Interpreting indicators of the commercial value of intellectual property

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by Daood Hamdani

Despite some limitations, various indicators of evaluating intellectual property provide useful insights. This article discusses measures of commercial value and their limitations.

Context
Findings
References
About the author

Context

Measuring the value of intellectual property (IP) is a relatively new and evolving activity. This note briefly reviews the methods of estimating the commercial value of IP, with a more detailed discussion of patents as an indicator of value.

Findings

Several aggregate approaches are used to estimate the commercial value of IP, notably the following: production or replacement cost; discounted cash flow; market capitalization minus the replacement cost of physical assets; and production cost plus return on capital used to capitalize research and development (R&D) expenditures. Each serves a useful purpose, but as measures of commercial value, they all have shortcomings: production cost is an input measure; the discounted cash flow method requires assumptions about economic and technological developments in the future; and the market capitalization approach measures more than IP and is subject to frequent and sizeable changes.

The indicators approach, however, deals with certain components of intellectual property. The most common metrics currently available from this approach are the following: contribution of new and substantially improved products and processes to a company’s sales; licence fees and royalties; and the number of patents held by an organization.

Some limitations of patents

These indicators provide useful insights, but they also have some limitations. Licence fees and royalties may not fully reflect a patent’s commercial potential. For example, IP owners may issue licences royalty-free or at a low fee in the expectation of benefits in the future. Free or discounted-rate licensing encourages adoption of the underlying technology as the industry standard. This can establish the licensor as a technological leader in the long run, or it can induce other firms to develop complementary lines of business, thereby diversifying the underlying technology’s applications and increasing its commercialization potential.

Some patents and copyrights may not be commercially viable

IP owners rarely commercialize all the patents and copyrights they hold. Some may not be economically viable under the prevailing market conditions. Changes in buyers’ preferences since the technology was patented can reduce its economic feasibility. Technological advances may have rendered it obsolete. The IP owner may have reoriented its business, the patented technology may no longer fit its new strategy, and it may take time to find a licensee who is willing to commercialize it. However, such instances are likely to be few.

Some patents are used as levers of business strategy

Many of the patents and copyrights that are not commercialized contribute to growth in other ways (Table 1). IP has been used as a lever in business strategy for years and as it continues to gain increasing recognition as a valuable asset in the legal system and financial markets, it is becoming a means of raising capital. Some of the patents held by an organization may not have been intended for economic exploitation in the first place; rather, they were acquired to pre-empt competitors from entering that particular field of technology. Other patents can serve as collateral for loans, as backing for securitization and as a way of attracting risk capital by offering venture capitalists and other investors the prospects of a quick return. The music and pharmaceutical industries are the most likely ones to engage in these activities: the investor’s or lender’s concern about the risk of piracy and litigation over property rights that characterizes IP in these industries is mitigated by using a portfolio of patents, rather than a single patent, as the security.

Table 1
How firms use Intellectual Property to create value

Learning about the characteristics of patents

Although measuring the commercialization of IP presents challenges, further insights can be gained by learning more about the characteristics that determine patents’ commercial value, notably the technical and exchange features of the underlying technology. For example, an asset is more valuable if it is easily transferable in an exchange, with no or little risk of litigation over property rights. A patent on an emerging technology offers more commercial value than one providing incremental improvement over an existing technology. Similarly, a patent portfolio with a longer-term structure of property rights is more valuable than one with rights about to expire in the near future.

References

Atuahene-Gima, Kwaku and Paul Patterson. 1993.  "Management perception of technology licensing as an alternative to internal R&D in new product development: An empirical investigation". R&D Management, Vol. 23, no 4.

Hamburg Institute for Economic Research, Kiel Institute for World Economics and National Research Council. 1996. Conflict and Cooperation in National Competition for High Technology Industry. Washington, D.C. National Academy Press.

Kamiyam, S., J. Sheehan and C. Martinez. 2006. Valuation and Exploitation of Intellectual Property, STI working paper 2006, OECD, Paris.

About the author

Daood Hamdani is with the Science, Innovation and Electronic Information Division (SIEID) at Statistics Canada. For more information about this article, please contact sieidinfo@statcan.gc.ca.