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Invention – A Financial Analysis
A mathematical model of the costs of associated with a product based on an invention are compared to the costs for a copier. The model shows that without property rights in inventions (patents) an inventing firm is at a competitive disadvantage.
By: Dale B. Halling
Despite this, I believe a simple mathematical model of the invention process will illustrate some important points. In addition, some people understand concepts better when presented in a mathematical model. Here is my model for the costs associated with introducing a new product based on an invention and me-too product:
Ci(n) = (Inv + Mi)/P + NRE + PC*n + OH*n (New Product based on invention)
Cmt(n) = NRE + PC*n + OH*n (Me-too product)
Where Ci is the cost of creating a product for the owner of the invention, Inv is the cost of creating the invention, P is probability of that the invention will succeed in the market, Mi is the incremental marketing and sales cost of introducing a new invention, n is the number of products that have been produced, NRE is the nonrecurring engineering cost of setting up production, PC is the production cost of the making n products and OH is the cost of overhead for producing n products, Cmt is the cost of creating a me-too product.
The reason I add the probability that the invention (P) will succeed is that not all inventions are successful. An economist who wants to capture all the costs associated with introducing a product based on a new invention has to include this probability to determine the true cost of inventing. This probability will vary based on the type of invention. For instance, line extension inventions are much more likely to succeed than inventions that create whole new markets. An example of an invention that created a new market was Webcrawler, which was the first full text web indexing search engine introduced in 1994. On the other hand adding image or video searching to Google is a line extension.
The cost for marketing and selling a product based on an invention (Mi) is separate from the cost of marketing and selling a me-too product. It takes significantly more money, time, and effort to sell a product based on an invention that is creating a whole new market than a me-too product. Any sales person who has tried to sell a truly unique product knows that it is much easier to sell an existing product or a me-too product because you do not have to explain the value of the product, how the product works, and why the customer would want the product. A true me-too product can be sold mainly on price. A line extension product takes less marketing and sales effort than a revolution product. Large companies tend to focus on line extension inventions because it reduces the risk that the product will not succeed and reduces the cost of marketing and selling. Many start-ups sell through marketing channels in order to reduce this cost.
I include the cost of selling, advertising, and marketing of me-too product in overhead. Once a product based on an invention is well known, then it will incur the same cost as a me-too product of selling, advertising, and marketing. I believe this is an accurate characterization. Non-recurring engineering (NRE) is the same for both the me-too product company and the inventor company. The reason for this is that me-too products will incur approximately the same cost of setting up production as the owner of the invention.
The values of these variables will vary based on the type of invention involved, the type of market in which the invention is sold, and the point in time the product is introduced. This model is not exact. For instance, overhead (OH), production costs (PC), and marketing cost of the invention (Mi) should all be functions of the number of products sold (n). Production costs usually decrease with the number of products sold. Marketing costs of the invention (Mi) should be spread out of the first X number of products sold. In addition, the total marketing cost of the invention (Mi) should not be included for failed products based on an invention, since the owner is likely to kill the project earlier and not spend as much as on a successful product launch. There are probably other shortcomings of these equations. However, certain facts are clear even with any flaws in these equations. The cost of inventing increases the cost to the inventing firm over the me-too firm. As a result, inventing is a market disadvantage without intellectual property.
Invention Law: The cost of inventing increasing the expenses of the inventing firm compared to the expenses of the me-too firm.
There are only two common ways to compensate or incentivize inventors. One is to provide the inventor with a property right (patent) in their invention. The other is to have the government pay for the cost of inventing. The first is consistent with a free market economy and has proven to be extremely successful. The second is consistent with a command and control economy (statism) and has proven to be inefficient and political.
Intellectual Property Law: Inventing is a market disadvantage without intellectual property.
(Please see the full article at http://hallingblog.com/
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Mr. Halling writes about patent law and innovation. He is a patent attorney and a BS in Electrical Engineering, an MS in Physics, and a JD. Mr. Halling is the author of the book “The Decline and Fall of the American Entrepreneur.”