This article is about patent strategy for companies that develop new technologies. The job of a CEO includes developing a vision for a company. This vision often includes development of a new technology product. The value of the company is based on successful execution of the vision by the CEO and company team. Sustaining this value requires protecting the commercial results of this execution. For technology companies that develop and sell new products, patents provide a key part of this protection.
Patents should be viewed as an investment in your company. To achieve a good return on this investment, an effective strategy must be used. For successful execution of the strategy, the CEO needs to ensure that team members understand the overall strategy and the reasons behind the strategy. The selected strategy should consider the basic characteristics of a patent.
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A patent protects a company’s products by excluding competitors from selling similar products, generally resulting in a limited supply of the products in the marketplace. As a result, a company owning the patent generally is able to sell its products at a higher price point. This increases the profit margins of the company, often over many years. The number of years is driven in part by the term of a patent, which is 20 years from the filing date of the original patent application. The increased profit margins make the company more valuable.
A patent strategy should be selected that has the end goal of boosting profit margins for the company’s sales. Implementing this strategy starts with identifying new products that the company has developed. Typically, the products have at least a few new features that have been developed by the company. These new features are often patentable.
To obtain a patent, the patent laws require that an invention is novel, and also that the invention is not an obvious variation of what is known in the field. However, a typical emerging growth company that is devoting significant effort to developing technology for its products or services will have several ideas that are patentable. The primary challenge is choosing the best patent strategy for the company.
Prominent examples of increasing profit margins using patents often are seen in the pharmaceutical industry. In a typical cycle, a pharmaceutical company develops a new drug, files for patent protection on the new drug, and then enjoys increased profits for many years. This example may seem obvious, but achieving the increased profits requires the presence of two key elements. First, the drug or other product must be in demand by customers. Second, the patent must effectively protect the drug or product that is sold.
There are numerous situations in which a company obtains patents for a new product, and the excitement about issued patents by company leadership is sometimes significant. However, if the actual product itself is not in demand by customers, then there are no sales to protect from competitors. If demand for the product never occurs, then blocking competitors from offering a similar product becomes irrelevant. In this situation, the return on investment in the patent is likely low.
Conversely, if the product is in high demand, then competitors will be attracted to the product space. Blocking competitors using the patent prevents a reduction in price caused by competition, and the patent owner can achieve an increased profit margin. In many cases, the profit margin can be increased by 30-80% or more, particularly in the pharmaceutical industry, or other industries in which extensive research and/or development is required to manufacture a physical product. Patents also support exclusive market share. For example, one commentator describes that branded drugs are predicted to lose their market share by up to 84 percent in the first year after the entry of generic drugs (Henry Grabowski et al., Recent Trends in Brand-Name and Generic Drug Competition, J. Med. Econ. 2013, at 1.).
How does a CEO know whether a patent application filed today will actually cover a future successful product? For those companies in a growth stage that are seeking investor funding, when selecting patents to file, the CEO should consider this helpful guidepost: what narrative or story about the company does the CEO tell investors such as venture capitalists? VCs are laser-focused on return on investment. An effective story is useful for more than merely making a sales pitch to an investor. The same story that resonates with investors helps to predict the dominant technology features of the company that will drive investment returns in the future. The investor’s decision to fund the company is an intelligent, and often the best, prediction of future customer behavior. The distinctive technology features of a new product highlighted in the CEO’s story should be protected by patents.
The product features that attract investors are likely the features that will attract future customers and which competitors will try to copy. Indeed, especially for companies that make hardware or other physical products, savvy investors will ask what patent protection the company has already secured. Investors understand that patents help to exclude competition, and that this has the potential to increase future profits. Patent applications should be filed to protect these product features. This will lead to obtaining future patents that effectively block competitors.
Prominent examples of investor interest in patent protection are seen on the popular television show Shark Tank. Many of the presenting companies have created technology products. Often, a shark will ask the company if it has a patent. If the answer is yes, then the value of the company typically immediately increases by $200K to $600K as seen by the offers made by the sharks after hearing about the existence of the patent. This is without the shark having any knowledge of the actual effectiveness of the patent.
Why would “Mr. Wonderful” or another investor pay more for a company because of a patent? Investors care about cash flow. This big increase in company value by the sharks is simply the present value of the increased pricing power for the company’s future product sales, which increases future profit margins. The shark expects higher selling prices because competition can be blocked by the patent.
Surprisingly, the sharks dramatically increase the value of a company even if no patent has yet issued. The increase often seems to be almost as large is if a patent has been granted. The sharks seem satisfied to hear that the founder has merely filed a patent application. Of course, the sharks expect that the company will ultimately get the patent. This is a wonderful example of how even a pending patent application that targets key product features can help a company obtain investor funding. The granted patent or pending patent application also helps a company obtain a higher valuation when funding is obtained.
A pending patent application is part of a strategy to deter competitors. Pending patent applications are usually published by the U.S. or other patent offices worldwide. Technology companies and investors frequently perform patent searches to determine pending or granted patent protection obtained by others. Thus, when potential competitors see that a company has filed for patent protection, this filing alone may act as a barrier to entry by a competitor. For example, a potential investor, having learned that an existing company has 5-15 patents on key product features, is deterred from making an investment in the competitor. In industries where a complex manufacturing facility is required to make a product, failure to obtain investor funding prevents a future competitor simply by denying the extensive funding needed to build the manufacturing facility.
A pending patent application also is useful in informing a market that your company has pending patent protection. For example, marketing pitches to potential customers or business partners can refer to pending patent protection. Potential competitors gradually learn of an established patent presence in the market, which may deter some of them from attempting to enter the market.
Author: Bruce T. Neel is patent counsel at Greenberg Traurig, LLP.
