IP executives frequently make two statements that require consideration by broader corporate management teams considering their IP return on invested capital:
- “Intangible assets (particularly, patents in technology firms) reflect approximately 80% of market valuation”; and
- “Small portions of a firm’s intangible assets are truly valuable to the firm (particularly patents, with common analysis citing less than 2% to 5%)”.
These statements invite the question: are corporate intangible asset inventories so vast that more than 95% spoilage is immaterial and acceptable?
More importantly, how can companies employ efficient, data-driven processes to create meaningful savings and returns from what is not valuable to their organisation?
This chapter describes how leading companies utilise a combination of analytics, expansive thinking of possible outcomes and improved decision-making processes to improve their return on invested capital for their patent portfolios, and – sometimes – broader portions of their intangible asset inventory.
Investments and carrying costs
Patents and other intangible assets are expensive to create. Technology-centric companies routinely invest 8% to 12% of gross revenues in R&D. For a theoretical company earning $1 billion in annual sales, this equates to approximately $100 million in R&D investment.
The following analysis translates investment into innovation and the resulting IP assets via a common metric and benchmark: patents to R&D. While inherently imprecise, this form of analysis illustrates that leading technology firms typically seek protection for approximately one patent family per year per $1 million in R&D.
Excluding the time cost (which likely dwarfs the monetary cost), the average cost to obtain a single patent family with geographic coverage in the United States, the European Union and Japan is approximately $100,000. This increases as companies expand their filing strategies to cover additional economies and markets (eg, Latin America, China, South Korea and other nations where manufacturing or sales may occur).
For a typical medium-sized company, the cost of maintaining this small, single patent family is approximately $250,000 to $400,000. Of course, companies do not have one patent family alone: they develop large portfolios of patents. For a firm that files 100 patent families per year, annual maintenance costs quickly escalate to more than $25 million to $40 million.
Further, the cost of obtaining patent protection is merely the initial investment. Patents require ongoing maintenance (and tax payments) to remain effective. Without payment of fees, the government-protected rights contained within the patent effectively die – although they can be revived at great cost in certain jurisdictions.
The annual cost of maintaining a simple patent family in the United States, Japan and the European Union over a full 20-year protection period is greater than $75,000. Where a firm files 100 patents per year, the annual carrying cost of the portfolio amounts to more than $7.5 million.
Because of the threat of certain and near-immediate 100% loss of investment if a patent maintenance tax is not paid, many companies and managers place their portfolios on autopilot and pay all fees for all patents unless a decision is made to the contrary.
If the company is holding older patents (ie, more than 10 years on average), these costs quickly escalate, as governments assume that those older patents are maintained due to the higher market value of the protected innovations and consequently tax them at a higher rate. However, this assumption is not true if IP executives are accurate in their common assessment that a very small number of their patents hold current value.
This future (and often under-appreciated) carrying cost further escalates in companies that are newly investing in patent protection and achieving a high growth rate in their patent filings.
Figure 1. Ratio of R&D spending to patent family filing
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Source: Questel and FactSet
The above example company faces the scenario outlined in Table 1. The figure of 90% waste might seem high; however, companies enjoy soft returns from even those patents that are unlikely to be enforced or do not align with the business. Examples include market vanity (ie, the ability to point to the portfolio as an indicator of innovation or technical leadership) and protection in the form of ‘patent thickets’, which may deter competitors by creating the sense that they must hide a deterrent of value. These soft returns incentivise waste.
Table 1. Financial analysis supports IP pruning and optimisation
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Portfolio pruning (or tuning) to make a firm’s R&D and patent expenses more efficient should be a high priority for management, IP executives, chief financial officers, chief technology officers and board directors, all of whom are directly affected by this inefficiency.
Reasons for excess patent carrying costs include the following:
- Portfolio misalignment – this results from fast technological churn in sectors such as information technology, telecommunications, consumer electronics and medical technology.
- Vanity patents – these include patents filed purely to associate the company’s name with an invention, regardless of commercial utility or value.
- Product/market evolution – this occurs when patents are maintained despite being relevant for discontinued or failed products and technologies.
- Changing rules – recent US Supreme Court rulings, legislation and regulations have dramatically affected patent values and validity standards. This is particularly true in high-tech sectors, where software and business method patents have been reduced through decisions such as Alice; and US Patent and Trademark Office proceedings, such as covered business method review (protecting the financial sector) and inter partes review, where many contested patents face a near-certain (90%) death when challenged.
- Mergers and acquisitions – consolidation following M&A activities frequently leads to disconnection between the more efficient merged businesses and their now-inefficient patent portfolios.
- Risk aversion – no manager wants to be identified as responsible for killing the critical patent. Thus, internal patent portfolio maintenance decision processes are designed to avoid letting patents expire through non-payment of fees.
Portfolio pruning and tuning
Portfolio pruning and tuning (or portfolio optimisation) are processes to reduce the abundant waste in many firms’ patent investments and patent balance sheets. Introducing the following practices into patent management calendars and corporate objectives can lead to exponential improvements in R&D and patent investment results.
The core drivers and objectives are identifying opportunities to:
- reduce unnecessary carrying costs and expenses (ie, wasted cash); and
- identify unanticipated IP asset monetisation opportunities (ie, new, unexpected, high-margin revenue).
A systematic, data-driven approach utilising best-in-class analytics and expertise supports both objectives.
Specific methods that leading companies routinely employ include the following:
- Portfolio pruning analysis – testing a portfolio across multiple metrics to identify potential value to self, potential value to others and assets of little to no value;
- Portfolio mapping to products – verifying relationships between products and patent portfolios; and
- Pre-M&A and post-consolidation portfolio alignment analysis – evaluating the combined portfolio and business to adjust for consolidated investment and growth objectives.
Portfolio pruning methodologies
Portfolio pruning processes generate multiple benefits. Perhaps the most important is the provision of structure to what is typically an ad hoc and untimed decision. Further, it introduces data-driven perspectives to support manager expert reviews so that they can build increasing confidence in portfolio management decisions over time as they spot opportunities for cost reduction and for new, unanticipated revenues.
Table 2. Frequency of actions to obtain and maintain optimal portfolio
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With the introduction of new, analytics-driven platforms, firms can quickly improve their decision-making processes relating to portfolio maintenance. First and most important is to move from managing the portfolio solely in the context of legal accounting (ie, patent docketing systems or IP management systems, which focus on ensuring that patent filing, prosecution and maintenance deadlines are met by internal departments, outside counsel and patent maintenance providers).
Patent portfolios can easily be loaded into secure applications that provide both internal and external perspectives on the portfolio’s components. In these platforms, structured and guided processes support decisions through portfolio categorisation, statistical analytics, patent ranking and management.
These analyses range from fully automated analyses to semi-automated and expert-driven reviews. Companies typically use expert-driven reviews for patents that are on the edge of value to self and value to others (eg, where new revenues might be possible or during the first efforts at introducing improved portfolio pruning and tuning processes). Of course, the introduction of human expertise and services can improve analysis fidelity and increase confidence in the results of the portfolio pruning process.
Portfolio pruning works best when firms first identify high-level portfolio categories to focus their analysis and decisions.
These categories include:
- most likely to abandon
- likely to abandon
- possible to abandon
- unlikely pruning candidates
Within best-in-class portfolio pruning analysis, firms use tools and platforms that facilitate the adjustment of key variables and perspectives to align with their corporate objectives. However, companies all too often use software tools that suggest that all businesses, industries and their patents exist in an identical context and can be measured with a common black-box algorithm.
First, identify what the portfolio to be pruned encompasses. A medium-sized to large company holds many products and technologies offering a mutual fund-like range of returns and value. Segmenting the portfolio takes some work, but is well worth the effort.
Second, identify comparable patents and portfolios. Sophisticated similarity algorithms, business intelligence and patent landscape techniques ease this process dramatically.
Third, consider key variables that might be adjusted to create alternate scenarios and perspectives given the specific risk-tolerance and decision-making bandwidth.
Example variables include the following:
- Patent age – older patents are more expensive to maintain and should be scrutinised for actual use in the market.
- Patent family size – larger families typically indicate a larger upfront investment and likely use; they are also more expensive to maintain and should be typically abandoned or transacted in whole.
- Forward citations – a high number of forward citations is a simple indicator of potential importance of this patent to the field and competitors.
- Citations per year – this perspective looks at velocity. For example, is the patent growing or decreasing in importance?
- Self-citations – this indicates how important this patent may be to the company. If highly self-cited, the patent is more likely to be core to the company’s interests.
- Originality – this analytic construction infers innovation characteristics and importance from patent data.
Figure 2. Questel Orbit analysis of tier-one automobile patent portfolio
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Running this analysis, conservatively, on a specific patent position in an international tier-one automotive company’s portfolio yields the results illustrated in Figure 2.
Even with conservative settings applied, 35% of the portfolio falls into the two categories ‘most likely to abandon’ and ‘likely to abandon’.
There are thus strong indicators that more than one-third of the firm’s patent portfolio has little economic value to other firms.
If some of the remaining patents have lesser value to the firm, yet may be valuable to others, the excess carrying cost and lost opportunity is significantly greater than 50% (sometimes 100%) of the cost to maintain the total portfolio.
As mentioned, good reasons may exist to maintain a portion of the assets identified during the portfolio pruning exercise. However, sound management and good stewardship of corporate funds should mandate a deeper analysis and specific steps to improve this situation.
Returning to the example portfolio, a firm with an annual portfolio carrying cost might save between $1.5 million and $2.5 million in the year following such an effort, even if focused on only the ‘most likely to abandon’ and ‘likely to abandon’ categories. Over the life of a portfolio, these savings (from one year’s pruned assets alone) might exceed $25 million to $50 million, depending on timing and regional parameters.
Should IP managers avoid this significant opportunity for increased efficiency and return on invested capital simply because they are adverse to the task?
Asset monetisation: from savings to revenue
Leading firms routinely use the portfolio pruning process to identify patent assets and related intangible assets (eg, know-how) that provide more than the opportunity for cost savings.
As mentioned, certain patent holdings simply become misaligned with current objectives through a shift in priorities or the product/market mix; or, while those patents may still hold value for the company, they may be increasingly non-core or hold applications in alternative uses and markets.
A solid portfolio pruning programme moves from cost-reduction analysis alone to identifying opportunities for high-margin revenue growth.
These assets are frequently found within the ‘likely to abandon’ category. Similar opportunities also exist in the margin between the ‘unlikely to abandon’ and ‘likely to abandon’ categories.
Another technique for identifying asset monetisation opportunities is to complete a second, complementary out-licensing analysis.
Figure 3 illustrates a high-level, four-step process supporting asset monetisation flowing out of an initial patent portfolio pruning exercise.
Figure 3. Asset monetisation process
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Using similar analytics, tuned towards revenue generation activities, companies benchmark candidate portfolios for asset monetisation against their industry and similar assets or strength and weakness. Key perspectives include a wide range of analytics, including legal, technical and geographic categories. As with the portfolio pruning analysis, these are tunable to a firm’s context and objectives, as the example of ranking patents against various value-determining criteria depicted in Figure 4 illustrates. Tuning analysis avoids ‘black-box’ statistical results that are difficult to understand or defend.
Figure 4. Patents ranked against adjustable value-determining criteria
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There are an untold variety of asset monetisation options. Outright sale of patents, sale and license-back, traditional patent and know-how licences and spin-outs are a few examples of methods to unlock untapped portfolio value and return high-margin income.
The upside opportunity from identifying high-value patents for licensing or sale can dwarf the millions in cost savings that firms routinely achieve in this process. At a minimum, a single patent sale – even at a depressed price – routinely returns far more than the cost of obtaining and maintaining the family over its life. Exploring other monetisation opportunities identified in a portfolio pruning effort can dramatically increase those returns.
- Start with a plan. Consider the positive returns (in both actual savings and potential revenue) that will result from a well-designed portfolio pruning exercise.
- Do not under-invest in the exercise. Mistakes are easy if ad hoc or emotion-based decisions drive the process.
- Consider many perspectives. In addition to the high-level perspectives described above, companies routinely draw on 40 to 50 analytics perspectives and complement those with additional expert assistance before taking final actions.
- Remember that portfolio pruning can both clear dead weight and bring cash and other returns on past R&D and patent investments.
- Lastly, do not avoid the process through risk aversion or (conversely) overestimate the resulting revenues. Portfolio pruning and potential asset monetisation are straightforward processes to evaluate a firm’s historical investments, reduce waste, optimise carrying costs and identify potential upside value.
Alexander Butler and Daniela Hoyos
This article first appeared in IAM magazine. For further information please visit www.iam-magazine.com.