Question 4 of 7: Protecting and commercializing an invention

Question 4: Protecting and commercializing an invention (15 marks)

Question text not reproduced: the examination questions are © Engineers and Geoscientists BC. Open the official past paper (linked at the top of this page) to read the question, then follow the worked solution below.

Part A — Five options for protecting an idea

Answered in the Canadian statutory frame, administered by the Canadian Intellectual Property Office (CIPO). The five instruments protect quite different things, and the commonest error is to assume that one of them protects "the idea", which none of them does.

Two others exist and are worth knowing: integrated circuit topography registration, and plant breeders' rights. Neither applies to a mechanical product.

Part B — One example of where each is best used

Take a single product — an adjustable office chair — and the five instruments fall naturally onto five different parts of it, which is the clearest way to see that they are complements rather than alternatives.

The choice between the first and the third is the one that carries real money, and it can be settled quantitatively rather than by instinct.

Given. An invention expected to earn CAD 150 000 a year in incremental margin; a discount rate of 9 per cent; a patent term of 20 years from filing with about 3 years of pendency before it is enforceable; and, if kept secret instead, an annual hazard of the secret being lost of $\lambda = 0.14$. Find. Which right is worth more, and how durable a secret would have to be to change the answer.

1. Value the patent as a finite annuity. Exclusivity runs for the term less the pendency, $N = 20 - 3 = 17$ years: $$PV_{\text{pat}} = R\,\frac{1-(1+i)^{-N}}{i} = 150\,000 \times \frac{1-1.09^{-17}}{0.09} = 150\,000 \times 8.5436 = \boxed{\text{CAD } 1\,281\,545}$$
2. Value the trade secret as a decaying perpetuity. A secret has no expiry but survives only until it leaks, and if the leak hazard is constant the expected cash flow decays exponentially, which discounts at the sum of the two rates: $$PV_{\text{sec}} = \frac{R}{i+\lambda} = \frac{150\,000}{0.09+0.14} = \boxed{\text{CAD } 652\,174}$$
3. Compare, and find the indifference point. The patent is worth CAD 629 371 more. Setting the two present values equal gives the hazard at which the inventor should be indifferent: $$\lambda^{*} = \frac{R}{PV_{\text{pat}}} - i = \frac{150\,000}{1\,281\,545} - 0.09 = \boxed{0.027\ \text{per year}}$$ which corresponds to an expected secret life of $1/\lambda^{*} \approx 37$ years.
4. Read the decision rule. Secrecy beats a patent only for information that can realistically stay hidden for several decades — a formulation, a process parameter, something never shipped in the product. Anything a customer can take apart leaks in a year or two, and for it the patent is worth roughly twice the secret. This is why the chair's compounding recipe is kept and its valve mechanism is filed.

Part C — Discussing an invention before it is fully protected

The governing fact is that public disclosure destroys novelty. Canada and the United States allow a 12-month grace period after the inventor's own disclosure, but most major jurisdictions, including the European Patent Office and China, apply absolute novelty: a public disclosure today extinguishes the foreign rights today. Relying on the Canadian grace period therefore forfeits most of the world market, and the process below is built to avoid ever needing it.

1. File first if it is at all possible. A filing establishes a priority date, after which disclosure is no longer fatal. A modest, properly drafted application filed before the first conversation removes the entire problem, and the 12 months that follow can be used to negotiate before national-phase costs are committed.
2. If a filing is not yet possible, execute a written non-disclosure agreement before anything is said. The agreement should define confidential information broadly and cover oral disclosure, require marking or written confirmation of oral disclosures within a fixed period, state a permitted purpose and forbid all other use, state expressly that no licence or right is granted, run for a term long enough to matter with trade secrets protected for as long as they remain secret, require return or destruction of materials, and — the clause most often overlooked — exclude any "residuals" provision, which would otherwise permit the recipient to use anything their staff remember.
3. Disclose in stages. Describe the problem and the demonstrated result before the mechanism. A serious counterparty can evaluate commercial interest from performance alone, and the enabling detail can wait until a term sheet exists.
4. Keep contemporaneous records. A dated and witnessed invention record, or a timestamped repository, establishes what was conceived and when. Under first-to-file this no longer wins priority contests, but it remains the evidence of ownership as between employer, contractor and inventor.
5. Check who owns it before disclosing at all. Employment agreements, university policies and consulting contracts routinely assign inventions. Discovering after a disclosure that the invention was never the inventor's to discuss is a common and expensive failure.

One practical caution: many established manufacturers refuse to sign an NDA before reviewing an unsolicited submission, precisely to protect themselves against later claims. That refusal is not bad faith, but it does mean that for those counterparties the only safe order is to file first.

Part D — Two options for commercializing the invention

Option 1: license the right to an established manufacturer. The inventor grants the right to make and sell in exchange for a royalty, typically with an upfront payment, minimum annual royalties to prevent the licensee from shelving it, a defined field of use and territory, and an obligation on the licensee to prosecute infringers. The inventor supplies no capital and carries no operating risk.

Option 2: manufacture and sell it directly. The inventor, alone or through a new company, invests in tooling, working capital and a route to market, and keeps the whole contribution margin. (A third route, outright assignment for a lump sum, is really the limiting case of licensing and is used when the inventor wants no further involvement.)

Given. Forecast sales of 40 000 units a year at a net selling price of CAD 118 over a 12-year horizon. Licensing pays a royalty of 5.5 per cent of net sales with no investment. Manufacturing earns a contribution margin of CAD 26 per unit against fixed overheads of CAD 380 000 a year and requires CAD 2 400 000 at the outset. The inventor discounts the licence at 12 per cent and the manufacturing venture at 20 per cent to reflect its operating risk. Find. Which route is worth more.

1. Value the licence. Net sales are $40\,000 \times 118 = \text{CAD } 4\,720\,000$ a year, so the royalty is $0.055 \times 4\,720\,000 = \text{CAD } 259\,600$ a year, and $$NPV_{\text{lic}} = 259\,600 \times \frac{1-1.12^{-12}}{0.12} = 259\,600 \times 6.1944 = \boxed{\text{CAD } 1\,608\,060}$$
2. Value manufacturing. The annual net cash flow is $40\,000 \times 26 - 380\,000 = \text{CAD } 660\,000$, discounted at the higher venture rate and net of the initial investment: $$NPV_{\text{mfg}} = 660\,000 \times \frac{1-1.20^{-12}}{0.20} - 2\,400\,000 = 660\,000 \times 4.4392 - 2\,400\,000 = \boxed{\text{CAD } 529\,883}$$
3. Identify what is actually driving the answer. Manufacturing generates two and a half times the annual cash flow and still loses, so test the risk premium by discounting both at 12 per cent: manufacturing then returns $660\,000 \times 6.1944 - 2\,400\,000 = \text{CAD } 1\,688\,287$ and narrowly wins. The entire decision is the eight-point risk premium, not the cash flows.
4. State the recommendation and its condition. An individual inventor without a balance sheet, a factory or a sales channel genuinely faces the higher rate, so licensing is the correct choice here. The advice reverses only for an inventor who already carries those capabilities, because for them the venture is not eight points riskier than a royalty cheque.