, and acting globally.

And so what are the public policies needed to foster (and regulate) this new breed? That is what we need to discover.