Corporate IP Strategy – a High-Level View

By Ian Maxwell

There are two good strategic reasons why any operating company should have patents, and they both relate to financial return on investment:

1.             To use a monopoly, suggested or realized by patents, to get a higher margin and/or higher revenues for products or services, and

2.             For the value of the patents themselves, either in license fees, enforcement proceeds, or asset sales

There are may be other reasons why companies might have patent portfolios but they can all be tracked back to these two strategic reasons. An example is a start-up seeking higher exit value because the patents embody some protection on higher margins or market share. Another is for corporations, where patents may represent implied or definable value to investors in a fund raising. Ensuring “Freedom to Operate” is, practically speaking, just another way of maintaining margins and revenues at a reasonable level, and above zero in the worst case scenario.

Any good corporate patent strategy should be built around the two key reasons listed above. Too often those promoting strategic patent advice focus on tactical questions such as “what is being protected?”, “How can competitors get around patent rights?” and “Can we license patents instead of creating them?” These are very valid tactical questions but they do not enter the domain of “strategy”.

Note that the two strategic points listed above are both couched in “financial’ terms – any corporate patent strategy should be economically profitable. The cost of developing a patent portfolio must be less than the risk-discounted net present value of the proposed future benefits of those same patents, as measured by higher margins or revenues, and other proceeds from the patents. Corporations are extremely good at financial planning and forecasting; in operating divisions, sales are forecasted, budgets are proposed, scenarios are imagined, probabilities are assigned and future profits are discounted for both time and execution-based risks. The offices of the CEO and CFO make key decisions on where they focus their limited resources, based on the probability of success and likely returns.

But rarely, in my experience, is this same discipline applied to the area of patenting. In football terms, most patent strategies are simply “Hail Mary’s”. Just once I would like to see a complete budget developed for a patent portfolio before it is created. Scenarios for the long term financial return (from higher margins or other proceeds) would be forecasted and discounted for risk and time. Just show me the Net Present Value of the proposed expenditure on patents before the money is spent and also show me the high economic value-add to the company.

My guess is that there are a small number of patent portfolios in the world, say 10% or less, that are profitable on a capital-return basis.  There is probably an even smaller number, say less than 1%, that are hugely profitable on an economic (i.e. discounted for risk) basis, and so much so that the initial expenditure on creating the portfolio is effectively negligible. And I am guessing that 90% of the world’s patent portfolios are loss-making exercises for the owners, when measured economically. Not surprisingly, given the proximity of the world of patents to new technology, this mirrors the Venture Capital sector, where a similar trend is seen (and is much easier to measure); around 90% of venture capital funds are unprofitable and never hit their economic hurdle (20% IRR) and most of the systematic profits in the Venture Capital sector can be attributed to the small number of Tier 1 Silicon Valley firms.

I must admit right up front that I do not have access to any research data to back these guesses for the financial returns on the global patent systems. However, if we assume for the sake of argument that these figures are correct, then we can draw some interesting conclusions.

First, in days past a single patent would often suffice to protect a key innovation, and often, say a U.S. company might only have a single U.S patent around a specific innovation. Today an operating company might have tens, hundreds or even thousands of patents around a single product area, and file these patents globally in up to fifty or a hundred countries, each occurring significant cost. The change in the number of countries has been due to the global nature of our economies in the 21st century. The rapid increase in the number of patents filed around a single product space has resulted from, firstly a trivialization of the concepts of innovation and novelty, and secondly a desire to create patent “thickets” to ensure that every combination and permutation of novelty and invention is covered by patent, hence ensuring that the large amount of “prior art” that exists in the 21st century is less likely to be able to be used to invalidate all the claims of the all the patents around an innovation.

What we have is a sort of arms race, where corporations are forced to have forests of patents, where once they may have had a few trees in the paddock. When this is all weighed up, the cost of patenting has sky-rocketed in the last 20-30 years, and this has changed the financial risk and return profile of patenting for corporations. Many have not properly noted this shift since they are effectively the “frog in the kettle”, slowly coming to the boil; this steady increase in patenting costs has been slow and incremental with no specific moment of sudden change.

Secondly, it is arguable that the total amount of money going into the global patent systems is actually more than the total global patent-attributable returns to companies and individuals owning patents. This is especially true when the returns to patent owners are discounted for economic risks (my best guess is that the value-add “hurdle” for an investment in patents should be around 12-15% IRR). I am proposing here that the global patent system destroys corporate value. If so, what is the point? Well, for a start, patents are an investment for increased productivity on behalf of society at large. Given that we do not “price” raw materials as found in nature and that we assume they are in infinite supply (in economic terms) this means that we can afford to invest in a loss-making system such as  patents because whatever we do, we are collectively profitable (until the raw materials run out, that is).

Thirdly, the patent system is supported because it has always been there and it also upholds certain hegemonies, such as the west over the rest. Whether or not patenting makes financial sense to the participants does not tend to influence their participation in the process, since the managers of large corporations tend to be conservative and would be very unwilling to deconstruct something they know they do not fully understand, and that has been with them for centuries. Intuitively they know it is part of the fabric of complexity and threat that helps them maintain their ascendency.

Fourthly, patents are actually a form of taxation on corporations. Since much of the cost of patenting ends up in the patent offices of individual countries, the patent system is really just providing public service employment, almost directly. As well, the patent system supports a whole layer of service providers, such as patent attorneys and IP managers and consultants. It is all simply a part of the redistribution of wealth required to keep our society functioning.  It would be fascinating to see what would happen if patent offices were outsourced to the private sector. If we can privatize jails then why not also privatize the patent offices?

Now comes the interesting bit. A fraction of the 1%-ers and 10%-ers that actually do make a financial return from patenting activities, do so on purpose. Here we are not talking about the horde of patent litigators running around after the fact, buying up the rights to patent portfolios for cents in the dollar (as required to develop them in the first place), and prosecuting the rights for profit. No, there are operating companies that have large and active patent portfolios that are demonstrably profitable in an economic sense. And even more startling, these companies know that an investment in patents will have a positive financial and economic return. These companies have, over time, accumulated operational know-how and have maintained a set of core competencies around patents, which is rare and often not appreciated by those outside these companies.

The key question for the rest of the companies out there is how to join the 1%-ers? If you cannot, or do not aspire to, you may as well get out of the patenting game altogether. Like all changes this has to start right at the top; the board and CEO not only have to be sympathetic to the plan, but must be responsible for the plan. Patenting is one of those very complex areas of practice where management must be experienced, or else they simply cannot manage it. A passing understanding of the patent system does not suffice – it can be more dangerous than no knowledge at all.

Any active plan in the patenting space must start with financial objectives, showing where the return on investment is going to come from. This plan should be measured and updated as the plan proceeds, just like any other operational group in a corporation. Patenting is not a “set and forget” area of activity; it is as far from this as is possible to imagine.

So once the appropriate senior management is in place, and the financial planning has been done, the patenting activity is just like any other investment a company may make in an operating activity. A company must hire the best people and keep up the highest level of planning and reporting, without crippling the troops with time-wasting refinements (keep to the Pareto rule!). A company must retain experienced advisers to ensure all strategic and tactical options are on the table and properly considered. Importantly, economic benefits to the product groups should be partially ascribed to the patent activities where this can be demonstrated. It is not rocket-science, but it is rarely done rigorously in my experience.

What is particularly of interest in 2012 is the recent emergence of new business models around patent portfolios. Large portfolio companies have emerged to make plays in super-sized diverse patent portfolios. This model is different to the “Patent Troll” model which is based on the idea making profits from patents with very little investment in the patents themselves – patent trolls are like the Chinese diggers in the gold rush trawling through the tailings looking for gold that was missed. But these new larger non-operating patent entities are actually making up-front investments in the patent portfolios. As such they are backing themselves to be in the 1% or 10%-groups. To achieve this without the benefit of an operating product group, and without the concomitant strategic marketing and related R&D know-how in the area of technology, is a breath-taking risk. Time will tell how this works out for them. Corporations might be well advised to keep an eye on these large patent portfolio companies – if and when they go under there could be some great bargains on offer.

[This post originally appeared at Accordia IP.]

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