August 2003

Evaluated your patents lately? The need to better understand which patents are your “crown jewels” which are “defensive”, and which ones need to be purged is becoming more important as management scrutinizes expenses and you try to rationalize the portfolio costs. Having a keen understanding of the roles your patents play is important if you are trying to position yourself as a key person supporting the business strategy. Your ability to articulate qualitatively how the IP portfolio or a specific patent supports the business drivers will help you discuss alignment with the business strategy.

Among all the topics that we have received letters and calls, the lack of understanding about the value of the IP portfolio and the ability to articulate this value is a critical concern. That is why this month we want to explore valuations and evaluations of intangibles.

PW believes that the questions that it poses this month are part of the basic “block and tackling” of a corporations IP program. Are you asking yourself these questions and are you getting satisfactory responses? Will you be asked these questions?

Look at PetrashWilliamson’s Principles on Measuring, share them with others; we apply them everyday as we work with companies. Measuring intangibles requires a different perspective on metrics. They are not the same view as measuring tangibles though the goals are the same. Organizations are still experimenting with measuring intangibles. We do not have the 400 years experience that we have in measuring tangibles. We have to recognize that we need a different view. We need to allow for more qualitative versus quantitative analysis. And we do need to measure where and how it makes sense . “cause positive change in approach towards achieving objectives”.

These guidelines are for your consideration. Some of the principals have been advanced and are being used successfully. They are not all inclusive, you may have others; we would like to hear them. Metrics of intangibles is a part of the cultural change needed to better manage your IP.

This month we are providing a very good overview of the primary valuation methods. Take a look at it and pass it along to your business and accounting personnel.

As I ask every month, send me a note let me know that we are hitting the relevant topics for IP Professionals.

Thank you

Rob Williamson

P.S. Look at our benchmarking study 10 Fortune 100 companies and see where you stand. It contains results of detailed interviews. Contact me for more details.

Key Questions

A FEW OF THE QUESTIONS Intellectual Property Professionals will need to answer in the coming months and years!

What is the patent worth?

Which patent is more valuable?

Is this worth patenting?

Corporations will need answers in order to better:

Negotiate licenses
Prioritize disclosures
Determine tax maintenance payment decisions
Satisfy FASB 142 requirements in acquisitions
Determine how much to spend in defending or asserting rights
Prune patent portfolio
Identifying the family jewels

Building a competency to be able to better manage (Value) an IP portfolio and answer these important questions will be required in the future to be competitive. This competency would give companies a competitive advantage today.

There are two basic approaches to building a corporate capability to value IP

Evaluation – A capability that allows decisions to be made about IP by using a qualitative approach. It is quicker and easier to use in making decisions about IP than a “valuation” approach. It is usually composed of a series of key questions that are weighted and scored. It also uses different dimensions of the IP. This approach can be learned _and adopted by organizations in a very short time and is a much less expensive approach.

Valuation – is a much more detailed and usually deeper valuations of IP usually resulting in a dollar value with a higher degree of accuracy. The methodologies for valuation are widely known and accepted and utilized when accuracy is critical. A valuation approach usually requires more time and resources to accomplish.

Evaluation and Valuation capabilities both accomplish the following:

A disciplined and consistent approach
A higher degree of accuracy proportionate to the quality of the inputs
Enhanced knowledge that can contribute to better decisions

Aspects of Evaluation and Valuation:

They are highly context dependant, on time, place, and complementary assets

Evaluation is used primarily for internal use for fast and inexpensive support of decisions

Valuation is used for IRS audits, large negotiations to satisfy regulatory requirements and where third party validation is needed. These more formal valuations are usually a much higher cost than evaluations

Evaluation and Valuation should be done only to meet specific needs to make decisions, because of the context and the time sensitivity and expense.

E-mail us what you think or if you would like to discuss how this question applies to you. (Please identify your role in the organization)

We will send an anonymous summary to those who respond.

All responses will be kept strictly confidential

TOP 14 CHALLENGES FOR INTELLECTUAL PROPERTY PROFESSIONALS

1. Excessive reporting requirements

2. Business people do not understand Intellectual Property

3. Delusional Management

4. Extensive reporting requirements

5. Lack of definition & context

6. Ad hoc processes

7. Determining where to start

8. No consistent process

9. Inefficient & costly

10. Functional silos

11. Under leveraged portfolio

12. Lack of alignment with business strategy

13. Difficult to develop metrics

14. More to-do and less resources

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Top Ten Intangible Asset Driven Business Trends

Trend #4 With greater frequency, sophistication and alacrity companies will develop strategies to leap frog their competition by managing and using their IP

· Amazon vs. Barnes and Nobel

· Microsoft vs. IBM

· DuPont Stainmaster

· Nutra Sweet vs. Sweet and Low

Implications

Playing the game smarter by developing products and services that meet compelling customer needs and permit value pricing will allow companies to bypass traditional paths to market leadership. Underdeveloped countries will invest in the development of Intellectual Asset’s and Intellectual Property as a short cut way to gain competitive advantage with developed countries

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Topic of the Month:

PetrashWilliamson’s Principles for Measures

1. MEASURES ARE NECESSARY – what is measured is improved. Whether we like it or not, many people see measuring as constricting and inhibiting, but it is required to garner top management support and employee high performance.

2. EVERYTHING CAN BE MEASURED (QUALITATIVE OR QUANTITATIVE) – It can be as simple as good, better, best or rising, falling, or flat. This is something every individual does consciously or unconsciously many times a day. Every time a purchase is made a measure of value is done.

3. VISUALIZE – MEASURE –MANAGE – If you can visualize it, you can measure, manage, and then continuously improve it. Visualizing is many times the most difficult step. Being able to articulate intangibles in such away so that there is a common interpretation and understanding of what “it” is.

4. THE PROCESS OF MEASURING HAS VALUE – regardless of the success or failure in developing a specific metric. The debate, the development of a common understanding, and the recognition and acknowledgement of differences in opinion has real value for teams of people responsible for a common objective. It can be a consensus team building exercise. It can be tool for discovery and development of new directions.

5. MEASURES ARE TOOLS – DECISION MUST BE BY “SOMEBODY” - Good measures are not expert processes that pump out silver bullet solutions. We must resist the temptation to let the measures make decisions for you. They are tools only! People use tools to make decisions. This is the “Somebody Factor”

6. ONLY MEASURES THAT ARE ACTIONABLE SHOULD BE TAKEN - Taking measurements takes time and resources – only measurements that are linked to specific action done as a result of them (i.e. numbers of patents is not as important as the value of them). Value measurement is the metric now – not feel good easy to gather measures many of which are still in the business frame work. Measures must help move us toward the future vision.

7. MEASURES SHOULD BE FEEDBACK TO STRATEGY ADJUSTMENT/REDIRECTION - Measures should be allowed to adjust strategic goals. It does help to have a corporate strategy, business plans, and functional plans aligned. All measures need to be aligned to corporate strategy….even if it as a thin thread. If this alignment is in place the feed back loop can only allow for improved dynamic strategies.

8. DISCIPLINE TO KEEP MEASURES CURRENT & ACCURATE IS CRITICAL - Measurements will die if they are not current. All measures should be looked at from a cost vs. benefit analysis. CRITICAL - some die for good reason, they are wrong. Meaningful measures improve the discipline to keep them current.

9. NEED TO BE SIMPLE – The simple measure is the most often the best measure also. All to often simple measures are made into complex ones.

10. CONTEXT DEPENDENT - Intangibles are highly context dependent. Where, when, who, and associated complementary assets are sensitive to an intangible value. A glass of water sitting at the comfort of your desk would have a very low value. A glass of water in the middle of a desert where you have not had a drink for 3 days would have a much higher value.

11. VALUE MEASURES (OBJECTIVES) & PROCESS MEASURES (INDICATORS) - Indicators are predictors of the future. Value measures should not be viewed without the associated process measures. Only looking at value measures leaves you vulnerable to not knowing if you are succeeding until it is to late. Process indicators are important in order to see if you are on track (if the gas gauge, alternator light, speedometer…etc in my car are all ok then I will have a higher confidence level that I will get to where I want to go). The importance and role of each of these measures has often times been confused and mixed up.

12. RANGE OF VALUES VS. ABSOLUTES ARE USUALLY SUFFICIENT FOR DECISION regarding intangibles. All to often people believe a measure needs to be an absolute. We have been conditioned to believe we must always strive to get to a point. In reality few decisions, even critical ones, are required for good decision making. This is particularly the case with intangibles. Does it really matter if you know an employee moral surveys result to the second decimal?.

13. VECTORS (DIRECTION/VELOCITY) (NEW MARKETS) VS POINT (STATIC/HISTORICAL) (CAPABILITIES) – as soon as you take it, it's history. Need to show direction and velocity (magnitude). Most valuable knowledge, is knowledge in motion not static. Tensor fields to get interaction as well. E.g.: Skandia document is a vector, they are looking at trends (like how many people are trained in a key area, focus not just on where we are now, but momentum of where we are going etc.) Some vectors do go down – that’s okay as it gives you opportunity to tell the story of why it’s going down and what you are doing to change it. World is changing do you expect that something will drop as competitors release new products or people leave, etc.

14. PREPONDERANCE OF EVIDENCE OF MEASURES IS THE ONLY WAY TO PROVE VALUE OF KM (Knowledge Management) - Some things are just to difficult to prove to a high degree of certainty. This particularly the case, many times, with KM

15. QUANTITATIVE MEASURES ARE OFTEN DEVELOPED FROM MULTIPLE QUALITATIVE MEASURES – Evan quantitative measures are often built from many smaller qualitative inputs.

16. GRAPHIC REPRESENTATION OF MEASURES IS SIGNIFICANTLY MORE POWERFUL THAN NUMBERS AND WORDS ONLY – Particularly for people who are not intimate with the subject matter and those that need to get to the bottom line ASAP.

17. STRONG INSIGHTFUL LEADERSHIP REQUIRES LESS MEASUREMENT – There are leaders who use measures as a delay mechanism or to test concepts further rather than on they’re insights. CEO’s like Shapiro, Welch, and Grove, can take a few inputs and move forward faster then most. They don’t need or want the next level of measures.

OVERVIEW OF VALUATION APPROACHES FOR INTANGIBLE ASSETS

This discussion concerns the primary methodologies applied in situations involving technology and intellectual property valuations.

Market Approach

The Market Approach establishes value based on recent sales or licensing of comparable assets. In the valuation of an intangible asset, similar assets recently sold or currently offered for sale are analyzed and compared with the intangible asset being valued. Since intangible assets are typically highly specialized, finding good market comparables is often difficult, particularly since financial details of sale or licensing transactions are rarely disclosed. Most often, the Market Approach has applications in other valuation methods that use comparable royalty rates.

Income Approach

The Income Approach to value calculates the present value of the future free cash flows expected to accrue to the owner of an asset during its remaining economic life. The Relief-From-Royalty Method and the Excess-Earnings Method may be employed for the Income Approach to identify the value attributable to the intangible asset.

The Relief-From-Royalty Method generally assumes that the asset owner licenses the protected technology for use to product manufacturers and receives a fair royalty return based on the manufacturers' applicable revenues. The Excess-Earnings Method generally assumes that the asset holder retains all protected rights to manufacture, sell, and enjoy excess returns or profits from an intangible idea or invention. Such returns may not otherwise normally be earned from only tangible assets.

The Relief-From-Royalty Method is a form of discounted cash flow premised on an analysis of the economic benefits provided to the owner of the intangible asset. If its user does not own the intangible asset being valued, the user would normally have to pay the owner a royalty for the right to use the asset.

The royalty is generally based on a percentage of revenues and is a function of the right being granted (e.g. exclusive versus non-exclusive) and other economic factors. The value of the intangible asset is measured through the cost savings afforded the owner by not having to pay royalties for the use of the asset. The Relief-From-Royalty Method is the single most widely used form of valuation of intangible assets.

Future avoided royalties are forecast and then discounted to the present at an appropriate rate. Since royalties are typically based on a percentage of revenues, the process of forecasting avoided royalties comprises (i) a reasonable forecast of future revenues obtained from the sale of products or services incorporating the intangible asset, and (ii) determination of a fair market royalty rate for the particular intangible asset in question.

Generally, the discount rate applied to avoided royalties is based on the risk of receiving the forecast royalties (cost savings). Since a licensing transaction is typically a process of passing risk from the licensor to the licensee, the royalty rate normally reflects only a portion of the risk associated with the intangible asset. Because of this, and since the royalty rate is a function of revenues, and not of profits or cash flow a relatively lower discount rate is commonly used.

The Excess-Earnings Method is based on the theory that economic returns, beyond those attributable to tangible assets, can be derived from certain intangible assets of a business. Initially, this method begins with a management forecast over a future period (e.g. five-years). Future debt-free cash flows available for distribution are derived, less a fair return on all other tangible and intangible assets, and including the terminal value (value of the asset at the end of the forecast period based on a constant growth methodology) and are discounted to the present at an appropriate rate (generally the weighted average cost of capital) to derive an indication of fair market value attributable to the value of the asset. The market or book value of total interest-bearing debt of the operating entity, if any, is then subtracted to arrive at an asset value free of debt.

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FUTURE TOPICS

Patent Maps and Trees: Look at your patents visually to evaluate categories and how technology has developed over time.

Portfolio Inventory: Organizing and Classifying your Portfolio.

Benchmarking: Evaluate outside company practices. The practice would result in: productivity gain, financial gain, risk reduction, and other gains.

Metrics: Identify the appropriate metrics for your IP scorecard. Drive performance improvements.

IPAM Model: Explained in detail the interaction of various disciplines to gain business alignment.

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T H E IPAM BEST PRACTICES S E M I N A R S E R I E S

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Metrics for Measuring Return on Intellectual Property Investments

Benchmarking

Forming Portfolio Management Teams

Developing an Intellectual Property Strategy

Valuations

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How to sell Intellectual Property Asset Management to the Executive Management

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Aligning Intellectual Property with Business Strategy & Metrics

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