Valuation of Intellectual Property, Intellectual Assets and Intellectual Capital
- Overview of Valuation Methods
- Valuation Methods for Patents and Portfolios
- Comparison of Approaches
- Qualitative Valuation Methods for Individual Patents
- Patent Valuation In The Context Of Its Business Use And Hype Cycle Position
- Qualitative Valuation Methods for Patent Portfolios
- Patent Value as an Indicator of the Robustness of Technical Communities
- Sources, References and Selected Bibliographic Information
A great deal has been written on the valuation of intellectual property. The best resources are available from the World Intellectual Property Organization (WIPO) and the Licensing Executives Society International. The focus is on three primary means to determine how much intellectual property is worth. These are cost approach, and income approach, and the market approach. Within each of these generalized approaches there are variety of tools and techniques that address the specific unique characteristics of the asset to be evaluated.
The value of intellectual property, intellectual assets, and human capital is always dependent upon the context of the evaluation. The three overall environments or contexts for valuation are: 1. Is the evaluation being done as a final stage of a legal action or lawsuit; 2. Is the reason for the evaluation to determine the fair value for an arm’s length friendly licensing negotiation; or 3. Is the evaluation being done to satisfy the requirements of tax authorities or business regulators? Each of these requires slightly different valuation methods.
When it comes to innovation management, it is the second environment relating to friendly licensing negotiations that is of most importance. For this situation three issues or questions become relevant. 1. How much can the company afford to pay for the right to use the licensed technology? 2. In what way should the licensee pay the licensor? 3. How much should the licensee pay the licensor?
The first of these issues is important because of prudent licensee cannot base decisions on the theoretical value of technology but rather on whether or not it will enhance his ability to gain revenues. If the price of the new technology, when added to the cost of the product, results in a cost of goods that is higher than what the market will bear, the licensee will lose money and the licensed negotiation will of been a wasted exercise. In win-win negotiations both licensee and licensor discuss and share the data related to this issue so that the ceiling for the value of the technology is established. Then below the ceiling, the value according to the cost approach, income approach, and market approach is established by a variety of methods. Again these methods are reviewed in great detail in the WIPO literature and will not be repeated here. What will be shared now are some of the nuances that are important.
One special case is when technology is being acquired or sold to entities in emerging economies. In this situation the laws and regulations must be carefully understood. There are five of them. They are: 1. compulsory registration; 2. limitations on confidentiality; 3. limitations on royalty; 4. export restrictions; and 5. requirements relative to use of local technology. These laws and regulations can greatly affect the value of the technology in emerging economies and must be fully accounted for when conducting such valuation exercises.
Other common factors that affect the value of intellectual property fall into six general categories. These are: 1. the type of license i.e., exclusive or nonexclusive; 2. whether or not sublicensing is allowed; 3. if the royalties are paid in advance or in arrears; 4. whether running royalties are to be paid; 5. any minimum amount of royalties; and 6. Length of the period for which the royalties are payable.
Another special case of note is the 25% of profits valuation rule. This rule is fallen into disfavor over the past decade but nonetheless is often found useful as a starting point for negotiations.
When considering valuation methods for patents and portfolios there are some fundamental concepts that need to be understood. Fair market value is one of them. Fair market value is defined as a price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts. The valuation methods described in this section are based on best determining the fair market value for intellectual property for the purpose of some transaction or accounting. How the precise definition varies in differing arenas is shown in the “Differing Fair Definitions” figure.
When valuing patents it is important to consider all the activities and assets that are needed to achieve commercialization. It is not just about the technology and product. Such things might include the financial capital, marketing, labor, production assets, distribution channels, contracts, and complementary technologies. Each of these elements is distinct and should be kept separate from the value of the patent.
The exact model to pick when valuing intellectual property should account for (1) the market and application of the intended product or service, (2) the technology, (3) legal elements, and (4) the complementary assets. Typical factors impacting the patents value are shown in the “Value Factors” figure. Two elements that influence greatly the value of any patent are (1) whether the market served is existing or new and (2) the stage of technology development.
In the “Stages of Technology Development” figure the timeline of an idea is shown progressing from its inception through to participation in a mature market. The first part of this process is represented by a funnel to indicate that in an R&D setting there are thousands of ideas that get winnowed down to a single commercial launch. In the second part of the graphic, an S-curve is shown to represent on a vertical scale the growth in revenues or profits, and on the horizontal scale, time since commercial launch. With respect to the valuation methodology best used at each time during the timeline of an idea three major breaks occur when (1) the idea exists but does not yet have a commercial use, (2) when the idea exists along with the business plan for commercial use, or (3) when the commercial product or service is being sold.
These three major valuation segmentations continue on as a product moves through its commercialization stages. These are shown in the “Stages of Market Development” figure. On the vertical scale is shown the revenue, profits, or marketers capitalization of the company that occurs as a new product or service is introduced. On the x-axis the time and years since product introduction. Revenues typically start slow and grow slowly as the first customers experiment with the product and give good reviews to the next customer. As interest in the product grows, revenues rise significantly especially when geographic distribution takes hold. This worldwide penetration is obtained. As alternative products enter the market the curve flattens at the top and ultimately declines as the product is replaced by others.
Over the course of the product’s commercial life more information becomes known about the product and its commercial value. Early on it is only a product that has a potential use and its value is mostly determined by the cost that the developer has invested in bringing it into the market. As sales grows and market feedback is obtained, discounted cash flow or net present value income-based models can be used since enough information is available to calculate present value with some certainty. As a market grows even larger and other similar products are introduced into the market, these comparable products’ transactions can be used to value the product vis-à-vis the value of others that may have been bought or sold between entities.
In the “Specific Valuation Methods” figure the variety of the most common valuation methodologies is shown. These are separated into those that fall under the high-level umbrella of Cost, Income or Market Based methodologies. Each of these methodologies or approaches will now be discussed in more detail.
The cost method is based on the licensor’s investment in the technology. The cost approach is based on the economic principle of substitution. An investor will pay no more for an asset than the cost to develop or obtain another asset of similar utility. The value of the intellectual property is equal to the cost to replace or re-create the intellectual property. The theory behind this approach is that the licensee avoids these costs by licensing the IP from others. It is represented by those costs associated with developing, protecting and commercializing the technology. These expenditures are known to the licensor and can be reasonably estimated by the potential licensee. They represent the base, or minimum that the licensor would want to recover, with interest. The relevant costs and the opportunity cost associated with the technology have to be considered. Examples of such costs may include: R&D (labor and overhead), testing and regulatory approval costs, patent prosecution costs, equipment and other capital investments, and opportunity cost of diverted resources.
Sometimes a cost approaches used to estimate all the costs that would be incurred if the licensee were to obtain, from their own internal development or a different outside source, technology that could deliver an identical product or process. This might be through a third party with competing but non-infringing technology. The cost approach is used to establish costs that would be involved in the creation of a similar technology that takes into account the prices and rates of payment on the date of the valuation. In these and other appropriate situations, the licensee would estimate the time and the cost of acquiring or developing alternative technology. The licensee is effectively determining the cost of the next best alternative, and this, where possible, can be a useful measure of the importance and value of the licensor’s source technology to the licensee.
One final comment about the Cost Method regarding the concept of obsolescence; all forms of obsolescence have to be identified, quantified, and subtracted from the cost of the asset in order to estimate its value. Common forms include (1) Physical deterioration (not usually applicable for intangible assets), (2) Functional obsolescence that doesn’t provide the same benefits for external or internal reasons as it did at origin (3) Technological obsolescence which occurs when the original intended function is no longer needed or wanted by the marketplace, and (4) Economic obsolescence (sometimes location-related or economic price/cost-related obsolescence)
The income or net present value (NPV) approach is based on the cash flow that results from introducing the covered technology to the marketplace. The intellectual property value as calculated by this method is the present value of the expected future income stream. The theory behind this approach is that the licensee will be willing to pay some portion of their economic gain from using the intellectual property. It is based on the fact that successful technology commercialization or licensing means, for the owner or licensee, increased profits because of the use of the intellectual property protected technology.
The income approach to valuation involves making educated guesses or more precise measures if possible, as to the amount of income that the new technology will generate over time. It involves taking all the costs of production, sales, and overhead into account and subtracting those from the sales or revenues produced each month, quarter, or year. Specifically there are three parameters associated with this method. They are: 1. Amount of the income stream, 2. Duration of the income stream, and 3. Risk associated with the realization of the income. This involves preparing a spreadsheet involving all the cash flows inflows and outflows, for the term of the agreement and then calculating the current or net present value of the technology. Note that this NPV calculation requires selection of a discount rate which is the cost of capital adjusted for risk, examples of which are shown in the “Risk Premiums” figures. Obviously, this method is only as good as the precision of the data that is put into it.
NET PRESENT VALUE METHODS The net present value or income approach is based upon the economic principle of anticipation. The investor expects a certain income stream to be earned from the ownership of the intangible asset. This future income stream is converted to present net worth after analysis of all the risk factors that impact the generation of this future income.
An example utilizing this methodology to value biotechnology companies and their intellectual property follows. It includes in the calculation the probability of different discounted cash flows being realized. When doing so it’s important to work backwards.
Step one is to start with the commercialization stage. To determine the value from market launch the end of the product life, estimates of the following are made: 1. Forecasted cash flow from market launch until the end of product life. 2. The discount rate to apply to the cash flows. 3. The net present value at the market launch date is then determined by applying the discount rate to the forecasted cash flows.
Forecasting cash flows from market launch to product expiry (product life) requires a quantification of: expected revenue; cost of sales; operating costs; and income taxes.
Step Two is to create the value back through the R&D stage. Expected future cash flows during the development stage until market launch are made up substantially of the costs of preclinical R&D and conducting clinical trials related to the specific indication. Therefore the valuation must estimate the: 1. Costs, 2. Timing, and 3. Risks; for each stage of the preclinical and clinical trials. A detailed buildup of the budgeted trial costs is developed from a bottom-up estimate. For such R&D processes the estimate of value can be improved by applying a decision tree to the model. This is particularly true for biotechnology and other nascent technical areas. Each stage of the R&D or clinical steps is a journey toward obtaining market approval from a regulatory authority or consumer base. By assessing the probabilities of achieving success at each stage of the development process, the specific assumptions can be quantified directly in the valuation model. The advantage of using this methodology is that it improves the quality of the valuation. The disadvantage is that the calculation is no better than the cost and probability estimates Incorporated into the calculation. For incremental and some next-generation work these estimates can be pretty solid. For advanced next-generation and breakthrough work this methodology can be subject to large errors.
Relief From Royalty
NPV DISCOUNTED FOR TECHNOLOGY RISK -RELIEF FROM ROYALTY METHOD This method is based on the assumption that the business is not own the patent under consideration and thus has to pay a royalty to the owners of the patent for its use. The value of the patent is considered to be the capitalized value of the after-tax royalties that the company is relieved from paying as a result of ownership of the patent. An example is shown in the “Relief From Royalty” figure. In this figure EAT is the earnings after taxes and DR is a discount rate for the technology.
Technology Factor Valuation Process
NPV USING A TECHNOLOGY FACTOR The technology factor is a measure of the extent to which incremental cash flow derived from the practice of a technology is based on that technology asset itself. It is measure the fair market value of the intellectual property. The” Technology Factor Valuation Process” figure shows how this valuation process starts with the patent claims, technology summary, and a business summary, and then defines the boundaries of the technology and its commercial, technical, and legal impact. When comparing the Residual Excess Earnings Method with the Technology Factor Method, the former treats intangible assets as a whole, whereas the latter splits the technology asset value out from the intangible assets value.
EXCESS EARNINGS METHODS These methods are based on the extra earning that a company obtains from an advantaged protected position that is covered by a patent or patent portfolio. The method was developed by the US Treasury Department in 1920. It is included herein for completeness but rarely used in establishing the value of a patent portfolio in a business transaction. The methodology is documented in Appeals And Review Memorandum 34. There are two variants to this approach. One calculates the Residual Excess Earnings and the other uses Comparable Values to determine the “excess”.
Residual Excess Earnings Method
The RESIDUAL EXCESS EARNINGS METHOD is used when the business financial elements are known for the patent or patent portfolio under evaluation. It is a holistic approach that computes the company’s equity value for tangibles and intangibles assets. First the return on the tangible assets is calculated. Second the return on the tangible assets is subtracted from the company’s equity or total enterprise value. Third the intangible value is capitalized to determine the total value of the intangible assets.
The COMPARABLE RESIDUAL EXCESS EARNING METHODS is used for patent portfolios when only the industry average financial elements are known. These numbers are typically derived from proprietary databases wherein one can obtain the equity values from similar companies. What is needed for the calculation is the equity value of both the tangibles and intangibles assets. As before the process is to calculate the return on the tangible assets. Then the return on the tangible assets is subtracted from the company’s equity. Finally the intangible value is capitalized to determine the total value of intangible assets.
OPTIONS METHODS To take into account the variations in the assumption values that go into the income method calculations, more elaborate income-based valuation technologies utilize decision trees, options and Monte Carlo simulations to improve the estimated values.
The DECISION TREE APPROACH is one of several that considers patents as options. Patents can be thought of options in the sense that they give the patent holder the option to preclude others from utilizing the innovation or acquiring the complementary assets in order to extract money from the innovation. A further argument for valuing patents as options is that there is a separation between the underlying asset in the option, and the obligation to use it. As the “Decision Tree Approach” figure illustrates, when a development or commercialization process completes its stage A, the work can either be stopped and the results sold as is (Payout B) or more work can continue on to reach another decision point where again the work can be stopped with the Payout C or continued on even further to reach Payout D. The company has no obligation to continue down the full route to Payout D. Modeling decisions of patent prosecution, global filing, maintenance, licensing, protection of commercial products advantaged positions, or litigation allows one to best estimate the value of the patent along the development and commercialization pathway of the technology it protects. This methodology is best utilized for patents which protect a narrow range of products against a few competitors.
For patent related processes there are a number of statistical values to can be used at the decision points. These are global values for all US patents. They are good starting points, but with more advanced databases these numbers are now available from commercial providers for industry segments and technology areas. That said, the following provides a viewpoint. First, the probability that a patent will be held invalid is 67%. Second, the probability that a patent will be enforceable is 86%. Third, the probability that patents will be infringed is 68%. Fourth, if the patentee asserts his patent in court he has a 68%’s chance of prevailing. For non-practicing entities (NPEs) the probability of winning drops to 29%. The “Decision Tree for Patent Litigation” figure shows an example tree which would use these values.
Another Options approach is the BLACK-SCHOLES APPROACH. It is standard practice in the financial industry use the black Scholes formula to calculate the value of an option. When doing so the Black Scholes model determines the value of the call option. In the financial world it is assumed that the risk-free interest rate is constant and also that the stock price volatility is constant. When applying this to patent valuation the Black-Scholes option pricing model is modified as shown in the “Black-Scholes Method” figure. Note that the issue with this method is that the assumptions the model is based upon may not be true. For example the Variance of Product Value Return and the Risk-free Rate are often not constant throughout the life of a patent. As with other income based valuation models, agreeing on the values to put in the model are subject to expert opinions.
The MARKET APPROACH is based on the economic principle that in a free market system the supply and demand factors will drive the price of any good to point of equilibrium. Intangible assets are valued by reference to transactions involving similar assets that have occurred recently in similar markets. The market-based valuation method assumes the intellectual property value is equal to the arm’s-length price paid in comparable transactions. The theory behind this method is that the licensee is not willing to pay more than others have paid for similar intellectual property. The best resource for valuation by this method are the books, articles and databases by Russell Parr.
This approach is best explained in terms of how purchasers of real estate and used cars operate. In these markets buyers can readily ascertain what other parties have agreed to for similar houses in the same area, or for the same make and year of car. The same approach is beneficial in valuing intellectual property, though perhaps not as useful because there will seldom be identical technology and intellectual property packages.
Six elements to consider when determining what constitutes a comparable transaction are: 1. Nature of technology and IP protection, 2. Market size characteristics (e.g., number of applications), 3. Scope and status of patent protection, 4. Terms of the agreement (e.g., field of use restrictions), 5. Growth outlook for relevant products, and 6. Barriers to entry. In addition, the commercial details of an agreement will not be ascertainable when they are considered by the parties involved to be competitor sensitive. To get around this issue it is useful to look at existing royalty rate ranges and other factors published by a variety of for-profit companies and professional society entities. Factors to consider when using this approach are: (1) royalty rate, (2) exclusivity, (3) geography, (4) duration, and (5) minimum/maximum caps.
Variation between royalty rates is also dependent upon which business area a company is working in. The “Variation of Royalty Rates Within Industries” figure shows this variation. Although the variation even within an industry seem to have a lot of variability, studies, particularly in the pharmaceutical area, show that 80-90% of licenses have royalty rates close to the average, versus being evenly distributed between the minimum and maximum.
VALUE GRID APPROACH This approach is based on the fact that royalty rates that can be charged by an owner of a technology are usually based on the economic benefits that can be derived from its use. The exact royalty rates for technology are difficult to get because patented technologies are unique. However there are comparable royalty rates that are available from professional societies and private sources that can be used to build a Value Grid. From this grid the most likely royalty rate can be ascertained.
The manner in which a value grid works is to set up a grid that captures a whole range of royalty rates that are being used in a specific industry. An example is shown for the chemical industry in the “Example Value Grid for Chemical Industry Product” figure. Such a grid is constructed for by utilizing overall values from commercial or professional society sources. Where individual grid elements are missing their values can be extrapolated from those that are present and available. For the product under evaluation the appropriate grid box is selected. This allows a user to identify the range of royalties for the technology under analysis.
Value Matrix Approach
In order to fine tune the analysis to arrive at a specific reasonable comparable royalty rate, a value matrix is constructed as shown in the “Value Matrix Valuation Approach” figure. Patents describing products very close to the patent under evaluation are pairwise placed on the matrix (shown as yellow dots). Once the pairwise placement is completed and the graphic points moved so that there are equal numbers of points above / below and left / right of the center lines, the patent under consideration can be evaluated by overlaying the “range correction contour lines”. The +/-100% contour lines correspond to the ranges derived from the Value Grid. Thus a fine tuned estimate of the royalty rate is obtained for the patent under consideration.
Commodity Royalty Rate Approach
COMMODITY ROYALTY RATE APPROACH This approach is easiest to apply when one gets lucky enough to have the technology and/or product under consideration already being licensed or sold to others at known rates. Utilizing such comparable royalty rates is a standard practice in the industry. Using such royalty rates is typical for a franchise licensing program. .
PROXY ROYALTY RATE APPROACH Exact royalty rates are very difficult to get because patent technologies are unique. To solve this problem comparable royalty rates for similar technologies and products that are known to professional societies and commercial providers are accessed. Royalty rate information is typically redacted in these databases so the individuals valuing the patent have to make sure that the royalty rates used are indeed for similar products and uses. This practice is typical and a standard practice in the pharmaceutical industry..
Patent Auction, Capital Market and Monopoly Values
PATENT AUCTIONS Another form of market-based valuation is to use comparable values derived from patent auctions. These became popular in the early 2000s, but the large public auctions have fallen into disuse because although there were plenty of patents offered, there were not many bids.
CAPITAL MARKET VALUE Yet another form of market valuation of patents comes from determining the fair capital market value of the intellectual property. This approach asserts that the market capitalizations of small or medium-sized pure-play technology companies are based solely on the value of their advantaged competitive position protected by their patents. As such the company value should be considered the value of the patent. The argument for using such approach is that incorporates the value effects of the target market value, the patent claims strength, the patent validity, and market entry costs. The major downside to this approach is that there are very few pure-play technology companies to use as a market comparable.
MONOPOLY VALUE Finally another way to establish the value of a patent is to consider the value of the monopoly it creates for the corporation. There are several rules of thumb that are derived from using this approach. First, a patent is worth four times the value of the annual monopoly it creates. This rule of thumb is derived from assuming that the patent term is 17 years and the discount rate is 25%. The second rule of thumb’s is that a patent is worth twice the annual profit generated by the patented product or process. This is assuming the product loses half of its market share upon patent expiration, which for most brand-name drugs is true.
Each of the three major methods for valuing patents has their own strengths and weaknesses. In the “Accuracy Versus Cost of Valuing Patents” figure the trade-off between the two can be seen. Although the X scale for time may be accurate for organizations with lots of valuation experience, many companies will find that the units are extended out, ranging from hours, to days, to months. The important thing to realize is that when valuing intellectual property for various purposes, the time available before a decision must be made can unfortunately affect the methodologies utilized.
Likewise a typical method used to value patents is related to the technology’s placement on the business or technology S-curve. A shown in the “S-curve’s Impact on Valuing Patents” figure, early stage patents are primarily valued on the basis of cost. This is because no market information is yet available for breakthrough products, and income methods have notoriously inaccurate assumptions. Later on, as the market starts to develop, the income methods become much more robust because of the experience with both the technology commercialization and market uptake. Late in the maturity curve when many competing technologies enter the market, the market-based method becomes the easiest and most robust method for evaluation.
For some regulatory requirements the particular method of valuation is not directly specified. For example, Sarbanes-Oxley and FSAS 141 & 142 requirements require that with respect to valuation each part of the portfolio be valued. They also require identification of how the value was measured and who measured the value. Given that different valuation methodologies require different amounts of time and effort to create and that in general the valuation methodologies tend to give values higher or lower vis-a-vis one another, careful selection of valuation methodologies for regulatory use is an important corporate decision. Typically when valuing IP for regulatory purposes the corporation’s or entity’s accounting and legal staff should drive the valuation process.
The above three general methods for valuing patents are aimed at putting a financial or dollar value on each. Once doing so the relative value of those patents can then be determined by simple rank ordering of these financial values. Given the complexity of the above analyses it is oftentimes more useful for an organization to determine the relative value of the patents in their own portfolio in their competitors’ portfolios. These alternative valuation methods have as their strength the ease and reproducibility of the measurement. Their weakness is their only moderate correlation to financial value. For strategy purposes however the nonfinancial rankings of patent values oftentimes provides more insight and predictive capability.
In the “Sample Rankings of Analysis Factors” figure, five major elements of patent value are offered. Under these headings, anchored scale ratings of 1 to 10 are also shown. Once the anchored scale value for each of the 5 major factors is determined an overall score can be obtained by adding or, if a company is more sophisticated, a weighted average or sum can be utilized. When comparing patents on relative performance versus relative cost measures, the anchored scale scores are even better visualized by graphing them on a five-point radar or spider diagram.
The “Frequently Used Relative Measures of Patent Value” that are detailed below shows a number of other measures derived from patent citations that reflects the strategic and tactical value of individual patents. Depending upon the type of R&D or IP Game of the Corporation and its competitors, each of these does a relatively better or worse job of predicting a patent’s competitive value. It should be noted that overall these metrics have a relatively weak correlation to a patents financial value. However in a particular industry and for a particular company versus its key competitors, these measures often predict accurately the relative value of each patent in a company’s portfolio.
- ORIGINALITY refers to the Measure of Originality and is based upon backward citations. The measure of Originality (on a three decimal point scale from 0 to I) is determined by dividing the number of patent classification cods cited (NPC, IPC or NBER) by the total number of patents cited. Therefore, the more patent classifications cited by a particular patent, the greater the measure of Originality. For example, a patent which cites 20 patents from 15 separate patent classifications will have an Originality of .750 (15/20) whereas a patent which cites 20 patents from only 3 patent classifications will have an Originality of only .150 (3/20).
- GENERALITY refers to the measure of generality is based upon forward citations. The logic is that if patents from wide variety of classes site the patent, it is a very general one. The measure of Generality is determined by dividing the number of patent classification codes cited forward by the number of forward citations. The more patent classifications a patent can be used in or applied to, the more general the patent is considered to be vs. having a more specific or unique application.
- SELFCITEDL refers to the percentage of Self-citations (patents citing the original patent which belong to the same assignee) received, and is thus based on forward citations. The Lower Bound index includes all patents cited. For example, if a patent receives 10 citations in total and 3 of those citations are from the same assignee/inventor as the original patent (self-citations), the SELFCITEDL index will be .300 (3/10).
- SELFCITEDU refers to the percentage of Self-citations (patents citing the original patent which belong to the same assignee) received, and is thus based on forward citations. The Upper Bound index includes only patents cited which have at least one assignee. For example, if a patent receives 10 citations in total, but only 6 of those citations have at least one assignee, and 3 of those citations are from the same assignee/inventor as the original patent (self-citations), the SELFCITEDU index will be .500 (3/6).
- SELFCITINGL refers to the percentage of Self-citations (patents cited by the original patent which belong to the same assignee) made, and is thus based on backward (or “prior art”) citations. The Lower Bound index includes all patents cited. For example, if the original patent cites 10 patents in total and 3 of those patents are to the same assignee/inventor as the original patent (self-citations), the SELFCITEDL index will be .300 (3/10).
- SELFCITINGU refers to the percentage of Self-citations (patents cited by the original patent which belong to the same assignee) made, and is thus based on backward (or “prior art”) citations. The Upper Bound index includes only patents cited which have at least one assignee. For example, if a the original patent cites 10 patents in total, but only 6 of those patents have one or more assignees, and 3 of those citations are to the same assignee/inventor as the original patent (self-citations), the SELFCITEDU index will be .500 (3/6).
Another method to determined relative patent value is to take any individual patent metric (be it the number of citations, number of inventors, or originality), and when rank ordering these values for patents in a portfolio, apply a statistical test to the results. For those patents that have an attribute whose value is over 3 times the standard deviation plus the average of the group, those “3 Sigma” patents are statistically “special” and worth many multiples of the financial value of the patents that do not meet this criteria.
One patent-based metric does have a reasonably good correlation to the financial value of a patent. This metric is the number of patent citations. This metric likewise is been used as a proxy for patent quality. When exploring the relationship between citations with the probability that a patent will be litigated, it is found that the ratio of forward citations to claims for a patent is positively correlated (in either direction, as a challenger as an infringement suit). It should be noted that the studies in which the correlation coefficients are very high, the technology involved tends to be those associated with the Safety Journey R&D and IP game type. For other R&D and IP game types, i.e. Mass Customization game type, using the number of citations as a quality or value metric is weak. When however a patent has over the Three Sigma limit for citations, it is almost always a very high value asset.
The above model takes into account the major factors affecting the value of intellectual property. A more complete list of elements to consider is shown in the “Attributes That Influence the Value, Damages, or Transfer Price of Intellectual Assets” figure. To the extent possible, analysts qualitatively and quantitatively consider each of these factors. Note that not all of these factors apply to every intangible or intellectual property asset, and that each attribute does not have an equal influence on the asset’s value. However, good analysts typically consider each of these factors, in either a quantitative or qualitative form.
A final general consideration for valuation of patents is the variation in patent value that arises from the number of patents in a portfolio. This variation is a general rule, not specific, and based on licensing transaction data. As shown in the “Patent Value vs. Portfolio Size” figure, the larger the portfolio offered for licensing, the lower the patent value per patent. This is typically explained by saying that the licensee is interested in a “sustained competitive advantage” from a licensing transaction, and is paying for this business outcome, no matter how many patents it takes to achieve it. Thus the business outcome is what creates the valuation relationship. Also larger portfolios also loosely imply that more tangential art is present in the field and this also reduces the business value of the art licensed.
Valuation of Software IP
A unique class of asset that is subject to intellectual property protection is software. The central constructs for software valuation are the identification of the software inventory components, possession by the corporation, and statements of ownership to the components. These are the primary constructs to keep in mind for software valuation. Another important point to remember in valuation of a software product is that only after the market has been established and demand is apparent, the software inventory contains the only assets with value. Then after the market is established current and future revenue of the software product will again be dependent upon these same intellectual asset components. In other words, quality of the software inventory will play an important part in fair and market valuation of software. The reason for this assertion is that software content is varied, as shown in the “Intangible Asset Inventory” figure. When it comes to IP protection of these assets, they can be bundled into “Software IP Packages”, as shown in the figure.
When it comes to valuation of software IP, determine the buyer’s motivation for fair value consideration and determine the amount of bias of the ownership value. Consider the applicability of market or income valuation approaches over ownership value. (Ownership value is the view of value if the owner is deprived of the ability to monetize and/or exclusively use.) Ideally, all three approaches should be considered. However, many valuators prefer the income approach for valuing unique, income-generating properties especially if patents are involved. A cost approach is seldom useful if only patents are to be valued, and the market approach may not be relevant because patents are unique by definition and comparable patents may be difficult to identify.
For an Income-Approach to Software Valuation it is important to separate patent valuation from software valuation if patents are involved. For patents, variations of an income approach to valuing patents can be broadly classified as royalty-based or profit-contribution methods. “Profit contribution” refers to the profit attributable to a patent. “Royalty” refers to the income stream expected by the patent holder under a licensing transaction. Whether a profit contribution or royalty method is more appropriate in a given situation depends upon the premise of value or expected future operations—for example, whether a patent is to be sold separately, used for reserve, or commercialized as part of a going concern. For software, the income approach will be used to look at the revenue derived by licensing the software times the number of licenses less the cost to maintain market share.
For a Market Approach to Software Valuation it is important to determine the motivation for market value consideration and determine the amount of bias of the ownership value. Again, consider the applicability of market or income valuation approaches over ownership value. Ideally, all three approaches should be considered. A market approach is seldom useful if only software is to be valued, and the market approach may not be relevant because software is unique by definition and comparable software products may be difficult to identify.
Another unique class of asset that is subject to intellectual property protection are Standard Essential Patents (SEP’s). These are patents that would be infringed if an industry or government standard were followed. Experts agree that it is most important to remember that just because a patent is declared standard essential, that does not make it one. What really counts is quality, not quantity. There is a real danger that losing sight of this may lead to flawed business, investment and policy decision making.
When valuing a SEP it is imperative to consider four elements. These are Unenforceability, Nondiscrimination, Reasonable Royalty, and Worldwide Conflicts. Unenforceability often comes when a patent owner doesn’t appropriately disclose the SEP to the standards body. Licensees of SEP’s have to be diligent in investigating the behavior of prior patent owners in this regard. Nondiscrimination comes about when licensors try and withhold licensing to competitors. However, IP policies say RAND applies to license terms and art must be licensed to all applicants. Nondiscrimination means what it says, all applicants have to be treated the same, irrespective of size or other attributes. RAND Royalty rates are typically determined by percent SEP count of the company over the total SEP count. It is important to note however that RAND law is still developing, with differing approaches and outcomes. Worldwide Conflicts refers to the court decisions in various countries. Courts hearing essentially the same case come to different outcomes. This makes valuation of SEP art difficult and variable. It is best done by solid subject matter experts.
It is been said that beauty is in the eyes of the beholder. The same is true for patent value. Value is in the eyes of the beholder or business user. Thus context is critical for valuing intellectual property assets. For example would you buy a bottle of water for hundred dollars? If you are at home or in a hotel probably not. If you’d been out in a desert alone for five days probably yes. The “Valuation Considerations of Business Use and Hype Cycle” figure shows the contextual elements that are used to establish whether a patent is in the high or low-end of the values that come from marketplace databases.
There are three elements to give insight on the business use environment. There are two elements related to understanding the marketplace and hype cycle environment. This context is then fine-tuned by many detailed measures to ascertain if a higher low patent value should be set. The advantages of using this method are that the information required is readily available from patent and marketplace databases.
The first driver business value is the dominant business need that the company has at any point in time. The hierarchy of these needs is shown in the “Business Needs & IP Roles” figure. Patents that are supporting the business needs on the lower portion of this Maslow hierarchy can be thousands of times more valuable than those needed to support the upper business needs such as “speed R&D and business product development”. As a point of clarification, patents that are supporting the topmost business need relating to industry standards that are decades away may have important strategic value but little current value. However those patents that support today’s industry standards fall into the “freedom to operate” area and are thus very valuable.
The second driver of business value has to do with the intellectual property environment that the company’s business lines are operating in. Patents in some industry segments are worth much more than in other segments. Generally speaking, on this grid the most valuable patents are found in the upper left quadrant, and lowest value to the business in the bottom right quadrant. In the uppermost left quadrant, if the timeline to commercialize the scientific patents is long or longer than the life of the patent, the patents have little commercial value. On the other hand if the industry is fast moving and the technology rapidly deployed, these are the highest value patents that exist in business. Likewise those covering pharmaceutical drugs and medical equipment are typically very high value patents. On the other hand those covering specialty food ingredients, newspaper, and clothing are much lower in value. This trend is borne out by the “average royalty rates by industry” published by several professional society organizations.
In the “Role of Patents by Industry Segment” figure some of the grid elements have been overlaid with which business need and IP role tends to dominate that selected industry. For example patents covering pharmaceutical drugs are typically aimed at sustaining an advantaged market position. This is in contrast to Internet and business method patents where the key is really to maintain freedom to operate by amassing large portfolios. The main use for specialty food ingredients, specialty chemicals, electronic equipment, and industrial controls is the ability to geographically out license in a way to rapidly grow revenue and profits. Without patents these geographic expansion programs are on a weak footing.
When it comes to business value of patents, the market size and market profitability are what patents protect. Patents that protect large portions of this advantaged position are valuable assets. As a business moves from embryonic through decline as shown in the “Business Hype Cycle” figure, the value of the patents also generally goes up and then flattens too.
The traditional S-Curve is many decades old and was upgraded in the 1990s with the understanding that there is a chasm or blip in the curve to be crossed as a business developes. Patent values in this critical stage of commercialization also experience a similar changes in value. By the 2000s Gartner Corporation when looking at the introduction of technologies found that there is an overpricing of businesses just before the chasm and a much slower increase in value afterwards. The latter slope up was very dependent on the industry segment that the technology plays in. This is similarly observed in patent values
Hype cycles, as illustrated in an “Example Gartner Hype Cycle” figure, explain the relative value of patents and small companies in an around the chasm portion of the S-curve. This is an important finding for those individuals and entities buying and selling patents as it guides selection of the right time to do so. These timing points are indicated on the “Hype Cycle Based IP Management” figure.
All of this information is now combined and used to determine which commercial or professional society databases to use for bracketing the actual patent value under consideration. The databases are typically derived from litigation awards, licensing transactions, open innovation technology transfer, or standards sources. Adding to this knowing the industry segment to use, or comparable industries to draw information from, is important in picking the right database information. Finally when using the database information it’s important to note the time when the specific valuation data point transaction/event occurred. These data points are arranged in order on a hype cycle template so that the appropriate over / undervaluation of the database entries is understood. In summary, the five uses, 11 industry segments, and three hype cycle positions create the context needed to determine which database to use and which time slice in that database is appropriate when selecting market comparables.
Once the appropriate database and data elements within that database have been selected for valuation purposes, more detailed measures are used to fine-tune the exact royalty rate or patent value within the range.
For business use and hype cycle positions that point to the highest patent value being related to litigation there are 10 measures available to fine tune patent value. These are shown in the “Examination Based Measures Used to Fine Tune Patent Value” figure. Each of these measures are assessed against an industry benchmark patent portfolio. This allows the statistical significance of the results can be ascertained and the overall pattern can be summed and weighted to establish the fine-tuned patent value or royalty rate.
For business use and hype cycle positions the point the highest patent value being related to excluding competitors from accessing the sustained advantage position protected by the patent, the 15 predominantly citation-based measures are best used to fine-tune the patent’s value. These measures are shown in the “Citation Based Measures Used to Fine Tune Patent Value” figure. As before each measure uses an industry benchmark patent portfolio and the results fine-tuned by the percentile position of the asset being evaluated.
Lastly for business use and hype cycle positions that indicate that the highest patent value will be obtained from geographic expansion with out-licensing programs, the 12 geographic based measures are best to use. These are shown in the “Geographic Based Measures Used to Fine Tune Patent Value” figure. This is a very important consideration for most patent value determinations as for many entities global filing is a haphazard process. The impact of lack of coverage is easily uncovered by such an analysis.
Using business use and marketplace environments provides the context needed to establish patent value from licensing, litigation and technology transfer databases. Within these databases data points selected on the highest value use of the patent can be fine-tuned based on examination, citation, and geographic based measures.
Valuation methods, both relative and financial, create a continuum of values. When one plots the “Number of Patents Versus the Value of Each Patent” one gets a lognormal distribution as shown in the figure. As mentioned in previous chapters, for most unmanaged portfolios, 1% of the patents generates 90% of the value. 50% of the patents enable and protect the business. 30% of the patents are available for immediate non-conflicting out-licensing revenue opportunities, and 15% of the patents are best donated or abandoned. Using the 3 Sigma test for individual patent attributes is often the best way to very quickly identify the very valuable patents in a portfolio.
Internal value of patents is really determined by the business use of that asset. Depending upon where in the business and technology cycle the patent’s protected property resides, and the business unit’s ability to create revenue from the asset, are the key factors to determining internal value. To determine this internal value patents are placed on a “Use Grid” as shown in the figure. They are placed on grid rows based on which business line they are protecting. Growth businesses are those that are growing double digits. Core businesses typically are growing in single digits. Mature businesses are barely holding their own or declining. For the columns, patents are placed based on the state of the product or process they protect. They might be protecting products that are commercially now offered for sale. Alternatively the products they protect may be contained in written strategic plans but not yet commercial. Even further out, patents may cover potentially strategic directions that are only in the general manager’s eyes, but which have not yet been captured in written business plans. Lastly there is art which is outside the strategic direction of the business unit or corporation. The highest internal value art is in the upper left-hand quadrant. The highest external value art is in the upper right quadrant. The lowest value art is across the bottom of this grid.
When determining the relative value of patents that protect very specific business product lines the use of Value Maps are warranted. As shown in the “Value Map of Patent Portfolios” figure, patents are placed on a grid denoted in this figure by text inserts and small dots. The x-axis placement is determined by the relative cost to create and deliver the product protected by the patent claims. The y-axis placement is determined by the relative performance of the product protected by the patent claims as perceived by customers. When placing patents on this matrix they are done one after the other. Each time a new patent is placed on the map the positions of all other patents are altered to be above or below the new patent so that an equal number of patents exist left or right of the cost average line, as well as an equal number of patents being above or below the relative quality, service, and design line. Art in the upper left is of high value to the Corporation. Art in the lower right is low value and should be donated or abandoned. Art in the upper right and lower left is kept or licensed per a company’s brand image.
When comparing relative value of differing patent portfolios especially among competitors radar or spider diagrams are particularly useful. These visualize the relative portfolio strength based on the multiple individual criteria. There are four key areas to assess when conducting’s such assessments. They are summarized on a star diagram as shown in the “Comparison of Patent Portfolios” figure. In this figure there are 4 quadrants. The first in the upper right shows the patent strength based on the portfolio’s overall size and scope. Values related to the patent portfolios validity and competitive value are shown in the lower right of the figure. The opportunity to license a portfolio based on its size, depth, and breadth is shown in the attributes found in the lower left of the figure. Lastly, the sustainability of the portfolio as evidenced by the attributes is shown in the upper left of the graphic. Using overlays of various competitor’s portfolios, the human eye can quickly determine which portfolio is stronger and of more value and why.
Another method for qualitatively valuing patent portfolios, especially for large portfolios held by entities participating in the “Mass Customization” R&D / IP Game Type field dominated by software and internet firms, is to use artificial intelligence to group patents into clusters of related art. The value of any one company’s art in the field is simply the percentage of patents owned by the company compared to the total number of patents in the same field. Artificial intelligence in this case refers to the use of patent classifiers based on AI that determine which patents do and do not belong in the total patent count considered. Knowing the total value of an advantaged position in the field from business data, the percentage of art owned by a company is applied to this total value. Expressed mathematically, the Mean Royalty Rate for a Specific Company and a Given Product Line is equal to the Mean Royalty Rate typically attributed to that Product Line, times the Number of Patents owned by that Company that read on the Given Product Line, divided by the Total Number of Patents reading on the Given Product Line regardless of owner. Although this is simplistic and doesn’t take into account the quality of the patents under consideration, it has become a common method for business, not legal, personnel to determine the relative value of large patent portfolios. Such methods are not employed in “Safety Journey” R&D / IP Game Types dominated by pharmaceutical companies.
Four overall measures of the technical robustness of a technical community are: 1. Affiliation rate, 2. Author rate, 3. Source rate, and 4. Longevity. These four measures are determined by looking at a field of technical research as defined by keywords, concepts, or patent classifications. Once the field of art is defined, the four measures can be calculated.
The affiliation rate is defined by plotting the number of assignees occurring in patents for each filing or issue year. This trend line shows how the number of investing entities in the technology is either growing or shrinking.
The author rate is defined by plotting the number of inventors occurring in patents for each filing or issue year. This trend line shows how the inventor pool is either growing or shrinking over time.
The source rate is defined by plotting the number of patents granted or applications filed at each filing or issue year. This metric shows the maturity of the technology over time. Over longer time frames it also acts as a leading indicator to the overall market size that the technology supports.
The longevity is defined by plotting the average number of years of life remaining in all patents in the portfolio at each filing or issue year. This metric indicates the commercial level of interest in the technology area.
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