Killer_Tofu:

Fashion Industry: Terrible example: The fashion industry has fixed capital equipment suitable for quick design changeovers. Minimal investment in capital innovation with long periods of payback for the capital. The only thing that changes are the clothing designs, not the way they are made.

On the other hand, manufacturing companies that make products requiring tooling and assembly lines can invest millions or tens of millions, and payback can be up to a decade. When a product is easily reverse engineered, the payback required to pay for development and the assembly line will either be extended to an unacceptable length of time, or will never be repaid. In either case, why invest?

Re innovators and inventors: An inventor is an innovator. An innovator is not necessarily an inventor. I agree with you that there are tons of innovators, but what they do is not necessarily novel or unique. However, in the industries I have worked, innovators typically are inventors, so I tend to forget that is not universally true.

Hey Mike, are you going to call Killer_Tofu on HIS name calling…roflmao…

Lonnie, you seem short sighted.

Yes, that is exactly what you said. However, note that I also laughed after what I said because your “name calling” was similar to the “name calling” by Anonymous Coward (? – Mike was saying someone else was calling names), not that I really considered it such.

And, if other industries (aside from fashion) would take that long to switch over their machines to make the new .. whatever it is they make, it would take their competitors just as long to switch over. That is after the first company is already on market with a product too, giving them a huge edge as well as name recognition.

Killer_Tofu, you have to tell me which manufacturing industry you are involved with, and perhaps that would help me explain better. Until I know the manufacturing processes you are most familiar with, I provide this explanation:

The fashion industry makes clothing on essentially the same equipment, year after year. There are incremental improvements to the equipment, but unless there is a big productivity gain that makes replacement worthwhile, the fashion industry (or, more broadly, the clothing industry) uses the same machines for years, perhaps decades.

Manufacturing companies that make transmissions, engines, cars, and all sorts of other interesting equipment, need to have specialized equipment for their specific design. For example, every die casting is unique to a particular design. A single die casting can cost anywhere from $150,000 to $500,000 or more. An engine can have several die castings, and they are built specifically for the components produced. When that component is no longer useful, the dies are scrapped.

However, these costs are not the actual costs of manufacturing. Developing a new engine, for example, can be a process that takes five years or more, partially because of the various government requirements of the nations where the engine will be used, but also because customers want more efficiency, lower heat generation, and other features. The cost to innovate and invent new components, prototype and test them will run into the millions.

A copier has a short cut: He can use his competitor’s device as a template for building his own copy, eliminating the millions spent on innovation, invention and trial and error. Further, the copier can eliminate mistakes made by the innovative and inventive company, potentially reducing costs.

Because I like you Killer_Tofu, here is an example:

Let’s say a company has decided that to increase or maintain market share it needs to develop a new product. Incidentally, everything I am using in this example is from personal knowledge and experience, but the product is unimportant. Let’s say that the cost of developing the new product is $5 million and the cost of taking it into production is $2 million.

Now, let’s say that the cost of the piece parts is $85, the cost of labor to build the unit is $5, and the cost of overhead to support marketing and application of the product, along with administrative costs, is $25. At this point, the “cost” of the product is $115 per unit, sans profit. Let’s say that the minimum profit needed just to justify producing the product as opposed to investing the money in something else is 5%, or $5.75 per unit. Now, we have to figure out how to pay back the $7 million invested in the unit thus far.

Let’s assume that the company decides payback needs to be in 5 years, and let’s assume that the sales per year are estimated to be 20,000, 100,000, 200,000, 300,000 and 400,000. The total sales are thus 1,020,000 units in five years, so the rounded off amount needed per unit for payback is $7 per unit. So the total price per unit is $127.75.

Okay, year one is fine. The company makes a payback profit of $140,000. However, because there is no IP, a non-creative copying competitor sees their design within weeks of its initial release, and immediately begins reverse engineering the innovations in the design. In addition, they also make some improvements to the design that will ultimately permit them to reduce piece part and labor costs, which we will return to in a moment.

The company does okay in the second year as well because its competitor is a little slow with some of the details of the innovations (no patents, so there are things about some of the innovations that they are trying to understand). So the company sells its 100,000 units in the second year and makes $700,000 in payback profit, thus totaling $840,000 in payback profit.

In the third year the competitor is finally able to reveal its offering. However, it got its piece part cost down to $80, its labor to $4.50, but let’s assume its administrative costs are $25, just like the innovative company. However, let’s say the competitor, who had no innovation costs to payback, only had to payback the $2 million for taking the copied design into production, and $300,000 for their copying efforts. Let’s say that their payback period is also five years, and they assume that assume the same unit sales curve as the innovative company, but they will scavenge the sales of the market maker rather than generating their own sales. They assume that because they will have a lower price, as soon as the market is aware of the product, the competitor assumes they will have 100% of the market. So their unit projections are 20,000 units the first year (third year of the innovator), 150,000 units the second year, 400,000 units the third year, and then 500,000 units the fifth year and every year thereafter (mature market). The amount of recovery is $2.15 per unit, which lets the non-creative competitor sell the unit (including the 5% profit) for $117.13.

Now, the copier scavenged 20,000 units from the 200,000 the innovator planned to sell, so their payback profit the third year is $1,260,000, or $2,100,000 total. The innovator only sells 150,000 units the third year, losing 150,000 units to the copier, so the innovator only makes $1,050,000 the fourth year, for a total of $3,150,000 payback profits. By the fourth year, the competitor has stolen all potential sales from the innovator, and the innovator not only has to eat $3,850,000 in loses, but lays off all the employees making those products as well as the support staff. The innovator quickly realizes there is no money in innovation and decides to copy instead, focusing on cheap crap instead of quality products. Innovation comes to a screeching halt.

The market will figure out how to take from the one company that dares to innovate and then run them out of business.

Question: How do you prevent this scenario from happening?

Incidentally, this scenario does happen today, but the innovator, frequently an individual or a smaller company attempting to hold its own against a larger competitor with more resources, or a foreign competitor (China, perhaps) where the innovator did not file for IP protection.