BVR. Free Download. Fundamental Principles of Patent Value. What It s Worth

Transcription

1 BVR What It s Worth Free Download Fundamental Principles of Patent Value Article published in the January 2012 IP Management & Valuation Authored by By Fernando Torres, MSc Thank you for visiting Business Valuation Resources, the leading provider of quality acquisition data and analysis. For more information about any of our premier valuation products or services, please call (503) ext. 2 or info@bvresources.com. You may also download our complete product brochure at: For permission requests, please permissions@bvresources.com. Business Valuation Resources, LLC 1000 SW Broadway, Suite 1200 Portland, OR (503) info@bvresources.com

2 Vol. 1, No. 1, January 2012 IP MANAGEMENT & VALUATION SUPPORTING SENIOR EXECUTIVES IN THE IDENTIFICATION, EVALUATION, PROTECTION AND GROWTH OF IP ASSETS Fundamental Principles of Patent Value By Fernando Torres, MSc Small and mid-sized business patentees often ask how they can get a back of the envelope assessment of the value of their patents, usually a single patent. On the surface, this sounds like a reasonable request: a specialist should be able to review and consider the issued patent document and determine an approximate market value. However, what is often overlooked is that a patented innovation s economic value cannot be reliably based only on the attributes of the innovation itself its value is derived from its current role in the economy. The invention itself may have scientific, engineering, or even artistic merits, but these are not sufficient attributes to determine economic value. This article addresses the fundamental principles driving the value of patents, and how this draws a more comprehensive picture of what must be considered in estimating a preliminary range of the fair market value (FMV) of a patent. Principle No. 1. A patent has no intrinsic value independent of the value of a business. At the risk of repeating what patent attorneys and IP professionals already know, a patent is only the temporary right to exclude others from a specific market delimited by a written description of an innovation. 1 It does not represent the right to practice an invention or title to a royalty income stream. Several factors determine the potential economic value of the opportunity the patent represents. For example, if an inventor is issued a patent on an innovation that he or she cannot implement directly and no one else needs such invention to operate their business and satisfy actual consumer demands, then no actual market segment exists for the invention. That patent is not simply worthless; it actually represents a net cost to the patent holder in covering drafting, drawings, filing fees, and other prosecution costs that, realistically, are no less than $1,500 and could be as high as 10 times that amount. 2 By contrast, consider a situation where there is market demand for, say, an accessory that props up touchscreen smartphones because: (a) a large number of such phones are in use; (b) the phones must be held at an angle for comfortable viewing of videos; (c) the cost of manufacturing the accessory is low relative to the phone at the appropriate volume levels; and (d) demand exists for accessories that enhance the functionality of the phones (see Figure 1). In this case, the value of this limited accessory business would be proportional to the net profits of the venture. Figure 1. Example Phone Accessory ( More specifically, a patent for that invention would likely have economic value because the patent holder can exclude others from making, importing, using, offering for sale, or selling 1 See, for example: 2 For the official filing fees see: offices/cfo/finance/fees.jsp. bvresources.com/ip

3 Fundamental Principles Of Patent Value that invention throughout the U.S. and sell the product at, or up to, a monopoly price the price at which the seller maximizes net profits beyond the market compensation of the capital and other resources employed. Typically, this price would be greater than the competitive price for the product, i.e., the price at which this seller would be operating at the general profitability level. Conceptually, the patent-holding seller would maximize profits at a lower production level that is more than proportionately compensated by a higher price. For example, suppose the average cost of production (including a normal profit margin for the capital involved) is $5 per unit, and the public is willing and able to buy up to 5,000 units of this product at $6, but only 4,000 if priced at $7. Then, the patent holder can net a normal profit ($5,000) selling at $6, 3 or make even more ($6,000) by selling at $7. 4 Since the patent prevents other suppliers from competing by selling the product and driving the price down to $6, the incremental profit at the monopoly price over the net profit at the competitive price is the measure of the value of the patent itself ($1,000). 3 $5,000 = ($6-$5)x5,000 units. 4 $6,000 = ($7-$5)x3,000 units. Executive Editor: Publisher: Legal Editor: Managing Editor: Graphic & Technical Designer: VP of Sales: President: Customer Service: Rebecca Morrow Randy Cochran Sherrye Henry Janice Prescott Monique Nijhout Lexie Gross Lucretia Lyons Stephanie Crader Dr. David Allen, Associate Vice President Technology Transfer Office University of Colorado System Boulder, CO Thayne Forbes, Principal Intangible Business, Ltd. London, UK Dr. Marie Kerbeshian, Vice President Technology Commercialization Indiana University Research and Technology Corporation Indianapolis, IN Generally, only the incremental profit would be attributable to the patent and therefore a measure of the economic value of the patent. The underlying business is making more profit ($6,000 in this example) than the value of the patent; these are two separate concepts and measurements. Referring back to the hypothetical phone accessory business, insofar as such a business can have value, a patent on the device would have economic value by excluding competitors. The value of that patent is related to, but different from, the value of the underlying business (and usually smaller if the business is profitable in a competitive environment). Consequently, an initial conclusion based on this principle is that the question for the patent holder is not What is my patent worth? Rather, it would be closer to What is the value of the underlying business, and how much can a patent contribute to that business value? Principle No. 2. A patent s use is a key arbiter of its economic value. In practice, patents can have several uses, and each alternative brings characteristics and contextual parameters that affect economic value. EDITORIAL ADVISORY BOARD IP Management & Valuation is published monthly by Business Valuation Resources, LLC, 1000 SW Broadway, Suite 1200, Portland, OR Application to mail at Periodicals Postage rate filed at Portland, OR. Postmaster: Send address changes to IP Management & Valuation, Business Valuation Resources, LLC, 1000 SW Broadway, Suite 1200, Portland, OR The annual subscription price for IP Management & Valuation is $299. Low-cost site licenses are available for those wishing to distribute IP Management & Valuation to their colleagues at the same address. Contact our sales department for details. Please feel free to contact us via at customerservice@bvresources.com, via phone at , via fax at ; or visit our web site at BVResources.com/ip. Editorial and subscription requests may be made via , mail, fax, or phone. Please note that by submitting material to IPMV, you are granting permission for the newsletter to republish your material in electronic form. Ron Laurie, Managing Director Inflexion Point Strategy Palo Alto, CA Dr. Jackie Maguire, CEO Coller IP Management, Ltd. Fugro House Wallingford, Oxfordshire, UK Dr. Kenan Patrick Jarboe, President Athena Alliance Washington, DC Mike Pellegrino, Founder Pellegrino and Associates Indianapolis, IN Although the information in this newsletter has been obtained from sources that BVR believes to be reliable, we do not guarantee its accuracy, and such information may be condensed or incomplete. This newsletter is intended for information purposes only, and it is not intended as financial, investment, legal, or consulting advice. Copyright 2011, Business Valuation Resources, LLC (BVR). All rights reserved. No part of this newsletter may be reproduced without express written consent from BVR.. 2 IP Management & Valuation January 2012

4 Fundamental Principles Of Patent Value Once a patent holder is in possession of an issued patent, it can be put to economic use in at least one of the following ways: 1. Internal. The patent holder may make use of the patent internally in an existing business (or firm). The patent may cover a specific aspect or an improvement of the manufacturing process used in the firm, or it might cover a specific feature of a product. In addition, the patent could be a method patent and claim a specific mode of operating the business or implementing a procedure in software, for example. Internal users typically supplement new patents with existing resources, trade secrets, and knowledge assets to put them in practical use. For example, Apple Inc. regularly obtains patents on its own future product designs or for product features that it plans to incorporate into its products Licensing. The patent holder may focus on licensing the patent to third parties, with the goal of developing a royalty income stream by relying on the licensees to bring together any additional resources to practice the claimed invention. IBM has been granted more patents than any other U.S. company during each year since It maintains a broad portfolio of patents in the computer industry specializing in the areas of display, storage, network computing and software. Yet IBM does not manufacture products in these areas anymore; it licenses its technologies to third parties that engage in manufacturing. One technique increasingly used to establish a licensing program has been the threat of litigation. This strategy has been the choice for companies described as non-practicing entities or, less euphemistically, patent trolls. 5 See, for example, the Patently Apple Blog: apple-patents-point-to-future-macbooks-with-ipstouch-displays.html. 6 See, among other sources, 3. Blocking. The patent holder might not use the process, manufacture a product, or license third parties, but rather hold on to it in order to block competitors from developing specific products or benefiting from some innovations. Typically, this use is not publicized, for obvious reasons. Take the example of a car manufacturer that had been the first to patent fuel injectors but did not use them in their vehicles nor license them. The competition would have to continue using carburetor-based engines as long as the threat of patent infringement was perceived as real, and the patent-holding car company could buy a head start in developing a better fuel injection system for the future, thus staying two steps ahead of the competition. 4. Mixed licensing. A patentee could have a patent on, for example, a way of compressing and decompressing video to facilitate its transmission over the Internet. The main way in which it can profit from this is if the whole industry uses it and, specifically, if it licenses everyone to use it (even at very low royalties) along with its own internal use. 5. Cross-licensing. In many industries that are host to active patenting, such as telecommunications or pharmaceutical research, patent holders often use patents as bartering pieces to cancel out the threat of infringement litigation from competitors. They do this by licensing some of their patents to the holders of patents they need to compete, or patents they are likely to be found infringing. A case in point is a recent agreement 7 whereby Intel Corp. (the company famous for its microprocessors) received a license to Nvidia Corp. s patents, while Nvidia (the company famous for its graphics processors) got a license to some of Intel s patents, thus resolving outstanding litigation between them. As part of the deal, 7 See the cross licensing report at: Intel--Nvidia-ink-cross-licensing-deal-. January 2012 bvresources.com/ip 3

5 Fundamental Principles Of Patent Value Intel will pay Nvidia $1.5 billion in royalties over the next five years. 6. Sleeping or submarine patents. Sometimes, patent holders do not apply, license, cross-license, or litigate their patents. Instead, they lie in wait until a suitable target appears, or patents are simply shelved (sometimes forgotten) as a consequence of an overly active patenting drive or bad management. How the actual pool of patents is divided among these uses is hard to ascertain. Nevertheless, relatively recent survey data from the European Commission indicates that the most frequent use Blocking Competitors 19% Licensing 6% Figure 2. Patents and Their Uses Cross-Licensing Mixed Licensing 3% 4% Sleeping Patents 17% Figure 3. Relative Patent Values by Uses Sleeping Licensing Mixed Licensing Blocking Internal Internal 51% is internal, at 51%, followed by blocking, at 19% (see Figure 2). 8 The European Commission also found that the distribution of the value of patents differs for its different uses (see Figure 3). Relative to the value of the average patent surveyed, the most valuable uses by far are, not surprisingly, internal use and cross-licensing. Both of these uses allow patent holders to operate in a more profitable protected environment. Blocking, while popular and profitable, is a slightly inferior use of a patent because competitors invest in non-infringing alternatives and defeat the purpose of blocking. The other licensing uses are naturally less valuable because licensing involves sharing a portion of the incremental profits with the licensees. It is no surprise, finally, that sleeping patents are the least valuable. In conclusion, from the perspective explored in this article, a follow-up question to correctly approach the valuation of new patent would be: What is the intended strategic use of the patent? Conclusion. The value principles examined here aim to provide, as a starting point, questions that must be posed and answered before a meaningful assessment of patent value is undertaken. There are many more details that are most easily answered by the patent documentation itself or through an interview with the inventor, the patentee, or a PHOSITA. 9 While these answers are not sufficient to complete the valuation, the production of the necessary inputs to quantify the relevant cash flows and begin the valuation process is best informed by this approach. Fernando Torres, MSc, is the chief economist at IPmetrics LLC, which was founded in 2001 as a firm specializing in expert valuation, monetization, and calculation of economic damages for intellectual property and intangible assets (on on the web at: Cross-Licensing Relative Value (Average = 1.00) 8 ec.europa.eu/internal_market/indprop/docs/patent/ studies/patentstudy-report_en.pdf. 9 Person Having Ordinary Skill in the Art. 4 IP Management & Valuation January 2012

6 Subscribe today to the leading and only publication dedicated to news on how top chief IP managers identify, measure, protect and increase the value of intangible assets. IPMV keeps you informed and promotes your mission to use IP and intangible assets to surpass your competitive, commercialization, and profitability goals. Subscribe Today! $249.00/year Benefits Include: New resources: keep current on tools, methods, and the practical techniques other chief IP officers are using to increase IP value New strategies: learn how your peers are improving their IP strategies New solutions: develop solutions to remain competitive, profitable, and sustainable through more effective use of your organization s IP Get complete coverage of thought leadership from the top experts in the world on IP valuation, litigation, asset protection, licensing, reputation enhancement, IP and damages, royalty rates, patent values, legal analysis, and more. Your subscription to the monthly IPMV also includes bi-weekly updates (via IP Value Wire ezine). Subscribe today at: Yes! I d like to subscribe to the IP Management & Valuation monthly newsletter for $249.00/year! Name: Address: Firm: City,State,Zip: Phone: Fax: Billing Information: Visa Mastercard AMEX Check payable to: Business Valuation Resources, LLC Credit Card #: Exp. Date: Sec. Code: Cardholder Name & Address (if different): PRIOR9215 Business Valuation Resources, LLC SW Broadway, Ste Portland, OR (503)