IP Valuation in a Regulatory Framework

When an invention requires regulatory approval, a patent is a secondary element of intellectual property protection.

Regulatory requirements trump patents as the primary form of protection or moat against a business.

Medical devices and pharmaceutical inventions operate within a regulatory framework: the Food and Drug Administration.  The moat for competitors is to first overcome the regulatory restrictions, and then – and only then – can they compete with you.

The value of the patents and other IP is diminished in proportion to the difficulty of the regulations.

Patents in a difficult regulatory environment.

Patents behave differently in a highly regulated industry.

The classic case is a pharmaceutical product, which requires many millions of dollars in clinical tests before being able to sell the first dose. This bar is obnoxiously high and very risky. A single death in a clinical study can doom hundreds of millions of dollars of research.

The first barrier to entry for any business, including a competitor, is to overcome the regulatory burden.

Before regulatory approval, a drug patent is completely and utterly worthless.

The patent is worthless because anyone who owned the patent still faces the multi-million dollar (and very high risk) regulatory process.

Patent valuation after regulatory approval is a different story. It is only after regulatory approval do we find out if the patent has value.

“The first one through the wall takes a lot of arrows.”

The regulatory process is very asymmetrical. The more unique the invention, the more regulatory scrutiny you get. This means the most valuable, game-changing inventions have the toughest, most expensive road through the bureaucracy.

However, once the road is paved by the first mover, the second competitor has a much lower hurdle. In fact, the Food and Drug Administration lowers the regulatory burden when you cite a predicate device that is substantially similar to your own.

We don’t find out if the patent is any good until after regulatory approval.

Patents have value if they protect the reason why someone buys your product.

Patents have value if they protect the single best way to address your customer’s need.

A product that goes through difficult, rigorous regulatory approval and then has commercial success tends to open up new markets. The new markets attract competitors, sometimes known as “fast followers.”

After regulatory approval, the competitors will try to find every way to address the customer needs by skirting close to the edge of your patent. Their innovation will be to thread the needle through your IP but not get in trouble. In some cases, especially in the medical device space, giant companies will often flat out copy you and dare you to sue them for patent infringement.

Companies who try to work around your patent will spend a lot of expensive engineering time to devise alternatives to your patent claims. In some cases, you might patent the single best way to address the customer needs, but a competitor may implement another solution that may give similar results but costs a few pennies more.

A ‘good’ patent attorney will think about how to design-around your claims, but there is no incentive to do so.

Part of the exercise of writing a patent is to imagine how someone else will design-around your patent. Sometimes patent attorneys will do this, but they are not equipped to do so and have incentives to avoid anything but a token effort.

A ‘good’ patent attorney will sometimes ask the inventor to come up with different ways that a competitor might try to get around the claims. This is often a helpful exercise to help the patent attorney get useful information into the patent application that will help them later on with the patent examiner.

But there is a huge disincentive to do this.

Neither the patent attorney nor the inventor want to undermine the patent that they are crafting, so they always do this exercise lightly. The patent attorney, obviously, has a strong financial incentive to digging too deep into design-around alternatives because they have to put food on their table. The inventor also wants the patent for fame, glory, or the dream of the lottery ticket.

Deep down in their hearts, the patent attorney and the inventor always worry that they did not do enough, that they missed something, or that they were flat out wrong. What this means is that neither the patent attorney or the inventor try very hard to challenge the patent. They get paid right now for the reward of filing a patent, and worry about whether it is really, truly valuable at some time in the future.

Competitors have a different incentive structure to design around your patent.

However, if the product makes it to market and starts to be a success, competitors will have a much, much stronger incentive to design around your patent or challenge it directly.

A competitor who wants to compete has very strong incentives to find the weaknesses in your patent. It is rare that businesses take an active step of analyzing patents ahead of time, but some still do it. The real incentive is when the competitor intentionally or accidentally infringes and gets caught with their pants down.

If that competitor is making real money, they will work day and night with their best engineers to try to find ways around the patent. They will spend endless dollars to find every weakness in the legal aspects of the patent. Their incentives to tear down that barrier to their revenue stream can be virtually endless.

Patent valuation is always a guess at how strong your patent will be when someone with the strongest incentives try to work their way around the patent – or crush it.

This is why design-around analyses are a critical (and almost always overlooked) part of patent valuation.