Intellectual Property in the Board Room

By Paul Adams

“Knowledge” as Francis Bacon observed “is power.” 500 years later, in today’s technology led economy Bacon’s observation is truer than ever. Study after study has demonstrated that companies that create and successfully leverage knowledge and innovation (intellectual property) consistently and significantly outperform their competitors and create lasting shareholder value.

Conversely those that fail to utilise IP effectively inevitably face increasing competition, declining margins and tolling from companies that own key industry innovations. Further, in the last five years increased litigation activity by IP owners now means Boards which fail to manage IP risk also leave their company exposed to damaging IP infringement actions including legal injunctions, major damages awards or product recalls.

Until recently however IP wasn’t even on the agenda for most Boards. Many directors regarded IP as an arcane and expensive operational issue best left to lawyers. Those days are now well and truly gone: IP and IP strategy is now increasingly and correctly recognised as central to business performance and longevity. This trend is only likely to intensify: for instance the report “Intellectual Property and the U.S. Economy” found that “the entire U.S. economy relies on some form of IP,” and estimated that “IP-intensive industries” accounted for 40 million American jobs and 35% of the U.S. GDP.

Despite this many Boards of Directors struggle with IP. The purpose of this article is to provide directors with an introduction to IP and the information to start asking the right questions of senior management teams. It is deliberately written from a pragmatic, commercial, governance focussed perspective rather than concentrating on the legal dimension which has been the traditional approach.

What is IP?

Many directors incorrectly believe that “IP = patents and (maybe) trademarks”. This is manifestly incorrect. IP includes not just the familiar “hard” IP assets such as patents and trademarks but also “soft” IP assets such as confidential information, copyright, know how, unregistered trademarks, domain names etc – all these things are “IP”. Despite the fact that patents get more attention, the overwhelming volume and value of the IP inside most companies is in these “soft” IP rights which (despite their name) are critically important: the company’s customer list, bill of materials, brand, production expertise – all these are IP.

Others erroneously assume their company “has no IP.” As can be seen from the above, this is incorrect for all but the simplest businesses. Multiple studies of large and small companies have shown that 80% of most businesses’ value is in intangible assets (IP) such as customer insights and production expertise (contained in know how and confidential information), brand and product names (contained in unregistered trademarks) and content, customer lists, software code or databases (contained in copyright or confidential information again). A good way to check how important IP is to a business: try not using any of its IP for a week and see how hard it is create revenue!

Here’s a useful way to think about IP: every day thousands of engineers, designers, scientists, product managers and factory staff across the world come up with new products ideas, improve on old ones or figure out how to make existing products faster and cheaper. Likewise marketing and product managers develop new channels and product strategies. Sales people develop new customer relationships insights. The output of all this activity? Intellectual property. But despite spending hundreds of millions of dollars on payroll, few organisations actively manage or leverage these IP outputs they have paid for.

IP is important and relevant

Some Boards believe IP is not relevant to their business because it is “impossible” to enforce and the only solution is to “run as fast as you can”. This is incorrect for a variety of reasons:

First, in the long run a strategy of rapid product iteration to offset weak IP is simply unsustainable. It requires constant and considerable resource injections just to stay ahead. In a global economy new competitors continually spring up and you simply cannot outrun everyone. Further, running fast doesn’t help when a large competitor shuts you out of the market using their IP or copies your product and does so for half the price because they have no sunk R&D cost.

Second, as stated above, IP is more than just patents. It’s brand, it’s confidential information, it’s copyright – none of these rights rely on spending millions of dollars on lawyers. Most of the IP companies use on a day to day basis is secrecy based – it involves keeping what you know confidential to maintain your advantage. Keeping valuable IP secret has far more to do with IP management process than legal enforcement.

Third, although a smaller company may not have the resources to sue a huge multi-national if your IP is valuable you can guarantee there will be someone out there who does. What about their competitor? Many will welcome (and pay for) the right to use your IP to knock out their (and your) foe. What about a litigation funder? These entities fund high value IP litigation. What about a well-resourced development partner or licensee? They don’t want to see their rights being eroded. The key point: you don’t necessarily need to be the person doing the enforcing.

Fourth, IP is a business tool and its highest value is often strategic. In many industries you can’t play unless you have a strong IP position (e.g. the mobile phone industry). IP also protects brand and can build reputation. It can generate revenue through licensing or sale. It can increase bargaining power in negotiations or enable access to other technologies via cross licensing or development agreements. IP can in fact reduce the threat of litigation (without an arsenal of your own you are an easy target and therefore more likely to be attacked). IP also opens new avenues for funding – financial institutions are beginning to finance against what are essentially highly valuable assets.

IP is urgent

Unfortunately even when IP is recognised as relevant management seldom see it as a burning issue – it is all too easy to put off in favour of business as usual. It only gets onto the Board agenda when something goes wrong: they discover a contractor, not them, owns a core piece of IP or their latest “breakthrough technology” actually broke through 10 years ago and the company is now infringing someone else’s IP. The problem is that IP is a “stitch in time saves nine” issue – it’s extraordinarily expensive to fix things up once they’ve gone wrong. It’s up to Boards to prevent this kind of behaviour by proactively working with the senior management team to manage the company’s IP and IP risk.

Infringing IP: it’s not just your IP that counts

Even if a company’s senior management team don’t think IP is relevant to thebusiness, you can guarantee someone else in the industry will be taking it very seriously. Here’s a useful way to think about it: if you think your company’s solution to a particular problem is valuable others are probably working on the same problem. In fact the more serious or valuable the problem, the more likely others are chasing the same dream. Consequently there’s a strong probability they are building their own IP. In Silicon Valley the general rule is that there are 20 – 30 teams working on the same “break-through” at any one time.

If one of those companies beats you to the punch and develops, files or acquires earlier IP rights the company can rapidly find itself on the wrong end of an extremely expensive IP infringement litigation. This means Boards needs to ensure their products have Freedom to Operate or “FTO”. FTO occurs when a company is not infringing third party intellectual property (IP) rights – in other words you have freedom to operate your technology, product or service. If you do not have FTO it means you are infringing someone else’s IP.

Just how serious is FTO? In August 2012 Samsung was ordered to pay Apple US$1 billion for infringing Apple’s IP and injuncted from selling its products. That’s the world of big corporates I hear some saying – this doesn’t happen in my sort of business! Yes it does. It’s less obvious but equally devastating.

• Well known company sued three times in four weeks following acquisition by US company.
• Tech company spent NZ$15M defending infringement suit before settling and paying license fees.
• Company effectively forcibly acquired following patent litigation by offshore competitor.
• Tech company bankrupted by another local company following litigation over disputed IP.

All of these IP driven events resulted in a drastic loss of shareholder value for which the Boards were ultimately responsible. A few key points to keep in mind about FTO:

1. Ignorance is not a strategy. A “see no evil, hear no evil” approach to FTO is a major mistake. FTO is relevant to any business with innovative products or an export orientation. Directors can be directly liable to shareholders for failing to take FTO seriously.
2. FTO is not just about patents – you can infringe any form of IP: copyright (software code, content), trademarks (brand), design rights (product designs), confidential information (processes and information).
3. Having your own patent does not grant you FTO. On this point – don’t ask for FTO advice from the same people who file your patents – the guy you paid $000’s to file your patent / trademark is unlikely to announce your “patented technology” is infringing third party IP.
4. Be wary of advisors who focus their FTO analysis primarily on your immediate market. Your greatest FTO threat will typically come from offshore – where the largest competitors, markets, manufacturing locations and potential exits are likely to be and where lack of FTO will be most damaging.

The key point: even if you don’t think IP is important, someone else will.

IP on the balance sheet

A further area where Board’s struggle with IP is around the Balance Sheet and can be neatly summarised by the comment: “it’s not in the financials so how important can it be?” In most companies IP is recorded on the Balance Sheet under the generic term “Good Will”. Where IP is recorded as a separate item it tends to be defined very narrowly to include patents and trademarks (the “hard IP” rights) only. Such rights are almost universally recorded at cost, which often grossly under (or over) states their true value. Soft IP rights (trade secrets, know how etc) are rarely recorded at all.

It is ironic that the Boards of many companies studiously ensure that the company asset register accurately records relatively minor items such as desks and computer screens but not critical pieces of IP such as brands, important software code or key trade secrets. These intangible assets are often far more important (and valuable) than their tangible cousins. This approach does not accurately reflect:

• the often critical role that IP plays in enabling revenue generation (i.e. a customer database used to communicate and sell to customers is a valuable trade secret – a class of IP)
• the often significant contribution to enterprise value IP plays both as a function of (a) and also as a stand-alone valuable asset (i.e. that same customer base could be valuable if sold or licensed to a third party – it is an asset)

This non-financial approach to IP assets tends to result in IP being very poorly managed. Valuable IP is not recognised as such and leaks out of the organisation and opportunities for leverage (strategic and financial) are lost. On the other hand Boards which require correct identification, valuation and recording of IP have:

• a more accurate picture of the true drivers of a company’s ability to generate EBIT
• a more realistic picture of the true nature and value of the company’s assets

This in turn enables the Board to better manage those assets (reduce risk, improve utilisation and make better capital allocation decisions).

IP Strategy and Management

So with these points in mind what should Boards do? They need to actively work with senior management teams to set a clear and robust IP strategy and ensure that IP assets are effectively managed.

Unfortunately the track record of many companies in crafting IP strategy and managing IP assets to drive growth and shareholder wealth is poor. Many Boards have not realised that IP is fundamentally a business tool. IP strategy is about tying this key business tool into the company’s broader business strategy to directly deliver against business goals. Hence why IP must be actively debated and monitored by the Board. It is worth keeping in mind that despite what some say, IP is not a legal issue and not something you should leave to patent attorneys or lawyers.

This is one of the biggest issues many companies face when transitioning away from the old approach to IP: traditionally they have allowed their patent attorney or lawyer to “manage” that IP. This is not advisable – a company’s IP strategy and management must be commercially not legally focused. IP strategy needs to be set at a Board level in consultation with the senior management team and independent external advisors and focus on commercial outcomes. Critically it should not, for obvious reasons, be defined by the person filing its patents or trademarks.

Fortunately the last decade has seen the emergence of specialist IP strategists whose job is to provide IP and technology owners with advice on if (and how) IP should be protected and how it can be commercialised. IP strategists look at IP and technology from primarily a commercial perspective to analyse what a company has, if it should be protected and what combination of the whole spectrum of IP classes should be used to create that protection.

IP management involves ensuring that the company’s most valuable asset – its IP – is proactively identified, assessed, protected and exploited and that the processes for doing this are efficient, transparent and easily understood. Done correctly it can dramatically reduce IP cost, ignite innovation, reduce risk, increase opportunities for engagement with suppliers, vendors and partners and generate increased revenue. It is a strategic function, not an administrative one and therefore must be on the Board agenda.

Day to day it involves activities as diverse as identifying innovation that otherwise might be shipped out the door unprotected, understanding the IP landscape to guide R&D, overseeing technology transfer with development partners and cost effectively managing service providers.
Unless a company is very large it’s unlikely to make commercial sense to employ the full team of Chief IP Officer / IP Strategist with the required administration support. A team of CIPO and IP administration is required to do the job properly because IP management has two core functions: a) strategy and b) administration. Strategy takes 20% of the time but adds 80% of the value. A good IP strategist will cost $150,000 plus. Administration takes 80% of the time but adds 20% of the value. A competent legal exec can do this and will cost $60,000 plus. It is impossible to combine these two functions into a single person: you are either paying your expensive strategist to do administration or your legal exec will be trying to do strategy.

However that doesn’t mean you have to do without. Just as companies large and small outsource IT, outsourcing IP management to a professional external provider delivers the benefits of a CIPO at a fraction of the cost of an FTE. A virtual CIPO also offers other advantages including:

• the security of dealing with a team rather than a single individual
• access to multi-disciplinary knowledge and networks
• no overhead, holiday or training costs (with FTEs these are typically 15 – 30% of salary).
• no IP database or license fee costs (these are typically part of the service).
• because it’s generally contract based the ability to cancel the outsourcing at will.
• like outsourced IT it can be “dialled up or down” as work load requires making it suitable for both large and small enterprises and especially fast growing companies.

An important point to keep in mind: a Board can’t manage what it can’t see. Effective IP management begins with understanding what IP you have now and what you do with the new stuff you are creating. The starting point for any IP management exercise is an independent IP Audit or IP Management Review, this should be conducted by someone other than your existing IP provider (just as you shouldn’t have your accountant as your auditor).

Pulling it altogether

Understanding why and how IP is important is best illustrated by the true story of a well-known New Zealand technology company: like many Kiwi companies they had succeeded for over a decade without paying any real attention to IP. In fact the early team were “anti-IP” (one key manager said he “didn’t believe in it”). There were no systems to manage internal IP or review external IP threats. They relied purely on speed to outwit competitors and the closest they came to an “IP strategy” was filing the occasional patent or trademark, which they never enforced or used. Multiple times the engineering team created innovative products which enabled them to be first mover in major new markets. However each time the company’s failure to manage the valuable IP in these products saw it slowly surrender market share and margin to competitors who out-manufactured and out-distributed them. On one occasion owing to the complete absence of IP management, an entire IP bundle was transferred to an offshore supplier, who copied it and became the Kiwi company’s biggest competitor in a highly lucrative market.

This was bad enough but the real problem came later. The strength of the engineering team eventually led to the company’s acquisition by a multi-billion dollar offshore corporation. Within weeks of acquisition the New Zealand company was sued multiple times for IP infringement. For years it had flown beneath the radar but now it was worth suing. To the New Zealand management team expecting big returns from the earn out this was a major problem. For the directors, various warranties and indemnity provisions in the Sale and Purchase agreement were suddenly examined in detail. Questions were asked: why had the IP function been ignored for so long? Despite being extremely innovative, a culture of ignoring IP rights (internal and external) had been allowed to permeate the entire company. No one had taken IP seriously. The result: a series of expensive back downs and settlements. Ultimately the multi-national divested itself of its troublesome acquisition.

The tragedy here is twofold: not only did a failure to take IP seriously led to missing multiple opportunities to secure a leadership position in billion dollar markets but the company essentially created an impermeable ceiling to its growth. Its failure to consider its own or anyone else’s IP meant not only was it violating third party IP, but it also had no arsenal to fight back with. Consequently it doomed itself so that every time it grew tall enough its head would be lopped off.

With a different approach to IP the story would have been very different: as the leading innovator in new markets it was well placed to create a dominant IP position it could have used to protect market share and extract high margins to fuel further growth. With more awareness of IP it could have avoided IP infringement or at least have had a portfolio to bargain with. Its shareholders and its country missed the opportunity to create a billion dollar technology leader.

The Take Away

To succeed in the 21st century companies have to be smarter and faster, not just in terms of the products and services they develop, but in how they protect and leverage what is their most valuable asset: intellectual property. The key take way: if you’re the director of a business employing smart people, you’re in the business of building IP, which means IP needs to be front and centre at the Board table.