What are Patents?
A patent is an exclusive right granted for the invention of a product, process, or design. It legally prevents any other party from making, using, or selling an invention, or even importing the same into the country.
U.S Patents and Trademark Office (USPTO) is vested with the authority to grant patents. They generally remain in force for a period of 20 years. Think of it as a contract between the inventor and the government. The government grants complete protection and exclusivity of the invention in exchange for the total disclosure of the design and science behind the patent. Upon expiry of the patented period, the patent enters the public domain and remains free for use without leading to infringement violations. It is upon the inventor to make the most of his patent during the designated period. Licencing is one of the most common and convenient ways of harnessing maximum potential out of this arrangement.
- What are Patents?
- Conditions to Qualify as Patent
- Types of Patents
- Patent Valuation
- Disadvantages of Patents
Every discovery is not patentable. It is not possible to obtain a patent on a law of nature or scientific principle even if a person is the first to discover it. For example, Isaac Newton cannot be bestowed with a patent for discovering the law of gravity or Albert Einstein for his formula of relativity E=mc2.
Conditions to Qualify as Patent
Any addition, alteration, or modification cannot qualify as a patent. To get patent rights, an invention must satisfy the below-mentioned criteria.
There must be a tangible idea, concept, process, or product capable of transforming into reality. Appliances, pharmaceutical drugs, new production processes, and software are examples of “patentable subject matter.” On the other hand, artistic creations, mathematical models, and naturally occurring plant and animal varieties are abstract discoveries not patentable.
This condition requires an invention to be completely new, undiscovered, and unheard of. The test of “novelty” is assessed as on the date of application. For this reason, it is important to sign a contract of confidentiality before disclosing the product or process to anyone.
This condition emphasizes the innovation aspect of the product or process. An invention should be such that its application should not be obvious to anyone skilled in a related field. This condition restricts new uses of existing products from getting patents since it is difficult to prove that such use was not already in practice before the supposed invention.
This condition emphasizes “industrial applicability.” Here, the term industry construes in a broader sense and includes services such as transport, education, agriculture, etc. Industrial applicability requires a patent to practically perform as demonstrated in theory. So any invention that is only good on paper shall not pass.
Types of Patents
According to USPTO, 90% of all patents are utility patents. It protects the functional and utility aspects of an invention. They mainly cover machines, processes, methods, compositions, or any improvement of an existing function enhancing utility. Most of the inventions fall into one or more of the aforementioned categories. However, an invention will be granted only a single utility patent irrespective of the number of categories it falls into. The invention acquires a “patent pending” status upon the immediate filing of an application, and it does not provide the same protection as a valid one. However, it serves as a warning sign to the competitors of the probable consequences. It remains valid for a period of 20 years from the date of application filing.
A design patent protects the ornamental and visual characteristics of a product. It focuses more on the outside than on the inside. For example, a utility patent can protect the software of an Apple iPhone. However, a design patent must be used to protect the look, design, and finish of the hardware, i.e., the handset phone. It is difficult to trace since it comprises technical drawings and images. Also, they are very vulnerable. Protection is granted only for the exact image submitted. Competitors and imitators can thus roll out the same design with slight variations and get away scath-free. They remain valid for a period of 15 years from the date of application.
They serve exactly what they say: protecting plants. Plant patents are issued to discover new and distinct species of plants. The only condition is that the production of such plants should be asexual, i.e., not by the normal course of nature. Thus, this patent essentially covers sports, hybrids, seedlings, mutants, cultivations, and other varieties of plants. The scope is not extended to include genetically modified organisms and is restricted to horticulture. A plant patent must be filed within one year of its discovery at any place in the world. Thus, even the mention of the new spices in a magazine or internet marks the beginning of one year period. Like utility patents, these last for a period of 20 years from the date of filing.
Patents are intellectual property. A factory does not “produce” patents. They are, in fact, the brainchild of an inventor. Patents only have the physical shape and form of the piece of paper, bestowing the patenting right. However, a strategic patent brings exponential value to the table. It is therefore important to value patents. Apart from finding the appropriate value to record in the books, patent valuations are often the main point of contention in mergers.
We shall discuss some of the quantitative methods of patent valuation.
This method suggests the value of a patent to be equivalent to the amount of expenditure incurred in the present day to replace the product. Emphasis is on the present value of expenditure and ignores the historical costs. The cost method mainly considers the direct costs and opportunity costs. Direct costs include expenditure on man, material, machinery, licensing, etc. Opportunity cost refers to the market share lost due to delayed production and loss of sales of another product due to resource re-allocation.
Replacement Cost = Direct Cost + Opportunity Cost
This valuation method is very similar to that of fixed-income securities. As per this method, the patent value is the present value of the income likely to generate from exploiting the patent. A patented asset can give rise to two possible streams of income.
- From the sale of produce of the patented technology.
- Royalty income by licensing the patents.
Example: (1) GoPro cameras are a patented invention whereby the inventor has patented the strapping of a camera device to any body part. Thus, the income from the sale of GoPro cameras will constitute direct income from the patent.
(2) The Microsoft operating system in our laptops is licensed software. The hardware (laptop) manufacturer must pay a royalty fee for pre-installing the software in the laptops sold by them.
Income from patent = NPV (Income/Royalty, i%)n ; where i= discount rate & n = remaining life of patent.
This method evaluates the viability and perception of the patent in the open market. This method heavily relies on a comparable transaction and an active market for the underlying asset. Therefore, it isn’t easy to trace markets and transactions for such a niche product. It is, therefore, difficult to gather appropriate sources of information to base decisions upon. Some of the suggested methods of gathering comparable data include:
- Hiring the services of market research and valuation companies such as Morningstar, Thomson Reuters, etc.
- Company annual reports
- Specialized royalty rate databases
- Court judgments and decisions in similar cases
Disadvantages of Patents
Patenting an invention provides obvious advantages of monopoly and complete control over the invention. However, it may not always be the best way to go and may do more harm than good. Despite the numerous advantages it offers, there does exist a downside.
Below mentioned are some drawbacks to patenting.
Loss of Privacy
The foremost condition for granting a patent is complete disclosure of the intellectual and technical design behind it. After that, upon patenting, the design and know-how of the invention enter the public domain. The invention becomes vulnerable to competition imitating and reproducing it with slight changes to circumvent the patent. Also, the law allows the patent to be exclusive only for a specific number of years, following which the inventor shall anyway lose all control and exclusivity.
An inventor will have to shell out several thousand dollars before he receives a grant for a patent. Even so, there is no guarantee that the patent will get approval. Some of the costs involved are:
- Legal expenses and attorney costs to process its applications and contracts.
- Technical fees for converting the idea into designs and documents presentable to the USPTO.
- Periodic maintenance fees to uphold its validity.
- Litigation expenditure in case of infringement and violation.
Limited Economic Life
Patents come with a clock ticking like a time bomb. Most of them have a validity of 15 to 20 years and are only renewable in some cases on payment of a hefty extension fee. The inventor, therefore, has very limited time to harness the patent to its maximum potential. Whether to sell or license, outsource or manufacture- all decisions must be quick without a margin for error.
Lack of Cross Country Validity
A patent only holds good in the country where it is filed. Therefore, an invention patented in the USA can be easily replicated in Europe without any repercussions. It only prevents the production, selling, and import of the protected product in and out of the country where it is filed. Therefore, this is typically disadvantageous for players who operate on a global level and hold a customer base across countries. Hence, in such cases, they must file for patents in multiple countries, which entails high costs.
The process from applying to processing to scrutiny to its ultimate approval is very time-consuming. And can easily take three to five years, depending upon the complexity and value of the patent. The inventor is always on the fence during this period. Therefore, his invention may lose validity due to technological upgrades, or consumer preferences may change to adversely impact his product potential.
Also, learn about other types of Intangible Assets.