Patents, Spotify, and Incentivizing Innovation

💊 PATENTS AND INCENTIVIZING INNOVATION

Tuesday brought decisions from both patent cases argued in front of the Supreme Court this term, Oil States Energy Services v. Greene’s Energy Group and SAS Institute v. Iancu. At issue in both cases was the process of inter partes review (IPR), which was instituted in 2012 after the passage of the America Invents Act. The process allows a competitor to bring call for an IPR, which, if institute, initiates a trial-like process engaging both parties. The USPTO has the sole discretion in reconsidering and potentially invalidating the patent at issue.

In Oil States v. Greene’s Energy, the question before the Court was whether the adjudication of IPR petitions by the USPTO is an exercise of the “judicial power” that under Article III of the Constitution can be exercised only by courts. The Supreme Court’s resident patent expert, Justice Clarence Thomas, wrote the opinion, holding that IPR does not violate the Constitution. Thomas wrote that because patents are a public right and the IPR process is simply a reconsideration of that grant, Congress has the authority to conduct the reconsideration. There has long been an academic argument about whether patents are public (e.g. statutorily created) rights or private (e.g. common law) rights, with Justice Thomas falling on the former side of that debate. But, Thomas was careful to articulate that the decision should not be misconstrued as suggesting that patents are not property for purposes of the Due Process Clause or Takings Clause.

According to Court documents, the IPR process has been used to invalidate some 1,300 patents since 2012. Tech companies are largely please with the decision, as it allows them to continue to use the IPR process to challenge patents instead of having to undergo long, drawn out litigation against alleged patent trolls.

But, pharmaceutical and biotech companies are more worried about the ruling, fearing it may open the door for competitors to more easily (and cheaply) invalidate patents through IPR. This gets to the difficulty of treating two fundamentally different industries (tech/internet companies and pharm/biotech companies) with different business models the same when it comes to intellectual property.

For modern tech companies, potential returns are much greater. Modern internet companies are driven by network effects that can generate massive returns to scale for innovation. They’re able to spread fixed costs over a massive user base that can scale quickly. Meanwhile, Moore’s Law (yea, I went there) implies that R&D cost, on a per unit basis, continues to decline for computing-based R&D.

On the other hand, evidence suggests that biotech and pharmaceutical R&D is only getting more difficult and more costly. Some have even referred to drug discovery as operating under a “reverse-Moore’s law,” and while machine learning may facilitate the drug discovery process, this promise is largely unfilled as of yet.

The Constitution gave Congress the power to “promote the progress of Science and and useful arts,” but the reality is spurring innovation requires different tactics in different industries. We can quibble about how strong patents should be in the biotech and pharmaceutical industries, but the heavy capital investment required to innovate in these sectors necessitates some statutory protection. But, the case for government-granted monopolies (patents) for software innovations is much more tenuous.

While we wait for the merging of software and biology (or, for software to eat biology), it’s important to recognize the different capital structures at play for different industries and structure incentives accordingly. We don’t need the government to incentive investment in the next “one-click buying” patent, but we do need to incentivize continued commercial investment in biological R&D. Government-granted monopolies are an impure means to an end (innovation), and it’s important to critically evaluate when and where they should actually be issued.

The second, less exciting opinion held that when the USPTO institutes an IPR process to review an already issued patent, it must decide the patentability of all claims the petitioner has challenged.

Photo by freestocks.org on Unsplash
Some inventions require patents (above). Some don’t. Photo by freestocks.org on Unsplash.

🎧 SPOTIFY THE HITMAKER

On April 24, Spotify announced its new free tier with a few major changes. First, it’ll recommend music to users on the fly using its machine learning. Second, and more importantly, it’ll let free-tier users listen on-demand to whatever song they want, as many times as they want, if the song appears on one of Spotify’s 15 personalized discovery playlists. These playlists account for about 750 tracks in total.

As I wrote after Spotify filed its F1, its success depends largely on its ability to cut out the music labels, whose content currently accounts for 87% of content streamed on Spotify. With the overhaul of its free tier, Spotify is attempting to mint new hints, allowing the 90 million users of its free tier to listen to certain songs, selected by Spotify, as often as they want. Spotify’s success depends in large part on its ability to serve as a platform for new or up-and-coming artists, helping users discover new artists while at the same time helping new artists get discovered. It’s a beneficial relationship for both listener and musician, with Spotify sitting in the middle taking a cut of the transaction. Providing free users access to unlimited listening of select songs drastically increases Spotify’s ability to be a hitmaker.

Apropos the patent discussion above, note that while Spotify has patents related to its machine learning and recommendation algorithms, these may not be essential to its business. The fact that it has 160 million total users makes the cost of acquiring these patents relatively trivial. Either way, the data Spotify continues to gather on its users is much more valuable (and protectable) than any patent it may or may not have acquired.


🎬 NETFLIX THEATRES?

From one subscription media business to another. Reports have emerged that Netflix is looking for ways to get into the movie theatre business. While it may not be interested in Mark Cuban’s Landmark Theatres anymore, it sounds like Netflix wants to get some of its productions in theatres so it can qualify for awards. Jeff Bezos has long been obsessed with garnering awards with his Prime Video service, so it seems he’s not the only one with a complex (the Prime Video section of his shareholder letter is basically one long sentence about how awesome Prime is because of all the meaningless awards its various shows received).

Of course, Netflix (and to a lesser extent, Prime Video), are successful illustrations of the “laddering up” strategy that Spotify is now pursuing. That is, they built businesses off of licensing copyrighted content from TV and movie studios, building a war chest to invest in their own original content and cut out the middle man.

But, there may be differences between music and video that make this strategy harder for Spotify. Namely, old music still holds a ton of value, while old TV shows and movies are less valuable. I love to bump the Beatles, but only watch I Love Lucy when I’m home during the holidays and my mom makes me.


🦅 Bird’s Eye View. In China, facial recognition technology was used to spot a man in a crowd of 60,000 concert goers.

💡 From the Printing Press to the Internet. A chart showing productivity from 1440 printing press to today. Other academics have studied causes of the productivity slowdown since 2004, illustrating it’s more than just a “measurement problem” (Business Insider, Marginal Revolution).

Advertisements

The Bundle is Back 🗞

From Spotify to Apple News, bundles are back; are they better than ever?

One of the business world’s great apocryphal sayings goes something like this: “there are only two ways to make money in business: One is to bundle; the other is unbundle.” Netscape founder Marc Andressen attributes it to his buddy Jim Barksdale.

A recent spate of bundling news makes it clear that a new age of bundling is upon us:

  • Hulu and Spotify announced a $12.99/ mo bundle that includes unlimited access to both services. It’s a nice savings, as Hulu (with ads) cost $7.99/ mo and Spotify premium costs $9.99/ mo. It’s an expansion of the two companies’ partnership: last year, they offered a student bundle for $4.99/ mo.
  • On the heels of acquiring Texture, “the Netflix of magazines,” there are now reports that Apple is working to launch a subscription news in its Apples News app later this year. Apple has recently been pushing to bring in more revenue from its Services (think App Store and Apple Music), so this move fits in line with its broader strategy. Speaking of Apple Music, it was also recently reported that Apple Music now has 40 million subscribers, creeping towards Spotify’s 70 million.
  • Comcast and Netflix announced that customers will soon be able to add a Netflix subscription to new and existing Comcast Xfinity packages.
  • Medium’s Ev Williams wrote about the Medium model, bragging that it’s “one of the largest bundles of original content of its type, so it’s a great value for readers.” Medium launched its subscription model a year ago, and apparently it’s going great (graph without a y-axis be damned).
  • Jeff Bezos revealed in his annual shareholder letter that Amazon Prime – the bundle of all bundles – has over 100 million subscribers. By tacking on benefits at recently acquired Whole Foods, the scope of the Prime bundle continues to expand.

In addition to Netflix and Spotify proving that subscription bundles can work, the recent fire Facebook and other ad-driven companies have come under has give the bundle even greater tail winds.

Meanwhile, with the official launch of ESPN+, the sports broadcasting giant has dipped its toes in the water of the over-the-top future, albeit cautiously. ESPN won’t offer many of its flagship sporting events on ESPN+, indicating a reluctance to fully embrace a digital future. Despite staff upheaval and non-stop talk of “cord cutters,” ESPN’s cable TV business remains profitable. Further, ESPN owns (and continues to bid on future) rights to sporting events, meaning it has an intellectual property moat that others don’t necessarily have. Sporting events need to be seen live, while very few other events do. As such, ESPN doesn’t want to make the shift to digital too soon, thereby undercutting its existing cable business before it needs to do so.

Really though, the pendulum swinging from bundled to unbundled and back again is a reflection of the underlying technology: in the early 2000s we all carried around individual songs on our iPods. They took forever to update – and we had to hardwire the iPod into our PC – so it was fine if we just bought a few songs. Then, as cloud storage and streaming became technically (and economically) feasible, consumers shifted to streaming services. Chris Dixon has a great explainer on bundling economics here, but the conclusion is this: in the end, bundling is beneficial for buyers and sellers.

But, bundling can also be used as an anti-competitive mechanism. I recently warned that Google’s Chrome ad-blocker may be an attempt to do this:

This forced tying of products together is what often gets monopolies in trouble with the law, in one way or another. AT&T’s attempt to force consumers to buy its own phones and network attachments was eventually deemed unreasonable and unnecessary by the FCC. Similarly, Microsoft’s attempt to bundle Internet Explorer with the OS eventually caught the DOJ’s attention, leading to a landmark antitrust case. And now Google is attempting to leverage its browser to squeeze the ad blocker market.

Of course, Spotify is nowhere near anti-competitive behavior: it’s not even profitable, and tech giants like Apple and Amazon are nipping at its heels. In fact, the bigger anti-competitive worry is these tech giants that can bundle together any number of services making it almost impossible for startups to compete.

nikita-kachanovsky-571468-unsplash
Sometimes, what’s old is new again. Photo by Nikita Kachanovsky on Unsplash.

THAT’S NOT (WAY)FAIR

On Tuesday, the Supreme Court heard oral arguments in South Dakota v. Wayfair. It’s a case on whether to overrule a 1992 decision that prohibits individual states from requiring out-of-state retailers that do not have a physical presence in the state to collect tax on sales to state residents. States claim they’re losing massive tax revenue. Online retailers are concerned about a patchwork system of state and local taxes, making it hard for them to efficiently conduct business. Since you asked, Amazon already collects sales tax when it sells its inventory through Amazon.com, but when third-party retailers sell through the Amazon Marketplace, the company leaves it up to them to collect the sales tax. Most probably don’t.

Even this Amazon example illustrates that large companies may be better able to collect local tax revenue, and it might be more difficult for small companies or merchants to collect the sales tax, robbing the smaller merchants of a single national marketplace. Thankfully, it seems as though our President has a handle on the matter:


☁️ Microsoft dismissed, but a cloudy future. With the hasty passing of the CLOUD Act, the Supreme Court dismissed a long-running dispute between Microsoft and the Department of Justice that had made it all the way to the Supreme Court.  The CLOUD Act clarifies that warrants for data held by service providers like Microsoft and Google reach data stored anywhere in the world. But, questions over whether Microsoft will challenge the new warrant issued under the CLOUD Act and how foreign governments will react to the new, hastily enacted legislation leaves the potential high for fresh disputes to surface.

The new legislation authorizes the U.S. to enter into bilateral data-sharing agreements for law enforcement purposes, while allowing service providers to move to quash a warrant if they believe there is a “material risk” that the request would violate the laws of a foreign government.

This sets the CLOUD Act on a collision course with international privacy laws like the EU’s forthcoming GDPR. Meanwhile,

Meanwhile, the EU has introduced a similar law, that allow European prosecutors to force companies to turn over data such as emails, text messages and pictures stored online in another country, within 10 days or as little as six hours in urgent cases (Reuters).


👮‍♂️ FCC adviser arrested. Perhaps taking a cue from her boss, broadband adviser Elizabeth Pierce was arrested on charges of tricking investors to dump $250m into a fiber optic scheme by faking contracts (The Verge).

🔑 Post hoc, ergo proper hoc. Visualizing errors and manipulation in logical thinking. Oh, and also it’s “raise the question,” not “beg the question.”

Bourgeois Culture is Dead, So Let’s Stop Talking About It

The internet is bad and boujee, and it’s only accelerating the pace of change

Dear Professor Amy Wax,

I remember when you burst onto the scene as a free speech victim late last year with your op-ed, “Paying the price for breakdown of the country’s bourgeois culture”. Let’s first put aside the irony of an article featuring a photo of John Wayne — a notorious womanizer who was divorced twice and had at least as many affairs — proceeding to talk about how people used to get married and stay married and that was good for society or something. The op-ed itself has been dissected and re-dissected ad nauseum by now.

It’s great to have you back this week with your Saturday Essay, enumerating the ways in which you’ve been oppressed since the op-ed was published. It’s another piece ripe for being ripped apart, but I’ll leave that to others (for the record, your basic point — that we must be able to engage in logical reasoning and civil discourse if we’re to survive is a society — is indisputable). The bigger point to be made is that none of this debate over “bourgeois culture” matters one bit. Technology, namely the internet, has fundamentally changed our society, and longing for 1950s values (or any form of “Make America Great Again-ism”) isn’t going to change that. To your credit, you (and Trump, for that matter) identify the core issue facing our country, perhaps accidentally, then proceed to arrive at exactly the wrong conclusion.

Continue reading Bourgeois Culture is Dead, So Let’s Stop Talking About It