FEDERAL TRIANGLE: Strategic Assets
Recent news on intellectual property (IP) rights in music and entertainment (Napster) may elicit a yawn from this journals' readers, but IP savvy can be critical, according to former Xerox CEO Richard Thoman: "Companies that are good at managing IP will win. The ones that aren't will lose." These strong words come from a man who in the 1990s at IBM grew annual patent royalty income from $30 million to $1 billion at the millennium, nearly 11% of IBM pretax profits. Other major companies (e.g., Microsoft, Gillette and Dow Chemical) are capitalizing on the knowledge economy, and so can small companies.
Patents are the best known IP, which also encompasses trade secrets (notoriously unprotected), trademarks and copyrights. Patents often are the sole, effective way to create a proprietary and defensible market advantage. And there are myriad nuances on how to use patents, often in unusual ways. Dell Computer, for example, was successful due to its method of selling, distributing and after-sale support, not because of computer quality. They have secured 42 issued and pending patents covering customer-configurable, on-line ordering, as well as its continuous flow manufacturing. Dell used its patent position as collateral for a $16-billion cross-license with IBM, which provides Dell with low-cost components to avoid millions in royalty payments to IBM (incidently, the European Union (EU) is taking a position that business-method patents should be disallowed). Hitachi develops products for which patents can aid in establishing a market dominant share. Gillette built a 22 patent wall around a razor with floated angle geometry, selecting specific designs with patent clustering and bracketing in mind so competitors would have the most difficulty getting around it.
In 1982, physical assets comprised 83% of manufacturers market value, but by 2000, it represented 31%, with the bulk of value in intellectual assets. A 1998 survey by BTG International found that 67% of U.S. companies own technology assets that they fail to use, valued at $115 billion, and that 35% of patented technology is wasted, a $1-trillion asset underutilization as estimated in a 2000 Harvard Business Review paper. In spite of this, patent licensing has increased in the past dozen years from $15 billion to over $110 billion. Patent portfolio mining can yield large and continuing returns. For instance, Lucent employed 266 people in a business unit to generate 12% of annual revenues via royalties. Recall that once issued, a patent is a sunk cost and as an asset, it should be required to generate returns. Patent IP can do more than protect a product line. For instance, three years ago, DuPont earned a $64-million tax write-off by donating 23 patents. In another case, Lockheed-Martin allowed an unused cache of flight simulator patents to be the core of a spin-off (now worth a few hundred million) in which this proud parent owns 40% equity. Yet another use is to enhance a competitive position, such as to improve merger and acquisition maneuvering.
A study by Baruch Lev at New York University found that companies whose patents are frequently cited in work by peers experience stock price rises, but he also found that hardly any financial analyst on Wall Street takes patents into account when they evaluate. I guess the message is that firms do financially better if they are imaginative and are recognized by their peers.
Therefore, it is important to assess IP from two perspectives: financial value and commercial value. Valuation begins with separating IP into core and noncore groups and quantifying the former monetary contribution as a percent of the owner's net present value. Noncore patents can be licensed or sold. Rather than divide the value of the core IP, subtract the company book value from market value to view knowledge-asset value. Alternatively, because book assets have no value above cost, subtract normalized annual earnings from tangible and financial assets to determine earnings generated by knowledge assets. Those earnings divided by knowledge capital discount rate values IP assets.
To evaluate business value of assets, it is essential to have an internal assessment of technology: plot assessor unit growth rate versus IP use by assessor. Most firms will learn (I hope) that they are not too different from a Dow Chemical audit that showed 51% of IP falls into the useful category, 36% had no direct use and 13% should be sold or abandoned.
Many U.S. businesses are sitting on a gold mine and don't know it. To paraphrase Thomas Jefferson, who believed incidently that invention cannot be a subject of property, we can all graze on the same intellectual commons without exhausting it.