Why Most Innovative Companies Miss the Mark with Patents

Few patents have the intended effect of enabling long term premium profit generation for the company that brings innovative products to the market. While patent attorneys, academics, and legislators argue strenuously about the reasons that patents are flawed in this regard, I have a simple hypothesis that has been demonstrated time and again in my IP Strategy practice: too many patents read like diagrams intended for use in assembling the product from separate pieces.

How Companies Can Hit the Mark with Patents

Such patents typically spend most of the disclosure describing in gory detail how the pieces and parts fit together, along the lines of “flange 15 is connectable to projection 20 and to provide hinge 25 in widget 10.” The resulting claims will read something like “a widget having a hinge comprising connection between a flange and a projection.” While the underlying product may have some really cool functionality that customers crave, it is usually wholly lost in the focus on structure in the patent application.

If the claim avoids the prior art, then YIPPEEE! the maker of the widget–let’s call them “WidgetCo”–will get a patent to the widget with the hinge that is generated from the arrangement of the flange and the projection. If they are actually making the widget having this structure, most clients would be happy with this result, and see this as a “patent win.” But, the patent may not have the intended affect of preventing competitors from pinching their customers, meaning it is actually a “patent fail.”

Let’s assume that the widget (“Widgetplus”) is a significant innovation in the relevant market. That is, there was a long unmet need to provide a widget that had superior functional characteristics, and thus Widgetplus was developed by WidgetCo at significant expense, time, and opportunity cost. In short, WidgetCo took a big bet on the Widgetplus innovation (and passed on other bets) based on the expectation that this risk would pay off and make its stakeholders rich. WidgetCo was right: customers loved the new functionality of this widget, and premium profits were generated.

What is good for WidgetCo is bad for ThingyCo, the company that ruled the market for the previous, less functional, version of widget. As a result, ThingyCo’s sales are falling. Stakeholders are unhappy. The CEO’s job is in jeopardy. Being a rational actor in the Free Market, ThingyCo’s CEO directs his team to come up with an alternative to WidgetCo’s innovation. Fortunately for ThingyCo, this is pretty easy, because customers have clearly and unambiguously shown what functionality they will pay extra for as shown by the popularity of WidgetPlus. This roadmap enables ThingyCo to design a competitive product and, because ThingyCo has existing manufacturing and distribution channels, the product makes it to customers in record time. Notably, ThingyCo’s cost to enter the market is substantially less, so it is able to sell the competitive product for lower cost. WidgetCo’s sales quickly start declining, and the company is forced to lower the price of Widgetplus in order to retain sales. While ThingyCo can lower prices and still make a profit because its costs to develop the product and enter the market were considerably lower, WidgetCo cannot do so well in this price eroding market. Indeed, if management had known that profits on Widgetplus would end up being this low, they WidgetCo may never have placed a bet on this product. Because promises made to stakeholders about profits were not met, WidgetCo’s CEO now finds his position at risk.

But what about the patent?!!! Well, Dear Reader, therein lies the proverbial rub. As discussed initially, the Widgetplus patent focused on the structure of the product, not the functional characteristics that are the underlying innovation. Notably, most people refer to a product’s solving an unmet need in the market, but this is wrong framing. Rather, it is the product’s function that drives customer demand, with the product being the “delivery system” for that needed function. In our Widgetplus example, that same function could be delivered by other products, which gave ThingyCo an opening to enter the market with a non-infringing product, as well as the opportunity to take market share from WidgetCo with less financial investment and, importantly, less risk. ThingyCo could do this without infringing WidgetCo’s patent because the patent covered only a single delivery system to for the function (i.e., Widgetplus), provided by the innovative product, as opposed to covering the innovation itself.

While this example is generic, it is not hypothetical. I see this happen all the time when I participate in valuation projects. Moreover, I have seen $150 million+ acquisitions go belly up because of lack of understanding of how patents cover the market opportunity being purchased vs. how they cover the product. This happens time and again because, unfortunately, it is exceedingly rare for a forensic analysis of business failure to be conducted where patents protection is considered to be a signal relevant for consideration. Accordingly, failed patent strategy is rarely, if ever, made accountable for failure of innovation activity to meet financial projections.

It also not only physical product innovations where value is destroyed by honing patent coverage too closely to the specifics of the product being sold to customers. Software-related patents are often little more than process flow charts, and don’t get me started on chemistry-related patents that read as if they were recipes leaving little margin for variation in the final product. Put simply, most patent applications are written to capture the end-point of an innovation process–the product that will be sold to the consumer, not the reason that the product was identified as needed in the first place. While a competent patent attorney will be able to broaden the claims to encompass variations on that product, the claims will still basically cover that product. If that product is only one way to solve the customer’s problem, the patent will not suffice to reduce competitive risk.

Of course, situations where patents can be blamed for failure of business bets are few and far between. For those companies (and investors) that are betting on the success of innovative products in the market and the premium profits that result, the risk of patent failure is greater, however. As I tell clients frequently “patents rarely matter, but when they matter, they matter A LOT.” In other words, for companies where innovation delivered to customers in product form is a driver of sustainable revenue and/or desired exit value, innovation in how patents are obtained is critical. This means that companies that do not make changes to their patent strategies are unlikely to attain the financial projections that made them make the bet on that innovation in the first place.

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