[Previous] Result 1 of 2  [Refine Search][Print][Email][Save][Go To Full Text] [Tips]
Title: The Reason for the Patent Wars.
Source: Business Horizons, Jul/Aug2000, Vol. 43 Issue 4, p33, 10p, 4 diagrams
Author(s): O'Hearn, Timothy J.
Subject(s): INTELLECTUAL property -- Government policy
BUSINESS
NET present value
Company/Entity: MED Instrument (Company)
Abstract: Discusses how companies can use intellectual property laws to protect their profits from innovation. Details on the marketing failure of Med Instrument; Management of appropriability among industries and projects; Use of net present value analysis. INSET: Securing the Frontier.
Full Text Word Count: 6242
AN: 3367519 ISSN: 00076813
Database: Business Source Premier
Print: Click here to mark for print.
View Item:[Full Page Image] Full Page Image [XML Icon] XML Full Text  

[Go To Citation]
     

THE REASON FOR THE PATENT WARS

How can companies best use intellectual property laws to guard profits from innovation?

This story takes place in a world with no intellectual property laws. Three years ago, the executive team of Med Instruments considered launching a new product. Investors were agitating for increased revenues or staff cuts to improve Med's profit margin. So management decided to apply the company's technical expertise to emerging treatments for arteriosclerosis.

After 18 months of intensive effort, the CORPORASTUS Trademark was ready. The new device was elegant in its simplicity. It had a nice modular design, it used diagnostic electronics, and it was adaptable to add features for a range of models built on a single platform. But the launch anniversary brought disturbing news. Med's chief rival, Lifetech, was about to introduce a product nearly identical to the CORPORASTUS Trademark.

Sales slowed in the following months despite growing acceptance among medical professionals. The profit margin was further eroded eight months later as a third competitor entered the market with another me-too product. Med's rising star seemed destined to mediocre profit performance. The board of directors succumbed to investor pressure and began staff cuts. The first area of deep cuts was research and development.

Why did this happen? Didn't the CORPORASTUS Trademark benefit the health and well-being of many patients? Should we care whether Med is about to abandon its R&D? After all, surely some competitor with longer-term financial stamina will continue to develop beneficial new medical products.

In economic terms, Med Instruments--and the patients that its products serve--have experienced a "market failure." The operation of free market capitalism failed to return a profit to Med that was commensurate with the cost of development (or, more important, with the value of the innovation to patients). Due to imitation of the CORPORASTUS Trademark, Med's competitors enjoyed a free ride on the company's R&D investment. The true value of the new technology leaked away from Med like water through a sieve. Because no rational firm in such a world would undertake such developments, the invisible hand of the free market has failed to advance medical technology.

This market failure would be reduced if Med Instruments was given the legal right to prevent imitation by Lifetech and others. Therein lies the central idea behind intellectual property rights, which are provided by the law of patents, trade secrets, copyrights, and trademarks to ensure that innovators receive a return on their innovations. Indeed, this body of law might just as well be called "imitation law" or "anti-imitation law." The legal power to prevent imitation allows innovators like Med to charge a higher price than that charged on the old technology, thereby capturing a return on its product development investment. In the long run, everyone benefits.

Technological innovation is a key source of economic growth and prosperity. Solow (1957) concluded that 87.5 percent of the economic growth in the United States between 1909 and 1949 was brought about by the advancement of science and technology. Baily and Chakrabarti (1988) found that the combined private and public return on investments in R&D was, on average, 30 to 60 percent higher than the return on investments in ordinary capital such as machinery. We are wealthier today, individually and collectively, because of technological innovation. Yet U.S. industry sometimes underinvests in R&D partly because of the "appropriability problem"--the difficulty of capturing an adequate return on R&D investment from the marketplace.

Product innovation is risky business. Mansfield et al. (1977) and other studies show that only one in perhaps 20 projects yields a return. Without a reasonable expectation of a significant return on development projects, no firm will direct capital toward the risky business of R&D, and economic growth suffers.

The "appropriability problem" is a vital concern for any firm engaged in innovation. Teece's (1986) helpful framework for analyzing the ability of private firms to profit from innovation identifies three fundamental factors: (1) the appropriability regime; (2) the involvement of complementary assets; and (3) the dominance of a design paradigm. As explained below, a close look at this framework reveals that only two variables in this mix are controllable: the steps taken to secure intellectual property rights, and those taken to gain control over complementary assets through contractual alliances or investments.

The Appropriability Regime

The appropriability regime refers to those environmental factors that influence a firm's ability to capture profits: (1) the nature of the technology; and (2) the strength of legal rules to prevent imitation. The first aspect, the nature of the technology, may be thought of as the location along a spectrum ranging from highly accessible to highly inaccessible. For example, a process technology that cannot be observed by the naked eye and is known only to a small circle of process gurus is highly inaccessible. Likewise, an extremely sophisticated technology that is difficult to understand may be relatively inaccessible. In contrast, a plastic hairstyling tool like the Topsy-Tail (discussed later) is easily accessible.

The less accessible the innovation, the better suited is the technology to appropriating private returns on innovation because imitation is less possible. This is an inherent feature of the firm's technology and cannot be altered by management actions.

The second aspect of appropriability is the effectiveness of legal rules of protection. Studies indicate that innovators often lack sufficient "excludability" to appropriate the full value of their innovations. Instead, Mansfield et al. showed that the free ride benefits accruing to competitors and consumers generally are more than double the private returns to the innovating firm. (The conclusions from this 1970s research undoubtedly have been altered somewhat by the creation of the Court of Appeals for The Federal Circuit in 1982, which, in some respects, has improved the enforcement of patent rights.) As a result, the efficacy of legal protection varies across industries and from one technology to another. Moreover, the legal regime often defies logic because the laws governing intellectual property are a patchwork quilt stitched from competing philosophical and political threads over many decades. So managers must do their best to get the most out of this aspect of the appropriability regime. It cannot be left to chance or to amateurs.

Complementary Assets

Another factor influencing innovation is the degree of interdependence between the invention and the complementary assets needed to produce and market it. In some cases, the assets are quite generic and readily accessible to any potential player, making imitation easy. Examples include general purpose manufacturing and fabricating facilities that can be purchased anywhere.

In other situations, the complementary assets are less available to imitators. For example, "specialized assets" are those that have a one-way interdependence with the innovation. Consider the relationship between containerized shipping and trucking. Such shipping designs depend on available trucking assets that are compatible, but trucking does not depend on the features or properties of containerized shipping assets.

"Co-specialized assets" are those in which a two-way interdependence exists. The innovation of a rotary engine in Mazda automobiles depends on the availability of specialized repair facilities; conversely, the presence of specialized repair facilities depends on the existence of rotary engines in need of repair.

When only generic assets are involved in producing and marketing an innovation, no competitor has an identifiable advantage. As the production and marketing become more dependent on specialized or co-specialized assets, competitors already in possession of those assets have an advantage in reaping the profits from the innovation, often to the detriment of the innovator. This observation is recognized intuitively by every entrepreneur who has lost sleep worrying that an innovation will be "stolen" by a large, established business with the preexisting manufacturing and marketing assets to dominate the start-up enterprise. Like the nature of the technology, this factor is an inherent feature of the company's business and cannot be altered in the short term by management action.

Pre- or Post-Paradigm

The third factor to consider is whether the technology has a dominant design paradigm. In the early stages of a new industry or new product, the designs are fluid, production capital is of a general nature, and manufacturing processes are loosely and adaptively organized. Eventually, the design competition begins to narrow the field to a range of dominant designs revolving around only a few paradigms. While innovation continues, competition begins to shift toward price and away from fundamental design alternatives.

What Is the Lesson?

An innovator operating in a pre-paradigm environment runs considerable risk of free-riding by competitors or customers unless (1) the business is protected against imitation by control over essential specialized or co-specialized assets, or (2) the nature of the technology and the legal doctrines available to exclude imitation provide strong imitation barriers. Without at least one of these safeguards, the innovator may invest a lot of money to perfect a design, only to have imitators modify it slightly and seize a large piece of the market. As Teece puts it, "When the game of musical chairs stops, and a dominant design emerges, the innovator might well end up positioned disadvantageously relative to a follower."

There is another clear message here for the technology manager. The question of whether a paradigm exists and whether the nature of the technology deters imitation are matters over which a manager has little or no control. In contrast, control over essential complementary assets can be arranged by contractual alliances or investments. Likewise, the quality of legal protection can be influenced by careful management.(n1) Managers should focus their attention, therefore, on these two fronts. Only then can innovators be confident that the benefits of good quality technical work and marketing will accrue to their firm, rather than to a competitor or a customer.

Legal Relations and Rules

Several legal actions touch on the controllable factors mentioned above--complementary assets and imitation law. In the broadest sense, these legal concepts can be grouped into three categories: contract law, intellectual property law, and antitrust law.

Contract law is the most basic and intuitive of these three. A contract is a promise that can be enforced by the machinery of the legal system. It can be a promise to take some specified action or to forebear from taking some specified action. Examples of such contracts include employment agreements, confidentiality arrangements with suppliers, distribution or franchise agreements with marketers, service agreements with manufacturers, and joint ventures or similar alliances with other companies. All of these arrangements involve legally enforceable obligations that affect control over complementary assets and barriers to imitation.

Intellectual property laws handle trade secrets, copyrights, trademarks, and patents. These laws can be traced back several centuries to basic concepts of economic fairness and public gain. Each has its own set of rules to prohibit particular kinds of imitation.

Finally, antitrust laws operate as a counterbalance. They limit the use of intellectual property laws and contractual arrangements in ways that may harm the public by unduly preventing competition.

MANAGING APPROPRIABILITY: VARIATIONS AMONG INDUSTRIES

In a perfect world, a project manager could determine exactly what level of resources to direct toward securing patents or other imitation barriers. In the absence of perfect knowledge, many executives rely on crude benchmarks, such as a fixed percentage of R&D spending. Experience shows, however, that the legal protection efforts must be tailored to the industry, the product, and the firm's competitive strategy.

High Development Cost, Easy Imitation

There is an important distinction between industries or product types in which the investment in and enforcement of solid legal barriers is essential and those in which it is discretionary. When development costs are high but imitation is technically easy, or when other firms are competitively situated with the complementary assets needed to commercialize an imitation, it is essential to secure the best available protection. Examples include pharmaceuticals, medical devices, and chemicals. Environmental technology may be added to this group over time as the social benefits of environmental innovations become valued more highly by consumers.

All members of these industries who are engaged in product innovation should (and generally do) spend whatever it takes to get the best protection against imitation that the law will provide. Companies are compelled to optimize the appropriability regime, or face the risk of steep declines in profit when imitators follow their development projects. The risk of squandering huge development costs compels close attention to erecting legal imitation barriers.

High-Volume or High-Priced Product

High-volume producers are another category in which intellectual property barriers are essential. If a product will be sold in a sufficiently high volume, a price gain of a fraction of a cent per unit is well worth the cost of securing legal protection.

Consider the case of the Topsy Tail, a simple, plastic hairstyling tool that enjoyed widespread commercial success. Reports indicate sales of $80 million in its first four years. Because the nature of the technology allowed easy imitation, and because generic manufacturing and distribution assets were all that were needed to compete, only legal barriers and perhaps strategic business alliances could be expected to ensure a return to the innovator. The developer secured patent protection and sued a number of imitators. Given the potential sales volume and profits, her investment in maximizing legal imitation barriers could only be considered compulsory. Similarly, in the case of such high-priced products as medical diagnostics equipment, even a small percentage price premium can mean great profit.

Low Development Cost, Low Volume, and Low Price

In the case of industries and products in which development costs are low and sales volume is low or moderate, the decision to invest in intellectual property barriers is often purely discretionary. The financial leakage from a weak appropriability regime is less apparent, and the profit potential from a strong appropriability regime is not so large. Managers in these businesses tend to follow widely varying standards because they lack a framework for analyzing the return on the effort. As a result, many overlook the opportunity to improve profit margins with the proper use of legal tools.

MANAGING APPROPRIABILITY: VARIATION AMONG PROJECTS

The literature on R&D activities emphasizes techniques for organizing and prioritizing development projects to improve efficiency and market focus. For example, Wheelwright and Clark (1992) present a mapping technique shown in Figure 1. This model divides projects into three basic categories: breakthrough, platform, and derivative. Each category must be viewed somewhat differently, and each presents different opportunities to create an environment that will improve financial returns.

Breakthrough Projects

Breakthrough projects involve developing an altogether new product or process. Most technology managers expect them to yield patent opportunities. While this is usually correct, history shows wide variations in how businesses have capitalized on the opportunity to legally block imitation. For executives who manage breakthrough projects, careful attention must be paid to high-quality efforts to secure the maximum protection the legal system provides. Because such projects typically represent a foray into a pre-paradigm territory, legal protection is often the only security against imitation and the threatening musical chair scenario.

Platform Projects

Platform projects are aimed at developing a new generation of an existing product or process. Wheelwright and Clark cite Hill-Rom Company as a good example. Setting out to develop a hospital bed with basic features that could serve as a single platform for an entire product line, Hill-Rom secured patent protection to minimize imitation of its developments. There is nothing revolutionary about most features of a hospital bed. So it may come as a surprise to see the thicket of patents Hill-Rom secured to prevent imitation:

Elevating and Trendelenburg Mechanism for an Adjustable Bed (2 patents)

Guard Including Electrical Controls and Slideable Underneath the Bed

Side Guard for Bed Including Means for Controlling Remote Electrical Devices

Hospital Bed Having Automatic Contour Mechanism

Control Circuit for Hospital Bed

Ground-Test Circuit with Minimal Ground Current

Pulsing Ground-Test Circuit

None of these patents prevents a competitor from making a hospital bed. But each prevents some degree of imitation and should help Hill-Rom reap the total value of its new platform through the price it can charge. One lesson for product managers from this example is that a well-integrated patent strategy applies to "platform" projects and not just breakthrough projects.

Derivative Projects

Derivative projects attempt to enhance an existing generation of products or processes. They are routinely overlooked by managers and patent professionals when it comes to preventing imitation. Even small technical advances in mature technologies can be shielded from imitation with careful attention. The technology for manufacturing beverage cans is well developed and mature in many respects. Nevertheless, Ball Corporation developed an improvement that would be classified as a derivative project, involving a technique to flow the metal from around the periphery of the lid of an aluminum can so as to cause "compression doming." The result is a small cost reduction on each one of millions of cans.

MANAGING APPROPRIABILITY: ORGANIZING AND MEASURING THE PROCESS

Influencing profits from innovation involves inherent factors that can not be changed (the nature of the technology, the dominance of a design paradigm) and controllable factors that can be managed (the quality of legal protection against imitation, control over critical complementary assets). Unfortunately, relatively few firms understand this, or manage the controllable factors well.

Best Practices

Adler, McDonald, and MacDonald (1992) provide a framework for examining the key elements of technical management. Drawing on their consulting experience, they identify four discrete stages of organizational quality, ranging from worst to best, that apply to each of these elements: isolated, reactive, proactive, and integrated.

Under the category of policies and procedures, Adler et al. address the firm's management of external linkages and intellectual property. In the best companies, intellectual property opportunities are: (1) part of the business strategy; (2) part of project selection criteria; and (3) part of project management criteria. Licensing in and out is regularly considered as a way to help maintain focus, speed, and learning opportunities. Comprehensive trade secret policies are in place, and technical personnel are given exposure to the intellectual property function.

The consultants observe, however, that "most companies are still stuck at stage one [isolated] or two [reactive] in their treatment of intellectual property policy; they either ignore them or delegate patent filing to legal technicians." In contrast, they cite 3M as an example of a company with advanced intellectual property policies:

"[3M] provides extensive training and includes intellectual property management in performance appraisals. Lab directors are responsible for monitoring and improving the value of their intellectual property portfolios. Business unit general managers are expected to have a strategic patent plan, which is assessed periodically by corporate staff."

In a well-integrated organization, these activities are ongoing. In the early stages of a project, the development team ordinarily gathers ideas from published patents and technical literature. This is an ideal time to manage the need for specialized assets and the legal and technical issues affecting appropriability. It is also the time to develop a preliminary assessment of infringement threats from competitive patents and assess patent opportunities from development efforts. Later in a project, details of those efforts begin to emerge. As the ideas develop, the imitation protection can be refined.

Although high-level commitment is essential, Adler et al. observe that it is ineffective if the policies and procedures are lacking to carry through on decisions and modify development plans as goals and market feedback dictate. Many firms fail to develop or implement effective intellectual property strategy because they follow outmoded procedures that produce random results. In many firms, for example, the technical staff send a description of the innovation to an attorney for a patentability opinion. If it appears to satisfy legal standards, it is passed on to a committee to critique the value of the invention as described by the inventor. If it passes this screening, a legal technician (patent agent or attorney) is instructed to file an application and proceed with a patent on what he was told of the invention.

The problem with this common procedure is the breakdown in the communication needed to integrate the lawyer's task with the firm's business and technical strategy. The legal technicalities of securing a patent present a huge range of opportunities to steer the process in one direction or another. Indeed, the U.S. Supreme Court has noted that the specifications and claims of a patent constitute one of the most difficult legal instruments to draw up with accuracy. Various tactics must be kept in mind throughout the process. Recent trends in U.S. patent law, for example, impose a harsh penalty on an innovator who does a second-rate job of securing patents. It is a wonder that some companies still entrust this service to the lowest bidder. Good decisions are impossible if the effort is compartmentalized and the legal technicians are kept in the dark about broader strategies of the technology and business. One person or cohesive group must provide integration. Whether the leader is an outside patent advisor or a knowledgeable in-house manager, he must have the authority and management access needed to guide the process. Otherwise, the process will fall into neglect or randomness.

Effective Communications Are Essential

In all but the smallest business, the process will require input from several people representing different functional groups. The best practice is for the appointed manager or group to conduct periodic meetings with the functional groups to establish future directions.

One way to enhance strategy is to use mapping techniques such as those provided by Ellis (1993) and shown in Figures 2, 3, and 4. Graphical depictions like these can be developed for each category of new product to provide a common vision of the firm's posture and direction in relation to its competitors. Similar graphics can help focus the efforts of the managers and legal technicians on the important features of each product development program as it evolves from concept through commercialization.

Measuring Efforts

Net Present Value. In most situations, legal protection will guard against imitation of certain facets of an innovation, but will not broadly dominate the technology. The question technology managers must consider, then, is what resources to invest in securing contracts, patents, trade secrets, copyrights, and other forms of imitation barriers.

Earlier we discussed, in qualitative terms, the differences among various types of industries and their dependence on imitation barriers. The analysis behind that discussion can be expressed more rigorously in quantitative terms using net present value (NPV) analysis.(n2) If the NPV of an effort exceeds zero, the investment adds value to the firm. We begin with a technical innovation having an annual value to its users: Vt. Such an innovation can take various forms, such as a lower-cost manufacturing method or a labor-saving consumer product. In the absence of any imitation, the innovator can appropriate the full value of the innovation, V[sub t], through an improved profit margin or increased market share or both. If the cost of conceiving and developing the innovation to the point of commercial use is RD, then the NPV is given by:

[Multiple line equation(s) cannot be represented in ASCII text]

where n is the number of years that the value V[sub t] continues to be appropriated solely by the innovating firm, and k is the cost of capital. We can see from this simple equation that in industries with high RD, such as pharmaceuticals, the NPV can easily be negative if prompt imitation produces a low value for n and prevents the innovator from gaining the value of the innovation.

The value of an innovation v[sub t] is captured through the pricing mechanism. If an innovation provides customer-preferred features over the old technology, the market will allow the innovator to charge a price premium over the price charged on the old technology. Alternatively, the innovator could hold to the old price and gain market share. Thus, V[sub t] can be expressed as:

V[sub t] = Delta P x Q[sub t]

where Delta P is the per unit price increase and Q[sub t] is the quantity of units sold in time t. Or, it can be expressed as:

V[sub t] = M x Delta Q[sub t]

where M is the normal profit margin and Delta Q[sub t] is the increased quantity of unit sales in time t.

We can see from these equations that the value of V[sub t], and thus the NPV of an innovation project, is likely to vary most in those cases in which Q or P is large. This is because in such situations one can expect that even a slight percentage change in price or sales quantity will yield significant dollars, in absolute terms, if prompt imitation can be prevented. If we assume further that at least one competitor is in a position to imitate the innovator, we can expect that the number of years n the innovator can appropriate V[sub t] from the marketplace will be quite limited in the absence of legal barriers to imitation.

In those industries with high development costs or with high-volume or expensive products, the transaction costs of securing imitation barriers (legal service' fees, government fees, and so on) are relatively small compared to the value these barriers can provide the innovator. In industries with low development costs, low sales volume, or low prices, these costs become proportionately larger. The decision of whether to make the investment in legal barriers again may be expressed in NPV analysis as:

[Multiple line equation(s) cannot be represented in ASCII text]

where CFS[sub t] is the cash flow surplus in time period t that is made possible by the imitation barriers (the cash flow that would not be captured if unrestrained imitation occurred); k is the cost of capital; and TC is the transaction cost of securing the legal barriers. In the case of patent protection, n can be taken as the life of a patent: 20 years from the application date. TC can vary over a broad range from a few thousand dollars to many tens of thousands, depending on the geographic reach and the complexities and sophistication of the legal protection program. If we assume serious competition and that imitation could occur quickly (that is, first mover advantage is shortlived), then CFS[sub t] nearly equals V[sub t] for all time periods beyond the first year or two, and the equation may be restated approximately as:

[Multiple line equation(s) cannot be represented in ASCII text]

If NPV is positive, then the investment in the legal imitation barriers adds value to the firm. As this equation shows, even a V[sub t] of just a few thousand dollars makes the investment worthwhile.

So far we have focused on only one of the economic effects of patent barriers: the increased cash flow it can provide to the rights holder. Another effect is the toll it can impose on a would-be imitator. The most obvious and most significant toll is a reduction in profitability from selling the old technology. The competitor who is barred from imitation will either lose market share or be forced to reduce its price. In the case of a two-supplier market, this cost roughly equals V[sub t]. In a market with multiple competitors, each competitor will suffer its market-share pro rata portion of V[sub t]. This cost, C, may be expressed as:

[Multiple line equation(s) cannot be represented in ASCII text]

where mktshr is the percentage of the market held by the competitor.

In addition, each competitor will suffer a cost associated with trying to circumvent the imitation barriers. Levin et al. (1987) report that patents, on average, increase a competitor's cost of imitation by 5 to 10 percent. This added cost represents, among other things, the expense associated with developing marketable alternatives to the patented innovation. Assuming a 10 percent cost of capital, we can gain some idea of this effect.

Let's say that Leader Corporation invests $1 million in a project to introduce a new heart catheter. Follower Corporation studies Leader's new catheter and attempts to imitate the product's popular features. Assume a cost of $750,000 for Follower to study and imitate Leader's product in the absence of legal barriers to imitation. By applying the 5-10 percent added cost benchmark mentioned above, Follower would be expected to incur at least an additional $37,500 to $75,000 in development costs if Leader had secured some form of patent protection. Taking the mean value between these figures, we will assume a toll of approximately $56,000 imposed if Leader has the benefit of patents (although this figure can vary widely depending on the ease or difficulty of design alternatives). If Leader had devoted, say, $25,000 to erecting the patent barriers, it could expect more than double that cost to be imposed on Follower as a "toll" over and above the market share and/or profitability losses mentioned above. Taken together, these costs can be severe and ensure profits to the innovator by deterring close imitation by competitors.

There is a valuable lesson in this analysis for the technology manager. The legal regime deserves a good deal of attention because it can both impose an imitation toll and improve profit margins and market share at the expense of competitors. An effective legal protection program can be evaluated for results based on these indicators and other indicators that are unique to each firm and its competitive environment.

Program Effectiveness. A company must develop ways to measure activities and conduct a post-completion audit. Without some periodic assessment and measurements, it is impossible to improve. Factors to watch include such things as: (1) time from idea to market; (2) time from idea to patent filing; (3) correlation among innovations, marketing focus, and imitation barriers; (4) relationship of technical direction to that of competitors; (5) efficiency of disseminating information internally; and (6) accuracy of forecasting. Because measurement techniques must be tailored to each enterprise and project, the range of possibilities is beyond the scope of this article. One method, however, is shown in Figure 5.

The importance--and elusiveness--of good quality measurement tools cannot be overstated. In recent years, firms have struggled to find ways of measuring intellectual capital. Major companies like Dow Chemical, Skandia, Hughes Aircraft, and others, reports Stewart (1994), have made efforts to manage these intangibles at a strategic level through the creation of new positions, such as Director of Intellectual Asset Management. This places the whole package in the hands of one person to serve as a facilitator and integrator.

"Things which matter most," says Covey (1989), "must never be at the mercy of things which matter least." For technology managers, this means staying focused on those variables that, in the long run, can have the greatest influence on profits from innovation: control of complementary assets and optimization of legal barriers to imitation. These are difficult, abstract issues to manage. If managed properly, however, they will ensure the proper rewards from innovation.

Securing the Frontier

Intellectual property law allows a firm to stake out property rights in new technological fields during the conceptual stage, long before commercialization. When a leading firm stakes out sufficient territory through its patenting activity, other firms will be unlikely to waste resources engaging in closely related R&D projects because the new technological field has already been claimed. The result is to minimize duplicated-and thereby wasteful--research efforts.

This "prospecting" function of intellectual property law can be realized through a deliberate program of brainstorming. In these sessions, leading designers and technologists gather to brainstorm about future development paths they anticipate will gain favor in the marketplace. Patent applications are written and filed based on these projections. Because prognostications occur far ahead of commercialization, many will be wrong. It only takes one on-target projection, however, to yield a nice return.

A more sophisticated use of this concept stems from portfolio analysis and science modeling. Most leading-edge commercial products represent practical implementations of scientific principles learned or mastered years earlier. In other words, the advancement of science is a necessary precursor to the development of technology. According to one theory, the progression of scientific knowledge at the leading edge resembles the formation of ice in a pool of water. Established scientific knowledge exhibits chaotic randomness (like liquid water molecules). The interface (where the crystalline structure is beginning to penetrate the chaotic water) is where important developments occur. This scientific knowledge, developed at the interface, provides the feed stock for technological development opportunities. Innovators who study and understand this evolution can use it as a tool to guide their technology planning and patent prospecting in emerging technical fields.

Notes

(n1.) The appropriability problem can be tackled by both government and private action. Policymakers in government and the courts can tighten the appropriability regime when needed through further refinement of intellectual property rights and related antitrust law principles. The passage of NAFTA and the completion of recent GATT rounds tend to tighten appropriability outside the United States, but much remains to be done domestically and abroad. At the private level, industry members can influence appropriability in the way they manage projects and apply legal services.

(n2.) Another valuation technique that may be better suited in many applications is real options valuation, which is beyond the scope of this article.

DIAGRAM: Figure 1; Research and Advanced Development Projects

DIAGRAM: Figure 2; Development Project Monitor

DIAGRAM: Figure 3; Map of Competition: The Access Control Industry

DIAGRAM: Figure 4; Specialiazed Opportunities: The Soft Drink Industry

Figure 5One Evaluation Method

Assumptions: static market size; technical advance of value

Benefit to Rights Holder

If no design-around possible = Price premium share or gain in market share for duration of fights

If design-around possible = Price premium gain or gain in market share (until design-around marketed) and improved margin or market share from use of the technology

Cost to Non-Holder

If no design-around possible = Loss of market share or margin squeeze

If design-around possible = Design-around cost (design and implementation costs plus operating costs)

References

3M vs. Johnson & Johnson Orthopedic Inc., 22 U.S.P.Q. 2d 1401 (D. Minn. 1991).

Paul S. Adler, D. McDonald, and F. MacDonald, "Strategic Management of Technical Functions," Sloan Management Review, Winter 1992, pp. 19-37.

Martin Neil Baily and Alok K. Chakrabarti, Innovation and the Productivity Crisis (Washington: The Brookings Institution, 1988).

William J. Baumol, Entrepreneurship, Management, and the Structure of Payoffs (Cambridge, MA: The MIT Press, 1993).

Jeffrey I. Bernstein and M. Ishaq Nadiri, "Interindustry R&D Spillovers, Rates of Return, and Production in High-Tech Industries," Working Paper No. 2554, NBER Working Paper Series, National Bureau of Economic Research, Cambridge, MA, 1988.

Stephen R. Covey, The Seven Habits of Highly Effective People (New York: Simon and Schuster, 1989).

R. Jeffery Ellis, "Proactive Competitive Intelligence: Using Competitor Scenarios to Exploit New Opportunities," Competitive Intelligence Review (Society of Competitive Intelligence Professionals, Alexandria, VA), Spring 1993, pp. 13-24.

Mark F. Grady and Jay I. Alexander, "Patent Law and Rent Dissipation," Virginia Law Review, February 1992, pp. 305-350.

Zvi Griliches, "The Search for R&D Spillovers," Working Paper No. 3768, NBER Working Paper Series, Cambridge, MA, 1991.

Gregory Ingram, review of Innovation and Growth in the Global Economy, by Gene M. Grossman and Elhanan Helpman, in Finance & Development, March 1993, p. 52.

Thomas M. Jorde and David J. Teece, Antitrust, Innovation, and Competitiveness (New York: Oxford University Press, 1992).

Thomas M. Jorde and David J. Teece, "Rule of Reason Analysis of Horizontal Arrangements: Agreements Designed to Advance Innovation and Commercialize Technology," Antitrust Law Journal, Winter 1993, pp. 579-619.

Erich Kaufer, The Economics of the Patent System (Chur, Switzerland and New York: Harwood Academic Publishers, 1989).

Edmund W. Kitch, "The Nature and Function of the Patent System," Journal of Law and Economics, October 1977, pp. 265-290.

Richard C. Levin, Alvin K. Klevorick, Richard R. Nelson and Sidney G. Winter, "Appropriating the Returns from Industrial Research and Development," Brookings Papers on Economic Activity, 3 (1987): 783-831.

Albert N. Link, Technological Change and Productivity Growth (Chur, Switzerland and New York: Harwood Academic Publishers, 1987).

Edwin Mansfield, "Contribution of R&D to Economic Growth in the United States," Science, February 4, 1972, pp. 477-486.

Edwin Mansfield, John Rapoport, Anthony Romeo, Edmond Villani, Samuel Wagner, and Frank Husic, The Production and Application of New Industrial Technology (New York: Norton, 1977).

Robert P. Merges, "Commercial Success and Patent Standards: Economic Perspectives on Innovation," California Law Review, July 1988, pp. 803-876.

Philip A. Roussel, Kamal N. Saad, and Tamara J. Erickson, Third Generation R&D (Boston, MA: Harvard Business School Press, 1991).

F.M. Scherer, "Firm Size, Market Structure, Opportunity, and the Output of Patented Inventions," in Innovation and Growth: Schumpeterian Perspectives (Cambridge, MA: MIT Press, 1984): pp. 175-206.

Robert M. Solow, "Technical Change and the Aggregate Production Function;" Review of Economics and Statistics, August 1957, pp. 312-320.

Thomas A. Stewart, "Your Company's Most Valuable Asset: Intellectual Capital," Fortune, October 3, 1994, pp. 68-74.

Robert Szakonyi, Technology Management: Case Studies in Innovation (Boston: Auerbach Publications, 1992).

David J. Teece, "Profiting from Technological Innovation: Implications for Integration, Collaboration, Licensing and Public Policy," Research Policy, December 1986, pp. 285-305.

Steven C. Wheelwright and Kim B. Clark, Revolutionizing Product Development: Quantum Leaps in Speed, Efficiency, and Quality (New York: Free Press, 1992).

Willard I. Zangwill, Lightning Strategies for Innovation (New York: Lexington Books, 1993).

~~~~~~~~

By Timothy J. O''Hearn

Timothy J. O'Hearn is a partner in the Intellectual Property Practice Area of Jones, Day, Reavis & Pogue, Cleveland, Ohio. This article is adapted from CMOST Working Paper 94-02, prepared for The Center for the Management of Science and Technology, Weatherhead School of Management, Case Western Reserve University, Cleveland, Ohio. It was originally developed for student and faculty use in the Center for the Management of Science and Technology. The views expressed here are the personal views of the author and do not necessarily reflect those of the clients or the law firm with which the author is associated.


Copyright of Business Horizons is the property of Elsevier Science Publishing Company, Inc. and its content may not be copied or emailed to multiple sites or posted to a listserv without the copyright holder's express written permission. However, users may print, download, or email articles for individual use.
Source: Business Horizons, Jul/Aug2000, Vol. 43 Issue 4, p33, 10p, 4 diagrams.
Item Number: 3367519

 [Previous] Result 1 of 2  [Refine Search][Print][Email][Save][Go To Full Text] [Tips]

© 2002 EBSCO Publishing. Privacy Policy - Terms of Use