The United States Constitution provides that Congress has the power to
reserve to inventors for a limited time the exclusive right to their inventions
because this will promote the useful arts.
Owners and managers of small to mid size, and even large companies, often
have doubts about the returns from investing in patents. Everyone will
admit that engineers like to have patents on their resume and will allow
that occasionally some idea is important enough to justify a patent; yet
it is not unusual for a business owner, or manager to have doubts about
the desirability of routinely patenting new products and new manufacturing
techniques developed by the company. The purpose of this essay is to provide
a rational framework for developing a budget for patents.
The principal use of patents for small to mid size companies is to differentiate
their products from their competitors' products. If a company develops
a successful new product, its competitors will notice the success and
bring out a competitive product to take advantage of the market demand
created by the original product. If a patent has been filed on the original
product the original product may lawfully be marked "Patent Pending."
A competitor reviewing the original product is thus placed on notice that
if the product is copied it may well be covered by the patent when it
Twenty years ago it was reasonably safe to infringe a patent because
most patents were, on appeal, found to be invalid. Patents were viewed
as monopolies which were not favorably viewed as a matter of public policy.
In the '70s the rise of strong foreign competitors which were utilizing
U.S. technology resulted in a sea change. Patents became viewed as instruments
to preserve the strong innovative advantage of the U.S. In order to promote
a uniform treatment of patents within the federal court system, a new
Court called the Court of Appeals for the Federal Circuit (CAFC) was formed
in 1982. This Court hears appeals from all patent cases decided in federal
district courts. The CAFC deals almost exclusively with patent and patent
related cases. The judges are therefore experienced in dealing with the
complexity of patent law and technology. The result has been a great increase
in the likelihood that a patent will ultimately be held valid.
If patents are usually held valid, then infringing a patent involves
considerable business risk. Patents typically take one to two years to
issue, during which time they are not available to the public, making
it difficult to assess the risk of infringement. Therefore a risk-adverse
competitor will do one of two thing: either postpone designing a competitive
product, or, after consulting patent counsel, design something very different.
Thus, even before a patent is obtained, it provides a one to two year
marketing advantage, limiting a competitor from directly competing with
a new product. This alone often justifies the cost of applying for patent
Once a patent issues its scope or coverage is defined by the patent claims.
These are one sentence statements of what the inventor believes is new
about the developed product or process. A patent claim is broad if it
covers a wide range of possible devices or methods. A broad patent, for
example would be one covering all engines using the diesel principal,
the laser principal, the electrostatic photocopying principle, etc. A
narrow patent covers only a specific implementation such as a diesel engine
utilizing a piston sealing ring having an elliptical shape, a diode laser
employing a Germanium substrate doped with gallium, a photocopier utilizing
a paper substrate on which an electrostatic image can be formed. Most
patents have relatively narrow claims because at least the general concept
for most products, or methods are old. You cannot get a valid patent on
something that is old (lacks novelty) or is obvious (is not inventive).
If the product or process which is patented represents a real product
at the time the application was written, the claims will generally cover
at least the particular solution which the marketed product uses to solve
a particular problem. Thus a competitor must choose a different approach
to avoid even relatively narrow claims. Typically, the competitor can
manufacture a product which is a functional substitute for the patented
product. However, assuming the patented product is enjoying some market
success, the customers of the original manufacturer will be looking for
a product just like the original ones. If a competitor can't supply a
product just like the patent owners', customers will be less likely to
purchase its product. Further, the owner of the patent can argue through
advertisement and sales representatives that customers should buy the
patented product because of the features which the competition can not
For a product with significant sales the cost of a patent is typically
a very small percentage of gross sales. Even a limited advantage, i.e.
delaying a competitor's entry into the market by a year, or preserving
a unique feature which the competition cannot supply, will justify the
investment in a patent.
A second motivation for obtaining patents is their use as bargaining
chips. Patents are typically used as barriers to entry to particular markets
and industries by preventing Free Riders from knocking off successful
products without significant investment in product development and market
development. It normally is the case that a given industry will have a
limited number of competitors. If one competitor begins to enforce a particular
patent against another in a particular market, they are often willing
to settle a patent suit by trading licenses. Trading a license to settle
a patent suit avoids expense in litigation for both parties, and secures
a competitive advantage for both parties versus competitors--particularly
Free Riders who have few or no patents and cannot expect to settle litigation
on such favorable terms.
A number of competitors in a market often results in the total market
expanding as a result of the collective advertising and promotion, innovation
and available selection of goods. At the same time, patents prevent non-contributors
from benefiting. Of course patents are an imperfect tool for excluding
Free Riders, but a reasonable portfolio of patents improves a company's
position within an industry even when used passively to settle lawsuits.
A related use of a patent portfolio is to make a suit by a competitor
a two-way street. Whether the competitor's suit relates to patents or
not, a patent counterclaim can often be made. Settlement of a suit is
often encouraged by both parties having downside risks. Litigation is
an inherently uncertain process and before initiating suit a competitor
must consider whether if suit is initiated a favorable outcome can be
assured. The fact that the target of the suit has a portfolio of patents
which could possibly be asserted will be a consideration which may prevent
suit or result in a rapid movement toward settlement before litigation
A related use of patents is in a new industry where competitors are investing
heavily in a new market hoping to bring a viable new industry into being.
It often happens that the successful solution requires a combination of
technologies from several or all of the companies in the new industry.
This can result in a trading of patent rights such that several players
will gain rights to sufficient technology to introduce competitive products.
Thus when heavily invested in new technology, even if the key technologies
are missed by your company in its investment strategy, a patent portfolio
which even partially facilitates the eventually successful technology
can be used to buy a seat at the table or obtain a royalty stream for
Cost justifying patents as bargaining chips or hedges to technology development
programs is less immediate and generally requires a budgeted approach
tempered by experience. Thus one to ten percent of R&D funds might be
allocated to patents, with the precise number being based on industry
norms and company experience. Patent expenses are similar in some ways
to R&D, advertising, and insurance expenses which do not generally result
in a clearly measurable immediate result but which over time make a clear
and sometimes decisive contribution to a business.
A third justification for patents relates to selling a small to medium
size business. Typically the most valuable thing about a business is the
fact it is a going concern which knows how to successfully build and sell
a range of products. However the purchase price must be allocated to various
assets, and patents provide the most substantive of the intangible assets.
Patent are routinely evaluated for scope and enforceability, and often
a value of millions is often attached to a relatively small portfolio
of patents which relate directly to the products being sold. Thus patents
which apart from a going concern might have limited value, can have substantial
value as part of a going concern. This is particularly true in terms of
their contribution to product differentiation as discussed above.
A fourth use of patents it is as a tactical tool in developing a product
to compete with a competitor's patented product.
All these uses and economic advantages of patents are largely passive:
the benefits of patent ownership accrue to the patent owner by the reaction
of competitors or others to the existence of the patents, either in providing
a competitive advantage in the marketplace, or in helping to avoid or
settle litigation brought by others, or contribute to value in the sale
of a business. Before discussing an active litigation strategy it is useful
to consider the practice of collecting royalties based on patents. Although
for many independent inventors and the general public, payment of royalties
is the first thing that comes to mind when considering patents, obtaining
significant revenues from patent licensing is in most cases of secondary
interest, and cannot be counted upon.
Large businesses, universities and research institutions, and the rare
independent inventor, and an occasional small company, can successfully
exploit a patent portfolio to command substantial income based on royalties.
However, in this realm the rule of ten applies. Out of every ten patents
one might be licensable, out of every one-hundred patents one might return
a substantial income, and out of one thousand patents one might dominate
an industry. This reality is exploited by university foundations which
obtain patents on university research and actively attempt to license
the patented technologies. One major state university figures that out
of thirty or forty ideas, one-half will be patented and of that half,
a few will be licensed, but only one will yield significant returns. That
one will pay for the cost of all the applications and licensing expenses
for the rest. A recent book Rembrandts
in the Attic discusses exploiting large patent portfolios as income
producing sources which are often overlooked as profit centers.
Although patents can be a source of business income, the scale of patenting
needed for reasonable likelihood of developing licensable technology is
such that most medium and small businesses will not justify a budget for
patents based on possible licensing revenue.
A patent gives the owner the right to exclude others from making, using,
selling, or offering for sale in the United States, or importing into
the United States products falling within the scope of a valid patent.
A patent gives the owner the right to keep others from contributing or
aiding and abetting, inducing, or acting as a accessory to an infringement.
A patent gives the owner the right to prevent importation of products
made by a patented process outside the country and the right to keep others
from manufacturing a product in this country which can be readily assembled
to form an infringing product in another country. A license is basically
an agreement not to exercise these rights against someone in return for
a royalty. A patent suit seeks to collect damages based on a trespass
on the patent owners rights.
For most small and medium size businesses, litigation will be undertaken
only for a clear business purpose. Litigation generally is expensive,
and patent litigation is even more so. A typical patent case which proceeds
through trial will require expenditures in excess of $500,000 for each
litigating party. Rarely are potential damages so high that the certain
litigation expenses and loss of management time and focus would not be
more advantageously invested in new products and new markets. Nevertheless,
litigation is justifiably undertaken to restrain a competitor who is damaging
the market by selling inferior goods, taking customers, or destroying
the economic incentives to innovation by copying a company's products.
A willingness to litigate can substantially increase the value of all
patents held by increasing the perceived risks associated with infringement.
An infringement action settled for a license can also supply a continual
source of information about a competitor as they are required to report
periodically sales of licensed products. Thus litigation is usually commenced
for long term market considerations rather than short term prospects of
Whether for short term or long term advantage; whether to protect an
emerging market or to make room in a developed one; and whether as an
instrument of passive threat, or active enforcement; the U.S. patent is
a powerful tool in the aid of a successful business enterprise, and the
merits of developing a patent portfolio should be examined by every ongoing