CHAPTER ELEVEN

INTELLECTUAL PROPERTY:
PROTECTING YOUR IDEAS

LECTURE NOTES

The purpose of this chapter is to explain how entrepreneurs can use intellectual property to help
their businesses.

CAPTURING THE PROFITS FORM NEW PRODUCTS AND SERVICES

Intellectual Property – the core ideas about a new product or service that make the
development of these products and services possible.

The Product Development Process

Learning Objective:
Explain why product development in new firms is difficult, but why new firms tend to be
better than established firms at product development in most industries.

Product development – the process by which the entrepreneur creates the product or
service that will be sold to customers.

Developing a new product or service is not easy.

The entrepreneur must recognize a need that people have, and then create a
solution to that need, which can be produced and marketed for less than the
customer would be willing to pay for it.

This is difficult because it is very uncertain.

Entrepreneurs do not know if the product development path will lead to a

successful new product or service.

The difficulty and uncertainty of product development means that entrepreneurs are most
effective at product development if they quickly screen new product opportunities to
identify the most promising ones.

You can do everything right in product development and still fail, if you are
unlucky.

New Firm Advantages at Product Development

Established firms have the following advantages:

1. Better at manufacturing products

a. Better access to capital

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 b. Develop tacit knowledge about production process from experience
c. Economies of scale
2. Tend to be better at marketing
a. Better access to customers’ needs and preferences
b. Have social ties with customers

New firms also have advantages:

1. Have superiority at product development

2. Develop new products more easily and cheaply
a. Can transfer information back and forth between marketing and
production more easily.
b. Can give equity and better incentives to new employees
c. Have more flexibility

Even though small firms tend to be better at product development than large firms, some
times they are not. Large firms better at product development than new, small firms:

1. when production is concentrated in a few firms

2. in industries that are capital and advertising intensive
3. in industries that are research and development intensive.

In industries where entrepreneurs are better at developing new products (i.e. medical
devices, computers, scientific instruments, etc.), entrepreneurs have a chance to compete.

Ease of Imitating Entrepreneurs’ Intellectual Property

Learning Objective:
Explain why established firms find it easy to imitate entrepreneurs’ intellectual property
quickly and at a low cost.

Most new products and services developed by entrepreneurs are easy to imitate and can
generally be copied at a fairly low cost.

The typical patented process innovation can be duplicated at less than 50% of the
cost and in a much shorter time.

The reasons for this include:

Reverse engineering – it is easy for a competitor to go out and buy the

product off the shelf, then take it apart to see how it works, and
manufacture it at a lower cost.

Hiring the entrepreneur’s employees – established firms can usually pay

higher salaries than the entrepreneur and can hire away the technical
people.

Competitors can often take the entrepreneur’s new development and

improve on it even more.

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 DANGER! PITFALL AHEAD!

The author’s (Scott Shane) student invented a medical device called a ”tissue grasper.”
While he came up with the ides of the device while working for his former employer, he
refined it after leaving that firmt. The student wanted to get the invention patented and
start his own company. However, he had signed two agreements at his previous
employment: a nondisclosure agreement and a non-compete agreement. These
agreements precluded him from getting the patent or starting his business without risking
a lawsuit from his previous employer.

Nondisclosure agreement – precludes a person from disclosing to others any information

valuable to the employer that was developed while working at the company, typically for
three to five years from the termination of employment.

Non-compete agreement – bars a person from working for a company that competes with
the employer for a set period of time, often one to two years.

LEGAL FORMS OF INTELLECTUAL PROPERTY PROTECTION

Patents

Learning Objective:
Define a patent, explain what conditions are necessary for in inventor to patent an
invention, and outline the pros and cons of patenting.

Patent – a legal right granted by a national government that allows an inventor to

preclude others from using the same invention for 20 years, in return for disclosing how
the invention works.

1. The invention must be novel.

2. It must not be obvious to a person trained in that field.
3. It must be valuable
4. It must be secret at the time that the patent application has been made.

What can be patented?

A process, machine, manufacturing technique, plants, chemical formula, design,

software, business methods, etc.

What cannot be patented?

A business idea, something that does not work, something patented before.

When getting a patent, the patent holder is required to disclose how the product is made.

This makes it easier for competitors to imitate the new product.

To obtain a patent:

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 1. Inventor files a provisional patent application, which marks the start of the
patent application process date and does not require disclosure.
2. Inventor files an application with U.S. Patent and Trademark Office.
3. U.S. Patent Office evaluates whether the invention is patentable.

Prior art – this is the set of previous patented inventions that are related to the new
invention.

The new invention must improve on prior art.

Set of claims – these are the statements in the application about what was invented.

These must be carefully written, to be as broad as possible.

The new patent only precludes people from duplicating what is contained in the
set of claims.

To defend your patent against patent infringers:

1. Is costly.
2. You must hire a lawyer.
3. The value of a patent is dependent upon how vigorously you defend it.
4. Failure to challenge a person infringing on your patent can undermine your
patent in other cases.

Disadvantages of patents:

1. They are difficult and costly to obtain and to enforce

2. They are not always effective
3. They require disclosure of the invention
4. They can be invented around.

There are no international patents. Reasons for getting patents in other countries are:

1. Failure to patent in a particular country means that it is legal for someone in

that country to copy your invention
2. Patent laws differ across countries

Trade Secrets

Learning Objective:
Define a trade secret, explain what conditions are necessary for an invention to be a
trade secret, and outline the pros and cons of trade secrets.

Trade secret – a piece of knowledge that confers an advantage on a firm and is protected
by nondisclosure.

Patents and trade secrets are mutually exclusive.

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 Advantage of trade secrets:

They provide a way to protect a competitive advantage without disclosing the

underlying technology.

Disadvantages of trade secrets include:

1. Difficult to keep the secret hidden

2. Must keep strict legal standards to maintain a legally valid trade secret
a. Employees must sign nondisclosure statements
b. Must have password protection on secret data on computers
c. Must limit access to only a few people
3. Trade secret does not provide inventor with a monopoly like a patent does
4. To enforce it in court, you must prove a loss of competitive advantage
a. With a patent, you need only show someone copied it

Trademarks

Learning Objective:
Define a trademark, describe why trademarks are useful to entrepreneurs, and explain
how an entrepreneur can obtain a trademark.

Trademark – a word or phrase, symbol or design that distinguishes the goods and services
of one company from another company.

You obtain a trademark by either

1. actually using the mark.

2. by filing an application with the U.S. Patent and Trademark Office.

The right to use the mark belongs to the first party to register or use it.

Copyrights

Learning Objective:
Define a copyright, and describe how it protects an entrepreneur’s intellectual property.

Copyright – a form of intellectual property protection provided to the authors of original

works of authorship.

What can be copyrighted?

1. Literary, dramatic, musical, artistic, and certain other creations.

2. Books, study materials, plays, pantomimes, choreography, pictures, sculptures, graphics,
motion pictures, recordings, architectural designs

What cannot be copyrighted?

Impromptu speech, titles, names, short phrases, slogans, ideas, procedures,

methods, systems, processes, principles, discoveries, devices, standard works
(like calendars) etc.

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 Copyright gives the sole right to reproduce the copyrighted material to the person holding
the copyright and those whom he or she permits to copy it.

Copyright is good for 100 years.

When someone working for you produces an original work of authorship, the employer
receives the copyright.

You do not have to do anything to obtain a copyright.

As soon as a document or CD, videotape, etc. is produced it has copyright

protection.

You can apply to the government for a copyright, but it is not necessary.

Showing the copyright symbol is not necessary to have a copyright.

NONLEGAL FORMS OF INTELECTUAL PROPERTY PROTECTION

Learning Curves, Lead Time, and the First-Mover Advantage

Learning Objective:
Describe a first-mover advantage and explain the conditions under which it provides a
useful form of intellectual property protection.

First-mover advantage – any benefit that a firm receives from being the first to offer a
product in a particular market.

Lead time – the benefits that are generated by doing something a few months or years
before someone else.

Early efforts to learn often put firms at a relative advantage over their
competitors.

Being a first mover can help protect the entrepreneur’s product or services against
imitation

1. When a business involves scarce assets, an entrepreneur can protect

intellectual property by obtaining control over the scarce assets before
others can get to them.
2. Being the first mover provides advantage when products become more
valuable as the number of people who use them increases.
3. Anytime there are high costs to customers to switch form one product to
another, the first movers have an advantage.
4. Any time people tent to be content with the status quo, being a first mover
gives an advantage
5. Being a first mover is an advantage whenever reputations are important.

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 6. Entrepreneurs benefit from a first-mover advantage whenever the learning
curve for producing a product or service is proprietary.

Since the more times someone does something, the better they get at it,
the earlier you can be in on something, the better you will be at it by the
time others enter into that field.

If you do not fit into one of the six advantages above, you might be better off not
to be a first-mover in that field.

Complementary Assets

Learning Objective:
Describe complementary assets, and explain when it is better for an entrepreneur to
obtain control over complementary assets than to be innovative.

Complementary assets - those assets that must be used along with an innovation to
provide a new product or service to customers.

Examples are manufacturing equipment for making the new innovation

Marketing and distribution facilities for the new innovation, etc.

If the entrepreneur cannot be one of the first with an innovation, he or she might still be
able to make money supplying complementary assets for the new innovation.

Sometimes it is better to control complementary assets than to be the innovator of

new products.

ANSWERS TO END OF CHAPTER DISCUSSION QUESTIONS

1. Suppose that you are founding a new company to produce a new form of surgical scalpel.
Large companies, such as Johnson & Johnson, also have the same idea. Would your
company or Johnson & Johnson be better at developing the new product? Explain why.

Answer: You would probably be better. Small firms tend to do well at product development in
medical devices. Moreover, new firms tend to develop new products more easily and cheaply
than established firms. New firms can transfer information back and forth between marketing
and product design people more easily. New firms can offer better equity incentives than can
large firms. New firms have more flexibility than do large firms. If the new surgical scalpel
represents a radical change in form or development, a new firm might have an even greater
advantage

2. Assume that you have now developed your surgical scalpel. Will it be easy or difficult
for Johnson & Johnson to imitate this new product? What could they do to imitate it? What
can you do to stop them?

Answer: Really understanding how others might steal an entrepreneur’s thunder can help
students learn to be more cautious. Johnson & Johnson can imitate the scalpel very easily.
Through reverse engineering, Johnson & Johnson can see how your scalpel is made. They can

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hire your technical people from your company. If the process of making the scalpel or the
scalpel itself can be patented, this is some protection for you, but to enforce your patent would
require great sums of money, time, and attention that you do not have. A patent lawsuit may have
some validity, but, again, it will be very costly.

3. Think of five inventions that could be patented. Should you patent them? What are the
advantages and disadvantages of patenting each item.

Answer: Answers will vary. Students should show they are aware of the requirements to patent a
product, as well as the advantages and disadvantages. Among the requirements are: making
proper application for a provisional patent or full patent to the U.S. Patent and Trademark Office,
demonstrating how the invention is different from existing patented inventions, and showing how
it improves upon prior art.

Advantages of patents include helping to raise capital by showing a competitive

advantage, raising the cost of imitation to competitors, providing a monopoly right by preventing
other people from doing the same thing, and preventing a second party from using the invention
as a trade secret. Disadvantages include the requirement that the idea be disclosed to the public,
the invention can be circumvented by a clever competitor, stringent legal enforcement must be
used to prevent infringement, with technological advances of today, it may be out-of-date by the
time the patent is issued, and it requires a patent application in all countries of the world.

4. Suppose that you are in charge of American Airlines’ computer reservation system. A
venture capital backed start-up that is creating an online airline reservation system wants to
hire you as chief technology officer because of your expertise with American’s reservation
system. Under what conditions would you be allowed to take the job?

Answer: You you probably could make the job change if you could show that you were not going
to be using any proprietary information gained from American Airlines on your new job, if you
had not signed a not to compete agreement, and if you had not signed a nondisclosure statement.

5. Suppose that you are the first entrepreneur to develop an online dating service. Would
being a first mover be an advantage in this business? Why or why not?

Answer: Remind students that timing is important in business. Being a first mover has six
advantages. (1) When a business involves scarce assets, an entrepreneur can protect her
intellectual property by obtaining control of the scarce assets before others can get to them. (2)
Being a first mover provides an entrepreneur with an advantage when products become more
valuable as the number of people who use them increases. (3) Anytime there are high costs to
customers to switch from one product to another, first movers have an advantage. (4) Anytime
people tend to be content with the status quo, being a first mover offers an advantage. (5) Being a
first mover is an advantage whenever reputations are important. (6) Entrepreneurs benefit from a
first-mover advantage whenever the learning curve for producing a product or service is
proprietary. Students should be able to take the online dating service through each of the six
advantages and discuss each advantage with respect to the online dating service.

ANSWERS TO INFOTRAC EXERCISES

1. From inventor to entrepreneur: safeguard your inventions and your profits. (includes a
list of resource organizations)(Tech Issues)(Brief Article) Monique R. Brown.

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Black Enterprise, Feb 1998 v28 n7 p54(2)

Full Text: COPYRIGHT 1998 Earl G. Graves Publishing Co., Inc.

Record: A20209030

SOLUTIONS

1. Because of inexperience and poor marketing

2. Use documentation to establish a claim for your invention; use nondisclosure agreements;
allow the company interested in your product to oversee the patent process; consider
licensing the invention
3. Licensing agreements allow you to grant someone (or a company) the legal right to
manufacture your idea in return for cash payments and/or royalties on a regular basis.
The process is fairly simple, and can be ideal for anyone who wants to profit from an
invention without giving up total control or assuming the complications of running a full-
time business.

Locking up intellectual property: Keep your secrets from walking out the door. (Small
Business Advisor). F.S. Brewer.

Utah Business, March 2002 v16 i3 p52(2)

Full Text: COPYRIGHT 2002 American Diversified Publishing Company, Inc.

Record: A84378378

SOLUTIONS

1. A trade secret can be any information--be it a formula, program, device, technique or

process--from which a company derives or could potentially derive economic value,
information that gives a company an edge over its competitors.
2. Assign trade secret status; taking strong measures to keep information away from
unwanted eyes; hire someone with the responsibility to protect intellectual property
assets; cover instances when a company decides to enter into negotiations with a potential
customer, joint venturer or licensee
3. Before negotiations begin and any information is shared, both parties should sign a
mutual non-disclosure agreement; when negotiations begin, both parties should enter into
a memorandum of understanding (MOU), outlining the structure of the deal, what
information will be shared and what obligations both parties have in keeping each other's
trade secrets protected; if a deal is struck, solidify MOU into a real contract, delineating
exactly what company owns what technology.

ANSWERS TO SMALL BUSINESS SCHOOL VIDEO DISCUSSION

TOPICS

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NoUVIR with Ruth Ellen Miller
This episode of Small Business School profiles Ruth Ellen and Jack Miller, owners of NoUVIR, a
company that is changing the way we view priceless art and artifacts on display. NoUVIR’s
product, the cold-nose projector, is so innovative and unique that the Millers have a number of
patents on the product. You might ask your students to think about what they have learned about
the protections and disadvantages of patents from this chapter in the text. Why would it make
sense for the Millers to obtain patents for their product? What aspects of the product or industry
might make patenting a more valuable option for the cold-nose projector than, say, patenting an
old family recipe for oatmeal-raisin cookies?

Topic for discussion: What did Jack and Ruth Ellen have to do to achieve their breakthrough?
Answer: They shut down a profitable consulting business and worked for three years before they
had something to show a museum director. Jack said, "it really is a quantum jump to go from
light bulbs to fiber optics."

Topic for discussion: Why make a drastic change in life-style by moving from California to
Delaware even before you have a product perfected?
Answer: These two could picture their success and they didn't like what they saw when it came
to the operations side of NoUVIR if they stayed in the Los Angeles area.
By selling land and homes in California and buying in Delaware, they freed up cash they
could use during the three years in which they had no income. Their research told them that taxes
in Delaware are low on businesses and the workforce would be plentiful. Their research paid off.
They have been profitable ever since they started selling the cold-nose projector.

Topic for discussion: Why do so few products succeed?

Answer: First, some inventors actually think a big company will give them millions for an idea
they sketch on a tablet. Many big companies buy-out small companies but only after the product
is made and proven by happy customers. Second, it takes time and most people aren't as patient
Jack and Ruth Ellen. Third, many projects don't have a good idea behind them. In the case of the
cold-nosed projector, the idea is fantastic. Using fiber optics lighting, museum directors can stop
the ruin of great paintings and treasured artifacts.

Topic for discussion: Why bother doing so much paperwork?

Answer: Multiple patents make it nearly impossible for someone to steal your idea. While a big
company, such as Microsoft, which is known for stealing ideas, won't think twice about
incorporating your idea into one of their products without paying you, they probably would not
attempt to copy a product that has multiple patents registered in the United States Patent office.
One reason it is so hard for small companies to make it big with new products is that big
companies are predators. They can't help themselves. Their market share gives them huge
advantage so they have cash for research and development and actually think they are smarter
than you. I can hear it now in the labs of GE, "We saw a new idea but we had actually done that
type of work a few years back and so it is really our idea." Taking time to do the paperwork can
actually save your life's work.

Topic for discussion: What is important about a trademark?

Answer: Create something unique. NoUVIR made up a word that is easy to protect. If they had
named their company "New Light," it would be hard to protect because both words are so
common. If they had chosen "New Light" then had a special logo designed, that design, which
includes the words, could be protected.

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 Also, use your trademark by putting it on everything. Usage is part of what a court would
look at if you were forced to defend your trademark. Protecting your ideas requires paperwork
and patience. It takes up to seven years to become fully registered.

Topic for discussion: How is wealth created by a protected idea?

Answer: A protected idea has more value than does an unprotected one. However, the MP3
technology turned millions of mostly young people into thieves. A thief is one who takes
something that doesn't belong to him. The creator of a song can spend days or months or years,
thinking about melody and lyrics. He spends money recording the song and puts it into album
form with a copyright mark. The creator sacrificed time and money to bring the product to market
and legally is protected.
If the thieves win, then the song has no value. If the creator wins, he will be compensated
and have the funds to create again. Paying for one song funds the creation of the next and
everybody then wins.

Topic for discussion: What is the hiring process at NoUVIR?

Answer: People are hired as temporary workers until Ruth Ellen can see clearly if she will make
the person permanent or ask the staffing service to send her another person to try out.
With less than one dozen employees, every single person who is added to the mix is so
powerful, Ruth believes she should date before she marries.

Topic for discussion: How does NoUVIR win new customers?

Answer: They do seminars that are hosted by museums where they can demonstrate the value of
their lighting. The seminars last an entire day! The big vision for NoUVIR is to change the way
we see and to protect the art and treasures of the world. With a big vision like this, they need a
whole day to explain. Really, NoUVIR is all about changing what has been institutionalized and
this makes the sale even harder.
Its customers are typically non-profit institutions with slow decision-making processes
that have to please a board of directors. NoUVIR must give the people who attend their seminars
detailed information that the attendees in turn can use to persuade the powers that be back at their
own museums.

Topic for discussion: Since life really is about decision-making and problem solving, why do so
many run from the difficult problems?
Answer: We're spoiled! Perhaps, we've come to this point in our lives by letting others solve the
hard problems and make the decisions that require complex work. Or, we have positioned
ourselves in such a way that we can do quite well without taking on difficult problems.
That's fine for some but not for entrepreneurs and small business owners. In fact, the
bigger problem an entrepreneur can solve, the bigger business she will build. Or, if an
entrepreneur finds a little problem that lots of people have, delivering the solution can mean a big
business.

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