information asymmetry on the software market and intellectual property rights

7/29/2019 Information asymmetry on the software market and intellectual property rights

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International Conference for Entrepreneurship, Innovation and Regional Development ICEIRD 2012

Information asymmetry in the software market:a failure of the intellectual property system

Ph.D. Miglena MolhovaUniversity of National and World Economy, Intellectual property Department, 8th DecemberBlvd., Student town Hristo Botev, Sofia, Bulgaria, [email protected]

The software market is a market in which the primary market value of the goodsresults from the information the goods contain. Given the intangible nature ofsoftware it is important on the one hand property to be established on it and on theother consumers to be able to recognize an opportunity to satisfy their needs with aparticular software solution. Users can not assess the usefulness of software beforeactually consuming it. Consumers rely more on critical analysis and evaluation fromthird parties and other secondary sources of information in forming their decision for

purchase rather than on information from the manufacturer himself. The intellectualproperty (IP) system offers protection of software and in terms of property rights itprovides software developers with a wide range of possibilities of usage andexcluding third parties from using the software without permission granted. The IPsystem also requires a commitment by the developers to reveal in depth thecharacteristics of the solution, in order that this solution to be used as prior art, andfor the creation of new and better software, when software is protected by a patent inparticular. Access to this information is free and users can benefit from it fully at anytime understanding software functionality and deciding if it can satisfy their needsor not. The intellectual property system is supposed to balance the interests ofdifferent stakeholders developers and users. However we consider that there isserious misbalance of interests that leads to various problems, one of the mostserious of which is the information asymmetry on the software market. Informationasymmetry is an intrinsic characteristic of the software market and is present in everytype of transaction. The problems of the existence of asymmetric information in themarket of software, respectively of the fact that software manufacturers have productinformation, which buyers do not have, can be viewed in several ways:

this is a prerequisite to purchase a lower quality product by the consumer;

this is a prerequisite for the formation of prices of products that do notcorrespond to their value and are much higher. Usually the software pricing

policies are unclear to users and they are unable to determine why the price theyare offered is such. Similar software solutions are available in very large pricerange and the user has no real expectations how much to pay for certain types ofsoftware; it is difficult to determine whether a price is high or low;

this is a prerequisite for software manufacturers to bear a higher risk ofdeveloping software products since imperfections and errors in software caneasily be attributed to bad faith use by the user.

Keywords: Information asymmetry, intellectual property, software market


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1. INTELLECTUAL PROPERTY ON THE SOFTWARE MARKET

Intellectual property (IP) has become one of the major issues of our global society, especiallyas the world moved toward a knowledge economy. How we regulate and manage theproduction of knowledge and the right of access to knowledge is at the center of how wellthis new economy works and of who benefits.

What intellectual property is, we already know. We know that software is intangible and beingintangible it is a part of the system of protection, since the creators should own what theyhave created. From this ownership, certain consequences flow and we are made aware ofthe fact that we cannot just copy or buy a copy of their works without consideration of theirrights. Each time we use such protected items, a part of what we pay goes back to theowners as recompense for the time, money, effort and thought they put into the creation ofthe work.

The IP system offers two possibilities for protection of software: under the copyright or thepatent law. Both copyright and patent protection give software developers an exclusive rightto make use of software, and by doing so, limit, for a specified duration, the possibilities ofusing the software by others. In return for this exclusive right, the patent system has a

second function. It requires the creator to disclose to the public the patent information aboutthe special knowledge or the resulting newly-developed technology, i.e. software. Thus forboth the developer and the public there is a cost and a benefit. The public has the benefit ofthe inventive technology and the creator has the benefit of an exclusive monopoly for alimited period of time. The second function of the patent system is often underestimated. Ifwe consider the number of patents and the resulting products and technology, which areavailable, it is evident that there are millions of existing sources of patent information. Thisdisclosure of patent information to the public is one of the foundations of the patent system,from which continuous development of technology and economic growth of local industriesshould spring.

There are numerous researches and analyses for the pros and cons of each type ofprotection. Furthermore there are serious questions as to why software needs such form oflegal protection at all and opinions, that all software should be open source. This researchpaper will not consider either of these areas of discussion. What we will focus on is theessence of the IP system and how it balances the interests of different stakeholders. In termsof software we consider that there is serious misbalance of interests that leads to variousproblems, one of the most serious of which is the information asymmetry on the softwaremarket.

2. IS THE SOFTWARE MARKET A MARKET

Before reaching the question as to why the IP system fails to balance the interests of allstakeholders on the software market, we would like to make a brief notion about the nature of

this market. The economic theory considers a market to be a set of economic relationsbetween entities, arising in connection with the movement of goods and money, based onmutual consent, equivalence and competition. Often in the transactions on the softwaremarket one side (the user) is put in a situation, in which he either must buy the software as itis offered from the manufacturer or to leave the transaction. So the moment of consent andagreement between the parties with respect to the purchase of software is missing. The usermust buy a product that he has not seen, has not tested and has a functionality, about whichhe can only speculate on the basis of information provided by the manufacturer (and actuallyit may be missing). This is the case for example in the so-called click-wrap and shrink-wraplicenses.

It is questionable also whether on the market of software there is competition - whether the

user has the option to buy the same software from other market participants, under different


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conditions.Another specific of the software market is that software is subject to intellectual propertyprotection and having an intangible nature it may be regarded as a set of content, objectiveform of the content (carrier or medium, in which it is materialized) and the rights to dispose ofthe content, which are subject of licensing. The social contract providing monopoly rights fora limited period of time for the creators of intellectual products occurs at a time very differentfrom the information age we live in today. These three elements of intellectual property rightshistorically were identified in one final product that consumers used, and it was not a problemwith respect to their inability to copy the product in large quantities and carry actions with it,infringing the rights of the authors. Today, however, the possibility of reproduction of digitalproducts, at almost zero cost makes owners distinguish these three elements and "sell" onlypart of the "product" on the market, namely the right to limit the usage. Thus the licenseoutlasts the carrier of the object; the content easily evolves; it can also be exploited, allowingcompanies to take advantage of a public long used to own its goods and which now has noownership at all.

There is no primary and secondary market for software. The value of the good stays thesame no matter how many people used it before you. Imagine buying a used car on the price

of a new one. Of course with time software manufacturers will provide upgrades to make theconsumer feel he is using obsolete and outdated version of his product. But why is theproduct obsolete: just because there are new operation systems not running it anymore?Furthermore the end user licensing agreements (EULA), which accompany software bundledwith new computer, prohibit selling the unused licenses without the computer. The consumercan sell the monitor, the keyboard, etc. just not the software, because, as according to thecourt ruling in one of the recent software cases Apple vs. Psystar, the user of the software islicensee and not owner and his options to use the software are very restricted.[1,2]

3. INFORMATION ASYMMETRY ON THE SOFTWARE MARKET

Information asymmetry is an intrinsic characteristic of the software market. The problems ofthe existence of asymmetric information in the market of software, respectively of the factthat software manufacturers have product information, which buyers do not have, can beviewed in several ways:

this is a prerequisite to purchase a lower quality product by the consumer, since he isoften unable to determine by himself if a software solution is good or bad. The softwaremarket is a market, in which the primary market value of the goods results from theinformation the goods contain. Given the intangible nature of software, the user can notassess its usefulness before actually consuming it. Consumers rely more on criticalanalysis and evaluation from third parties and other secondary sources of information in

forming their decision for purchase rather than on information from the manufacturerhimself. This is good for the software developers who do not suffer the consequencesfrom a misunderstanding of the product information from the consumer since they are notthe ones who provided it. Furthermore whether software is good or bad is a question notthat simple.

this is a prerequisite for the formation of prices of products that do not correspond to theirvalue and are much higher. Usually the software pricing policies are unclear to users andthey are unable to determine why the price they are offered is such. Similar softwaresolutions are available in very large price range and the user has no real expectationshow much to pay for certain types of software; it is difficult to determine whether a priceis high or low;


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this is a prerequisite for software manufacturers to bear a higher risk of developingsoftware products since imperfections and errors in software can easily be attributed tobad faith use by the user;

users are prone to illegal use of software, since they do not understand fully the legal

parameters of the deals. One of the key findings of the 2010 Global Software PiracyStudy of Business Software Alliance (BSA) was that many PC users lack a clearunderstanding of whether common ways of acquiring software are legal or illegal,especially in high-piracy markets. [3]

4. THE FAILURE OF THE INTELLECTUAL PROPERTY SYSTEM WITH REGARD TOSOFTWARE

The reasons why we speak about failure of the IP system in terms of software protection andmisbalance of the interests of the different stakeholders on the software market, because ofwhich information asymmetry arises, can be summarised as follows:

The patent system fails to provide the necessary information to the customer.

When we speak about information asymmetry we speak about disparity of the level ofinformation each party in the transaction has. In order for the problems with informationasymmetry to be solved the information needs to be revealed. And the question is whichinformation? If there is unexploited value, buyers and sellers have an incentive to find waysto capture that value. So what makes the software valuable? Simple as it is: value is in theeye of the beholder. It might be many things: shorter time to perform tasks, possibility tosolve problems, ease of use, etc. Developers see that as functionality. But according to aresearch, performed by Standish Group in 2002, in one typical software solution 7% of the

functions are used always, 13% often, 16% from time to time, 19% seldom and 45%never.[4]

So, on the one hand we have the software developers trying to make software with more andmore functions and customers on the other, not using them. So developers fail to signal thefunctionality of the software to the buyers, in the best possible way. If the customersunderstood the full functionality wouldnt they use it? One will say there are manuals how touse the software. And there are of course, but first they are not always provided with thesoftware and second if the people actually read them would we have expression as read thefreaking manual (RTFM). Which brings us to the main question: what kind of informationshould be revealed? Apparently customers do not want to hear about functionality, they wantto hear about productivity, effectiveness and problems solved. But if a seller tries to markethis product in such a way, there will always be the question how credible that information is,which is related of course with reputation and image of the company. What if there was athird party, credible enough, which can provide that information and furthermore free ofcharge for the customer?

A patent gives an inventor an exclusive right to make use of software, and by doing so, limits,for a specified duration, the possibilities of using the software by others. In return for thisexclusive right, the patent system requires the creator to disclose to the public the patentinformation about the software. The patent system requires the disclosure of information tobe made not only in terms of description of functionality of the invention (software), but alsoin terms of problems solved and effects produced. So this information can be used by thecustomer to see what kind of problems the software solves and based on that the customerscan make his decision for purchase. Furthermore the patent document has the following

distinct features: it provides details of the invention, including information on how the reader


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could carry out the invention; it describes the invention claimed in essence identifying thelegal scope of the patent right; and it identifies the inventor and the patent owner (which aresometimes different entities) and any other legal information, which could be of help whenone wants to commercially use the invention. So the customer should be able to understandthe legal scope of using the software.

Patented software is not offered to the market as a distinguished product, as otherpatented products as medicines, or particular technology.

Marketing software as a protected intellectual product can help software publishers on theone hand to maximize their profits, offering it at higher prices, and on the other hand reducealso the pirated use of their software. The number of patent applications with regard tosoftware related inventions in the European patent office shows a steady trend, evenincreasing in the last 10 years, which means that companies are definitely interested (seeTable 1) [5].

Table 1 Patent applications filed before the European patent office 2001-2010

by technological field

Field of technology 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Electrical engineering Electrical machinery, apparatus, energy 6630 5791 6201 6342 6590 7064 7271 8121 7782 8241

Audio-visual technology 5086 4627 5452 6349 6799 6577 6134 5793 4741 5151

Telecommunications 5889 5117 5317 5581 5633 5740 6117 5963 4497 4391

Digital communication 3126 3257 3921 4388 4856 5367 5815 6362 7153 7959

Basic communication processes 1552 1359 1491 1406 1389 1398 1243 1249 1031 1129

Computer technology 7185 7610 8338 8874 9034 8796 8703 9198 8013 8257

IT methods for management 19 64 62 100 507 1052 1125 1158 1190 1173

Semiconductors 2533 2091 2591 2686 2862 3146 3194 3598 2958 3714

If protected software was marketed as a distinguished product on the market would notcustomers buy more of it even if it is sold at higher prices? The answer is yes, they would, asthere are many examples from other industries. If so, why owners of software patents do notmarket their products in this way? The answer to this question however is not that simple. Itcould be because they know buyers would not read that information as desired and wouldnot take the higher price. It could be because software patent is still a dirty word for most ofthe customers. However the 2010 Global Software Piracy Study of BSA highlighted few veryimportant issues with this regard: public opinion strongly favours intellectual property rights

(seven PC users in 10 support paying innovators for their creations to promote moretechnology advances); PC users around the world recognize licensed software to be betterthan pirated software, with 81 percent saying it is more secure and reliable.[3] If we believethe figures software publishers should pay attention on this feature, when marketing theirproducts.

Software companies devalue their own products to establish market share or destroycompetitors (predatory pricing problem). Because of the elastic value, one software companycan undersell its competitors by wrapping products together and selling them cheaper(bundling), giving products away until their competitors are bankrupt (dumping), changingelements which break competitors programs (monkey-wrenching), and offering buybacks ofcompetitors licenses (slamming).[6]


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No matter what the licensing policy a company uses is, the price of the software remainsunclear for the customer. Even experts say that valuing intellectual property is an interestingmix of art and science, (Brian W. Napper, a partner in Intellectual Asset ManagementConsulting at Deloitte & Touche in San Francisco). Some practitioners even call it the fudgefactor, which apart elements like the total costs involved for development, the hourly rate,hours worked on the project, the value of a similar product plus an undetermined percentagebased on the new products uniqueness, a clients expected use and number of users,include also: what the market will bear; how desperate is the client; how many alternativesolutions are there; what is the client's budget, etc.

Or may be the reason why software developers do not market their products in this way isbecause customers do not believe that patented software is better than the software, whichis not protected. Why does not the system prove that protected software is of high quality?This is yet another argument for the failure of the IP system.

Patented software is not regarded as better or as software of higher quality compared tonot protected solutions.

The question with the quality of the software brings us to what is good and what is badsoftware. It is more than obvious that the user/stakeholder and the developer have differentnotions about it and different methods how to differentiate good and bad software product.

An end-user primarily makes his assessment based on his ability to use the software productto accomplish the task he wishes to accomplish with the software product. This in itself isinteresting, because from an end-user perspective, the software product that does the bestjob at helping him accomplish his task, may be priced to highly for him to afford, or be toohard to learn, or not work on his system - thus making it "bad" in his eyes.

On the other hand, a stakeholder may view a software product as good if it generatessufficient revenue or publicity, if it reduces costs, if it optimizes processes, even if it referredto generally as low quality product.

Since the patent system has very strict requirements about the novelty, applicability andinnovative character of the software and these requirements should be met if a softwaredeveloper wants its product to be protected we may say that if a software solution isprotected then the problems it is told to solve are really solved, thus making the softwaregood product. Furthermore if one software product is protected and third parties are excludedfrom the possibility to use it, these parties are urged to develop their own solutions (to protecteventually), which must go one step further than what already exists, thus providing morevalue for the customer. The fact that customers do not regard protected software as bettercompared to not protected software could mean that the requirements of the patent systemare not adequate with regard to software. Possible reasons for that could be that: abstractalgorithms can be described in so many ways; jargon and lack of tangible components canmake a routine software idea sound technical; it is impossible for a patent examiner to judge

obviousness, since software developers use so many ideas during their work that only asmall percent ever get submitted to the patent office or otherwise published.

5. CONCLUSIONS

Information asymmetry creates number of problems on the software market related to qualityof product, risk of adverse selection, piracy and considering the characteristics of theintellectual property system it seems that there is a possible solution in hand.

But the intellectual property system fails to balance the interests of software developers andcustomers, thus failing to provide a solution for the information asymmetry on the softwaremarket. Patent protection for software is inadequate since the patents so far prove to be

used mainly as instrument in lawsuits rather than incentive for innovation and factor for


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welfare. Customers do not rely on the information in patent documents to understand whatsoftware does and how it can solve particular problem. They rely more on third partiesassessments of the quality of the software. Furthermore they do not recognize patentedsoftware as quality software, despite of the heavy requirements a software invention shouldmeet in order to be protected.

The patent system does not play a significant role in the market success of protectedsoftware either, thus not allowing creators to form prices of software, which on the one handcould maximise their profits and on the other leave the customer with the clear understandingof why he pays the price and how it is formed.

What to say about copyright protection it is even more inadequate. On the one hand allsoftware is subject of protection; there are no clear requirements of the level of creativity putin the software in order for it to deserve this protection and customers are very well aware ofthat. On the other hand the scope of rights is so unclear that it is no surprise most of thecustomers do not understand which use of the software is legal and which is not. The term ofprotection is long, which might be good for software developers, but considering the fastchanging technological field it reasonably puts the question is it really necessary.

So what is the solution? First of all we need credible data of how information asymmetry

influences trade on the software market. Then we will have to search for ways to solve theproblems it creates. The intellectual property system offers such a possibility. But in order forthis possibility to be truly a possibility and a solution, the system must change. This changeshould be in a direction to really balance the interests of creators of software, customers andsociety as a whole. May be we should opt for sui generis protection of software with specificrequirements for the innovative character of the software solutions, not binding them withhardware, with specific scope of legal protection, defining what one can and cannot do, andnot interpreting existing scope of rights with regard to software.

References

1 Lawinski, J., Psystar Releases Mac Clone, But Has Apple Shut Them Down?, CRN, April 14, 2008http://www.crn.com/blogs-op-ed/components-peripherals/207200440/psystar-releases-mac-clone-but-has-apple-shut-them-down.htm

2 Case3:08-cv-03251-WHA,Document214,Filed11/13/09,http://www.groklaw.net/pdf2/Psystar-214.pdf3 Business Software Alliance, Global piracy study 2010, http://portal.bsa.org/globalpiracy2010/4 Johnson, J., Standish Group Study, reported at XP2002,

http://martinfowler.com/articles/xp2002.html5 European patent application 2001-2010 per technical field, http://www.epo.org/about-

us/statistics.html6 Pollack, J., True Property: A free market solution for information licenses, (c) 1995, 1997, 2000,

2003, http://www.jordanpollack.com/softwaremarket/

information asymmetry on the software market and intellectual property rights

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