Towards a Strategy of Valuing Patents as Intellectual Capital¹

The Need for a Patent Valuation Methodology
Patents are a major force in the world economy, and one of only a few metrics commonly employed to gauge the tides of new ideas and innovation that are driving our economy.

Even with the present declining rates of R&D investment, leading nations spend over $1 billion dollars each day generating intellectual property.

Today, there are over 7 million patents in force worldwide, growing at 12 to 14% per year. Patent licensing revenues are growing at 25 to 35% per year, generating global revenues in excess of $150 billion. In the U.S., the leading patent generating nation in the world, annual patent issuances have nearly doubled from 96,727 in 1990 to 187,822 in 2001. And, during 2002, 45 to 75% of the market capitalization of the Fortune 500 companies consisted of intangible, intellectual capital assets such as brands, patents, and knowledge.

...we have a patent valuation method for any patent or set of patents when we... (follow) the same model employed with brands and traditional tangible assets....

While top brands have been valued, tracked, indexed, and published annually for years, we remain generally unaware of patent values. As of yet, we have no generally accepted accounting practices in place to segment and specify the patent element of market capitalization. Although we may suspect there are many valuable patents other than those that make headlines, and certainly portfolios of patents that are very valuable, we do not know this with any specificity. Thus, under normal business circumstances, we cannot benchmark or report these assets, nor manage and exploit them for gain to advance our society, culture, or global civilization.

Brand Valuation as a Model for Valuing Intangible Assets
After a decade of debate and experimentation, brand valuation, as the most visible form of intangible asset valuation, has resulted in an elegant theory and practice that is nearing final formalization with the imminent imprimatur of the Financial Accounting Standards Board. This is likely to be followed with the formulation of Generally Accepted Accounting Practices.

The same cannot yet be said regarding patent valuation, where the whole body of knowledge seems so inchoate, confusing, and inadequate. The present state of the discipline allows only incomplete evaluation, resulting in ongoing uncertainty relative to the more confident practice of brand valuation and the long-accepted, and nearly absolute practices surrounding tangible assets like plant, property, and equipment.

A Strategy for Patent Valuation
Accounting as a discipline has laid down the “hard science” of asset valuation. So, to be broadly accepted and functional in real business, the valuation of any intangible asset must follow this basic accounting model. It should follow, as closely as possible, the traditional assessments of cost, market, and income while also advancing a category-specific asset calculus.

Patent valuation has seemed unamenable to the traditional asset valuation provided by the cost, market, and income approaches. Why is this? These fundamentals, when applied to the valuation of brands have proven to be entirely satisfactory when supplemented with an integrative calculus that allows a qualitative assessment of a brand per se. Why hasn’t patent valuation reached such a broadly accepted practical usefulness?

Part of the reason is the innumerable special situations and considerations under which a patent or patents may need to be evaluated. These can range from the need to set value for a licensing arrangement or acquisition, to segmenting market capitalization or monetarizing a patent. Yet these special circumstances are no less existent in brand transactions.

It seem harder to get a handle on patents primarily because they rarely, individually or as a portfolio, intersect directly with the public marketplace in the way brands do. While both brands and patents always imply usage in a marketplace, patents per se rarely reach into the marketplace. With the exception of a breakthrough patent, patents are usually incremental improvements to known devices or processes, thus submerging their respective value within the overall invention or procedure. But this obstacle is only superficial, and falls away upon closer examination. In fact, we have a patent valuation method for any patent or set of patents when we look at it in the right manner, i.e., following the same model employed with brands and traditional tangible assets to achieve consensus and set acceptable value. We don’t need to “reinvent the wheel,” or make the setting of the value of any intangible asset more occult than setting the value of, for example, real estate.

With patents increasingly sharing the spotlight with brands in the world of intellectual capital assets and market capitalization analyses, it has become essential that patents join brands in lining up against traditional approaches to setting asset values.

Thus, following generally accepted accounting practices now used with brands, we have an approach that ensures both adequacy and completeness and allows patent valuation decidability. Building on the foundation used to assess other assets, we need only proceed to assess the qualitative value dimensions of the asset. The primary dimensions for patent strength assessment can be portrayed along a five-point scale from least to most. As generally practiced by patent managers, these are, briefly:

1) Degree or Scope of Innovation
Innovation falls into three general categories: breakthrough, major, minor. Breakthrough patents, ones that establish whole new platforms or paradigms, are among the most valuable, with each of the other classifications falling along the scale.

2) Market/Industry Applications
The number and value (dollar size) of markets and industries for which the patent has significance is a leading indicator of the potential value of the patent. Similarly, we must consider whether or not a patent is central to the core of an enterprise, is more tangential, or is relevant to a non-business application.

3) Term
Early-term patents are generally more powerful than those that have been in force beyond a few years, and certainly more valuable than those which are beyond their midpoint.

4) Third-Party Citations
While clearly a “lagging indicator,” the degree to which other patents have been issued around the technology of a given patent is a measure of the significance of that patent. Patent citation mapping can quickly suggest the significance of a patent and its contribution to subsequent invention.

5) Special Considerations

a) Ability to expand patent scope: Are there significant areas within which an invention may be subject to further expansion?

b) Use in bracketing or clustering strategies and tactics: Can this patent be instrumental in blocking another patent, or providing additional competitive advantage by filling out an existing portfolio?

c) Patent equity transfer into a brand: Can the equity in this patent be converted into a brand?

As we consider and balance these various perspectives we derive the value of the patent. At the same time we see that we do have the theory, with asset-specific modifications, for valuing any intangible asset, since the valuation of any intangible asset can be approached in this same manner.

Summary
With patents increasingly sharing the spotlight with brands in the world of intellectual capital assets and market capitalization analyses, it has become essential that patents join brands in lining up against traditional approaches to setting asset values. Despite the many factors impacting the value of a patent, the methods successfully pioneered by brand valuation provide the model for patent valuation methodology and the key to intangible asset valuation. A composite valuation, which consists of the three core elements of all asset valuation (cost, market, and income assessments) coupled with a patent strength assessment, provides a reliable method for setting patent valuations. Both in theory and practice, this is no different than tangible asset valuations for complex entities such as real estate.

Those responsible for patent valuations need to focus their efforts on answering the traditional asset valuation questions, rather than eventuating yet another idiosyncratic or unduly complex calculus to set patent value.

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1) Because the assessment of damages in patent litigation are statutory and fixed by the court (35 U.S.C. sec 284), this article does not address patent valuation within the framework of patent infringement litigation.

© 2003, Dr. Lindsay Moore and Mrs. Lesley Craig, Esq., All rights reserved.