Lowering intellectual property (IP) risk when outsourcing manufacturing

The benefits of outsource contract manufacturing and globalization are significant. However, with these benefits comes the risk of company executives losing intellectual property (IP) - often the most valuable asset of any product-based organization. This increased risk is because contract manufacturing or product design firms may:

• not fully understand IP, and the importance of IP rights
• be unclear with regards to your company's position regarding IP
• begin to understand your company's technology as well as you do
• develop invention(s) around your company's technology space
• not have an incentive to assist with IP issues around this invention
• reveal your company's proprietary information to please other customers they perform work for
• not have loyalty to your organization

Organizations can lower IP risk when partnering with contract manufactures or product designers. Specifically, to lower IP risk associated with these outsourcing activities, companies should:

1. Firewall key product or process areas
2. Strategically identify where to outsource
3. Extract and file IP before outsourcing
4. Establish jointly-developed IP ownership and confidentiality requirements with contract manufacturing or product design firms before engagement
5. Extract and file IP during and after outsourcing
6. Outsource strategically to multiple contract manufacturing or product design firms to reduce potential for knowledge transfer
7. Reduce possibility of contract manufacturers or product designers working with competitors

Firewall key product or process areas The most important decision an organization might make during a contract manufacturing or product design engagement is deciding what not to outsource. In many instances, these critical areas should be ‘firewalled' from contract manufacturers and product designers and performed, in-house, despite additional costs. Identifying such areas requires organizations to carefully break-down products or processes into component parts and firewall component areas from contract manufacturers or product designers that:

• add the most value to a product or process;
• significantly differentiate the product or process; and
• cannot be reverse engineered

Manufacturing of product areas that do not meet the above requirements can be outsourced with relatively low risk. Understanding this critical issue will also help direct future invention efforts to purposefully develop products with a significant amount of components that can be outsourced at low risk. For example, organizations should:

• purposefully develop non-reverse ‘engineerable' component areas that can be manufactured and easily introduced into outsourced components
• separate and/or run key algorithms or software from on-shore servers; and/or
• add ‘tracers' to monitor copying (such as a non-functional component intentionally added to a device which creates no real value add in doing so, this provides a way for actual IP owners to then identify a specific compound or component added for the sole purpose of monitoring unauthorized duplication)

Strategically identify where to outsource IP registration should not only be filed in geographic locations or destinations where companies sell and use their technology, but also in areas where they currently, or potentially, would enter into contract manufacturing or product design partnerships. However, enforcement of IP rights varies from foreign jurisdiction to foreign jurisdiction and is constantly changing. Therefore, identifying where to outsource, based on IP enforceability, is just as important as identifying what to outsource. It is critical these decisions be made in conjunction with proper patent counsel with a current and thorough understanding of which foreign jurisdictions have laws more favorable for IP enforcement. Identifying where to outsource should include the following considerations:

• identifying which products and technologies are likely candidates for contract manufacturing or product design engagements
• developing a standard jurisdictional filing strategy for such products and technologies based on both current IP enforceability and costs of manufacture or design associated with each foreign jurisdiction; and
• regular reference to an updated foreign jurisdictional filing strategy based on changing IP laws

However, keep in mind IP costs can rise significantly when filing IP in multiple foreign jurisdictions. A cost-benefit analysis of IP protection versus outsourcing risks is always required to validate decisions from an economic standpoint. Extract and file IP before outsourcing Organizations should work to fully extract and document all IP associated with a potential contract manufacturing or product design partnership before the engagement begins so company executives can understand their current IP position. Following this extraction and documentation, IP weaknesses may be identified and filed if necessary. Advanced tactics used by IP-savvy companies and executives include conducting ‘directed invention brainstorming sessions' before outsourcing engagements begin to identify likely improvements to their technology. This exercise will often result in anticipating, beforehand, potentially valuable incremental improvements that could otherwise be developed by the contract manufacturer or product designer and, therefore, allow such forward-thinking organizations to claim and retain ownership of the IP rights associated with these valuable improvements. For example, prior to an outsourcing engagement, an organization may gather technologists and patent counsel to discuss likely problems to be encountered by product designers and contract manufacturers. Possible solutions could be developed and filed as IP, even if these improvements are not implemented, to help leverage against potential IP claims of ownership or future infringement by contract manufacturers, product designers, or other outsourcing vendors or providers. Establish jointly-developed IP ownership and confidentiality requirements with contract manufacturing or product design firms before engagement Parties to any contract manufacturing or product design engagement should always clearly articulate their rights and responsibilities before IP issues arise, where possible. A simple exercise clearly establishing who will own; document, and file IP on any jointly-developed inventions will significantly reduce potential IP risk associated with disputing ownership of valuable innovations. Additionally, establishing confidentiality requirements and compliance are critical to the success of outsource contract manufacturing or product design relationships. Make this point well-known before the transfer of confidential information occurs by both parties executing a thorough non-disclosure agreement and also by companies verbally reinforcing to the contract manufacturer or product designer the value their company places on confidentiality compliance. Extract and file IP during and after outsourcing Just as it is critical for organizations to extract and document IP before an outsourcing engagement begins, it is also critical to extract and document IP during and after contract manufacturing or product design engagements. Valuable invention is often lost because inventors do not realize its importance or believe something is not patentable. Having organizations systematically document and extract IP allows company executives; technologists, and patent counsel to make more informed critical decisions regarding value and patentability. This also serves to further indicate to contract manufacturing or product design partners how important IP is to your business, often helping to improve IP compliance. Outsource strategically to multiple contract manufacturing or product design firms to reduce potential for knowledge transfer A valuable method for companies and executives to maintain competitive advantages due to IP and knowledge transfer is to strategically outsource various product design and process components of a product to multiple product designers or contract manufacturers. When done properly, no single outsourcing partner may understand enough of your proprietary technology to reproduce or divulge this information in a way that would otherwise be detrimental to your strategic business priorities. Reduce possibility of contract manufacturers or product designers working with competitors Outsourcing or offshoring product design or contract manufacturing firms often perform work for multiple competitors. This is a significant reason for executive concern considering some of these potential outsourcing partners could essentially possess a thorough understanding of your company's technology and IP position. Therefore, where possible, executives should do the following to help mitigate the risk of such outsourcing partners also ‘working' with competing firms:

• execute contracts that place ‘field of business' restrictions on contract manufacturers or product designers;
• pay higher rates to help increase loyalty;
• pay for exclusivity from the contract manufacturer or product designer; and/or
• provide licensing revenue incentives to any jointly-developed IP in return for exclusivity

Justin Kunz and John Cronin also contributed to this article. VentureOutsource.com, June 2007