November 2009 Archives

Utilizing the government's bio-assets

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The National Park Service is reviewing a new policy to share in some of the profits from patents derived from research on organisms found in the parks. According to a story in this morning's Washington Post, this policy is the result of a decade long lawsuit on "bio-prospecting" in Yellowstone. Settlement of that suit required an Environmental Impact Statement, which has now been completed. The original mandate for the "benefits sharing" programs comes from the National Parks Omnibus Management Act of 1998. It was the first agreement in 1999 that triggered the lawsuit. Least you think this is no big deal, the Post story points out that:
In the mid-1980s, scientists discovered that a bacteria species from a Yellowstone hot spring could make DNA testing much more practical. Because of that Nobel Prize-winning research, DNA testing has since become commonplace -- an industry worth hundreds of millions of dollars a year.
The National Park Service has not directly shared in those profits even though the bacteria species, Thermus aquaticus, arguably belonged to the American public.
The EIS describes the preferred alternative:
The NPS benefits-sharing proposal would apply to research projects involving research specimens collected from units of the National Park System that subsequently resulted in useful discoveries or inventions with some valuable commercial application. A benefits-sharing agreement would provide the terms and conditions for the further development and use of such valuable discoveries, inventions, or other research results. All such researchers would be required to enter into a benefits-sharing agreement with the NPS before using their research results for any commercial purpose. Consistent with the terms of their research permits, researchers would be responsible for initiating benefits-sharing negotiations with the NPS.
Benefits-sharing agreements would not authorize any research activities (or any other activities that require a permit) in parks. A benefits-sharing agreement would be negotiated with researchers who held an NPS research permit only after the permit applicant had met all the regulatory requirements, the park unit had met all resource protection requirements, the permit had been issued, and, usually, after research had already been conducted.
Two points are especially interesting. The first is that the agreements will take the form of the standard government Cooperative Research and Development Agreement (CRADA's). The National Parks are already considered a federal laboratory under the technology transfer laws. The CRADA process has worked rather well. This is an interesting extension of the CRADA concept.

The second is that this is a benefits-sharing agreement. The benefits need not be monetary:
The NPS has identified four types of non-monetary benefits that could occur under some or all benefits-sharing agreements: knowledge and research relationships, training and education, research-related equipment, and special services (such as laboratory analyses). The particular knowledge and capabilities of the benefits-sharing researcher partner would determine the specific non-monetary benefits generated and managed by each benefits-sharing agreement.
The NPS has identified two types of monetary benefits that could occur under some or all benefits-sharing agreements: 1) up-front funding for research projects that support the park's research activities or 2) performance-based payments paid as a percentage of any CRADA-related income received by a researcher's institution (e.g., from licensing intermediate research results or from selling products developed from the knowledge gained from the research).
The NPS press release states that the Park Service Director will review the finds of the EIS and make a final decision on the policy in early 2010. One of the major decisions will be how much of the financial agreement should be made public. The EIS contains a range from all to none. The argument for withholding information is to prevent a "chilling-effect" that full disclosure might have on researchers and companies not wanting to make public what they might consider proprietary information. On the other hand, the public should be able to see some of the information - to see whether the agreements are in the public interest. Proprietary information is usually protected under CRADA's, but I am not sure about all financial information. I would especially like to see some disclosure of royalty rates - as that is an important piece of information for both market-making in intangible assets and public accountability.

I would also urge a review of the program in a reasonable time period, say five years. The program could be a model for other bio-prospecting activities involving government land. But an evaluation is needed before it is widely copied.

Happy Thanksgiving

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This turkey is off for the holiday -- back next week.

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Losing the knowledge base

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For some time, I (along with a number of others) have been worried about the loss of productive capability in the US -- for example see my earlier posting on production and research. At issue is the myth that the US can abandon manufacturing and production as it moves up the value chain -- or, in its most simplistic form, as the US becomes a "service" economy. I've posted a number of pieces on the fallacy of this argument. For example, there is the idea that somehow this is a natural progression out of production just like we got out of agriculture. Of course, this argument ignores the fact that the US did not "get out" of agriculture -- we transformed agriculture from a labor intensive to a capital (machine) intensive industry -- just as we are now transforming both agriculture and manufacturing into a knowledge intensive activity.

The important point is that as the economy shifts, it builds on rather than abandons the past. The knowledge and production base is expanded and transformed, not forgotten. In our rush to shed production, we run the risk of losing the ability to make the transformation.

Two Harvard Business School professors, Gary Pisano and Willy Shih, have written an HBR article outlining the case - "Restoring American Competitiveness":
Companies operating in the U.S. were steadily outsourcing development and manufacturing work to specialists abroad and cutting their spending on basic research. In making their decisions to outsource, executives were heeding the advice du jour of business gurus and Wall Street: Focus on your core competencies, off-load your low-value-added activities, and redeploy the savings to innovation, the true source of your competitive advantage. But in reality, the outsourcing has not stopped with low-value tasks like simple assembly or circuit-board stuffing. Sophisticated engineering and manufacturing capabilities that underpin innovation in a wide range of products have been rapidly leaving too. As a result, the U.S. has lost or is in the process of losing the knowledge, skilled people, and supplier infrastructure needed to manufacture many of the cutting-edge products it invented.
They document case after case of supposed "high-tech" industries we have already lost. And they note -- as I do when I publish the monthly trade -- that we run a deficit in advanced technology products.

I should note that the HBR blog also has a number of pieces debating the Pisano & Shih thesis - including some contrary opinions.

A different take on the issue can be found in a recent special report in the Economist on Japanese middle companies as technology champions -- "Invisible but indispensable". The report describes how medium size companies in Japan have become the guardians of the knowledge base. More importantly, these companies have used that knowledge base to create a competitive advantage. These companies dominate the market in component after component. As the story notes, "It doesn't matter if the brand on the casing says Apple, Nokia or Samsung: the innards are stuffed with Japanese wares."

The Economist goes on to describe the reasons for this success:
Japan's technology champions share certain characteristics. They invest handsomely in research and development (R&D). Many have factories abroad for basic products but keep the high-end stuff at home--in a "black box", they like to say. They often own their supply chains: chip companies that might use crystal components generally grow their own. Some firms even make the very machines they use, in order to control costs, remain independent of suppliers and maintain a deep understanding of their technology.
When asked what is the main reason for their success, executives invariably gush about the quality of their customers. The response initially sounds scripted, or perhaps typically humble. Of course, good customers impose strict standards, forcing suppliers to raise their game. But there is more to it than that. As Susumu Kohyama, the boss of Covalent, points out, the components, tools and materials in which Japanese firms excel are highly customised. It is only by working closely with clients over many years that suppliers gain insight into their future technical plans and are trusted to learn about thorny problems that a clever supplier might solve. Once firms become technology leaders, it is harder to unseat them.
Moreover, the knowledge about the technology is tacit, not formal. It cannot be transmitted by writing a manual or reading a patent application. Rather, it accumulates by working with colleagues over many years. This poses a barrier to entry for rivals. It is also why firms try to maintain lifetime employment in specialised high-tech sectors, though it is ebbing elsewhere in the economy.
This belief that the strength of the company is stored in the collective mind of employees--rather than in the share price of the moment--also helps explain why Japanese companies disdain mergers and acquisitions. Firms resist takeovers, rather than viewing them as the natural combinatory process of business, as in the West.
In other words, they protect, develop, and exploit their intangible assets. And that begins with the realization that a nation needed to hand on to its production knowledge base. This was important in the industrial era; it is even more important in the I-Cubed Economy.

3Q GDP revised

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In my posting on the September trade data, I mentioned that the 3rd quarter GDP numbers would probably be revised in light of the great than estimated trade deficit. Well, they have been. BEA announced this morning GDP grew by 2.8% in the 3rd quarter, not the 3.5% reported in the advance estimate (see earlier posting). The third estimate is due out December 22. I don't anticipate as big a revision next time.


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Pushing innovation policy

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As I've mentioned before, there is talk in Washington about a new jobs bill and possibly a new look at innovation policies. Should there be a new round of policy initiatives, here are a few suggestions (many of which I've discussed in the past).

Review and implement the America COMPETES Act. Parts of the Act were never implemented. Two parts specifically should be implemented immediately:
 • convene the President's Council on Innovation and Competitiveness as a mechanism to highlight Cabinet-level attention to innovation and coordinate government action
 • fund the study of how the federal government could support research and teaching related to the services industries and service functions in the manufacturing sector.

Rename the Baldrige Quality Award the Baldrige Quality, Productivity, and Innovation Award. Over the years, the criteria for the Baldrige Award have changed with the times. As these criteria have shifted and broadened, the award has become much more productivity and innovation focused. Much of this shift, however, has not been recognized. The change in the name would both better advertise the broader nature of the award and provide an opportunity to review and modify the criteria to reflect this broader view. In addition to changing the name, the award should be given greater visibility by the President. By presenting the awards personally, the President could use it as an opportunity to showcase innovative American companies and collaborations. The National Science and Technology medal criteria could also be broadened to recognize a small number of individual contributions to innovation that are not solely technology based.

MEP and innovation. Double the budget for Manufacturing Extension Partnership (MEP) - and explicitly expanding the scope of MEP's services to include innovation, new product development and utilization of intellectual capital. This should be a phased expansion of the program's budget and staffing into areas of marketing, finance, and business model development beyond simply new product development and process adoption.

EDA and innovation. Increase the Economic Development Administration (EDA) budget for incubators and allow funds to be used for entrepreneur support programs in those incubators, not just brick and mortar.

Create a knowledge tax credit to pay workers to take training. This could be a part of the proposed job sharing program where unemployment insurance funds are used for part of a workers salary to compensate for lost hours. Or the tax credit could be changed to a payment in lieu so companies receive an up-front payment. This would have the dual effect: It would increase our human capital -- a major input to the innovation ecosystem. And it would immediately increase consumer demand as companies would use the funds to pay workers to take classes (thereby creating more employments slots for others to fill the working hours of those in the classes).

Expand the R&D tax credit to include process R&D. Currently expenditures on product R&D are eligible for the credit tax law but not expenditure to develop new production machines or processes to increase productivity. Offer a bonus credit for expenditures over next two years.

Up front funding for clean manufacturing. Modify the current tax credit for clean energy technology manufacturing facilities to be an up front payment in lieu so that companies who are trying to build facilities like wind turbine manufacturing facilities can get the start-up cash they need. Such a payment in lieu of tax credits was already created for alternative energy production facilities in Section 1603 of the America Recovery and Reinvestment Act.

SBA loans to fund innovation. Explicitly change Small Business Administration (SBA) underwriting to allow companies to use their IP as collateral on loans. SBA already allows funds to be used to buy intangibles as part of the acquisition of a company by a new owner. Allowing IP to be used as collateral will increase the amount of funds a high-tech company would qualify for.

Create an IP-back loan fund. China has developed a special program to encourage IP-based finance. A similar program in the U.S. should be set up on a pilot bases. The program could be run by the SBA, to take advantage of their lending expertise. Technical support could be provided by the SBA's Office of Technology, which coordinated the Small Business Innovation Research (SBIR) program and the Commerce Department's National Institute of Standards and Technology (NIST), which runs the Technology Innovation Program along with other science and technology related activities. Such a direct lending program would be a step beyond SBA's current loan guarantee programs. Direct lending is necessary, however, to jump start the process. Once the process of utilizing IP as collateral was fully established, the program could be converted to a loan guarantee program.

Improve technology transfer. Review the technology transfer laws, including Bayh-Dole, to make sure that they support spin off companies from universities and federal labs, not just licensing of intellectual property.

Support "design thinking." Enable the National Science Foundation's (NSF) Engineering Research Centers program to support the creation of Design Research Centers as well as promote research and teaching of integrated design thinking. Innovation success is heavily reliant on design as a key component but not simply involving the physical appearance of products. A new approach to applied problem solving and innovation is emerging under the rubric of design thinking. Successful models include the Stanford Design School and the Institute of Design at the Illinois Institute of Technology (IIT), among others.

Improve innovation metrics. Endorse, operationalize, and fund the recommendations of former Commerce Secretary Gutierrez's Advisory Committee on Innovation Measurement in the 21st Century. Among other things, this means supporting and accelerating efforts of the DOC's Bureau of Economic Analysis to revise the national economic accounts by converting intangible business assets (R&D, software, intellectual property, human capital, brand identification, and organizational capacity) from expenses to investments with future returns. Although Federal Reserve Board staff studies--corroborated by similar analyses in the UK and Japan--find that intangible investments exceed spending on plants and equipment and account for a significant portion of economic and productivity growth, that fact is unlikely to be given full weight in economic policymaking until reflected in the nation's official accounting.

Foster intellectual capital management. Intangible assets are the fuel for innovation. To foster best practices for management of intellectual assets and intangibles in the United States, the relevant federal agencies--such as SEC, Department of the Treasury, and DOC--should establish an advisory committee to make recommendations on ways of providing investors with an improved method for assessing the impact intangibles have on the accuracy of a company's financial picture and supporting industry trade associations in an effort to adopt guidelines for intellectual asset management and intangible disclosure appropriate to particular industry sectors.

Increase disclosure of intangible assets. The Securities and Exchange Commission (SEC) should be asked to undertake a study examining barriers to disclosure of intangible assets on corporate financial statements, assess past disclosure requirements (such as the 2003 guidance on the Management's Discussion and Analysis [MD&A] section in financial statements), and the merits of a safe harbor for limited disclosure of financial information on intangibles not currently allowed in financial statements.

Fund National Academies study on intangibles. As proposed at a June 2008 conference sponsored by the Bureau of Economic Analysis (BEA) at the National Academies, a broader study of intangibles could include (1) a survey of efforts in other countries to advance the understanding of intangibles and their role in corporate performance and economic growth, promote financial investments in intangible assets, and foster the utilization of intangibles; (2) an inventory of federally owned intangible assets and how to exploit them for economic growth; and (3) recommendations of policies to accelerate private investment in and management of the types of intangible assets most likely to contribute to growth.

Manage government intangible assets. Undertake a budgetary cross-cut of government investments in intangible. The federal government is a major investor in intangibles, but we don't know the size of that investment or even where it really goes. For some time the federal budget, as prepared by the Office of Management and Budget (OMB), has included a capital budget that includes physical capital, R&D, and education and training. The budget documents also include a separate analysis of funding of statistical agencies, which is not included in the investment budget. These and other budget analyses already undertaken by OBM can serve as the starting point for a cross-cutting budgetary analysis of federal investments in intangible assets.

Put in place a process for assessing longer term actions, including:
 • establishing an analyze capability for reviewing regulatory activities with an innovation impact;
 • better managing the allocation of R&D spending among and within federal agencies through a joint OSTP and OMB review agency spending plans in key areas with an eye to making mid-course adjustments;
 • strengthening the White House role in reviewing and balancing intellectual property policy as broadly defined;
 • consider establishment of a National Foundation for Science, Technology, and Creativity patterned after the United Kingdom's National Endowment for Science, Technology and the Arts (NESTA);
 • greater use of government procurement to push new business models, including use of new collaborative work tools, such as Virtual Worlds.

The expectations game

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It is widely understood that the expectations game looms large on Wall Street. Miss your earnings target by even a small amount, and it doesn't matter how well you really did - your stock price gets hammered. Case in point is this morning stock market lead in the online Wall Street Journal - Dell Results Depress Stocks: "Stocks opened weaker Friday, hurt by Dell's worse-than-forecast drop in net profit."

The same game gets played in Washington on the economy. Case in point is the most recent leading indicators. According to the Conference Board, the Index of Leading Indicators rose 0.3% in October, after a 1.0% rise in September and a 0.4% rise in August. Here is the analysis of the data in the press release:
Says Ataman Ozyildirim, Economist at The Conference Board: "After half a year of consecutive increases, the month-to-month growth of the LEI is stabilizing and the gains continue to be broad-based. Meanwhile, the coincident economic index has been essentially flat since June, after declining since November 2007. The composite indexes suggest the recovery is unfolding and economic activity should continue improving in the near term."
Says Ken Goldstein, Economist at The Conference Board: "The data indicates that economic recovery is finally setting in. We can expect slow growth through the first half of 2010. The pace of growth, however, will depend critically on how much demand picks up, and how soon."
In other words, the economic is recovering, slowly. What is the standard press response? The headline of the AP story in the New York Times: U.S. Economic Indicators Weaker Than Expected. Why? Because a poll of economist expected a rise of 0.5%!

So, what is the real story here? Is it "Economy Bad"? Or is it "Economists Guess Wrong"? I would argue for the latter. Unfortunately, the expectations game has taken root -- so the story that is running in the media is the former.

I have to say, I am guilty as well. In my monthly trade and employment postings, I including the economist estimates. I do so because it gives some indication of how the numbers will be perceived. I will have to rethink that.

Grand challenges - expanded

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Catching up on some older news, BusinessWeek ran a special report a couple of weeks ago on Growth Through Innovation. One of the interesting features was a slideshow on Obama's 25 ways to Rebuild America. Right now, there is a lot of talk in Washington about the next jobs and economic agenda -- including what to do to spur innovation. I've been to numerous meetings and conferences trying to come up with and refine specific policy ideas. The BusinessWeek list is different. It takes of a technology and industry specific (industrial policy?) approach. Other than the idea of using prizes, such as the X-prize, the entire list is of technological challenges in areas such as energy, environment, health, and transportation. The BusinessWeek list looks an expansion of the "Grand Challenges" described at the end of the Obama Innovation White Paper released a few months ago (see earlier postings). So there seems to be some consensus. The question now, of course, is what are the mechanisms for addressing those challenges. There are a number of policy tools -- from direct funding of R&D to loans for production to government procurement to prizes to regulations. Figuring out the appropriate mix of policies will be the real challenge.

By the way, the Business Week special report has more on innovation than just these Grand Challenges. For example, in includes an essay by Roger Martin on his new book, The Design of Business. More on that later.
Newsweek is running a story on a poll (co-sponsored with Intel) on public attitudes toward technology and economic growth. Not surprisingly, most people think technological innovation is an important factor in economic growth. Interestingly, more American's think technology will be more important in the coming decades than do Chinese (78% of Americans; 61% of Chinese). In somewhat of a surprise, the Chinese have a stronger belief than Americans that the US will remain the technology leaders in the future.

There was one part of the poll I found most surprising - and disturbing. When parents in the two nations were asked what was the most important skill their children needed to drive innovation in the future, the answers differed dramatically. 52% of American parents said "math and computer science"; only 9% of Chinese parents did. But 45% of Chinese parents said "creative approaches to problem solving" while only 18% of American parents did.

Is America on the wrong side of the future? Don't misunderstand, STEM (science, technology, engineering and mathematics) is important. But the heart of innovation is not technical skills but problem solving.

Of course, it may be the case that the public is simply responding to the rhetoric of recent years. In the US we have been complaining about the problems with STEM, while the Chinese have been criticized for lacking creativity and attention to entrepreneurship.

But fixing the problems is not the same as being attentive to priority factors. With American parents putting priority of math and computers over problem solving, we run the risk of failing to build on our strengths. If that is the case, I fear that we have so narrowed our definition of "innovation" to technical activities that we have lost the big picture.

China and IP finance

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In our most recent report, Maximizing Intellectual Property and Intangible Assets: Case Studies in Intangible Asset Finance (also in pdf version), we mentioned that China has been active in IP-backed financing. The report specifically cites a Chinese program to make loans backed by patents as collateral. Over at the IAM blog, Joff Wild goes into some more new details in his posting "China emerges as a world leader in IP finance." He also raises some important questions about these loans:
What we do not know about what is happening in China is how decisions are made as to which companies should qualify for the money being offered, except that it is designed for SMEs which may otherwise struggle to attract support from the banks. How, for example, is the relevant IP assessed in terms of its valuation, its potential application and, particularly important in China I would have thought, its vulnerability to copying?
Joff highlights one particular issue about the government's involvement:
in the end for these loans to mean anything the banks doing the loaning have to be making a commercial decision; otherwise all we are really talking about here are government subsidies.
So, the key is the underwriting standards. If the banks have solid standards, the Chinese can be an example to the rest of the world. If not, this may just be another example of tech-mercantilism.

Tinkering and innovation

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And speaking of user-driven innovation, check out this story in last week's Wall Street Journal - Tinkering Makes Comeback Amid Crisis. The article describes a new trend toward making things:
Engineering schools across the country report students are showing an enthusiasm for hands-on work that hasn't been seen in years. Workshops for people to share tools and ideas -- called "hackerspaces" -- are popping up all over the country; there are 124 hackerspaces in the U.S., according to a member-run group that keeps track, up from a handful at the start of last year. SparkFun Electronics Inc., which sells electronic parts to tinkerers, expects sales of about $10 million this year, up from $6 million in 2008. "Make" magazine, with articles on building items such as solar hot tubs and autopilots for robots, has grown from 22,000 subscribers in 2005 to more than 100,000 now. Its annual "Maker Faire" in San Mateo, Calif., attracted 75,000 people this year.
The story does on to highlight a number of there shared workshops and their products -- from bicycle-sprockets to 2 wheel electric cars to robots.

In large part, this trend is being fueled by new tools for rapid prototyping -- including 3D printers -- and access to cheaper versions of more traditional tools like milling machines. But there is also something else going on. As the story notes:
There were 27% more undergraduates who earned mechanical-engineering degrees in 2008 than in 2003, according to the American Association of Engineering Societies. Over the same period, the number of computer-engineering graduates slipped by 31%.
Maybe, just maybe, the trend to "tinkering" is the future of a manufacturing revival in America?

TI and user driven innovation -- not

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Later today, I'm off to a workshop on user driven innovation (see DataMaven for details). Open and user driven innovation is the hottest topic in both business and policy circles today.

But here comes a story in today's Wall Street Journal that one company, Texas Instruments (aka TI) is actively fighting user driven innovation. Turns out there is an active group of programmers who are turning their TI calculators into multi-function devices:
Calculator hackers are a small band of enthusiasts who revel in making their clunky devices perform sometimes oddball tasks. One has made his work like an Etch A Sketch. Another has programmed his calculator to play a version of the popular videogame Tetris. And another has turned it into a synthesizer.
Somehow, TI thinks this is a bad idea and has sent cease-and-desist letters. TI claims that this is a violation of their intellectual property.

The programmers are fighting back, with the help of the Electronic Frontier Foundation (EFF):
EFF lawyer Jennifer Granick sent Texas Instruments a letter telling the firm to back off. She says the hobbyists have every right to install whatever they want on their devices as long as they're not violating basic copyright laws by tweaking and then distributing Texas Instruments' copyrighted programs.
I must say I an baffled by TI's actions. They seem to be stuck in the old models of IP -- lock it up and throw away the key. Here we have a case of some people vastly expanding their product as a platform -- for free no less. And TI is trying to shut this down!

TI is missing a wonderful opportunity. Rather than shut down these new programs, they should embrace them. Think iPod/iPhone: call them "apps" and set up a website where they can be distributed (and by the way, you can check to make sure they aren't distributing proprietary parts of the software).

What an example of open versus closed innovation. Too bad TI is on the wrong side of history on this one.

Pet peeve: what is technology?

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The Wall Street Journal today ran a story about Boeing's continuing problems using advanced materials in its new 787 Dreamliner. As soon as they fix one problem arising from the use of composite materials, another one seems to be created. As the story notes, "Boeing's use of composites throughout the Dreamliner is the most extensive use of these materials ever attempted in a large commercial jetliner."

So, where does the Journal place this story? In the "business" section, of course. But not also in their "technology" section. Apparently, the trials and tribulations of pushing the envelope in advanced materials is not "technology." Nor is news about the nation's largest aerospace company, which is also the source of most of our exports of advanced technology products.

For the Wall Street Journal, "technology" means almost exclusively information and communications technology -- with a little bio-tech thrown in. I don't mean to pick on just the Journal. This mindset is widespread. Unfortunately, it is also limiting. By narrowing the definition, we narrow our imagination. Thus we get caught in a conversation on public policy that is built on the follow unstated assumption: "innovation" = "technology" = "information and communications technology."

It is bad enough that other forms of innovation get left out. It is worse when other areas of technology, just as advanced materials, are also dropped from the conversation.

Training time rather than job sharing

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In his column today -- "Free to Lose" -- Paul Krugman comes out in favor of trying a job sharing program. Let me suggest an alternative: paid training time. As I've suggested a couple of times before, we should be paying workers to be in training programs. The job sharing programs compensate workers for lose wages due to working fewer hours. Rather than reduce their hours, we should use those hours for training. It can be on-the-job training or classroom training.

This would have the dual effect: It would increase our human capital -- a major input to the innovation ecosystem. And it would immediately increase consumer demand as companies would use the funds to pay workers to take classes (thereby creating more employments slots for others to fill the working hours of those in the classes).

As I have said over and over again, rather than pay workers to stand in unemployment lines or stay at home, let's pay them to sit in a classroom.

September trade in intangibles

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The September trade data from BEA, released this morning, showed an increased in the deficit to $36.5 billion, up from August's revised deficit of $30.8 billion. The deficit was greater than expected. According to the Wall Street Journal, "Economists surveyed by Dow Jones Newswires had expected the September deficit would widen to just $32 billion." The increase was due to imports growing much faster than exports. The deficit increased for both petroleum and non-petroleum products as imports surged. This reverses the trend toward an improving trade deficit that occurred during the recession. Thus, it raises the concern that the economic downturn may not have any lasting impact on the trade deficit. As a side note, it probably also means that the 3rd quarter GDP numbers may be revised downward, as a deficit counts as a negative on economic growth.

Our intangibles trade surplus was essentially unchanged. As was the case in August, exports and imports of both business services and royalties rose. But, once again, the increases was so slight that the intangible trade balance has essentially remained unchanged for the past 8 months -- hovering at about $11.1 billion.

Our deficit in Advanced Technology Products also worsened slightly with the September deficit rising to almost $6 billion. Increased exports in aerospace were more than offset by increased imports of biotechnology, life sciences, information and communications technologies, and optoelectronics. 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.

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Intangibles versus Goods
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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.

Agriculture as a knowledge intensive activity

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I have often complained about the overly simplistic framework of economic "advancement" that is generally used - that is agriculture was replaced by manufacturing which is being replaced by services. Here is an example from Simon Johnson, the former chief economist at the International Monetary Fund. When asked repeatedly about the erosion of manufacturing on the Wall Street Journal Economix blog, his answer was don't worry about manufacturing:
Economic development involves moving from agriculture into manufacturing and, later, from manufacturing into services.
I don't mean to pick on Mr. Johnson, this is the standard economic orthodoxy. It is also incredibly misguided.

The actual change was much more dramatic and interesting. Manufacturing did not replace/eliminate agriculture; it transformed it. Agriculture, like every other economic activity, became mechanized and industrialized. At the same time "services" also become mechanized and industrialized.

Now, information and knowledge (often grossly lumped in as "services") is transforming economic activity, such as those we now referred to as agriculture and manufacturing. That transformation in agriculture to a more knowledge and information intensive activity is illustrated in two stories in the most recent edition of the Economist.

The article Harvest moon describes the use of satellites:
For farmers, working out the optimal amount of seed, fertiliser, pesticide and water to scatter on a field can make, or break, the subsequent harvest. Regular laboratory analyses of soil and plant samples from various parts of the field can help--but such expertise is costly, and often unavailable. A new and cheaper method of doing this analysis, though, is now on offer. Precise prescriptions for growing crops can be obtained quickly, and less expensively, by measuring electromagnetic radiation reflected from farmland. The data are collected by orbiting satellites.
The second article Nanobiotechnology: Seeding the seedsis about fertilizer:
Manure, compost and ash were used as fertilisers for centuries before the 1800s, but people did not understand how they worked until the science of chemistry was developed in the 19th century and it became clear that they supply plants with nitrogen, phosphorous and potassium. Today, something similar may be happening with a different sort of fertiliser altogether. For reasons that are not yet entirely clear, it looks as though exposing seeds to carbon nanotubes before they germinate makes the seedlings that subsequently sprout grow faster and larger.
In exactly the same manner, manufacturing is becoming a knowledge intensive activity.

So keep in mind those farm watching satellites and nanotube fertilizers when some one describes agriculture or manufacturing as sectors of the past. They obviously don't yet understand.

SCOTUS and business patents

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Yesterday, the Supreme Court hear oral arguments in the re Bilski case on business process patents (see earlier postings - and see the IAM blog for other coverage). Reading the Court's tea leaves is always a risky undertaking, but the general impression that the Justices are leaning toward narrowing the scope of business patents. Several Justices poised hypothetical questions about the patentability of certain ideas. According to the Washington Post:
some of the justices seemed to be skeptical of the claim, asking incredulously whether giving patents for some business methods might mean giving patents for new ways of teaching a class, or even horse whispering.
"Let's take training horses," Justice Antonin Scalia said. "Don't you think that some people, horse whisperers or others, had some, you know, some insights into the best way to train horses? And that should have been patentable on your theory."
"They might have, yes," [Bilski and Warsaw attorney J. Michael] Jakes said.
Likewise, Justice Stephen G. Breyer noted that he has a "wonderful" way of teaching antitrust law.
"It kept 80 percent of the students awake," he said. "I could probably have reduced it to a set of steps and other teachers could have followed it. That, you are going to say, is patentable, too?"
"Potentially," Jakes said.
As the New York Times noted:
Justice Kennedy described the beginnings of the insurance industry in the late 17th century, thanks to the development of calculus and the ability to create actuarial tables. "It's difficult for me to think Congress would have wanted to give only one person the capacity to issue insurance," he said.
Still, one should not read too much into these comments. The patentability of embedding business process ideas in software is still open. The Times reports that the Chief Justice raised that based on a footnote in the government's written argument. And Justice Ginsburg apparently noted that the case could be decided on narrow grounds. So the final decision may not be the final word on business patents.

Biotech patent securitization

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While intangible asset securitization has been quiet, is it not extinct. Last week, PDL BioPharma, Inc. announced that it closed on $300 million securitization of some of its patents. From what I can tell, it looks like exactly the type of straightforward transaction the market needs right now. Here are the details of the transaction, from the press release:
Under the terms of the securitization transaction, PDL sold to QHP Royalty Sub LLC ("QHP"), a newly-formed wholly-owned subsidiary of PDL, certain rights under its non-exclusive license agreements with Genentech, Inc., a wholly-owned subsidiary of Roche Holding, Ltd., including the right to receive 60% of the royalties from sales of Avastin® (Bevacizumab), Herceptin® (Trastuzumab), Lucentis® (Ranibizumab) and Xolair® (Omalizumab) and from sales of future products, if any, for which Genentech may take a license under the related agreements with Genentech.
QHP issued $300 million in aggregate principal amount of its QHP PhaRMA(SM) Senior Secured Notes due 2015 (the "Notes") in a non-registered offering pursuant to Rule 144A. The Notes bear an interest rate of 10.25%. The royalties and other payments, if any, that QHP will be entitled to receive under the agreements with Genentech, together with any funds made available from certain accounts of QHP, will be the sole source of payment of principal of, and interest and premium on, the Notes, which are secured by a continuing security interest granted by QHP in its rights to receive payments under such agreements and all of its other assets and a pledge by PDL of its equity ownership interest in QHP. The Notes may be redeemed at any time prior to maturity, in whole or in part, at the option of QHP at a make-whole redemption price.
Note the relatively high interest rate of 10.25%. That means that the market still sees these deals as risky. So we are still a long way away from intangibles entering the financial mainstream. But, on the bright side, the market is still alive.

Why not reporting intangibles hurts

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Michael Mandel over at Business Week makes an excellent point is his posting on Ford's recent earning announcement:
The company reported that it:
...reduced its Automotive structural costs by $1 billion in the quarter, largely driven by lower manufacturing and engineering costs, which included benefits from improved productivity, personnel reduction actions primarily in North America and Europe, and progress on implementing its common global platforms and product development processes.
So this leaves two questions: First, how much of these cost reductions came from cuts in intangible investments such as engineering, research and development?

The answer is: The earnings report doesn't tell us. R&D and product development are not broken out separately on a quarterly basis, even though Ford has had an enormous budget for these items ($7.3 billion in 2008, according to the 10K).
In other words, we have no idea whether Ford is cutting fat or muscle. The entire point of the financial reporting system is to give the owners - the shareholders -- information about the future prospects of the company. If our financial reports can't differentiate between streamlining costs and eating the seed corn, what use are they?

October employment

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BLS's October employment data showed a jump in the unemployment rate to 10.2%. Payrolls declined by 190,000 - which was much less than the 263,000 jobs lost in September but worse than expected. According to the Wall Street Journal, "Economists had expected a 175,000 decrease." Note that even if the number had come in as expected, the unemployment rate would still have climbed over 10%. And once again, the data on the number of involuntary underemployed (part time for economic reasons) was disappointing, rising slightly. All in all, not good news.

Involuntaryunderemployed-1009.gif

Buffett's Bet

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Yesterday's announcement that Warren Buffet (actually Berkshire Hathaway) is buying a railroad has touch off some competing views. The optimistic view is illustrated in a Wall Street Journal article:
Berkshire Hathaway Inc.'s planned purchase of Burlington Northern Santa Fe Corp. represents a bet that upcoming Washington policies to improve infrastructure and combat climate change will be a boon to the freight-railroad industry.
But Michael Mandel at Business Week has a different, more pessimistic, take:
In essence, Buffett is betting that the next ten years will look a lot like the last ten: A lot of growth in imports, construction, energy and agricultural products. If he thought that innovation was going to be the driver of the next ten years--biotech, energy, and infotech--he wouldn't be buying Burlington Northern.
I tend to agree with the more optimistic view. Leave aside the fact that Buffet does not invest in tech stocks because he says he does not understand them. The issue is whether physical infrastructure is still a factor in the knowledge society. I believe it is. Movements of goods are still important and the demand for the services of railroads will continue. It is not either bits or atoms. It is both. Just as a transformed manufacturing section will remain a key in the knowledge economy, so will transformed railroads. Take the example of agriculture. Agricultural has gone from a hand/animal activity to being an industrialized activity and is on its way to becoming a knowledge using industry. Thinking about innovation and future technology development should not be limited to only a couple of sectors - what I call the "high-tech" fallacy.

So I could out with thinking Buffett's bet is a god deal for both him and the future of the US economy. It should improve our physical infrastructure - and that is an important part of the knowledge economy.



FYI: for some news comments on this storry, see this video from Newsy.com

Update on Skype

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I've posted a number of items over the past few months on the Skype patent lawsuit -- because it illustrates the importance of properly managing intangible assets. According to the New York Times, the End to a Fight Over Skype May Be Near:
The legal settlement, according to two people briefed on its outlines, would restructure the group that is buying Skype. Niklas Zennstrom and Janus Friis, who created Skype and sold it to eBay in 2005, would take a significant stake in the new Skype.
In other words, the parties who brought the lawsuit will get what they want -- not infringement damages but backing to the game of owning Skype.

So the case may end up begin an illustration of a different point about management of intangibles. Infringement cases aren't necessarily about infringement. They are tools in a broader strategy - which is why critics of the current patent system say there is so much defense patenting. It is also interesting to note that the proposed settlement isn't even with eBay but between the proposed buyers and the want-to-be buyers. eBay may have fumbled with the management of their intangibles - but it looks like they we come out of this on top.

Recharging small business - invest in intangibles

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This morning, Mark Zandi, chief economist at Moody's Economy.com, has an op-ed in the New York Times "Help Small Businesses Hire Again." He argues that more needs to be done to ease the credit crunch facing small business and to promote job sharing in small businesses as an alternative to layoffs. Both of these are excellent suggestions. Let me add two extensions to those ideas: improving credit flow by monetizing intangibles and increasing worker training through a knowledge tax credit or training subsidy.

On increasing credit, I will refer you to the report we published yesterday Maximizing Intellectual Property and Intangible Assets: Case Studies in Intangible Asset Finance (also in pdf version). That report looks at the emerging new means of financing innovation based on intangible assets in public, private and venture capital markets. Intangible assets have become a valuable asset class. In response, firms specializing in intangible-based financing are springing up, using them to raise capital for the next round of innovation. The paper details equity, equity-debt, debt, and sale-leaseback transactions, both private and public, that have helped companies raise capital, based on careful, rigorous analysis and conservative underwriting standards. The paper also touches upon what can be done to promote these financial tools, including recommending that SBA work with commercial lenders to develop standards for using intangible assets as collateral. By better understanding and utilizing intangibles assets as collateral, SBA could quickly and safely increase the flow of credit to small businesses.

The job sharing idea is especially interesting. Small businesses have a different level of intangible assets in their workforce. In a small business, key skills are more likely to be concentrated in a few employees, simply because there are fewer of them with fewer opportunities to have multiple people with the same skill sets. Loss of that concentrate firm specific knowledge can be more harmful to a small business than a larger one. Retaining those skills is critical for future growth. In addition, as Zandi notes:
Nothing damages morale at a company more than layoffs; the experience not only is crushing for those who lose their jobs, but also weighs on those who remain, including managers. Layoffs are also costly, given severance expenses and the costs of rehiring or training new employees when business picks up again.
Under his proposed job sharing plan, workers would reduce hours with portion of the workers' lost wages covered by unemployment insurance (UI). But why should those workers simply remain idle? As I've said before, lets have them sitting in a classroom rather than standing in an unemployment line.

We can tie training to job sharing in two ways. The UI payments could be greater if the worker is in training during the "shared" hours. As either an alternative or in conjunction with UI payments, the companies could be given a tax credit for the cost of the training -- for both direct costs and the payroll cost of those workers participating in the training. The program could even be taken a step beyond a tax credit. As with a recent change to clean energy tax credit, the tax credit could be front loaded by either offering payments in lieu or allowing monetization of the tax credit in the financial markets (see earlier posting). This way, small businesses would get the money as they need it to pay the workers in the training program.

Importantly, the training need not be off-site. On the job training at the small business location should be covered as well.

In this way, those "lost" hours from job sharing aren't lost at all. They are an investment in future growth. The knowledge credit covers both the short term problem of maintaining incomes in a downturn and the long term problem of improving skills needed to maintain competitiveness.
As innovative companies struggle to raise funds, intellectual property and intangible assets are providing alternative ways of financing innovation. But greater awareness of them as an asset class is needed. Raising that awareness is the focus of a new report from Athena Alliance, Maximizing Intellectual Property and Intangible Assets: Case Studies in Intangible Asset Finance (also in pdf version) by Ian Ellis, a former U.S. Department of Commerce official specializing in intellectual property and international trade. The report outlines increasing, but still nascent, means of financing innovation based on these assets in public, private and venture capital markets. As industry has invested capital in research and development to develop new technology and advance other creative activities, intellectual capital has become a valuable asset class, according to the paper. In response, firms specializing in intangible-based financing are springing up, using them to raise capital for the next round of innovation.

The paper details equity, equity-debt, debt, and sale-leaseback transactions, both private and public, that have helped companies raise capital, based on careful, rigorous analysis and conservative underwriting standards. For example, the author notes that in 2000, there were two public deals using royalty securitization, raising $145 million. In 2007-08, $3.3 billion was raised in 19 deals.

Unlike some of the exotic financial vehicles, however, the financial products discussed in this report are some of the most basic financing mechanisms in business. The innovation is in recognizing the value of intangible assets for corporate finance. These new financial firms are using traditional financial techniques in new ways to help innovative companies.

But more should be done.

One important step would be developing sound, industry-wide, underwriting standards, according to the report. For example, Small Business Administration (SBA) rules permit its loans to be used for acquisition of intangible assets when buying on-going businesses. Rules are unclear on whether those assets can be used as collateral. The paper recommends that SBA work with commercial lenders to develop standards for using intangible assets as collateral.

The report builds on earlier Athena Alliance papers, notably Intangible Asset Monetization: The Promise and the Reality. A summary of the public policy recommendations in that report are available in an earlier posting.
    Note: the views expressed here are solely those of the author and do not necessarily represent those of Athena Alliance.


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