May 2009 Archives

Is weak copyright good copyright?

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A couple of months ago, I was at the NBER Innovation Policy and the Economy seminar. One of the presentations was by Felix Oberholzer-Gee on copyright. His paper, File-Sharing and Copyright, co-authored with Koleman Strumpf, is now available. The paper attempts to answer the question of whether reduced copyright protection (in the form of free filing sharing) has reduced production. To answer this, they set up a series of questions.

First, does file-sharing reduce the sale of copyrighted materials? There have been a number of studies apparently both ways on this question. But the authors answer is, after comparing the data across the studies and examining the methodologies, that file sharing is unrelated to changes in sales.

Second, how important are complementary sources of income, such as concerts? I've noted in earlier postings that to survive the business model in music must shift toward live performances as the major source of income. It looks like that is happening. Artists are touring more now and concert ticket prices have risen faster than inflation. Therefore "income from the sale of complements can more than compensate artists for any harm that file sharing might do to their primary activity." For example, Paul McCartney earned an estimated $65 million from concerts in 2002 and only $4.4 million from recordings and publishing. For The Rolling Stones, the figures were $40 million from concerts and around $3 million from recordings and publishing. With only a couple of rare exceptions, the top 35 earners in 2002 all made more from concerts than recordings and publishing.

Finally, does file-sharing undermine artistic production? Apparently not. They cite figures which show the number of music albums created more than doubled between 2000 and 2007. "Even if file sharing were the reason that sales have fallen, the new technology does not appear to have exacted a toll on the quantity of music produced." Their conclusion is that "this makes it difficult to argue that weaker copyright protection has had a negative impact on artists' incentives to be creative."

As one would expect, the discussion at the meeting provoked a strong defense of strong copyright. One questioner took issue with the Paul McCartney example - stating that he had become wealthy because of the ownership of the rights to his songs, like Yesterday. Thus, they complained that weaker copyright would prevent new bands from following in the Beatles footsteps - young musician would not be able to make a living with music, as the Beatles did in the beginning by playing in clubs in Hamburg.

This response underscores the emotional attachment to the issue - in disregard of both the data presented and other facts. For example, in the McCartney case, he does not own the rights to his own songs - like Yesterday. He has invested in the right to many songs. But Michael Jackson bought the Beatles portfolio years ago. Thus his income from much of the music portfolio McCartney owns comes from his role as an investor, not as a creator.

The reference to the Beatles day's in Hamburg was especially amusing and completely off target. It displayed a complete lack of understanding on the music business and of what the paper presented. In fact, it makes the author's point: most musicians when they are starting out make their money by playing live gigs, not through recordings. The Beatles were able to get started by playing live clubs (Hamburg and Liverpool) - not because they had any royalty income from songs, which in some cases they haven't even written yet. In fact, the Beatles early live gigs were comprised other people's song as well as some of their own material. Without these "cover" these songs, the Beatles would not have had enough material to play at the clubs and refine their talent. So, in fact, it can be said that the early Beatles - like every other start up band - only survive on other people's music.

I highlight this one response to make a point. Oberholzer-Gee is trying to pull off a very difficult task: to change the terms of the debate. Rather than focus on copyright as fixed property, he is looking at it as a mechanism to increase consumer choice by stimulating artistic production. And he has come up with a conclusion in the music case, at least, that does not fit with those who argue for ever stricter protection.

Such a conclusion might not hold for all areas of copyright. For example, few authors can make a living through live performances, unlike musicians. And we all understand the problem facing the news business in generating enough revenue to paying people for content.

Nonetheless, I wish Professor Oberholzer-Gee luck in trying to re-frame the debate. After all, he is simply trying to return the copyright (and patent) debate to its original purpose, as expressed in Article I, section 8 of the Constitution: "To promote the Progress of Science and useful Arts."

(For more of Professor Oberholzer-Gee papers see his website.)

Future economic growth

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Yesterday, the head of the CBO, Doug Elmendorf, testifed on state of the economy. That assessment was generally somber

In the Congressional Budget Office's (CBO's) judgment, the economy will stop contracting and resume growing during the second half of this year, but the hardships caused by the recession will persist for some time. The growth in output later this year and next year is likely to be sufficiently weak that the unemployment rate will probably continue to rise into the second half of next year and peak above 10 percent. Economic growth over time will ultimately bring the unemployment rate back down to the neighborhood of 5 percent seen before this downturn began, but that process is likely to take several years.

As the Wall Street Journal noted:

The CBO's most recent forecast shows that the economy's output gap -- the difference between its actual and potential output -- will average 7% of gross domestic product (about $1 trillion) this year and next year. And that output gap will not close until 2013.

The concept of an output gap is a standard macroeconomic notion. It is how fast the economy can grow, given a certain level of increased capital and labor inputs (more machines & more people) and increased productivity (working smarter). In an earlier posting last November I discussed the fact that an underlying premise of the Obama economic stimulus package was transformation. Given that, I'm not sure what the longer term potential economic output really is. Rather than highlight the gap, let's focus on the actual output levels - and think more about what a transformed economy means in terms raising that actual level of output.

Not yet bottom

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The Conference Board announced today that its Index of Leading Economic Indicators (LEI) rose in April for the first time in many many many months (the LEI peaked in July 2007). However, the Index of Coincident Economic Indicators (CEI) continued down. The CEI is one of the best monthly gauges of how the economy is doing.

So, we haven't hit bottom yet. But it may be in sight.

Good financial innovation

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In this time of financial melt down and lock up, it is only natural to think of the bad side of financial innovation. We are so concerned with the downside right now that policy makers are seriously considering a financial consumer product safety organization (see my earlier posting and a recent story in the Washington Post).

But Melinda Gates, writing in Newsweek - Helping the Poor Save Money, highlights some good financial innovation:

The success of microloans has opened new opportunities for many poor people and has been a crucial factor in reducing poverty. But loans are not enough. Savings accounts could help people in the developing world weather unexpected events, accumulate money to invest in education, increase their productivity and income, and build their financial security. Fortunately, this is a moment of opportunity. Innovation and new policy ideas are uniting in ways that will lower the cost of savings and bring safe financial services to the doorsteps of the poor.
She goes on to specifically cite agent banking and mobile phone cash-transfer services.

We need to keep this in mind as we think about innovation -- of all kinds. Remember, innovation is neither good nor bad - nor is it neutral.

Buying the brand - not the concept

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I've posted a number of entries calling on someone to buy the Saturn franchise as part of a deal to save GM. It looks like that may occur -- but in a manner that undercuts the brands strongest intangible assets. According to a story in today's Washington Post, A Foreign Buyer Could Put Saturn's Image Into Orbit:

A few potential buyers are considering tapping Saturn's strong dealer network to distribute vehicles made by foreign manufacturers into the United States. Such a move would transform a brand that was designed to reinvent how Americans built and sold cars.

This is apparently based on the analysis that the dealer network is Saturn's most important intangible asset. However, that analysis overlooks the tight interconnection between intangible assets. As the Post story goes on to note:

Thomas A. Kochan, an MIT professor who wrote a book about Saturn, said a foreign partnership faces tall hurdles.

"They're kidding themselves if they think dealers themselves can sustain the brand," he said. "This was a tightly integrated model. People related to Saturn because of the aura of the company as an American company."

. . .

For a while Saturn successfully competed with Japanese rivals. Thanks to its unique dealer arrangement, it introduced "no haggle, no hassle" car buying, in which people paid the posted sticker price.

The company prided itself on a collaborative culture, where dealers and workers regularly gave input into the products. The union relaxed work rules that had pigeonholed workers into one kind of job. Instead of pensions, employees got 401(k)s. Raises were based on performance, not negotiations.

"The sad part is that they didn't learn very much from it," Kochan said. "They didn't stay committed to the organization once initial champions retired."
That lack of commitment is what helped turn Saturn from a pioneer in reviving American competitiveness to just another brand (and one that everyone is telling GM to ditch).

The new buyers need to understand that Saturn will only survive as a complete concept. Unless the package is revived, the enterprise will simply continue its downward slide. As my friend Nir Kossovsky likes to say, "intangibles are like the stones of a Roman arch where the loss of any one stone could cause catastrophic collapse."

Unfortunately, it looks like the potential buyers are attempting to buy a couple of the stones - and are running the risk of collapsing what is left of the arch. Isn't there any body out there interested in rebuilding the structure?

Asking the right economic questions

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Yesterday, the Senate Commerce Committee held a hearing several nominations. The transportation folks were focused on J. Randolph Babbitt, nominated to be FAA Administrator and John Porcari, nominated to be DOT Deputy Secretary. Techies wanted to hear from Aneesh Chopra, nominated to be Chief Technology Officer and Associate Director for Technology at OSTP and Larry Strickling, nominated to head NTIA. But also in that mix was Rebecca Blank to be Commerce Under Secretary for Economic Affairs. This is an important and often overlooked position - one that is critical to our innovation and intangibles agenda. The previous Under Secretary, Cynthia Glassman, was instrumental in pushing for better understanding of intangibles (see her remarks at our December 2007 conference).

Thus, it is important that the Under Secretary ask the right questions. In her testimony before the Committee, Dr. Blank got it right:

Particularly in the current economic environment, as we deal with the worst recession in the past 60 years, good economic analysis is in high demand. I look forward to taking on some questions that are particularly relevant to the Department of Commerce and its interests; questions such as "How is the current recession leading to restructuring in manufacturing industries in the U.S. and abroad and what are the implications for jobs, productivity, and profits among U.S. manufacturers?" "Is the U.S. as competitive as it should be? Which industries are leading in productivity, innovation, and competitiveness in the U.S., as we come out of the current recession?" or "What would rapid growth in environmentally-focused products mean in terms of industry and job expansion?"

That sounds like a good start. As the head of our economics statistical system, I hope she continues the work of her predecessor - with the focus innovation and intangibles.

Building intangibles - block at a time

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Mary Adams has a great presentation that shows the interrelations between various types of intangible assets (human capital, structural capital, relationship capital) and how it can be build block at a time. Check it out:

Obama's get it - the importance of the arts

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About a year and a half ago, I praised then-Presidential candidate Mike Huckabee for making the case that arts and music instruction was just as important for creativity and economic competitiveness as math and science. While I did not support his candidacy, I thought he was on the right track on this one.

Now comes a comment regarding my candidate in that race, who, by the way, won. First Lady Michelle Obama was in New York yesterday to promote the arts. According to today's New York Times, she made the following remark:

"My husband and I believe strongly that arts education is essential for building innovative thinkers who will be our nation's leaders of tomorrow," said Mrs. Obama, who introduced a performance by a multiracial cast of young dancers.

For me, that emphasis on the link between innovation/creativity and the arts is one of the most important - and most overlooked - factors. Yes, art for art's sake is good. Arts help define what it means to be human -- and raise the level of our collective humanity.

But there is also a hard nosed economic bottom line to the arts. In most cases, arts advocates try to make this case in terms of the economic contribution of the arts. The arts are big business - as study after study have shown. As a report from the National Governors Association (NGA) Arts & the Economy: Using Arts and Culture to Stimulate State Economic Development explains:

Arts and culture-related industries, also known as "creative industries," provide direct economic benefits to states and communities: They create jobs, attract investments, generate tax revenues, and stimulate local economies through tourism and consumer purchases.

But that is an incomplete case. As the very next sentence in that NGA report states:

These industries also provide an array of other benefits, such as infusing other industries with creative insight for their products and services and preparing workers to participate in the contemporary workforce.

Just as math is a foundational skill, so are the arts. As Huckabee was quoted as saying in my earlier posting, "If you don't stimulate both sides of a human's brain, you're simply generating half the capacity."

Last November, the British Arts and Humanities Research Council and their National Endowment for Science, Technology and the Arts (NESTA) put out a report on Arts and Humanities Research and Innovation. That report took a unique (and somewhat radical) view of innovation:

Traditional understandings of innovation emphasise the importance of science and technology research. In contrast, this paper investigates the role that arts and humanities research plays in the innovation system.

Just as research is the keystone to science and technology, so should it be for arts and humanities. We often label this activity "scholarship" rather than "research." Yet, as the NESTA report points out, it should be viewed in the same light:

As shown in this paper, the arts and humanities make vital contributions to the innovation system, even though some arts and humanities researchers may not perceive themselves as part of this system, and may resent attempts to assess the relevance of their work in this way.
. . .
Arts and humanities researchers have often taken a robustly independent line in this area, and there is generally less of a tradition of societal problem-orientation than found in other disciplines. Yet we have seen how the arts and humanities already offer new and innovative approaches that can have profound effects on society. The arts and humanities have the critical and analytical capacity to challenge assumptions
and ways of working, while providing a sense of the historical context, traditions and cultural setting in which society and the economy function.

This is a line of think we need to pursue in this country as well. Maybe the First Lady's comments will help lead us in that direction.

BEA budget includes innovation measures

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The Administration's FY 2010 budget proposal includes funding for work on including innovation data in the GDP. For more on this see the Athena Alliance report Frameworks for Measuring Innovation: Initial Approaches, the STPI background paper Measuring Innovation and Intangibles: A Business Perspective and the BEA article "Toward Better Measurement of Innovation and Intangibles."

From the BEA's Congressional Justification briefing:

GDP Innovation Account

Background: All countries acknowledge that business investment in tangible assets as a major contributor to economic activity. In the U.S., they are thought by experts to be fully equal to investment in intangible assets. No country has yet included a comprehensive estimate of business investment in intangible assets in the GDP, yet such investments are increasingly the drivers of economic growth. BEA will expand its 2009 R&D initiative with this broader innovation account, resulting from the Secretary's Advisory Committee on Measuring Innovation in the 21st Century. Building on its work with the National Science Foundation (NSF) measuring R&D, BEA will develop estimates of investments in innovative activities. Working with NSF, BEA produced the first U.S. R&D account in 2006 and is prepared to develop that further with this initiative.

As BEA confronts the challenges of measuring a dynamic and ever-changing economy, there are gaps in the economic statistics BEA produces that must be filled. To more effectively and comprehensively measure the 21st century economy, BEA must build on its development of the R&D satellite account and significantly improve its measures of broader innovative economic activities. Investments in innovation, or knowledge-based activities, are thought to be important engines of economic growth. Yet very little is understood about their role in the economy. Much of the growth that the U.S. economy has experienced in the last ten years is not captured by traditional economic measures--many economists believe that as much as 40 percent of that unexplained growth can be accounted for by knowledge-based activities. Understanding the role of these activities in the economy is critical to accurately measuring and encouraging a strong U.S. economy.

Proposal: Early results from BEA's work on R&D suggest that investments in R&D account for roughly 1/5 of the contribution of knowledge-based activities to economic growth. This new initiative will expand on the R&D statistics BEA has been developing, and will fully research, identify, and quantify the other components of innovation and their contribution to growth. BEA will develop an innovation account that estimates investments in human capital, the design and development of new goods and services, and improved business processes. BEA proposes the following specific products:

• Work with NSF to develop a framework and prototype estimates of investments in innovative activities by the end of FY 2010. BEA will work with the NSF to develop measures of innovation activities that reach beyond the scientific R&D statistics that are currently provided by NSF and have been incorporated into BEA's R&D satellite account. These innovative activities--including important intangibles like new product development and firm-specific training--are thought to be important contributors to economic growth.

• Work with NSF and Census to develop detailed estimates of innovation-related intermediate inputs in FY 2011. In understanding the contributions of R&D to economic growth, it is important to not only measure the uses of R&D by industry, but to understand the inputs into R&D. These inputs, ranging from IT equipment to scientists and engineers, are critical to understanding the sources of R&D's own contributions to growth and in designing public policies to encourage innovation and growth.

• Work with BLS to develop aggregate and industry-level measures of the contributions of investments in innovation total factor productivity. BEA's work on R&D has demonstrated that there are important differences across industries with respect to investment in R&D and the contribution of those investments to overall total factor productivity. Because these differences are also likely to exist for the broader classes of innovative activity, BEA will develop industry-level estimates of innovative investments that will facilitate measurement of individual industries' contributions to economic growth.

• Work with NSF and Census to publish innovation statistics on firm and establishment-level data. BEA will publish innovation statistics based on data on firms as well as establishments to provide more comprehensive estimates of employment in innovation occupations.

This work is part of a $4.5 million new Navigating the 21st Century Economy statistically initiative that also includes better data on energy usage and retirement incomes.

Intangible tax proposal - further thoughts

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Having had a few days to ruminate, I have some further thoughts on the President's tax proposal on transfer of intangible assets (see earlier posting). Looking over the proposals in more detail, it became clear that it contain three separate proposals: an expansion of the definition of intangibles; dealing with the issue of transfer of multiple intangible properties; and, a valuation issue.

Let me deal with them in reverse order. The last proposal calls for the valuation of the intangible "at its highest and best use, as it would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts." In other words, a market transaction. Generally, there are three accepted methods of valuation: the market approach, the cost approach, and the income approach. Under current law, the income approach is used -- specifically Section 367(d)(2)(A) of the Internal Revenue Code requires the treating the transaction as "receiving amounts which reasonably reflect the amounts which would have been received annually in the form of such payments over the useful life of such property."

If this provision becomes law, it will be interesting to see how it is implemented. It will have to be based on the use of comparable sales - which will make it interesting to define the comps.

On this, let me propose a slightly different idea. In Medieval Denmark, the King levied tolls on ships passing through the Øresund (the channel connecting the Baltic and the North Sea between the modern border of Denmark and Sweden). Tolls were collected at Elsinore (better known in literature as Hamlet's castle). The method of valuation was a simple self-declaration. But the King reserved the right to purchase any and all of the cargo at the stated valuation. Such methods of market checks on self-valuation are rare, but not unheard of. (For a discussion of this method of self-valuation see Sound taxation? On the use of self-declared value). Such a method may not be practical when assessing the valuation of intangible for international transfer pricing tax purposes -- but it is worth further exploration.

The second proposal goes to the power of the IRS Commissioner under Section 482 to place his/her own value on a transfer whenever "necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses." The proposal would allow the Commissioner to value the intangible on an aggregate basis. This appears to go after the well-know issue that portfolios on intangibles are more valuable than the individual items taken separately. This issue is also tied to the market valuation issue -- as the current rules of using income appear to require tying the income to each specific intangible.

The last proposal is the most interesting. It would expand the definition of intangibles include workforce in place, goodwill and going concern value. It is also, at least to me, attacking a very different issue than the other two. Those three intangibles are essentially "whole-enterprise" assets. They can not be split off from the enterprise. As such, they are generally not transferred from entity to another as individual components like a patent or a trademark could be.

Thus, the issue of international transfer pricing is different in this case. It is about transferring control of the enterprise to a foreign owner. This is a slightly different "loophole" the IRS has been going after. Beginning 2007, the IRS has defined workforce in place as an intangible asset for purposes of what is called Section 936 Exit Strategies (see Industry Director Directive on Section 936 Exit Strategies # 1 and Industry Director Directive on Section 936 Exit Strategies # 2). These are specific transactions having to do with the restructuring of companies who had gained tax credits for operating in Puerto Rico as those credits have been phased out. The classification of workforce in place as an intangible asset made such a transfer a taxable event. Not surprisingly, this is view as a very controversial move. (For more information see the KPMG write up The Transfer of Workforce in Place to a Foreign Corporation.) It appears that this latest proposal is an extension of that same principle -- that all asset transfers should be subject to taxation -- to all transactions.

As such, this may the politically most difficult - but the least directly tied to the issue of the transfer of intangibles to tax havens. We will see how the politics of the various proposals plays out.

Liar loans and bank assets

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Benjamin Friedman recent piece in the New York Review of Books (The Failure of the Economy & the Economists) had this wonderful comment on "mark-to-myth":

In the same effort, the Financial Accounting Standards Board--the independent organization designated by the SEC to set accounting standards--acting at the strong urging of Congress, recently changed its rules to allow banks more latitude to claim that assets on their balance sheets are worth more than what anyone is willing to pay for them. (Next time you apply for a loan, try mentioning FAS 157-4 and telling your banker that you should be allowed to calculate your net worth with your house priced not at what comparable houses are selling for now but at what you paid for it and what you hope you'll get for it if you hold on to it for some years. The banker will laugh, even while the bank applies just such standards to its own balance sheet.)

Good point, since it was "mark-to-myth" with the original loans - aka "liar loans" - that caused the problem in the first place.

Airport landing slots and intangibles

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Last year, I posted an item about a GAO ruling on FAA's proposed "Congestion Management Rules" for New York City area airports. GAO ruled that the FAA had no legal authority to conduct an auction of airport landing slot. FAA argued that these landing slots were intangible property and therefore fell under their existing statutory authority to dispose of property. GAO disagreed, saying that the context of that statutory authority make clear that landing slots are not "property" under that authority. The GAO ruling also cites cases where courts have ruled that license held by the government do not create a property right. GAO also raised concerns that the auctions were a backdoor funding mechanism not authorized by statute

Notwithstanding the GAO opinion, the Bush Administration published the final rules.

Today, the FAA has published two Federal Register notices (for JFK and Newark and for LaGuardia) of a proposed rescission of the rules. As those notices state, "The rulemaking was highly controversial." In fact, last December the United States Court of Appeals for the District of Columbia Circuit issued an order staying the rule. And the Omnibus Appropriations Act, 2009 contained a provision denying any funds to implement the auctions. So today's action is basically a recognition by the FAA of the inevitable.

Left unresolved, however, is issue of whether government licenses are property. Today's Federal Register notices clear continue to assert that the FAA has the authority for these actions. The Appeals Court order simply recognized that the "Petitioners have satisfied the stringent standards required for a stay pending court review."

This is an issue that will need to be clarified further as topic of government management of intangible assets is explored. The GAO ruling raises a number of red flags, including the value of existing government intangible assets. As they point out with the landing slots, "FAA's argument that slots are property proves too much--it suggests that the agency has been improperly giving away potentially millions of dollars of federal property, for no compensation, since it created the slot system in 1968."

That is a very good question indeed.

New twist to the patent wars

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Here is a new development in the patent wars, from today's New York Times -- Cancer Patients Challenge the Patenting of a Gene:

Ms. [Genae] Girard took a genetic test to see if her genes also put her at increased risk for ovarian cancer, which might require the removal of her ovaries. The test came back positive, so she wanted a second opinion from another test. But there can be no second opinion. A decision by the government more than 10 years ago allowed a single company, Myriad Genetics, to own the patent on two genes that are closely associated with increased risk for breast cancer and ovarian cancer, and on the testing that measures that risk.

On Tuesday, Ms. Girard, 39, who lives in the Austin, Tex., area, filed a lawsuit against Myriad and the Patent Office, challenging the decision to grant a patent on a gene to Myriad and companies like it. She was joined by four other cancer patients, by professional organizations of pathologists with more than 100,000 members and by several individual pathologists and genetic researchers.

The lawsuit, believed to be the first of its kind, was organized by the American Civil Liberties Union and filed in federal court in New York. It blends patent law, medical science, breast cancer activism and an unusual civil liberties argument in ways that could make it a landmark case.

That last sentence may be an understatement. This looks like one of the most interesting patent cases ever. So stay tuned.

By the way, the Times story has a video link to a Today show segment on the issue.

Notes from the copyright wars

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From Intellectual Property Watch - The World Is Going Flat(-Rate)

A landmark study by the Institute of European Media Law (EML) found that a levy on internet usage legalising non-commercial online exchanges of creative works conforms with German and European copyright law, even though it requires changes in both. The German and European factions of the Green Party who had commissioned the study will make the "culture flat-rate," as the model is being called in Germany, an issue in their policies. The global debate on a new social contract between creatives and society is getting more pronounced by the day. Two models are emerging: a free-market approach based on private blanket licences and voluntary subscriptions, and a legal licence approach based on exceptions in copyright law and mandatory levies, that now has been proven legally feasible and appropriate by the EML study.

Over that the Wall Street Journal author and commentator Mark Helprin has a piece Copyright Critics Rationalize Theft:

But copyright, the rampart of the mythical city, is besieged by a widespread movement antagonistic to authorial right and the legitimacy of intellectual property. So-called public interest groups serve the new information super powers, the Standard Oils of our age, whose interests would be advanced if they did not have to bother with permissions and payments for what they call "content." The Creative Commons organization, for example, is richly financed by Google, Microsoft, Yahoo, Mozilla, Sun, the Hewlett Foundation, and others of type.

And the Economist has started an on-line debate forum (Copyright and wrongs) to discuss the following motion: "This house believes that existing copyright laws do more harm than good." Note that the debate closes tomorrow.

Let the debate continue!

Tax haven crackdown to include intangibles

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Yesterday, the Obama Administration released the details of the FY 2010 budget, including its tax proposals (see Treasury Department's General Explanations of the Administration's Fiscal Year 2010 Revenue Proposals otherwise know as the Green Book). In my earlier postings, I wondered whether they would take on the issue of transfer pricing and intangibles.

Well, they did -- page 32 of the Green Book reads as follows:

LIMIT SHIFTING OF INCOME THROUGH INTANGIBLE PROPERTY TRANSFERS

Current Law

Section 482 permits the Commissioner to distribute, apportion, or allocate gross income, deductions, credits, and other allowances between or among two or more organizations, trades, or businesses under common ownership or control whenever "necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses." Section 482 also provides that in the case of any transfer (or license) of intangible property (as defined in section 936(h)(3)(B)), the income with respect to such transfer or license must be commensurate with the income attributable to the intangible property. Further, under section 367(d), if a U.S. person transfers intangible property (as defined in section 936(h)(3)(B)) to a foreign corporation in certain nonrecognition transactions, the U.S. person is treated as selling the intangible property for a series of payments contingent on the productivity, use, or disposition of the property that are commensurate with the transferee's income from the property. The payments generally continue annually over the useful life of the property.

Reasons for Change

Controversy often arises concerning the value of intangible property transferred between related persons. Further, the scope of the intangible property subject to sections 482 and 367(d) is not entirely clear or consistent. This lack of clarity and consistency may result in the inappropriate avoidance of U.S. tax and misuse of the rules applicable to transfers of intangible property to foreign persons.

Proposal

To prevent inappropriate shifting of income outside the United States, the proposal would clarify the definition of intangible property for purposes of sections 367(d) and 482 to include workforce in place, goodwill and going concern value. The proposal would also clarify that in a transfer of multiple intangible properties, the Commissioner may value the intangible properties on an aggregate basis where that achieves a more reliable result. The proposal would also clarify that intangible property must be valued at its highest and best use, as it would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.
The proposal would be effective for taxable years beginning after December 31, 2010.

This proposal is relatively small change in the overall plan. Treasury estimates it raises $548 million between 2010 and 2014 and $2.9 billion over 10 years (2010-2019). In contrast, the two big changes to international taxation, reforming business entity classification rules for foreign entities and defering deduction of expenses tied to defered income, raise $86.5 billion and $60 billion respectively.

Those two provisions have already drawn strong opposition, as the Wall Street Journal notes:

"The proposed tax increases on U.S. companies by the Treasury threaten the jobs of tens of millions of U.S. workers and our future economic growth," said John Castellani, president of the Business Roundtable. "Adopting these changes will hamstring American competitiveness."
It is unclear how strong the opposition will be to the intangible provisions.

UPDATE: for an overview of the coming fight on this issue, see Politico's story today How Business will wage war on Obama tax plan.

March Trade in Intangibles

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The March BEA trade data released this morning showed a break in the recent trend toward a smaller deficit as the deficit increased slightly by $1.5 billion. Exports declined by $3.0 billion while import dropped by $1.6 billion. The decline in imports was smaller than in previous months - perhaps signaling a stabilizing of consumer spending. Imports of consumer goods actually increased in March while imports of industrial supplies and materials and capital goods declined.

However, the increased deficit was due in part to rising oil imports and prices. As the Wall Street Journal pointed out:

The value of crude oil imports increased in March to $11.98 billion, from $10.00 billion in February. The Commerce report's average price per barrel of imported crude in March rose by $2.14 to $41.36 from $39.22. It was the first increase in eight months. Last year, imported oil topped at $124.66 billion in July, and then started a deep slide.
As for the March volume of oil imported, it rose to 289.69 million barrels from 254.87 million in February.
The decline in exports is also not good news - and indicates that February's increase in exports may not be sustainable. Exports peaked in July 2008 and have declined steadily ever since (not withstanding February's increase).

The intangibles balance was essentially unchanged. Revenues (exports) and payments (imports) of royalties both declined; exports and imports of business services increased. A slight increase in the business services trade surplus was offset by a slight decline in the trade surplus in royalties.

The trade deficit in Advanced Technology Products reversed in March, growing by $1.2 billion as aerospace exports declined and imports of information and communications technologies (ICT) increased. 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.


Intangibles trade-Mar09.gif



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.



Patents and creativity

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Speaking of patents (see earlier posting), I have to unload on one of my pet peeves. The most recent issue of Forbes is running a story "The 15 Most Creative States." Their indicator of "creativity" is the number of patents per capita. Come on guys, if you want to do a story about patenting, ok. But at least get the headline right. Everyone agrees that patents are important. But everyone also agrees that patents are a best only one indicator of and at worst a very bad proxy for creativity and innovation.

So the basic lesson is that 15 Most Patenting States is in no way the same as 15 Most Creative States.

For a leading business magazine to make such a fundamental mistake is ridiculous. It indicates intellectual and journalist sloppiness. Or maybe they really don't understand?

The 2008 annual report of the European Patent Office has an interesting section in it: Quality over quantity: on course to raise the bar:

A portfolio of measures set to launch in the spring of 2010 will raise the bar on the quality of patents while simultaneously improving the efficiency of the granting process. These steps will better protect inventors who turn to the European Patent Office and, at the same time, see the EPO grant patents only for innovations having sufficient inventive merit and meeting the needs of society.

This programme of measures has been designed with three aims in mind: to secure a clear scope for the search at the beginning of the procedure and thereby build on solid foundations; to save time in the application process by reducing the procedural steps through which inventors and the EPO must pass; and, ultimately, to increase the chances of worthy applicants being granted robust patents.
The stated reason for this new initiative is that:
While the volume of applications the EPO has to examine has been on an upward trend, the same cannot be said of their quality. Applications that are inconsistent with European Patent Convention (EPC) standards, the many procedural steps through which they must pass - and the legal uncertainties that sometimes result - have all engendered a backlog at the EPO and a rethink of quality management.
EPO wants to ensure that "resources are not squandered on systematically avoidable procedural matters and that the balance between the teaching of the patent specification and the benefits of private monopoly is redressed."

Here are some of the proposal changes:
(1) Clarification of the scope of protection sought prior to search. A cap on the number of independent claims per application and the opportunity for the examiner to have the claims clarified before searching will help examiners perform a more focused search - and reduce the risk of missing an important document.

(2) Mandatory response to the written opinion issued with the search report. This reply from applicants, required before entering examination, will allow them six months to research and justify any issues raised in the written opinion.

(3) One opportunity to file voluntary amendments. Once in possession of the written opinion and the search report, applicants will be granted only one chance to make amendments of their own volition. This will focus attention and activity earlier in the examination process and reduce the average number of communications required up to grant.

(4) Mandatory provision of the basis for amendments. Since applicants are better placed than anyone else to outline the basis for amendments, they are now obliged to clearly identify any changes they seek.

It looks like EPO is trying to get ahead of the problem that many feel has plagued the USPTO.

Manufacturing and services - part 3

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In an update to my earlier posting on how Oracle is an example of the fusion of manufacturing and services, the Wall Street Journal is running a story on Larry Ellison's view of the software/hardware marriage (Oracle is in the Hardware Business to Stay):

But Ellison said in the interview that companies that combine their hardware with software, such as Apple and Cisco, can charge a premium because the pieces are made to work together. "If a company designs both hardware and software, it can build much better systems than if they only design the software," he said. "That's why Apple's iPhone is so much better than Microsoft phones.

I have long argued that the key to Apple's success is the business model - not just the technology or design. Beginning with the iPod, Apple has successful combined services and manufacturing. iTunes was as an important feature of the iPod success as anything else.

But, the interview with Larry Ellison (part of the SEC filings on the Oracle/Sun deal) makes one thing very clear. In his mind, a product company is different from a manufacturing company. A company can fuse products and services into a holistic offering with out actually manufacturing. As he states:

Just because we're buying Sun does not mean Oracle is becoming a manufacturer. Sun outsources almost all of its manufacturing to companies like Flextronics and Fujitsu. With one tiny exception, Sun does no manufacturing; neither will we.

That may be the case in electronics -- it certainly has been for decades as cross-national production strategies have broken up the process into discrete subcomponents. But I still think that manufacturing expertise is critical in product development and design -- and in understanding the issues of after-sales servicing.

So we need to understand both the fusion of product and service in a business model -- and the relationship between manufacturing and other parts of the value network. Those are two different concepts. And I will try from now on to keep them separate.

Rays of light in umemployment data?

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This morning's jobs data from BLS contained good news and bad news. The bad news is that the unemployment rate jumped from 8.5% to 8.9%. Nonfarm payrolls declined by fell 539,000. The good news is that the payroll decline was less than expected as the Wall Street Journal noted, "slightly better than Wall Street expectations for a 610,000 decline, according to a Dow Jones Newswires survey." The other good news is that the number of involuntary underemployed (part time for economic reasons) actually decline by 130,000. And remember that unemployment is a lagging indicator.

However, this does not mean that the recovery has begun. The New York Times quotes Ethan Harris, co-head of United States economic research at Barclays Capital:
"These are still extremely ugly numbers," Mr. Harris said. "It's telling you more about where we're coming from and a little less abut where we're going, which is probably a very slow recovery."
That would be my bet as well.

Capitalism in Crisis

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Richard Posner in today's Wall Street Journal on Capitalism in Crisis:

The key to understanding is that a capitalist economy, while immensely dynamic and productive, is not inherently stable.

We knew that at one time. And we constructed government regulations to cope with that fact. But then government became the problem - and we forgot that fact.

So, now when the future debate roles around the next time about shrinking government "to the point where it can be drowned in the bathtub" ( to quote anti-government cheerleader Grorver Norquist), will we remember that fact?

I would like to hope so. But judging by the anti-government regulation comments that Judge Posner's article has elicited, I doubt it.

Kauffman Index of Entrepreneurial Activity

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The Kauffman Foundation recently released its 2009 Index of Entrepreneurial Activity. The report covers trends in entrepreneurship from 1966 to 2008. The index shows a rather steady level of business formation:

In 2008, an average of 0.32 percent of the adult population, or 320 out of 100,000 adults, created a new business each month. This business-creation rate translates into 530,000 new businesses being created each month during the year. The entrepreneurial activity rate increased only slightly from 2007, when it was 0.30 percent. Over the past twelve years, the business creation rate fluctuated between 0.27 percent and 0.32 percent.

However, within that steady sate there are dynamic changes. For example, the rate of low-income potential new business is different than high-income potential business:

Low- and medium-income potential business-creation rates generally decreased when economic conditions were strong, whereas high-income-potential business creation generally increased. When economic conditions worsened, high-income-potential entrepreneurship rates generally decreased and low- and medium income- potential entrepreneurship rates increased.

Thus, the rate of formation of low income potential business declined in the late 1990's and has increased recently. Likewise, the entrepreneurship rate among those with less than a high school education declined in good economic times and rose in bad. And, not surprising, the highest rates of entrepreneurship were in construction.

Entrepreneurial activity was also different by region:

New-business-creation rates are highest in the West and South. From 2007 to 2008, the largest increase in entrepreneurial activity occurred in the West (0.37 percent to 0.42 percent). Entrepreneurial activity rates also increased in the Northeast (0.26 percent to 0.29 percent) and South (0.31 percent to 0.33 percent), whereas entrepreneurial activity rates declined in the Midwest (0.25 percent to 0.23 percent).


According to analysis of the data by RealClear Politics, the top ten entrepreneurial cities are:

Atlanta
Phoenix
Riverside, CA
Los Angeles
Miami
New York
San Francisco
Dallas-Fort Worth
Houston
Washington, DC


Since I'm based in DC, it would good to see that it made the list. I suspect, however, that this would not be true in previous years.

Manufacturing and services - part 2

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In a posting over a year ago, I discussed the fusion of manufacturing and services as a characteristic of the I-Cubed Economy - using Rolls Royce as an example. Rolls Royce gains a great deal of its revenues for servicing its products. The two are inseparable: High quality servicing requires that RR make the product (in order to understand it). The result is a complete customer package:

"They aren't selling engines, they are selling hot air out the back of an engine," says an investment analyst.

A recent story in the Economist on Oracle's take over of Sun (Mr Ellison helps himself) illustrates the same point in the IT sector. The story describes the dynamics of the industry:

Since the early 1990s the industry has resembled a cake made of horizontal layers of technology, with each layer dominated by a few companies. Cisco, for instance, provided most of the networking gear. Sun and HP sold servers. Oracle was the leader in databases. IBM's mainstay was services. SAP, a German giant, ruled in business software.

This structure is now collapsing as the industry's heavyweights move into each other's layers. HP bulked up its services division by buying EDS, for example, and has also moved more into networking. Cisco will soon start selling servers, and has formed an alliance with several smaller hardware and software firms to build, in effect, a data centre in a box. The industry is, in other words, going back to its past, when it was dominated by a few integrated companies that tried to do it all.

This is, in part, a consequence of the industry's maturity: to keep growing, firms have to invade each other's markets. In addition, customers increasingly prefer to buy integrated systems from one vendor, rather than doing the plumbing themselves. New technologies such as virtualisation and "cloud computing" are also blurring the boundaries between the industry's layers. A server can now easily switch between being a computer, a storage device or a router (a box that directs network traffic). For computing to become a utility, which is the promise of the cloud, a data centre cannot be a hotch-potch of boxes cobbled together from different vendors, but must be tightly integrated.

The Oracle purchase of Sun fits with that dynamic:

Taking over Sun, he [Larry Ellison] said this week, provides Oracle with all the pieces to put together systems that reach from "application to disk". Oracle's engineers are already brainstorming about how to build "industries in a box"--complete computer systems that come fine-tuned for, say, banking or retailing.
In other words, Oracle will fuse hardware and services into one customer service application.

Another good example of the fusion of services and manufacturing in the I-Cubed Economy.

Tax Havens and intangibles - update

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In follow up to my posting yesterday, it looks like the Obama plan sidesteps the issues I raised. As the New York Times reports:
The most widely used tactic not covered by the plan is known as transfer pricing, which multinational corporations employ routinely to reduce the taxes they owe to the United States by keeping their profits offshore in low-tax or no-tax havens.
The story goes on to say:
As part of the tax code, the tactic allows corporations, typically Fortune 500 companies like Wal-Mart, Exxon Mobil and General Electric, to reduce their United States taxes by calculating the prices they charge on goods and services transferred between their global divisions.
While corporations are supposed to compute those costs as if they had been assessed between independent, neutral entities, and to pay any taxes owed on them -- the top rate is around 35 percent -- corporations often fudge the numbers to their advantage, according to senior analysts.
In other words, corporations routinely abuse the tactic to minimize their taxes by undercharging or overpaying their foreign subsidiaries for goods and services.
With the Obama plan closing other loopholes, corporations are "now going to get crazy with their transfer pricing," said Lee Sheppard, a commentator for Tax Analysts, a trade publication.
Much of the commentary on the proposal has been skeptical - pointing out the possible negative competitiveness implications (for example, see New York Times, Wall Street Journal, Washington Post). Much of the speculation is that this is part of the larger budget battles. Robert Reich notes that is can be a strategic move to both create a bargaining chip for corporate support on health care and a way to make the deficit hawks come to the table on the costs of health care reform (by proposing a way to pay for health care via the tax haven crack down).

My own sense is that this is more an opening salvo in a future tax reform battle. By laying down this marker early, the Administration is beginning the positioning for that fight. If I am right, then tax reform might be on the agenda sooner rather than later. At that time, I hope the issue of transfer pricing -- including of intangibles -- is back on the table.

Patent Reform notes

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The Kaufman Foundation's Policy Dialog on Entrepreneurship has a good piece on Patent Reform and Our Innovation Economy -- including a fact sheet on reform proposals. As they state:
The existing system contains deficiencies that are worrisome from the perspective of entrepreneurship. While patents for new inventions provide a strong incentive for people to both create and publicize their intellectual property, patent laws are increasingly cumbersome.
Their two reform principles flow from that analysis: "(1) patents should only be provided for truly non-obvious inventions; and (2) consistent with the first objective, the procedures for contesting patents should entail minimum cost." I would agree.

On another note on patents, the Economist recently ran a story on Intellectual Property in China. That story notes how Chinese firms have taken to patent enforcement:
Since 2006 more patent lawsuits have been filed in China than anywhere else, even litigious America. Most pit domestic firms against each other, but in recent years foreigners have found themselves on the receiving end too. In December Samsung, a South Korean conglomerate, was ordered to pay compensation to Holley, a Chinese telecoms firm. The recent victories and lucrative awards will open the floodgates to more suits, predicts Tony Chen of Jones Day, a law firm.
Increased use of patent lawsuits by the Chinese is a trend I wrote about in earlier postings a couple of years ago. The Economist goes on to note:
Chinese firms are also increasingly seeking patents abroad, a sign that they plan to protect their technology when exporting it to rich countries. They won 90 patents in America in 1999 but last year they received 1,225. That is still relatively few--IBM, an American technology giant, receives around 3,000 a year--but it is increasing quickly. Because it takes three to five years to issue a patent, the number issued to Chinese firms is expected to soar soon. The quality of patents issued in China is also improving. Revisions to the patent law that take effect in October strengthen the requirement for a patent's novelty, bringing it up to global standards. Stronger patents are easier to enforce, opening the door to more lawsuits
As I warned before, patent lawsuits are a game that two can play. And the Chinese are likely to play it very well. Which makes the second principle in the Kaufman Foundation fact sheet mentioned earlier -- procedures for contesting patents should entail minimum cost -- that much more important.

Tax havens and intangibles

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Later this morning, President Obama and Treasury Secretary Geithner will outline their new proposals for cracking down on offshore tax havens. According to the Wall Street Journal:

It aims to change the legal treatment of offshore subsidiaries and structures that companies have used to avoid not only U.S. taxes, but taxes in other developed countries as well.

In addition, the administration will strive to tighten rules that have encouraged thousands of Americans to open offshore bank accounts in an effort to duck U.S. taxes. The plan would increase information reporting and tax withholding as well as penalties, and make it harder for foreign account-holders to win cases in court. The administration promised new enforcement tools to crack down on tax-haven abuse.
It is unclear from the preliminary news reports whether the proposals will also target the issue of transfer of intangible (specifically patents) to low tax countries. As we noted in our report, Intangible Asset Monetization: The Promise and the Reality, companies can transfer their intellectual property to subsidiaries located in countries where the royalty income is tax at a low rate or not taxed at all. The parent company "sells" the IP to the subsidiary and then pays royalties to that subsidiary for the use of the IP. The key question is the fair market value of that transfer. US law requires that the transfer be valued at the same level as if it was an arms-length transaction between two independent entities. The parent would then pay US taxes on that income.

However, as recently as 2006, then IRS Commissioner Mark Everson complained to a Senate subcommittee that:
Taxpayers, especially in the high technology and pharmaceutical industries, are shifting profits offshore through a variety of arrangements that result in the transfer of valuable intangibles to related foreign entities for inadequate consideration.
In other words, they are low balling the value of the IP, "selling" it cheaply so as to minimize the amount of US taxes they have to pay on the income from those sales. The US loses in two ways, the tax on the income from the sale and the tax on the income from the royalties.

By the way, this concern over internal transfer pricing is at the heart of many corporate tax issues.

As we note in our report, taxation is an important policy tool that has not yet fully come to grips with the rise of importance of intangibles assets. For example, we have long advocated the expansion of the R&D tax credit into a knowledge tax credit by incorporating tax incentives for investments human capital as well as research.

As part of a review of the intangibles and taxation, we suggest that it might be time to "explore lowering the tax rate on intangible asset royalties, in conjunction with stricter regulations on international transfer-pricing mechanisms and cost-sharing arrangements and on passive investment companies." The report goes on to say:
Providing a more direct tax incentive to the licensing of intangibles by lowering the rate on intangible asset royalties, such as to the capital gains rate, is a more controversial proposal. This lower rate could be crafted to apply only to royalties for new licenses for a limited time, such as a sliding scale for three years. In crafting such an incentive, safeguards would need to be established to prevent the incentive from being used for simply transferring existing licenses to SPEs and to ensure that the incentive went to new licensing activities only.

In conjunction with such a tax incentive, the problem of tax havens should be addressed. Transfer pricing mechanisms and cost sharing arrangements need to prevent those transfers that, as the IRS describes, are "for inadequate consideration." The issue (some would say the abuse) of "passive investment companies" should also be handled.

The notion of tax havens and loopholes is often a matter of perspective. One person's loophole is another person's incentive. However, there is a growing concern that the tax code has become overly complex and that rates could be lowered in conjunction with the elimination of certain specific provisions. Any such tax reform, including the possibility of closing loopholes currently applied to intangibles and lowering the tax rate on royalties, should be looked at very carefully in the context of the impact on the creation and utilization of intangible assets
From some of the press reports, this appears to be in part the strategy that the Obama Administration wants to use -- tighten up the overseas tax havens to raise funds to pay for other business tax incentives, such as the R&D tax credit.

We will see if it extends to other areas of taxation of intangibles as well.

Is reconstruction innovation?

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The MIT Sloan Management Review has a new article on The Profit-Making Allure of Product Reconstruction. As they describe it:

Reconstruction, which covers a continuum of activities from recycling to refurbishing to remanufacturing, allows companies to sell goods at lower prices than if they were to assemble nearly identical new products. In most cases, the prices of remanufactured products are 50 to 75% lower than those of new ones. Despite lower prices, however, reconstruction provides customers with high-performance goods.

Normally, such activities would not necessarily be considered as "innovation." One of the most standard metrics of innovation is amount of sales from new products (see OECD's Oslo Manual: Guidelines for Collecting and Interpreting Innovation Data, 3rd Edition). Even the broad definitions of innovation (see earlier posting) emphasis the "newness" of the activity or product.

From that point of view, recycling and refurbishing are not innovation. As defined by the article, "Recycling is the process by which a used product is broken down into its constituent parts, which are then used in the manufacturing of new products," and "Refurbishing is the process by which a product is restored to its original condition, without modification, so that it can be used for the same purpose as initially intended." Neither of these activities results in new (i.e. different) products.

On the other hand, according to the article, "Remanufacturing is the process of completely disassembling a used product, repairing or replacing worn or obsolete components and adding enhancements." That last part, "adding enhancement" would make this innovation under the standard definitions.

But even here, the article makes clear that the motivation of a customer to use a reconstructed product is often times the desire to avoid having to do something new -- i.e. an upgrade. So, reconstruction is essentially a non-innovative solution. In fact, it is an innovation avoidance strategy. It keeps the old tech going while shunning the new.

Well, let's take a different view of innovation -- from the process point of view. The idea of recycling, in and of itself, is an innovative idea. What can be more innovative than turning what was a waste product into a source of raw materials? The old mindset was from earth-to-earth -- i.e. from mine or farm to garbage landfill. Recycling is a totally different mindset based more on a circular product life-cycle approach. It wasn't just the technology (i.e. the electric arc furnace) that made the steel minimills so innovative. It was the massive use of scrap as the primary raw material. Yes, scrap has always been a raw material. Generations of church bells were melted down to make cannons. But the rise of recycling as a standard mode of operation is an innovation in the post-WWII consumerist economy. The mere fact that there is an article in the MIT Sloan Management Review touting the idea shows how novel the concept still is.

Refurbishment is also an innovative idea for many. Product design long ago went from the idea as repair to the concept of replacement as the standard mode of product maintenance. Refurbishment and remanufacturing are an innovative way of changing the maintenance process once again. Rather than repair on site, refurbishment and remanufacturing uses the replacement process with a previously repaired product. For example, the copier is not fixed in the office, but replaced with an identical model that has been refurbished (repaired) previously. The copier is then taken to a repair/refurbishment location to be fixed up for another customer. The customer doesn't get back its old "fixed" product; the customer gets a "new" version of the same product.

Thus, viewed as a process innovation, reconstruction is clearly an innovative idea -- at least for some.

This raises yet another question about defining innovation. Is it still "innovation" if people have been doing it for a long time. For example, refurbishing and remanufacturing copy machine has been a standard part of the industry for many years. The formation of a new copy refurbishing company would not be considered an innovative undertaking. Yet another steel scrap yard or paper recycling plant would not be innovative. But recycling restaurant grease into bio-fuel is an example of innovation.

So the key to answering the question original question posed in the title of this posting comes down to "where" and "when." Implementing these ideas in places where they have not been used before is process innovation. In the end, it is still the "newness" of the activity that counts. And judging "newness" is a subjective activity: new to the world, new to my neighborhood, new to me? At what point does it stop being innovation and start becoming replication?

Our standard innovation question is tied to "new to the firm." So if the local diner installs a dishwashing machine (to replace the hand washing), that counts as innovation. Does it also count as innovation if they add a "patty melt" to the menu? It is a new product for them. What if they switch to a tex-mex format? Then all of their sales would be coming from "new products."

These are the types of issues we need to grapple with, if the concept of innovation has any meaning at all from a public policy point of view. The goal of policy is to create incentives and remove barriers to innovation. That requires knowing what innovation is, and is not. Otherwise, innovation becomes such an open-end phrase that it can be used to justify anything - and therefore helps nothing.

    Note: the views expressed here are solely those of the author and do not necessarily represent those of Athena Alliance.


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