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How Startup Can Protect Intellectual Property

 Introduction

For startup companies, barriers to entry into the marketplace used to be physical – factories, distribution, mass-marketing campaigns, or even skilled employees. In the modern world of business, many duties can be subcontracted, and a startup no longer needs to pull together large amounts of capital for physical assets. Prototyping and manufacturing can be outsourced to any number of factories overseas. In many cases, FedEx, UPS, or DHL can take the place of traditional shipping departments. The Internet can be used as the primary marketing medium and even as the main distribution channel (consider online retail sites like Amazon, eBay and thousands of smaller, lesser-known companies). Thus, the cost of starting a company has never been lower.

The barriers to entry discussed above also acted as barriers to competition. Now, any new and successful product on the market can expect nearly instant competition from other manufacturing companies, former employees, ex-suppliers, and coat-tail riders. Today, intellectual property (IP), not physical assets, is the arbiter of whether a successful startup will become a lasting company or succeed only in creating a market for low-margin copycats and pirates. Modern startups need to leverage the cost-efficiencies of the modern outsourcing climate and simultaneously use intellectual property to create a barrier to entry for competitors. There is no better example of the perils of failing to understand these new rules than Crocs, Inc., the Niwot-based shoe manufacturer. Using Crocs as an example, this article discusses the life cycle of a startup, as well as employing an effective IP strategy to protect the product and market.

The New Life Cycle of a Startup

Over the course of only six years, Crocs illustrated the modern life cycle of a startup. First, there was a big idea and a person or persons with the drive to take that idea to the next level. In the case of Crocs, the big idea was the now-ubiquitous, brightly coloured resin shoe. In general, with a startup, a round of angel funding or initial venture capital gets the business off the ground and the personalities take it from there. If the startup is successful, next comes the private growth phase, in which the product becomes popular and sales dramatically increase. This usually is when the first knockoffs begin to appear. In the next phase, most successful startups take one of several paths: initial public offering (IPO); buyout; or mature, private operation. Regardless of the path taken, the mature phase typically includes a two-pronged approach of trying to protect market share for the original product and trying to develop new or next-generation products to replicate the success of the original. Crocs followed this life cycle exactly, going from startup in 2003, through an IPO in 2006, to a mature company today, buying startups with promising new products to bolster revenues due to flagging sales of their original product. This is the life cycle of a startup in a microcosm of six years.

The Modern World of Instant Competition

As soon as a startup has a successful product, it can expect instant competition. This can be particularly frustrating to the original entrepreneurs, because the competitors typically are doing nothing more than capitalizing on the startup's success in creating a market for a new product. The competitors may range from companies that design and market a similar product for a lower price, to pure knockoff companies that sell almost-exact copies of the original under a different trademark, to pirates selling counterfeits. It is not uncommon for these competitors' products to be made by the same oversees facilities that make the original. In Crocs' case, the instant competition was built-in. Crocs was not the original manufacturer of the shoe; the company was one of many footwear companies that bought the shoe from a manufacturer that Crocs later purchased outright in 2004. When Crocs purchased the manufacturer, it cut off sales to the other footwear companies. Those companies, however, immediately found suppliers willing to recreate the shoe and continued competing. The level of competition was exacerbated by Crocs' success, which led to problems meeting demand for its shoes, a situation that its competitors capitalized on by supplying nearly identical products to erstwhile Crocs' distributors.

Protecting Market by Using IP as Barrier to Entry for Competitors

In this climate of instant competition, it is imperative that modern startups plan for that competition from the very beginning. There are many simple things a startup can do in each phase of the life cycle of the company to strategically create intellectual property to prevent or inhibit competitors. The most important thing is to develop a comprehensive IP strategy early in the life cycle of a product. Each startup is unique and should approach its intellectual property lawyer with the question, “What is the best mix of intellectual property protection for my product?” This is a larger question than “Should I get a patent?” or “Should I register my trademark?”

It is a question about developing the best strategy and tools for dealing with the inevitable competition that comes with success. Such a strategy should take into account the startup's current financial realities, as well as the anticipated future trajectory of the startup and its IP. It also should develop efficient ways to counter the expected competition. A good comprehensive strategy will include a mutually supporting mix of different types of IP protection to prevent the most egregious competition. For example, copyright registration (as opposed to common law copyrights) can be very valuable in preventing counterfeiters. Copyright registration is available to protect distinctive products, even when the product itself has been on the market for some time. The threat of a lawsuit in federal court in which statutory damages and lawyer’s fees are available is a powerful tool against infringers.

Copyright registration provides protection for a very long time. Adding a design patent on the same product provides a startup with a simple and cheap one-two punch that will slow down any counterfeiters and knockoff manufacturers. The pinnacle of IP protection is provided by utility patents. However, utility patents are expensive and hard to obtain on big ideas, such as selling dog food over the Internet, a device that can deliver advertisements to a person based on his or her current location, a cellular phone that automatically selects the cheapest available communication network when making calls, or a vehicle that can run on multiple types of fuel. Utility patents also require significant forethought, effort, and expense on the part of the startup, usually at a time when money is tight and the value of the product is unclear.

As the startup progresses into phase two, the early successful growth phase, many opportunities arise to obtain blocking patents that can hamstring the competition. In this context, a blocking patent is a patent on some (usually small but important) aspect of a product or service that effectively blocks a competitor from providing that product or service to the market in a way that is either cost-competitive or feature-competitive. For example, a patent on spell-checking may be a blocking patent to word processing software. Likewise, a patent on a manufacturing technique that reduces the production cost of a drug or chemical by 99 percent may be a blocking patent. In neither preceding example was the blocking patent a patent on the product; instead, it was a patent that affected the features or cost of the product. These patents (referred to here as Tier 2 patents) grow out of the experience obtained by first movers in an industry or market. They are not patents on the big idea, but rather patents on the subsequent little ideas that every subsequent competitor will have to address. These are patents on how to use the product; the best way to manufacture, package, and ship the product; new or expanded features for the product; and next-generation improvements to the product that consumers refuse to live without after their introduction.

Wrapping together all of these pieces is trademark protection. Trademarks for a successful company can act as a force multiplier that increases the value of the company and provides for greater visibility and sales. By deliberately incorporating trademarks and trade dress into a product's design or distribution at an early stage, a startup may be able to distinguish its products from any competition other than counterfeits.

In Crocs' case, they faced difficulties from the beginning. By their own admission, the original Crocs shoe design was a slight modification of a pre-existing and unprotected clog design. Although Crocs was able to get utility patent protection for the slight modification, the scope of that protection apparently is so narrow that Crocs has been unsuccessful in preventing knockoffs by patent infringement actions. Furthermore, because Crocs was not the original manufacturer of the shoe, Crocs was limited to using the little intellectual property that came with the purchase of the original shoe manufacturer – that is, common law copyright and trade dress claims.

It is unclear whether Crocs, if it had been involved with the manufacturing from the beginning, would have been able to register copyrights or obtain a more comprehensive utility patent, design patent, or trademark protection on the original shoes, their shapes, and their colours. It does seem that Crocs has learned from its early mistakes. The company has instituted a comprehensive IP plan going forward. It has filed extensively to protect its newer designs with design patents, although it does not appear to be using copyright protection for the shoe designs. Crocs also is applying its IP strategy to its new acquisitions, as evidenced by its recent $28.9 million and $27.2 million infringement awards against two Chinese knockoff manufacturers by its Jibbitz division.

 Conclusion

The hyper-competition in today's business climate requires attention to intellectual property to provide the best mix of utility patent, design patent, trademark, copyright, and trade secret protection for that product. The strategy should be implemented in the same way as any other major project – with clear goals and constant management to make sure those goals ultimately are met. For a startup, that goal should be to quickly and effectively stymie the competition.