* Retailing On The Internet

With commerce on the Internet in its infancy, companies are duking it out over your money.

By Erik J. Heels

First published 12/1/1996; Student Lawyer magazine, “Online” column; publisher: American Bar Association

Recently, I purchased my first product on the Internet, a book from Amazon.Com Books (http://www.amazon.com). I received, via e-mail, confirmation of both the order and the shipment. And the price was right. The state in which Amazon.Com is located (Washington) apparently does not charge sales tax for goods shipped out of state (in this case, to me in Massachusetts).

This is the way Internet commerce should be: an inexpensive, efficient, satisfying shopping experience. And the Internet is ideally suited for buying and selling software or other digital data for which a box and postage are unnecessary. But recent legal developments could increase the cost of Internet commercial transactions and make life on the Internet less than satisfying (at best) and downright annoying (at worst).

Specifically, a patent held by a company called E-Data Systems could increase the cost of each commercial transaction on the Internet. And a landmark court case between Cyber Promotions and online service giant America Online could open the floodgates for so-called “junk” e-mail.

If you believe E-Data Systems, the patent in question covers many commercial transactions on the Internet, including something as simple as purchasing software upgrades online. E-Data has been aggressively trying to capitalize on its patent, which expires in the year 2003; according to E-Data’s website (http://www.e-data.com), the company has sued 43 companies for patent infringement.

Five of those companies–Adobe, First Virtual Holdings, VocalTec, CD-Max and MicroPatent–have settled the lawsuit by licensing rights to the E-Data patent. These companies obviously felt it was more cost-effective for them to get a license from E-Data than to fight a lawsuit in court. Maybe so.

The problem, however, is that because E-Data uses a sliding scale to determine licensing fees, the licensing fee hurts small licensees the most. A license for its patent can represent as much as 5 percent or more of the annual net sales of a small licensee’s business. For large licensees, that percentage decreases. For example, for a company with annual net sales of $1 million, the licensing fees average $19,500 per year for the remaining seven years of the E-Data patent’s statutory lifetime. That’s the equivalent of a 1.95 percent tax. For a company with annual net sales of $10,000, though, the licensing fees average $650 per year–or 6.5 percent.

The threat to online commerce from the E-Data patent should be clear. It is very expensive for a small company with less that $10,000 in annual sales to part with 6.5 percent of its revenue. It would bankrupt such a company to fight the patent in court. And all companies that choose the licensing route will pass the increased cost on to consumers. Consumers are more than willing to go elsewhere to avoid such transaction costs, as they drive from Massachusetts to New Hampshire to avoid sales tax.

I firmly believe that patents are necessary to encourage and reward innovation. And whether you believe that patents are the cause or the effect of innovation, the simple truth of the matter is that every major industrialized nation on the planet has patents.

Unfortunately, reports about patents, especially software-related patents, in the popular press frequently miss the mark. The scope of a patent is defined by its claims, which define the thing or process that is the invention. The E-Data patent has three independent claims (claims that do not depend on other claims for their validity).

The first claim relates to a “method for reproducing information in material objects utilizing information manufacturing machines located at point of sale locations.” One of the steps of the patented method is “providing a request reproduction code including a catalog code uniquely identifying the information to be reproduced to the information manufacturing machine requesting to reproduce certain information identified by the catalog code in a material object.”

This excerpt from one of the patent claims raises many questions. Is a computer connected to the Internet an information-manufacturing machine? Is a website a point-of-sale location? Is a credit card number a request reproduction code? Is a Uniform Resource Locator (URL) a catalog code? Is a piece of software purchased with a credit card and delivered via the Internet subject to the E-Data patent?

Maybe, maybe, maybe, maybe and maybe. It’s the last question that has many Internet vendors worrying. But it is unlikely that a court will interpret the claims as broadly as E-Data would like.

Unfortunately, both for E-Data and for the U.S. Patent and Trademark Office, the methods used by E-Data to enforce its rights have angered many on the Internet, causing some to call for the end of all software patents. True, E-Data’s methods (including sending letters to 75,000 vendors offering a license under E-Data’s “amnesty” program) were aggressive (some would say obnoxious), but they were also legal. E-Data’s patent is presumed valid until proven otherwise.

E-Data might have been better off had it chosen a lower-key approach to licensing. For example, the acceptance of Dolby noise-reduction circuitry as a stereophonic industry standard was largely due to Mr. Dolby making inexpensive licenses available. And in an age where intangible assets make up a large percentage of a company’s value, it’s rather odd for E-Data to aggressively increase the value of one of its intangible assets (its patent rights) at the expense of another (its good will).

Another lawsuit relating to Internet commerce involves Cyber Promotions (http://www.cyberpromo.com) suing America Online (AOL). Cyber Promotions is in the business of sending unsolicited bulk e-mail for its clients. Some call it junk e-mail, others call it “spamming.” America Online calls it annoying. Cyber Promotions is suing America Online for blocking e-mail sent from Cyber Promotions to AOL e-mail accounts. Because America Online charges its subscribers based on connect-time, the e-mailings from Cyber Promotions are (oddly enough) a source of income for America Online. But the company is probably losing subscribers because of the bulk e-mailing and probably is also burning customer support hours responding to customer complaints.

Cyber Promotions is accusing America Online of trying to put it out of business. Its argument is based on the fact that the selective blocking of e-mail by America Online amounts to an unfair trade practice. In fact, some people have wrongly characterized this case as a First Amendment case. For First Amendment freedom-of-speech rights to be implicated, however, there has to be a limiting government action involved. Last time I checked, America Online was not a government entity.

As of this writing, Cyber Promotions had won an injunction preventing America Online from blocking its bulk e-mail. Cyber Promotions will probably prevail on the merits. Imagine if the post office refused to deliver the Publisher’s Clearinghouse Sweepstakes entry to your house! If you were Publisher’s Clearinghouse, would you sue? The analogy isn’t perfect, because the U.S. Postal Service is a government entity, but you get the idea.

The real problem for America Online is that its pay-by-the-hour billing is no longer competitive. With unlimited flat-rate Internet access available from many Internet service providers (including http://www.idt.net, http://www.netcom.com, and http://www.earthlink.net), America Online probably will continue to lose subscribers. Rather than trying to block bulk e-mail from particular sources, the company should provide its users with the ability to filter out unwanted e-mail, and it should revise its outdated pricing scheme. I receive unsolicited bulk e-mail all the time. I also follow the instructions for removing myself from such e-mail lists. And, as with bulk Postal Service mail, some of the bulk e-mail interests me. Like E-Data, Cyber Promotions has seen its good will take a beating on the Internet. It has been listed on the Internet’s “blacklist” of advertisers (http://math-www.uni-paderborn.de/~axel/BL/), and many users have had trouble unsubscribing from its bulk e-mail lists.

Another barrier to Internet commerce is the lack of low-cost, high-speed Internet access. Those fortunate enough to live in or near major metropolitan areas already have local access telephone number for dial-up Internet access. Those in major cities with technologically clued local telephone companies (such as Ameritech in Chicago) can connect at 128 Kbps via ISDN (integrated services digital network) lines with no per-minute charges. Those with technologically clueless local telephone companies (such as Nynex in Boston) have to pay about $200 a month for a mere 20 hours of ISDN time.

I look forward to the day when Internet commerce is readily available to the majority of Internet users via high-speed Internet connections. In the grand scheme of things, the E-Data patent and “spam” e-mail from Cyber Promotions are merely bumps in the road to widespread acceptance of Internet commerce.

Oh, by the way, Spam is a registered trademark of the Hormel Foods Corporation.

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