Introduction
In his book The Innovation Stack, Jim McKelvey describes going "'nose-to-toe' against the world's most dangerous company" and surviving. McKelvey, who co-founded Square with Jack Dorsey in 2009, recalls Amazon copying Square's product and undercutting its pricing. But after about six years, Amazon discontinued its competing product – and even mailed a Square card reader to its former customers. Naturally, this raised questions. Why did Amazon discontinue its competing product? Why did Square survive the Amazon threat?
After reflecting for three years on what Square had done and why it worked against Amazon, McKelvey noticed a pattern. This pattern often appears in businesses whose aim is to "square up" bringing fairness to a previously unfair system." Squaring up, righting a wrong, driven by a survival instinct, forces creativity and sparks a series of interlocking inventions, which he calls the "Innovation Stack."
McKelvey noticed that innovation stacks were at the core of world changing businesses throughout history. But a stack alone does not adequately protect its innovators. We believe that adequate protection using intellectual property – is critical to truly edging out competitors – and refer to this as the "Invention Stack."
Problem Solving
McKelvey and Dorsey had wanted to solve a problem, a problem that was personal for them and the people they knew – making payment processing for small merchants cheaper and easier. They wanted to "square up" the world of 52 million small merchants that paid 45 times more than larger merchants when processing credit card payments. Square's "innovation stack" resulted from this decision to serve people outside the existing market.
McKelvey gives an example of a company with an innovation stack that many are likely familiar with: IKEA. He describes its origins as a furniture business that was banned from furniture trade fairs in Sweden for undercutting its competitors. With no way to present its wares publicly, IKEA turned to sending a catalog directly to consumers. Because of a boycott by manufacturers in its home country, IKEA had to turn to overseas manufacturing. But overseas manufacturing had old factories with poor quality, so it had to build efficient, modern factories. This led to reduced costs. But shipping furniture from overseas was expensive. So IKEA started shipping furniture in a disassembled fashion. Reassembling disassembled furniture requires high labor costs, so the furniture was designed to be assembled by consumers.
McKelvey uses this example to make the point that solving a problem – whether it be economic, practical, physical, or otherwise – with a new solution generally leads to the discovery of more problems, each of which requires their own solution. This iterative problem-solving process leads to a massive "stack" of innovations that differentiates the ultimate offering from other, similarly-situated solutions.
While the end solution alone might not be something irreplaceable, the stack of solutions to the multiple problems identified along the way can create an irreproducible market differentiator – the sort of thing that separates middling companies that follow innovation from those that lead innovation. Anyone can copy the end result of "self-assembled furniture," but IKEA was able to harness its learnings from each step along the path – catalogs, overseas manufacturing, factory improvements, disassembled custom furniture – to make the end result cost effective and efficient. Without copying each aspect of the stack, competitors cannot compete effectively.
Invention Stack
In addition to providing a straight business advantage, in many situations, this innovation stack can be harnessed from an IP perspective. For example, each technologically advantageous solution can provide the foundation for a new patent application or a new trade secret. For example, along the path to "self-assembled furniture," developing factory improvements can yield innovations such as new machine tools, process management efficiencies, or logistics optimizations. Each of those innovations may have one or more protectable inventions therein. The differentiation that comes from each solution can be harnessed on a business level and on an exclusionary level.
Innovative organizations need a way to capture each innovation that is developed through that iterative problem-solution-problem-solution process. Focusing only on the ultimate solution means leaving valuable ideas uncaptured and unprotected. Failing to protect those intermediate solutions can lead to competitors copying most of your ultimate innovation, which takes away from its distinctiveness and market-differentiating aspects. On the other hand, capturing those innovations needs to be easy: with too onerous of a process, would-be inventors simply will hold back on disclosing their results.
Innovative organizations need a way to capture each innovation that is developed through that iterative problem-solution-problem-solution process. Focusing only on the ultimate solution means leaving valuable ideas uncaptured and unprotected. Failing to protect those intermediate solutions can lead to competitors copying most of your ultimate innovation, which takes away from its distinctiveness and market-differentiating aspects. On the other hand, capturing those innovations needs to be easy: with too onerous of a process, would-be inventors simply will hold back on disclosing their results.
As we argued in our piece in Corporate Counsel magazine last year, an easy invention disclosure process is critical to keeping the "patent flywheel" moving. Here, too, an easy invention disclosure process is critical for capturing as many of the innovations as possible. Inventors need to be able to easily submit as many invention disclosures as they desire – and they should be encouraged to over-submit rather than under-submit.
Each incremental solution may not be individually patentable, of course. Indeed, McKelvey even notes that they never successfully patented the iconic "credit card reader that plugs into a headset jack" that is no commonplace these days, despite it being a strong differentiator. But an effective stack does not require everything to be patented. Instead, it is critical to have a regular check-in with inventors to uncover as many solutions as possible.
In-house and outside counsel would do well to treat invention disclosure meetings like a probing deposition – asking inventors what the basis of the problem they identified was, what direction they went in first, what solution they came up with, what problems that led to, and where it went to next. For particularly complex inventions, counsel should also schedule follow-up meetings to uncover potential variations or additional solutions.
Why Protect the Stack?
If the innovation stack itself – that interlocking stack of innovations – provides a market differentiator, why go through the hassle – the time, the expense, the struggle - of protecting innovations with IP? First, patents help to foreclose any meaningful copying by would-be competitors. Patents in the innovation stack can block competitors from entering the field by raising their transaction costs to copy even parts of the ultimate solution. Protecting certain aspects with trade secrets can prevent those intermediate solutions from being expropriated to a competitor.
IP also has financial value. A 2006 study by Hsu et al, "Patents as Quality Signals for Entrepreneurial Ventures," found that doubling the size of a patent portfolio led to a 28% increase in overall valuation. A 2021 study by Richardson et al[1]. found that the asking price for the average patent was $208,000. And recent cases with damages into the millions and billions show that trade secrets can be quite valuable as well.
The ability of IP to enable its owners to exclusively commercialize its innovations induces competitors to spend time and resources inventing around the stack – even if only part of the stack is protected. Strategically aligned patents further provide the opportunity to capture all of the economic value that the patented innovations generate.
Companies can also leverage the IP they generate through this process defensively or offensively. For example, if that company is sued for infringement, the patents for the solutions that are uncovered during the problem-solving process can be used for counter-assertion (or, better yet, deter would-be plaintiffs from suing at all).
Conclusion
McKelvey's innovation stack is a fantastic insight into what makes innovative companies distinctive and what keeps them competitive in the marketplace. Identifying not just the ultimate solution to a problem as an "invention" but many solutions to the problems that unfold along the way to the ultimate solution is how a company can maintain its competitive edge. To keep that edge, and to develop future value, innovative companies should also protect their stack with IP.
Footnote
1 https://www.ipwatchdog.com/2017/04/18/2016- patent-prices-key-diligence-data/id=81708
Co-authored by Leonard Stewart, Assistant General Counsel for Fidelity Information Services.
Originally published by The Patent Lawyer in the May/June 2024 magazine.
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