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4.4: Intellectual Property & Isolating Mechanisms

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    53971
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    Intellectual Property

    Defining Intellectual Property

    The inability of competitors to imitate a strategic resource is a key to leveraging the resource to achieve long–term competitive advantages. Companies are clever, and effective imitation is often very possible. But resources that involve intellectual property reduce or even eliminate this risk. As a result, developing intellectual property is important to many organizations.

    Intellectual property refers to creations of the mind, such as inventions, artistic products, and symbols. The four main types of intellectual property are patents, trademarks, copyrights, and trade secrets (Table 4.5). If a piece of intellectual property is also valuable, rare, difficult to imitate, and organized to capture value, it constitutes a strategic resource. Even if a piece of intellectual property does not meet all four criteria for serving as a strategic resource, it can be bundled with other resources and activities to create a resource.

    A variety of formal and informal methods are available to protect a firm’s intellectual property from imitation by rivals. Some forms of intellectual property are best protected by legal means, while defending others depends on surrounding them in secrecy. This can be contrasted with Southwest Airlines’s well-known culture, which rivals are free to attempt to copy if they wish. Southwest’s culture thus is not intellectual property, although some of its complements such as Southwest’s logo and unique color schemes are.

    The term intellectual property refers to creations of the mind, such as inventions, artistic products, and symbols. Some forms of intellectual property are protected by law while others can best be defended by surrounding them in secrecy.

    Table 4.5 Intellectual Property
    Types of Intellectual Property
    Patents protect inventions from direct imitation for a limited period of time. Within the pharmaceutical industry, patents protect the new drugs created by firms such as Merck and Pfizer for up to twenty years. If a new drug gains acceptance in the market, its patent creates a window of opportunity for the patent holder to enjoy excellent profits.
    Trademarks are phrases, pictures, names, or symbols used to identify a particular organization. McDonald’s golden arches, the phrase “Intel Inside,” and the brand name Virginia Tech are examples of trademarks.
    Copyrights provide exclusive rights to the creators of original artistic works such as books, movies, songs, and screenplays. Sometimes copyrights are sold and licensed. The late pop star Michael Jackson bought the rights to The Beatles’ music catalog and later licensed songs to Target and other companies for use in television advertisements.
    Trade secrets refer to formulas, practices, and designs that are central to a firm’s business and that remain unknown to competitors. One famous example is the blend of eleven herbs and spices used in Kentucky Fried Chicken’s original recipe chicken. KFC protects this secret by having multiple suppliers each produce a portion of the herb and spice blend; no one supplier knows the full recipe.

    Patents

    Patents protect inventions from direct imitation for a limited period of time. Some examples and key issues surrounding patents are illustrated below.

    Table 4.6 Patents
    Examples of Patents
    To earn a patent from the US Patent and Trademark Office, an inventor must demonstrate that an invention is new, non obvious, and useful.
    Perhaps the greatest inventor in history was Thomas Edison, who was awarded over one thousand patents.
    As several different inventors raced to create a workable system for voice transmission over wires, Alexander Graham Bell was awarded a patent for the telephone in 1876.
    Apple and Samsung began suing each other in 2011 for patent infringement, with numerous court cases and appeals. The multiple lawsuits were finally settled in 2018, with a jury awarding Apple $539 million (Reuters, 2018).

    Patents are legal decrees that protect inventions from direct imitation for a limited period of time (Table 4.6). Obtaining a patent involves navigating a challenging process. To earn a patent from the US Patent and Trademark Office, an inventor must demonstrate that an invention is new, non-obvious, and useful. If the owner of a patent believes that a company or person has infringed on the patent, the owner can sue for damages. Patenting an invention is important because patents can fuel enormous profits. Imagine, for example, the potential for lost profits if the Slinky had not been patented. Shipyard engineer Richard James came up with the idea for the Slinky by accident in 1943 while he was trying to create springs for use in ship instruments. When James accidentally tipped over one of his springs, he noticed that it moved downhill in a captivating way. James spent his free time perfecting the Slinky and then applied for a patent in 1946. To date, more than three hundred million Slinkys have been sold by the company that Richard James and his wife Betty created.

    Metal slinky with both ends resting on a table.
    Figure 4.7: Patenting inventions such as the Slinky helps ensure that the invention is protected from imitation.

    Trademarks

    Trademarks are phrases, pictures, names, or symbols used to identify a particular organization (Table 4.7). Trademarks are important because they help an organization stand out and build an identity in the marketplace. Some trademarks are so iconic that almost all consumers recognize them, including McDonald’s golden arches, the Nike swoosh, and Apple’s outline of an apple.

    Other trademarks help rising companies carve out a unique niche for themselves. For example, French shoe designer Christian Louboutin has trademarked the signature red sole of his designer shoes. Because these shoes sell for many hundreds of dollars via upscale retailers such as Neiman Marcus and Saks Fifth Avenue, competitors would love to copy their look. Thus, legally protecting the distinctive red sole from imitation helps preserve Louboutin’s profits.

    A pair of Louboutin's black So Kate shoes on a white table with a white background.
    Figure 4.8: Fashionistas instantly recognize the trademark red sole of Christian Louboutin’s high-end shoes.

    Trademarks are important to colleges and universities. Schools earn tremendous sums of money through royalties on t-shirts, sweatshirts, hats, backpacks, and other consumer goods sporting their names and logos. On any given day, there are probably several students in your class wearing one or more pieces of clothing featuring your school’s insignia; your school benefits every time items like this are sold. Schools’ trademarks are easy to counterfeit, however, and the sales of counterfeit goods take money away from colleges and universities. Not surprisingly, many schools fight to protect their trademarks. Virginia Tech filed a lawsuit in 2011 against a new local business called Hokie Real Estate, claiming trademark infringement. Virginia Tech had received a legal trademark for its nickname Hokies. Hokie Real Estate prevailed, as there were a number of other businesses in the locality also using the Hokie name.

    An organization’s trademarks consist of phrases, pictures, names, or symbols that are closely associated with the organization. Some examples and key issues surrounding trademarks are illustrated below.

    Table 4.7 Trademarks
    Examples of Trademarks
    To be fully protected in the United States, a trademark must be registered with the United States Patent and Trademark Office. A capital R with a circle around it denotes a registered trademark.
    As part of the punishment for German aggression during World War I, German drug maker Bayer lost its trademark on “Aspirin” in France, Russia, the United Kingdom, and the United States. Today, Bayer still retains its trademark in Germany, Canada, Mexico and dozens of other countries.
    Many small companies use their founders’ name as the basis for a trademarked company name.
    The distinctive pattern of clothing retailer Burberry Ltd. is an example of a trademark that does not involve words or symbols.

    Copyrights

    The rights of creators of original artistic works such as books, movies, songs, and screenplays are protected by copyrights. Some examples and key issues surrounding copyrights are illustrated below.

    Table 4.8 Copyrights
    Examples of Copyrights
    Illegal downloads of music are copyright infringements. In spite of laws and increased enforcement, millions of songs are obtained illegally.
    Today’s cheesy television ads aimed at inventors follow a long tradition of companies offering to help individuals copyright their ideas—for a small fee, of course.
    The presence of the copyright symbol tells consumers that they are not allowed to duplicate the product that carries the copyright.
    A painting such as Johannes Vermeer’s “Girl with a Pearl Earring” enters the public domain (i.e., is not subject to copyright) one hundred years after its creator’s death.
    When it became apparent that The Verve’s 1997 hit single “Bittersweet Symphony” duplicated a Rolling Stones song, The Verve was forced to give up the copyright for the song.

    Copyrights provide exclusive rights to the creators of original artistic works such as books, movies, songs, and screenplays for an author’s lifetime plus 70 years (Figure 4.8). Sometimes copyrights are sold and licensed. In the late 1960’s, Buick thought it had an agreement in place to license the number one hit, “Light My Fire” by The Doors, for a television advertisement until the band’s volatile lead singer Jim Morrison loudly protested what he saw as mistreating a work of art. Classic rock by The Beatles has been used in television ads in recent years. After the late pop star Michael Jackson bought the rights to the band’s music catalog, he licensed songs to Target and other companies. Some devoted music fans consider such ads to be abominations, perhaps proving the merit of Morrison’s protest decades ago.

    Black and white ariel view of Jim Morrison and 3 other band members on stage.
    Figure 4.9: He looks calm here, but the licensing of a copyrighted song for a car commercial enraged rock legend Jim Morrison.

    Over time, piracy has become a huge issue for the owners of copyrighted works. In China, millions of pirated DVDs are sold each year, and music piracy is estimated to account for at least 95% of music sales. This piracy deprives movie studios, record labels, and artists of millions of dollars in royalties. In response to the damage piracy has caused, the US government has pressed its Chinese counterpart and other national governments to better enforce copyrights.

    Trade Secrets

    Trade secrets refer to formulas, practices, and designs that are central to a firm’s business and that remain unknown to competitors (Table 4.9). Trade secrets are protected by laws on theft, but once a secret is revealed, it cannot be a secret any longer. This leads firms to rely mainly on silence and privacy rather than the legal system to protect trade secrets.

    Trade secrets are formulas, practices, and designs that are central to a firm’s business and that remain unknown to competitors. Everyone loves a good mystery, so it is no surprise that legends have arisen around some trade secrets. Some examples and key issues surrounding trade secrets are illustrated below.

    Table 4.9 Trade Secrets
    Examples of Trade Secrets
    Low-end fast food chain Long John Silver’s considers its “crumblies” (small bits of fried batter) to be a trade secret, but would anyone really want to solve the mystery?
    In 2006, Pepsi was offered a chance to buy a stolen copy of Coca-Cola’s secret recipe. An FBI sting was created and the thieves were arrested.
    WD-40 was developed to repel water and prevent corrosion, but it was later found to have over two thousand uses. Creating WD-40 took a lot of work: the product’s unusual name stands for “Water Displacement, 40th attempt.” Despite being created in 1953, the formula for making WD-40 remains unknown outside the company that sells it.
    FarmVille creator Zynga alleged in a lawsuit that Disney had lured away Zynga employees to work for Disney and then urged the employees to turn over a secret “playbook” that described Zynga’s strategy. The case was settled out of court in late 2010.
    In a 1995 episode of the hit comedy Seinfeld, a very successful but mean-spirited restaurateur nicknamed the “Soup Nazi” saw his business collapse when his secret recipes were revealed to customers. Individuals could now make delicious soups at home rather than endure the Soup Nazi’s verbal abuse when buying soup.

    Some trade secrets have become legendary, perhaps because a mystique arises around the unknown. One famous example is the blend of eleven herbs and spices used in Kentucky Fried Chicken’s original recipe chicken. KFC protects this secret by having multiple suppliers each produce a portion of the herb and spice blend; no one supplier knows the full recipe. The formulation of Coca-Cola is also shrouded in mystery. In 2006, Pepsi was approached by shady individuals who were offering a chance to buy a stolen copy of Coca-Cola’s secret recipe. Pepsi wisely refused. An FBI sting was used to bring the thieves to justice. The soft-drink industry has other secrets too. Dr Pepper’s recipe remains unknown outside the company. Although Coke’s formula has been the subject of greater speculation, Dr Pepper is actually the original secret soft drink; it was created a year before Coca-Cola.

    Side view of a brick building displaying a faded Dr. Pepper mural.
    Figure 4.10: The recipe for Dr Pepper is a secret dating back to the 1880s.

    Section Video

    Understanding Intellectual Property (IP) [02:14]

    The video for this lesson further explains intellectual property.

    You can view this video here: https://youtu.be/UqZJPuyK9VY.

    Isolating Mechanisms

    The goal of a firm is to have a sustained competitive advantage, whereby a resource or capability of the firm provides a competitive edge for a long time. The length of time a firm can maintain a sustained competitive advantage depends on the industry. A company in a fast-moving industry, such as information technology or fast fashion, may be quite satisfied if they can hold a competitive advantage for a year. A sustained competitive advantage in another type of industry, like feminine hygiene that does not have such frequent changes may last much longer. No firm is able to keep a sustained competitive advantage indefinitely. The competition is always attempting to gain its own competitive advantage.

    If a firm can prevent a competitor from imitating the resource or capability that gives it a competitive advantage, it is able to sustain that advantage longer. This strategy is called isolating mechanisms. A patent, for example, is a legal way to prevent imitation. Sometimes a competitor is able to “re-engineer” the patented concept by making slight changes, working around the patent to imitate the idea without infringing on the patent. There are other isolating mechanisms a firm may be able to employ to lessen the likelihood of imitation by a competitor. These other isolating mechanisms are Social Complexity, Path Dependence, and Causal Ambiguity.

    Social Complexity

    The interrelationships within a firm, along with relationships within or across a business process, can be difficult to imitate. For example, key relationships that members of a firm have with a supplier of a key strategic resource create a condition that a competitor cannot duplicate. This social complexity creates a barrier to imitation and can prolong a competitive advantage possessed by an organization. Social complexity might arise through certain customer relationships or with key political figures, provided they can help the firm’s competitive position. For example, a CEO of a firm in the defense industry may cultivate relationships with key members of Congress that help bring business to that firm, at the expense of the competition (in this example, this might be called collusion, but that is a story for another day, and Chapter 11 on corporate ethics).

    Path Dependence

    The path that a firm takes over time to achieve the point of a competitive advantage may also provide a barrier to imitation. Decisions made in the past that brought a firm to its current position may make it very difficult for other firms to imitate. The accumulated learning and experience gained along the historical path are not easily duplicated. This path dependence can serve as an isolating mechanism to block competitors from gaining the same position in the market. Warby Parker, for example, made a decision early in its development to build relationships with a variety of suppliers and to use the “buy one, give one” strategy, where a pair of glasses is given away to someone in need for every pair sold. This decision and path created loyal suppliers and customers within the online eye wear industry, and a copycat strategy by a competitor would likely be cost prohibitive.

    Causal Ambiguity

    The third isolating mechanism, causal ambiguity, means the reason for achieving a competitive advantage is not apparent. The cause for success is obscure and not understood well. Because the firm itself does not really know why it has achieved success, it is quite difficult for a competitor to replicate it. For example, why does Netflix still enjoy immense popularity in spite of numerous streaming competitors? In 2020 Netflix had a market penetration of 54%, while Amazon Prime is a distant second at 30% (Roxorough, 2019). Is it because they were the first mainline streaming service? Is it related to CEO Reed Hastings? Does content make a big difference? Competitors find it difficult to duplicate Netflix’s success model because it is not clear what has caused it.

    It was noted earlier in this chapter that intangible resources are usually more valuable than tangible ones in the context of sustained competitive advantage. The reason for this is due, in part, to the isolating mechanisms discussed above. Physical resources tend to be in abundance and are far easier to obtain. So, if two firms have the same physical resources, then there is little to no differentiation. The key distinction that firms can make is how they use those physical resources in their value chain. The intangible resources including skills, knowledge, or brand name used to capitalize on physical resources are far more likely to produce an advantage for firms than simply possessing a physical resource alone. In this way, firms such as Nike can capitalize on marketing and their brand to sell shoes at a premium when their shoes have few physical differences from their competitors. In some cases, a manufacturing facility may very well produce the same product for multiple companies (e.g., t-shirts). In such cases the difference to consumers is the brand.

    Key Takeaway

    • Intellectual property can serve as a strategic resource for organizations. While some sources of intellectual property such as patents, trademarks, and copyrights can receive special legal protection, trade secrets provide competitive advantages by simply staying hidden from competitors.
    • Utilizing isolating mechanisms strategically is a way for organizations to prevent imitation and maintain their competitive advantage.

    Exercises

    1. What designs for your college or university are protected by trademarks?
    2. What type of intellectual property provides the most protection for firms?
    3. Why would a firm protect a resource through trade secrets rather than by a formal patent?

    References

    Reuters. (2018, May 24). Jury awards apple $539 million in Samsung patent case. The New York Times. https://www.nytimes.com/2018/05/24/business/apple-samsung-patent-trial.html#:~:text=The%20world’s%20top%20smartphone%20rivals,to%20a%20retrial%20over%20damages.

    Roxborough, S. (2019, November 13) Netflix dominates global SVOD market, but local services gain ground, study finds. The Hollywood Reporter. https://www.hollywoodreporter.com/news/netflix-dominates-global-svod-market-but-local-services-gain-ground-1254438.

    Image Credits

    Figure 4.7: McLassus, Roger. “Metal slinky.” CC BY-SA 3.0. Retrieved from https://upload.wikimedia.org/wikipedia/commons/f/f3/2006-02-04_Metal_spiral.jpg.

    Figure 4.8: Arroser. “Christian Louboutin.” CC BY-SA 3.0. Retrieved from https://upload.wikimedia.org/wikipedia/commons/6/62/Louboutin_altadama140.jpg.

    Figure 4.9: Persson, Jan and Polfoto. “The Doors performing for Danish television in Copenhagen.” Public Domain. Retrieved from https://upload.wikimedia.org/wikipedia/commons/1/15/The_Doors_in_Copenhagen_1968.jpg.

    Figure 4.10: Anyjazz65. “Dr. Pepper.” CC BY 2.0. Retrieved from https://flic.kr/p/7uDd8e.

    Video Credits

    Federallabs. (2019, March 27). Understanding intellectual property (IP) [Video]. YouTube. https://youtu.be/UqZJPuyK9VY.


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