Many business organizations look at patents from the narrow perspective of obtaining protection against copying. However, patents can be advantageous in many additional ways that extend well beyond preventing competitors from copying innovative technology. In the specific commercial scenario of a supplier to an OEM (original equipment manufacturer), patents can be leveraged advantageously by the supplier to negotiate a more favourable business relationship.
Typically, OEMs purchase individual components from a plurality of different suppliers (such as tire manufacturers, engine manufacturers, etc.) and combine these components, as well as some of the OEM’s own components, into an overall product (such as an automobile) that is sold under the OEM’s name or brand. There is a delicate balance in any business relationship between a supplier and an OEM since the two parties often have diverging commercial interests. What is beneficial for one party usually comes at the expense of the other.
When negotiating with one or more suppliers, OEMs generally want to be able to strictly control the terms of the supply arrangement such that they can obtain the supplied parts at the cheapest possible price, ensure the availability of parts (especially critical parts) by having multiple suppliers, and prevent the technology that they are purchasing from being supplied to competing OEMs. In contrast, it is usually in the supplier’s best interest to have the relationship set up in exactly the opposite manner. The supplier wants to be able to sell the parts at the highest possible price, be the sole provider of certain types of parts to the OEM, and have no restrictions on the sale of their parts to other OEMs.
This dynamic can create tension which in practice is often resolved in favour of the OEM simply because the supplier needs the OEM more than the OEM needs the supplier. Unfortunately for the supplier, this often puts the OEM in a position to be able to dictate the terms of the business relationship to the supplier, and the supplier often has no choice but to accept those terms if the supplier wants to continue doing business with the OEM.
This is where a commitment to innovation backed by a strong patent portfolio in the hands of the supplier can be strategic. When a supplier’s technology includes innovation that will provide value to the OEM’s end product, it is quite likely that the OEM will see a clear benefit in including the supplier’s technology in its product line. A supplier that has built a strong patent portfolio covering its desirable technology is then in a position to leverage its patent assets to negotiate a more even-handed business relationship with the OEM. In fact, if the technology is truly desirable to the OEM and the patent protection covering the technology is strong, the roles may very well be reversed. In other words, that OEM may then need the supplier more than the supplier needs that OEM.
One tangible way that a supplier can extract?value from its patent portfolio when?negotiating a supply agreement is by charging the OEM a premium for access to the supplier’s innovative patent-protected technology. For example, consider the hypothetical situation of SoundBite Inc., a?supplier of car stereo systems to a large car manufacturer (the OEM). SoundBite is aware that one of the major issues in car stereo systems today is the question of volume control. Currently, stereo systems require a user to manually press buttons, either on the stereo system itself or on the steering wheel. This requirement for manual control forces the driver to remove his/her eyes from the road, which has been known to cause accidents. To solve this problem, SoundBite has developed and obtained patent protection for a stereo system that can be controlled using voice commands. Given the benefits of this improved stereo system, the OEM will obviously be interested in integrating this new voice-controlled stereo system into its product lines.
As such, when negotiating the price for the voice-controlled stereo system, SoundBite is in a position to ask for an “innovation premium” in exchange for giving the OEM access to the patented technology. The price to the OEM may then be determined based on (1) SoundBite’s costs (how much it costs SoundBite to make the car radio system), (2)?a reasonable profit based on SoundBite’s manufacturing operation and (3) the innovation premium. Based on these criteria, the total price for the voice-controlled stereo system may be calculated according to a formula such as: price = costs + reasonable profit + innovation premium.
The notion of an innovation premium can be justified on the grounds that the technology is broadly covered with patents and the OEM therefore cannot get that technology from anywhere but that supplier. The innovation premium may be determined based on factors that include the desirability of the technology, the strength of the patent protection, and whether the OEM is getting the exclusive rights to the technology. Obviously, the more desirable the technology and the stronger the exclusivity, the higher the premium can be.
In the above scenario, SoundBite did not obtain patent protection solely for defensive reasons, i.e. to prevent others from copying its technology. Rather, Soundbite’s motivation was to use these patents to increase the margins on the products sold to the OEM.
For a supplier to be able to charge an innovation premium to an OEM, a few things have to happen. First, innovation is essential. Creating desirable, innovative technology needs to be a primary focus, with patent protection following naturally from the innovation process. In other words, building a strong patent portfolio should come secondary to investing in and being committed to ongoing innovation.
But not any innovation will do. Long-term product and market vision is important. Consider what innovative technology will go into products being supplied to the OEM three to four years down the road. What technology will consumers want to see in the OEM’s overall product in the future? Keeping with the example of a supplier of stereo systems to a large car manufacturer, the supplier that knows its niche inside out is in an excellent position to forecast what the market will need in the future. Accordingly, the supplier may very well be capable of seeking patent protection today for stereo technologies unknown to OEMs at present but likely to be coveted by them in the future.
In an ideal world, by the time the OEM discusses with the supplier what technology it?would like to purchase, the supplier will already have patent protection covering the innovative aspects and features of that technology. In such a scenario, suppliers should see themselves not just as manufac-turers of parts but also as suppliers of innovation, which should be taken into account when negotiating with an OEM.
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