9:30 a.m. - 11:30 a.m.

What Roles Do Antitrust and Intellectual Property Protection Play in Promoting Innovation and Competition? How do Licensing Practices Affect Competition in Various Industries?

Thank you, Commissioners, for the opportunity to testify.

A. Background of the Witness

I am Robert H. Kohn, Senior Vice President of Corporate Affairs and General Counsel of Borland International, Inc., a leading developer and marketer of software development tools, including Delphi, Borland C++, Interbase, dBASE, and Paradox. I have worked in the entertainment and computer software industries my entire career. My experience in the software industry includes many types of application and utility software for both mainframe and desktop computers. After a brief period in private practice and as Associate Editor of the Entertainment Law Reporter, I joined the legal department of Ashton-Tate Corporation in 1983. Until its acquisition by Borland in 1991, Ashton-Tate was one of the largest software companies in the world. In 1985, I became associate general counsel to Candle Corporation, a leading supplier of IBM mainframe software. In 1987, I joined Borland, a publicly traded, Silicon Valley company, as General Counsel. In addition to my day job, I am adjunct professor of law at Monterey College of Law in Monterey, California where I teach Business Organizations.

I want to emphasize that I am sensitive to the need for intellectual property protection on both a professional and personal level. My professional career has focused on protecting the valuable intellectual property assets of software companies. I am also an author myself, having recently written a book on music licensing that was published by Prentice Hall, more about which may be found at Kohn On Music Licensing. So I can certainly appreciate the need to protect intellectual property.

I am testifying today in my capacity as Senior Vice President and General Counsel of Borland, on behalf of whom I want to comment specifically on the question, "What Roles Do Antitrust and Intellectual Property Protection Play in Promoting Innovation and Competition?"

B. Enforcement vs. Scope of Protection

Excellence, said Aristotle, is a mean between two vices, the one by way of excess, the other by way of deficiency. This "doctrine of the mean" is taken to be the philosopher's most distinctive contribution to ethics, and were Aristotle alive today, this same doctrine could well have become his most distinctive contribution to the law of intellectual property.

Like all other software companies, Borland invests heavily in both the creation and acquisition of new software products. And, like other companies, Borland needs strong governmental enforcement of existing intellectual property rights, especially in foreign markets, in order to protect its investment. But it is particularly unproductive, at forums for public debate of these issues, to hear two extreme views espoused: one group, generally small inventors or users, argues for no protection or, perhaps, at best, very weak protection. A second group, generally large companies, addresses the issue of scope rather than enforcement, arguing that broader protection for software is necessary and, indeed, the broader the protection the better.

We believe that much of the polarization you have heard, and will hear, is the result of a confusion over what is being debated. Protectionist interests, in particular, confuse enforcement of what is an undisputed intellectual property right with the underlying scope of intellectual property protection. We in the industry all understand that software, as a product, is particularly susceptible to unauthorized duplication. We therefore need strong enforcement of existing intellectual property rights to make sure that we are protected against the piratical copying and counterfeiting of our software.

But issues concerning the enforcement of intellectual property rights must not be confused with issues concerning the scope of intellectual property protection. It is too easy to wrap oneself in the proverbial American Flag of anti-piracy and anti-counterfeiting enforcement. There is no dispute that strong anti-piracy enforcement is required to promote the resources necessary for research and innovation. But it does not follow that, because strong enforcement of intellectual property promotes innovation, a broader scope of intellectual property protection will also.

We should understand that many of those who very responsibly argue for limitations on the scope of intellectual property protection are not trying to defend pirates. They are, rather, trying to strike a medium under which the proper scope of intellectual property protection, as established by Congress and the courts, is respected and strongly enforced by the administrative branch of government.

C. The Role of Intellectual Property in Promoting Innovation

Intellectual property law endows the owner with a monopoly, -- a monopoly in the form of a legally enforceable right to exclude others from engaging in certain kinds of activity (including the exercise of speech). We recognize this monopoly to remedy what economists call the problem of the public good -- a good which one person may consume without impeding the ability of another to consume the same good. Unlike the owner of a birthday cake, who may use his possession of the cake to exclude others from consuming it, the owner of a song would have difficulty excluding others from making a copy or rendering a public performance without paying for it.

In the absence of a right to exclude, the product of creative and inventive activity would provide benefits to users of works of authorship and inventions at no cost to them. This would result in under-investment in the production of creative works and inventions, with authors less able to devote full time to authorship and inventive activity heavily biased toward inventions that could be kept a secret.

The monopoly provided by intellectual property laws remedies this public good problem by endowing the creator or inventor with a monopoly that enables him or her to exact a fee in return for the benefits provided to others from the work. The prospect of receiving compensation provides an incentive for the production of ideas and inventions. Thus, the monopoly of intellectual property promotes innovation by remedying the potential underproduction of works of authorship and invention.

D. The Role of Intellectual Property in Inhibiting Innovation

If, in the absence of intellectual property rights, there would be under compensation for authorship and invention, it must be the case that with such rights there could be over compensation. Over-compensation produces the same effect as under-compensation: a reduction in the number of works produced. An author or inventor with too broad a monopoly over a work can seek compensation from authors or inventors of subsequent or complementary works, driving up the cost of such works, resulting in fewer works being produced. Thus, the monopoly of intellectual property may inhibit innovation by overcompensating authorship and invention.

E. The Optimal Scope of Protection

It would appear, then, that intellectual property should be enforced only to the extent that the benefits it bestows upon society outweighs the costs it imposes. The notion of balance in the scope of protection is not new to intellectual property. In considering the proper duration of protection, Lord MacCaulay aptly framed the question in a speech he delivered to the British House of Commons in 1866:

"It is good that authors should be remunerated; and the least exceptional way of remunerating them is by a monopoly. Yet monopoly is evil. For the sake of good we must submit to evil; but evil ought not last a day longer than is necessary for the purpose of securing the good."

The notion that there is a balance between the "evil" granted by monopoly and the "good" it secures is not limited to issues of duration. Over a century later, CONTU recognized that,

"Copyright should not grant anyone more economic power than is necessary to achieve the incentive to create."

Just how much monopoly power is necessary for the purpose of securing this incentive? If you are not too adverse to more Aristotle, the following might help guide our course:

"Now our treatment of this science will be adequate, if it achieves that amount of precision which belongs to its subject matter. The same exactness must not be expected in all departments of philosophy alike, any more than in all the products of the arts and crafts. . . . We must therefore be content if, in dealing with subjects and starting from premises thus uncertain, we succeed in presenting a broad outline of the truth . . . for it is the mark of an educated mind to expect that amount of exactness in each kind which the nature of the particular subject admits. It is equally unreasonable to accept merely probable conclusions from a mathematician and to demand strict demonstration from an orator." Aristotle, Nicomachean Ethics I. iii. 1-4. (Loeb Classical Library 1934)

F. Monopoly in Computer Programs

Looking first at the monopoly accorded to owners of computer software, we find that the copyright law provides several powerful means by which innovation is promoted. It has long been settled that a software developer can use the copyright law in the following ways:

(1) to prevent commercial counterfeiters from duplicating verbatim copies of its object code;
(2) to prevent end users from duplicating verbatim copies of its object code and giving copies to co-workers and friends;
(3) to prevent others from copying portions of its source code, either verbatim copying or by translating the code from one language to another (what is known as copying the structure, sequence and operation of the program); and
(4) to prevent others from copying its artistic or aesthetic screen displays, such as the audiovisual output of a computer game.

With the possible exception of the extent to which libraries and other users may make a "fair use" of protected works for educational and related purposes, no one is seriously concerned that any of the aforementioned protections subsisting in the monopoly of copyright could cause an overcompensation concern. Indeed, the intellectual property industries have expressed legitimate concerns about the ease with which their works may be copied and the increasing difficulties of enforcing the non-controversial aspects of their intellectual property rights.

However, those concerns are not at issue here. The center of today’s intellectual property debate -- and the crux of the antitrust problem in the computer software industry -- concerns a newly proposed level of copyright protection: the protection of what may be called interface standards, but also have been recognized under a number of other names such as interface specifications, compatibility standards, command languages, command structures, or application programming interfaces (APIs), -- by whatever name, they each describe the method by which a computer program operates or communicates with a human or another computer program.

G. Monopoly in Standard Interface Specifications

Users adopt a particular interface standard by investing money in the purchase of a product and investing time and resources in learning how to operate the product efficiently. Users increase this investment by purchasing complementary products (i.e., products that are compatible with the interface standard of the original product) and by making similar investments in learning how to operate these complementary products.

The personal computer software industry exhibits a particular set of conditions known to economists as “network effects.” In short, a network effect is present when the value of a product or service increases with the cumulative number of purchasers. The presence of a network effect means that each additional purchase raises the value of the product to existing users as well as the expected value of the product to future adopters. An example of a network effect is found in the telephone system: owning a telephone has no value if only a single person is connected to the network, but with every new household that is connected to the network, the value of telephone service increases to each existing and potential subscriber. The same effects are present in the market for personal computers, where a software product, such as an operating system, gains in value as more users purchase and adopt it.

Network effects permit a first entrant to a market to achieve domination of that market by getting a head start in building an installed base of users, each addition to which increases the value of the first entrant’s product. Facilitating this result are the aggregate investments that users make in learning and using the first entrant’s interface standard or command structure -- the means by which the first entrant’s software operates or interacts with other software, hardware, and users.

Ultimately, a market leader in control of an interface standard, aided by network effects inherent in a market and the investments that users make in the standard, may substantially raise the cost to consumers of switching to alternative product offerings of subsequent market entrants, even those offerings that may be better, cheaper, and more innovative.

H. The Means By Which Innovation May Be Promoted

How, then, may the optimal level of innovation be promoted? Promoting innovation is a function of (i) properly circumscribing the scope of intellectual property protection and (ii) enforcing the antitrust laws to prevent dominating players who control an interface standard in one market from using that standard to maintain its monopoly or extend it into other markets.

1. Circumscribing the Scope of Intellectual Property Protection

Congress has established a regime of intellectual property protection that includes protection for works of authorship under the Copyright Law and protection of inventions under the Patent Law.

Under the copyright law, a work need only be original with the author to earn statutory protection: originality requires only a trivial level of creativity. Protection, which subsists upon the fixation of the work in tangible form, and lasts for 75 to 100 or more years, is thus uncritical and virtually automatic.

By contrast, in order to secure a patent, an inventor must set forth in a patent application, that is subject to substantial examination, the particulars of his invention with the detail that is necessary to fully disclose the invention to the public. Further, the invention must be nonobvious and must be novel -- actually adding something new to the prior art in the field. Once protection is recognized, the invention must be dedicated to the public domain after a period of 17-20 years.

Because of the uncritical and automatic nature of copyright protection, there is a substantial risk of overcompensation if copyright protection is extended to interface standards. As noted earlier, copyright law already provides several powerful means by which innovation is promoted, including the protection of object code, source code, and the original, artistic audiovisual displays of computer programs. In the realm of artistic or audiovisual works, providing too much protection will merely require subsequent authors to take a few more steps away from the artistic expression of the original. The costs of these mistakes are not likely to be significant compared with the cost of providing too much protection for interface specifications. Given the powerful network effects arising from investments in those specifications made by users, the blow to innovation from extending easily obtainable protection to interface specifications could be substantial. Users will be reluctant to switch to innovative products that operate outside of the standard due to technological lock-in and the number of new products developed using the standard would be reduced by the increased costs associated with using the standard.

If we must, as Aristotle suggests, be content with "a broad outline of the truth," then the patent law, with its higher threshold of protection and shorter duration would appear to produce a more efficient level of protection for interface and command structures.

2. Enforcing the Antitrust Laws

Circumscribing the boundaries of intellectual property will not be enough to promote innovation in markets that involve interface standards. Markets characterized by strong network effects tend to be dominated by a single standard, rather than be shared by two incompatible standards. The classic example occurred in the market for video cassette recorders (“VCRs”), where, after the VHS specification developed a slight market share lead, the market rapidly “ran to standard,” virtually eliminating the Betamax specification within a few short years. In today’s market for desktop operating system software, there exists only one successful operating system standard.

Firms in control of dominate standards will, naturally, tout the efficiency of a single standard. Whether or not that efficiency outweighs the costs associated with its burdens, such firms cannot defend their use of the standards they control to extend their control into other areas, particularly in the development of complementary products.

Though there is evidence that these firms take the position that interface specifications enjoy uncritical and automatic protection of the copyright law, as a practical matter, dominant players have been more successful using the trade secret law to engage in anticompetitive practices.

That success has been enjoyed both in court and in the marketplace. For example, in Stac Electronics v. Microsoft, Microsoft obtained a $13.7 million judgment for misappropriation of trade secrets relating to information concerning its operating system specifications. In press release following the jury verdict, the General Counsel of Microsoft stated,

"We are gratified that the jury found that STAC had stolen our trade secrets, which protect the fundamental design of MS-DOS."

Apparently, the design to which he was referring was neither patented nor copyrightable, but fundamental design specifications necessary for Stac, the maker of a complementary product, to produce its product.

In the marketplace, by withholding information regarding the interface standard from competitors until the dominant player’s own complementary product groups can establish a lead in development and market entry, the dominant player may continually assure its own development and marketing groups a first entrant advantage. In this way, a firm in control of a dominant interface standard in one market uses that standard, riding on the network effect, to monopolize another market.

In the end, fewer complementary products will be produced by competitors. If competition itself truly plays an important role in promoting innovation, as we think it does, then the reduction in competition among complementary products provides a serious disincentive to innovate.

3. The Remedy

Firms that attempt to extend their monopolies by controlling interface standards may object to such measures on the grounds that their intellectual property rights are being abridged, but it must be remembered that intellectual property is a government granted monopoly and is of use only by means of government action. Writing in 1776, Adam Smith expressed his guarded view of those who seek and abuse government granted monopolies:

"Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to, only so far as it may necessary for promoting that of the consumer. The maxim is so perfectly self-evident, that it would be absurd to attempt to prove it. But in the mercantile system, the interest of the consumer is almost constantly sacrificed to that of the producer. . . . In the restraints upon the importation of all foreign commodities which can come into competition with those of our own growth, or manufacture, the interest of the home-consumer is evidently sacrificed to that of the producer. It is altogether for the benefit of the latter, that the former is obliged to pay that enhancement of price which this monopoly almost always occasions." The Wealth of Nations, Chapter 8, Section II.

Those whose responsibility it is to enforce our antitrust laws should not be deceived by those who would abuse a monopoly acquired by whatever means and then attempt to shield themselves with the aegis of intellectual property. A healthy skepticism of monopolists who pretend to espouse what is in the public interest is, again, no where better expressed than in Adam Smith’s The Weath of Nations,

"Merchants and master manufacturers are . . .the two classes of people who commonly employ the largest capitals, and who by their wealth draw to themselves the greatest share of the public consideration. . . . Their superiority over the country gentleman is, not so much in their knowledge of the public interest, as in their having a better knowledge of their own interest than he has of his. It is by this superior knowledge of their own interest that they have frequently imposed upon his generosity, and persuaded him to give up both his own interest and that of the public, from a very simple but honest conviction, that their interest, and not his, was the interest of the public.

"The interest of the dealers, however, in any particular branch of trade or manufacture, is always in some respects different from, and even opposite to, that of the public. To widen the market and to narrow the competition, is always in the interest of the dealers. To widen the market may frequently be agreeable enough to the interest of the public; but to narrow the competition must always be against it, and can serve only to enable the dealers, by raising their profits above what they naturally would be, to levy, for their own benefit, an absurd tax upon the rest of their fellow-citizens."

Thank you for the opportunity to appear today and I would be happy to answer any questions from the Commissioners.

Comments: RobtKohn@aol.com
Copyright © 1995, 1996 Bob Kohn
A Theoria Publication
(1/15/96)