This morning BEA came out with its second estimate of 4Q GDP. As expected, the growth rate of the economy was revised downward slightly to 2.2% from the earlier advanced estimate of 2.6%. Economist had expected a growth rate of only 2%.
However, business investment was revised upwards, especially in R&D investment. The growth in business investment in intellectual property products (IPP) was revised upward to 10.9% from the earlier estimate of 7.1%. Software investment was revised upward to 10.1% from the 9.4% growth rate in advanced estimate and compared with a 8.9% growth rate in 3Q. Contrary to the previous estimate, R&D investment grew by 14% compared to a 10.6% increase in 3Q (the advanced estimate had it slipping somewhat to 6.1% in 4Q). Growth in investment in entertainment, literary, and artistic originals remained steady at 2.6% in 4Q.
The 2015 Economic Report of the President came out earlier this week. While it contains a number of statistics and policy proposals (see summary), I want to highlight just one small section on intellectual property:
Box 7-1: Trade in Ideas
In 2013, U.S. companies paid $39 billion in royalties and licensing fees to foreign companies, and were paid $129 billion by foreign companies seeking access to intellectual property held in the United States. While this “trade in ideas” represents just 14.6 percent of all U.S. trade in services, it generates 40 percent of our $225 billion services trade surplus. Figure 7-i shows the level of imports and exports in 2013 for each of the four major categories of trade in intellectual property. Roughly two-thirds of this trade is intra-firm, with a greater share of this intra-company trade occurring in the trademark and franchise fees category (76 percent) than for industrial processes (69 percent), software (58 percent), or audio-visual materials (42 percent).
Trade in ideas is partly influenced by differences in countries’ intellectual property laws; as such, harmonizing the international treatment of intellectual property rights has become an important, and sometimes controversial, aspect of international trade negotiations. For example, the WTO Agreement on Trade Related Aspects of Intellectual Property Rights established minimum standards for various forms of intellectual property protection. Several economic studies, such as papers by Branstetter, Fisman, and Foley (2006) and Cockburn, Lanjouw, and Schankerman (2014), suggest that stronger patent protection in destination countries does promote outbound technology transfer, both within and between firms.
One reason that trade in intellectual property can be controversial is that ideas are non-rival goods that can be used by many parties at the same time, with little or no incremental cost per user. This feature of intellectual property also creates challenges for measuring international technology transfer because it implies that the location of an idea, which determines the direction of trade flows, is somewhat arbitrary. To compound that problem, there is no obvious market price for many intra-company transactions, so both the magnitude and direction of intra-company trade in ideas may reflect corporate tax and legal strategies, as much as they do business or economic realities.
All of these complications can produce some unusual outcomes in the trade statistics. For example, U.S. intellectual property exports to Bermuda were $3 billion in 2013, with 98 percent of that trade occurring between affiliated companies, a trade that largely occurs for tax reasons rather than economic reasons, as discussed in Chapter 5 of this Report. These intellectual property exports are about two-thirds the size of Bermuda’s $4.5 billion GDP. In the same year, U.S. intellectual property exports to France, whose GDP is 600 times larger than Bermuda’s, totaled $3.4 billion, with only 42 percent transpiring between related companies. Lipsey (2010) shows that foreign affiliates of U.S. multinationals located in a variety of low-tax countries report unusually high levels of intangible assets relative to both employees and physical capital.
While it is difficult to estimate the size of any measurement bias created by geographic reallocation of intellectual property within multinational firms, it is possible to say something about the likely impact on trade statistics. In particular, transfers of intellectual capital abroad at below-market rates and intra-company pricing that shifts income outside the United States will lead the official statistics to underestimate the true size of the U.S. services trade surplus–that is, what would be observed under competitive market prices or in a tax neutral environment. For example, the true value of intellectual property exports in Figure 7-i may be higher, and the value of imports lower, particularly for trade in ideas related to trademark and franchise fees, where the share of intra-company transactions is highest. This type of bias would also make U.S. companies that trade in intellectual property appear less productive, by artificially lowering their revenues and inflating their costs. The continued growth of intra-company cross-border trade within large multinationals suggests that these measurement challenges will only grow in importance for both tax authorities and government statisticians.
And, unfortunately, the measurement challenges are even greater than this description notes. This part of the Report only covers trade in formal intellectual property. That is far from a complete inventory of ideas or how ideas are traded. Nothing about non-IP protected ideas. Nothing about non-technological innovations. Nothing about other forms of intangible capital. Nothing about the value of ideas embedded in advanced technology goods and services. Nothing about non-monetized and non-market mechanisms of information/knowledge exchanges. In other words, the real story is much more complicated and thus more difficult to get our policy response right.
Over on the INSEAD Knowledge blog, Professor Manuel Sosa has an insightful peice on design and innovation: “The Innovative Organisation: Learning From Design Firms“. The key, he stresses, is not “design” as an outcome but design as a process.
Samsung and Apple traced out a path to 21st-century success admired and followed by other brands. But too many companies still stash their design in a silo, where it can have little to no overall organisational influence.
A silo approach fails to capitalise on everything designers bring to the table in addition to creativity. Top design firms such as IDEO, Continuum, and Eight, Inc. have not only a well-tooled process for converting innovation opportunities into real innovations, but also a set of organisational elements perfectly aligned with that process. If companies require an innovation role model, they need look no further than design firms.
. . .
By observing how many design firms work, I have identified three core organisational capabilities at which they particularly excel, which also comprise the rudiments of any innovation journey: user-centric insighting, deep and diverse ideating, and rapid and cheap iterating.
A good description of the design thinking paradigm (see earlier posting).
A little over a year ago, the UK Intellectual Property Office (IPO) issued a report on Banking on IP? The role of intellectual property and intangible assets in facilitating business finance (see earlier posting). And last spring, that office outlined a number of specific steps to be taken to increase the use of intangibles in financing decisions: Banking on IP: An Active Response. As I noted before, one of the most important first steps that the UK IPO is undertaking is the development of common terminology to be used when describing and valuing IP and intangible assets. This will lead to development of templates for IP related assets “that can either be directly incorporated into this existing documentation or which can be used as a databank for information likely to be required by lenders.”
On February 24 at 9 am EST, Oxfirst will be hosting a webinar by Tony Clayton, Chief Economist of the UK IPO, which should give us an update on these efforts:
Tony Clayton is Chief Economist at the U.K. Intellectual Property Office. He has led the Economics, Research and Evidence team since 2010. The UKIPO’s research program and results are at http://www.ipo.gov.uk/pro-ipresearch.htm.Tony has also worked as Director of Economic Analysis at the Office for National Statistics, focusing on the economic impact of technology and innovation, productivity, and on measuring software and other intangibles in the ‘knowledge economy’. He represented the UK on OECD’s Working Group on ICT measurement, chairing it from 2005, and served on NSF’s ‘Science of Science’ panel in 2009.
What this talk is About
So why is it that the banking sector is unable to connect with the main value creating – and fastest growing – form of business investment in developed economies – Intellectual Property? And what can we do about it?
Is it true that that patents cannot be valued for sale in transparent markets? Do they have intrinsic features to prevent the establishment of secondary markets for innovation? Or is it that investors are rather ignorant about patents, brands, software and are not well informed on their risk and reward structures?
Technology entrepreneurs seeking to commercialize their patents often may not have necessary skill sets to communicate the value of IP. Current accounting standards that only partially reflect the value of intangible assets do not make things easier. This leads to market failure, where valuable technology either can’t be exploited, or can’t be scaled up to create competitive global enterprises, while investors miss out on attractive financial opportunities.
Against this background, this talk discusses how we can develop financial markets which support 21st century knowledge businesses.
Registration is available at https://attendee.gotowebinar.com/register/2089319847147747329.
However, the organizers state that they will only accept registrations “undertaken with professional email addresses (i.e. we can’t accept registrations from yahoo, gmail or similar private accounts).”
Here is an interesting trend: “The design partner–a designer who helps manage and select investments–is becoming a mainstay role at venture capital firms.” A recent article in Fast Company (“Why VC Firms Are Snapping Up Designers“) notes that design is becoming an increasingly important attribute in digital products. So it makes sense to have someone with those skills on the investment team.
But, the article also notes that design is more than skin deep. As Irene Au, former head of Google’s user interaction team, points out, a design oriented approach helps diagnose problems:
“I don’t necessarily expect to be vetting potential investments, but where there’s poor design, that’s usually a reflection of a deeper underlying issue that has to be solved. If a design is cluttered, it probably suggests that to the company, the value proposition isn’t clear to themselves,” she says. “You can start to use a design as a tool to spot where the problems are in a company.”
Design-thinking goes deeper than diagnosing problems in a company. It is a means of generating ideas, as the article notes:
The crew of four design partners at Google Ventures operates differently. The team embeds itself at portfolio companies for five-day “design sprints,” which work sort of like Extreme Home Makeover for startups, in which new ideas go from problem to sketch to prototype to market-tested product within a week.
Finally, the article quotes John Maeda, former head of the Rhode Island School of Design, who uses design as a strategic tool: “My role is to find strategic insights as to where design can have the most business impact. A designer can bring a viewpoint of not just aesthetics, but economics and usage.”
All of this attention to design as a factor in the VC process doesn’t surprise me. A recent paper from the OCED on Measuring Design and its Role in Innovation discusses the importance of design as an integrated element in the innovation process (see earlier posting)
And as a Wall Street Journal story from a year or so ago reported (“Forget B-School, D-School Is Hot“), more and more business schools are incorporating courses on “design thinking.”
Design thinking is a different process that the standard linear model of innovation: ideation, prototyping, consumer testing of final options. As I noted in a posting a number of years ago:
Design thinkers must set out like anthropologists or psychologists, investigating how people experience the world emotionally and cognitively. While designing a new hospital, IDEO staff stretched out on a gurney to see what the emergency room experience felt like. “You see 20 minutes of ceiling tiles,” says [Tim] Brown [CEO of the design firm IDEO], and realize the “most important thing is telling people what’s going on.” In a completely different venue, IDEO visited a NASCAR pit crew to come up with a more effective design for operating theaters.
Wikipedia uses this definition:
Design Thinking is a process for practical, creative resolution of problems or issues that looks for an improved future result. It is the essential ability to combine empathy, creativity and rationality to meet user needs and drive business success. Unlike analytical thinking, design thinking is a creative process based around the “building up” of ideas. There are no judgments early on in design thinking. This eliminates the fear of failure and encourages maximum input and participation in the ideation and prototype phases. Outside the box thinking is encouraged in these earlier processes since this can often lead to creative solutions.
Key to the process is involving the client in the design process – which is made possible by rapid-prototyping. As the Deputy Chief Executive of the UK Design Council (Trust me, I’m a Designer: How Design Research Can Influence Businesses, Governments and Policy Makers?) put it:
More and more business leaders and policy makers also see design as a strategic business process that helps to identify and meet real user needs.
Because of the increasing importance of this new model of innovation, I have long advocated greater attention to promoting design thinking. Specifically I have called for support for creating d.schools similar to what we give (and is proposed) for engineering schools (see earlier posting). In addition, one of the new Institutes in the National Network for Manufacturing Innovation should be devoted to the embedding of design thinking in the product development and production process (see earlier posting).
With VC’s slowly getting the message about the role of design thinking in innovation, maybe policymakers will as well.
In a recent interview with the Washington Post (“When we were small: Pandora“), Pandora’s founder Tim Westergren talks about how they shifted their view on their IP assets and made the company a run-away success:
[Washington Post reporter J.D.] Harrison : During those first few years, what was your revenue model?
Westergren: Our original idea was that we were going to build a technology that we would license out to other companies. So if you were a portal or a music retailer, you could take what we called the Music Genome Project and embed it in your Web site, and that would allow you to help your own consumers navigate catalogues. So we thought of ourselves as a B2B license technology. We chased after that business plan for years, really.
Really, what we were doing was looking for lily pads — someplace to keep us going, some partnership, some sign of progress that would help us raise our next round of financing. So we improvised all sorts of things.
Harrison: When did you pivot to the personalized music streaming service?
Westergren: In 2004, we raised our second financing round, and when we did that, we basically had the time to hit the pause button and say, “Okay, we have this Music Genome Project, this really big piece of intellectual property, but we haven’t figured out the business model yet. Let’s sit down and figure out what we want to do with this thing.” What we realized was that radio was a healthy part of the music industry, and lo and behold, this thing we had been building was perfectly suited to personalized playlists. So we peeled off a team of engineers and built what we called One Click Custom Radio.
In other words, Pandora went for an external monetization model (i.e. developing IP for others to use) to an internal monetization model (i.e. operating using its own IP).
The lesson I take away from this: your IP is only as good as there is someone willing to use it.
Today’s job numbers from BLS show a steady economy. Employment was up by 257,000 in January with a 5.7% unemployment rate. As BLS notes, employment was up in retail trade, construction, health care, financial activities, and manufacturing.
While the sector breakdown from BLS is useful, today I am a unveiling a preliminary attempt to take a different look at the U.S. economy and employment. According to my estimates, employment in tangible producing industries grew by 154,100 in January. The biggest gain in percentage was in Construction & Mining and Repair & Maintenance. Intangible producing industries added 103,800 jobs with the biggest percentage gains in Information and Financial Activities.
As the charts below show, U.S. employment is roughly divided in half between tangible producing industries and intangible producing industries. However, employment in intangible producing industries has exceeded employment in tangible producing industries since the Great Recession. While the structure of the U.S. economy is shifting, tangible production is still (and always will be) a major part of the Intangible Economy. And there are lots of intangibles in the tangible producing industries not captured by this data.
As readers of this blog know, I believe that the standard mental image of the economic as made up of manufacturing and services is outdated. Rather than break up the economy into manufacturing versus services, it may be more useful to look at the economy as tangible and intangible. Tangible activities are primarily physical; intangible are primarily mental. Cutting hair, ringing up a sale at a cash register, making a car, harvesting a crop – all of these are primarily a physical activity. The transaction involves the movement of atoms. Designing a poster, negotiating a deal, writing an article for the Washington Post – these are primarily mental involving the manipulation of information bits.
Intangible, mental activities are more important than ever in this information economy. But tangible, physical activities are just as important. Some of those physical activities are captured by the current classification system as part of construction, agriculture and manufacturing. And some of those mental activities are correctly classified as services. Only some, however. For example, the construction sector contains many mental activities such as architecture, engineering and logistical planning. The service sector contains physical activities, such as truck drivers, barbers and gardeners.
The tangible sector is made up of the following industries: Construction & Mining; Manufacturing; Trade, Transportation & Utilities; Accommodation & Food Services; Repair & Maintenance; Personal & Laundry Services; Telecommunications; Tangible business services (such as Waste Management & Remediation Services, Services to Buildings & Dwellings, and the U. S. Postal Service); and Tangible education & health services (such as Nursing & Residential Care Facilities and Child Day Care Services).
The intangible sector consists of Membership associations & organizations; Arts, Entertainment, & Recreation; Information (excluding telecommunications); Financial Activities; Professional & Business Services (excluding tangible services); Educational & Health Services (excluding tangible services); Government (excluding Postal Service).
Admittedly, this is not a perfect breakdown. But I believe it is a close enough approximation to give us a better understanding of the Intangible Economy.
This morning’s trade data from BEA has some sobering economic news: the deficit grew by $6.8 billion to $46.6 billion in December. Exports were down $1.5 billion while imports were up $5.3 billion. Economists had expected the deficit to narrow. The larger deficit will likely cause a downward revision in the 4th quarter 2014 GDP estimate. The increase deficit was due to a turnabout in petroleum goods. While the deficit in petroleum goods for the year is the lowest since 2009 as a result of lower oil prices, December saw an unexpected spike in the deficit. Meanwhile, the deficit in non-petroleum goods continues to increase.
Our surplus in pure intangibles, however, improved in December to a level of $14.8 billion as exports grew more than imports. The surpluses in maintenance & repair services and financial services improved while the deficit in insurance services was slightly lower. Net revenues from the use of intellectual property increased as revenues from foreign sources (exports) grew faster than charges for the use of intellectual property paid out to foreign sources (imports). The bad news is that the surplus in business services again declined, for the 11th month in a row. Exports of business services continue to grow but imports of those services grew even faster.
On an annual basis, our intangibles surplus was up by 5% in 2014. All areas showed improvement except business services and telecommunication. The surplus in business services declined by 11% in 2014 and by 6% in 2013. Telecommunications services went from a slight surplus in 2013 to a slight deficit in 2014.
Our Advanced Technology deficit also improved dramatically in December, dropping to $8 billion from $11.4 billion in November. All categories except Advanced Materials saw an improvement. However, the biggest change was an almost $3 billion improvement in the Information and Communications Technology (ICT) deficit as imports dropped by $2 billion and exports were up almost $1 billion.
Advanced Technology goods also represent trade in intangibles. These goods are competitive because their value is based on knowledge and other intangibles. While not a perfect measure, Advanced Technology goods serve as an approximation of our trade in embedded intangibles. Adding the pure and embedded intangibles shows an overall surplus of $6.8 billion in December, up from $3.1 billion in November. Again, much of this was due to the lower ICT imports and higher exports.
Note: I am now reporting the trade data using the new BEA classifications for services trade, which breaks services into more categories. In the past, the intangible trade data was the sum of Royalties and License Fees and Other Private Services. Under the new classification system, intangibles trade data is the sum of the following items: maintenance and repair services n.i.e. (not included elsewhere); insurance services; financial services; charges for the use of intellectual property n.i.e.; telecommunications, computer, and information services; other business services.
Charges for the use of intellectual property n.i.e. is simply a renaming of Royalties and License Fees. This includes 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.
Maintenance and repair services n.i.e., financial services, and insurance services, were previously included in Other Private Services. Telecommunications, computer, and information services is a combination of those two items (telecommunications and computer & information services) that were also previously included in Other Private Services. Three categories previously in Other Private Services — education-related and health-related travel and the expenditures on goods and services by border, seasonal, and other short-term workers — were removed and reclassified to travel. The new category of other business services is a continuation of the older category Other Private Services with those components removed.
Thus, other business services includes categories such as advertising services; research, development, and testing services; management, consulting, and public relations services; legal services; construction, engineering, architectural, and mining services; and industrial engineering services. It also includes personal, cultural, and recreational services which includes fees related to the production of motion pictures, radio and television programs, and musical recordings; payments or receipts for renting audiovisual and related products, downloaded recordings and manuscripts; telemedicine; online education; and receipts or payments for cultural, sporting, and performing arts activities.
For more information on the changes, see the March 2014 Survey of Current Business article, “The Comprehensive Restructuring of the International Economic Accounts: Changes in Definitions, Classifications, and Presentations.”
A number of years ago, I did a quick analysis of the Washington DC areas’ economy. According to my finding, metro area employment was 57% in intangibles – dominated by Government, Professional & Business Services and Educational & Health Services. The employment would have been even higher if I had not excluded what I called “tangible services”: those services involving the movement of atoms rather than bits, such as administrative and support services. The tangible serves also include the Accommodation and Food Services industries – which make up another large part of the area’s economy.
Based on my quick look and other data I’ve seen during my activities with local economic development, I have liked to characterize the Washington DC economy as BLT: bureaucrats, lobbyists/lawyers and tourism. This is especially true for the District’s economy, as compared to the entire metro region. As a result, I have advocated for measures to diversify the economy, from advanced technology to the arts and fashion.
A recent study from the Brookings Institute, America’s Advanced Industries: What They Are, Where They Are, and Why They Matter, takes a different look at a same idea. The result reinforces the general feeling that the Washington metro area is becoming more diversified in it knowledge based industries. According to the study, the metro area is third nationally in the number of “advanced industry” jobs with a total of 503,470. These indirectly support another 402,780 jobs. The top “advanced” industries in the Washington metro area are:
• Computer Systems Design and Related Services: 199,110 jobs
• Management, Scientific, and Technical Consulting Services: 114,280 jobs
• Architectural, Engineering, and Related Services: 60,750 jobs
• Scientific Research and Development Services: 49,730 jobs
• Data Processing, Hosting, and Related Services: 11,390 jobs
Based on this I need to add something to my BLT sandwich. Maybe some avocado or “A” for “advanced industries”?