Intellectual Property 101

Hello!

Thesis: Intellectual property is becoming exponentially more valuable across all company lifecycles and is an excellent way for companies to increase their differentiation in comparison to their competition.

This is going to be a dense read for those not versed in the language of law and the terminology behind intellectual property. Let’s start with some initial definitions to get everyone up to speed.

Definitions:

• Intellectual Property (IP): Intangible assets that are protected under law, including patents, trademarks, copyrights, and trade secrets.
• Patent: Legal right to exclude others from making, using, or selling an invention for a certain period of time (typically ~20 years).
• Trademark: A word, phrase, or design that differentiates one good or service from another.
• Copyright: A legal right that protects original works of authorship.
• Trade Secret: Confidential information giving a competitive advantage.
• Licensing: Giving permission to another party to use intellectual property in exchange for a royalty payment.
• Royalty: A payment made by a licensee to a licensor in exchange for the right to use an intellectual property asset.

Why do I care about Intellectual Property?

While at Penn State interning with the Department of Entrepreneurship, I had the opportunity to do quite a bit of research into the area of intellectual property (specifically technology transfer - which will be the topic of a later blog post). This was my first time interacting with intellectual property on a deeper level and it’s started this journey of research since then.

What is Intellectual Property?

Intellectual property are valuable intangible assets (meaning not physical). They traditionally come in the following forms: patents, trademarks, copyrights, and trade secrets (see definitions above).

Let’s talk about the process of protecting intellectual property. Here’s an example for instance:

Step 1 - Develop Idea: When beginning the intellectual property process, a researcher will start with identifying a problem and formulating potential solutions to that problem. This is an initial triage that is similar to the common myth about Thomas Edison inventing the lightbulb, “In the 1920s, a journalist asked Thomas Edison how it felt to fail 1000 times in his attempt to invent the incandescent lightbulb. He replied, ‘I didn't fail 1000 times. The lightbulb was an invention with 1000 steps.’”

Step 2 - Design Product: As the researcher settles down on more feasible solutions, they will begin designing a potential product. This step potentially takes years as complex prototypes and many rounds of testing may need to occur. Unfortunately, this step also takes quite a bit of money, and many quality inventions stagnate at this stage.

Step 3 - Protection: Once a completed product has been mostly finalized, the researcher will begin the process of intellectual property protection, traditionally working with lawyers to complete this process. Depending on the complexity of the invention, this process may take years. To simplify this process into simple language, the government generally looks at 2 things (among others):

• Prior Art - the idea that the government is trying to determine whether this protection infringes upon any previously granted intellectual property protection.
• Whether this invention deserves intellectual property protection at all (I’m not competent enough to talk about this point so we’ll keep it general).

Step 4 - Licensing: After protection is in place, the researcher would then work with specialized marketing professionals to either build a company themselves (the entrepreneurship route) around the product or to license the rights to the product to a 3rd party (the take your money and run route). Licensing is the act of the researcher giving the right to use their protected research (their ideas/design essentially) to another entity within certain boundaries in return for payments.

Now we understand a bit about Intellectual Property, what now?

I think intellectual property is extremely valuable and important to companies. Let’s talk about a hypothetical situation, specifically, the economics behind the concept of a small biotech company. Why would someone want to found a new small biotech company researching the cure for… let’s say life-saving cancer drugs?

Starting with general economic concepts of supply and demand, there is a lot of demand for cancer drugs, meaning that generally the price will be elevated. Given that to my knowledge there currently isn’t a life-saving cancer drug on the market today, the supply of treatments aimed at doing this are very limited, leaving the supply line very steep. See the graph below:

As you can see, currently (before our biotech firm enters the market), the price is relatively high for the current drugs on the market and the supply is decently low. So, let’s say now the biotech firm starts to develop ideas for a new cancer drug and come up with 3 they think are worth looking into further.

Say they start going through this further development and find out that 1 of these drugs has true potential, so now we’re going to explain 2 different scenarios. First, we’ll walk through what happens in the market if they go through with fully developing this drug and don’t protect the idea. Second, we’ll walk through what happens in the market if they go through with fully developing this drug and protect the idea.

Scenario #1 - No Protection

Let’s assume the drug works 100% of the time. Given its size, the biotech firm manufactures thousands of these drugs (let’s assume enough for 1% of the market) and they go on the market as well as the drugs from 4-10 other major pharmaceutical identical company copycats (copied directly off of the research) and these identical copycat drugs are able to provide for the other 99% of the market.

So what happens to supply and demand?

Well, demand doesn’t truly change as the people who need the drug still need the drug. Yet supply drastically increases, dramatically lowering price as all of the companies have identical products (meaning they have no differentiation) so they compete only on price - driving the price down exponentially. See the diagram below:

As you can see in this scenario, the small biotech firm isn’t able to make a massive product as the average consumer can easily substitute away from their product combined with the fact that the price is so low. In economic terms, a lot of value is created but is failing to be captured.

Scenario #2 - Protection

Let’s assume the drug works 100% of the time in this scenario too. But, before going to deployment, the company effectively sought and achieved intellectual property protection for their product. So, no other companies were able to make copycat drugs of their drug by law.

Given its size, the biotech firm manufactures thousands of these drugs (let’s assume enough for 1% of the market) and they go on the market.

So what happens to supply and demand?

Well, demand doesn’t truly change as the people who need the drug still need the drug. Yet supply drastically decreases as the current drugs that “prolong the inevitable” won’t truly cut it anymore as people will demand to have the product that will truly cure them - driving the price through the roof. See the diagram below:

So, as you can see in this scenario, the small biotech firm is able to create a large amount of value and also capture most of that value, leading to a very positive scenario for the small biotech firm.

**Little note here, let’s not get started on whether this example of withholding important medical treatment was ethical or not - that’s not the point, the point is to show the beneficial nature of intellectual property as a way to create and capture value**

This example illustrates the value of intellectual property to companies as a way to create and maintain a unique and powerful product that ultimately allows you to “beat” your competition. Phrased in another way, it’s like you’re playing golf with the other company and you have a full set of clubs and they only have a feather.

My hope is that you’ve enjoyed this primer on intellectual property and the potential it has for value to individuals and companies. There will be further blog posts written on this subject, so please let me know if there are any specifics you’re interested in in the comments and by email. I’ll end with a recent stat that 90% of the value of S&P 500 companies is due to intangible assets (which includes goodwill and intellectual property).

Anywho, that’s all for today.

-Drew Jackson