Patents – the new black?

Written on 8 Jul 2015

A report of our Patent Strategies round table event on 30th June 2015

Once the preserve of R&D departments and a specialist group of patent attorneys, patents have hit the headlines over the last decade not only through the high profile litigation between mobile phone companies but also through the stellar prices paid for a series of patent portfolios.  Nortel and Kodak, both bankrupt, proved to have been the owners of patent portfolios valued by their competitors (though not by their own management) in the hundreds of millions of dollars. Google bought the ailing Motorola Mobility’s patents for a net $9.6 billion, while Microsoft paid over $1 billion for 800 AOL patents.  But if those are real values, then why have such deals not been done before?

One take is that these are transactions driven by a very particular set of circumstances: the categorical need to have a patent portfolio by way of bargaining currency in view of the complex cross-licensing needed in order to make and sell mobile phones, each of which operates using technology developed by numerous companies and subject to patents held by those companies. The owner of such a portfolio is in a rare position to set a price, since there are few of them and most are not available for sale. Even though the buyer was surely aware in each case that the majority of patents in the portfolio are not going to add much value (although it is impossible to do effective due diligence on portfolios of this size: the negotiation will have focussed on a top 20-30, leaving the vast majority unexamined), the deal is a ‘take it or leave it’ scenario and so large numbers change hands. Notably, having bought AOL’s patents Microsoft promptly sold 70% of them on to Facebook, for the bargain price of only $550 million. They had extracted the 30% they considered relevant for their business.

Such transactions are both a good and a bad thing: they bring the potential value of patents to management’s attention, but they may also raise unrealistic expectations as to what return the patent portfolio of a less exceptionally-placed company might deliver. Even though the astounding prices in these examples represented good value in those particular circumstances, as a general rule the size of a portfolio is not a useful measure of its value: the established research reputation of the companies which had developed those technologies is a better guarantee that at least some (but by no means all) of the patents concerned were likely to be strategic assets. A company which decides on a strategy of simply getting a portfolio as large as possible may well be able to do so: patents can be granted for minor improvements on existing technology, and a creative and persistent patent attorney can often persuade the patent office to let a relatively weak application through. But as the battlefield of mobile phone patent wars has shown, a determined competitor can just as well persuade a court to revoke that patent, if it does not genuinely represent a novel and inventive development.

So not all patents, and not all patent portfolios are an untapped seam of gold. But since many have genuine potential, it is disturbing that so little executive attention is paid to them. The uncertainty hanging over any value put on a specific individual patent is one reason why corporate management rarely gets involved in hands-on management of patents as an asset. And it is true to say that a significant part of the value of the technology as a package is not the patents themselves but the history and know-how about the technology development carried in the heads of the teams which built it. Just as noteworthy as Microsoft’s sale on to Facebook was Google’s sale on to Lenovo: not the patents, but the remainder of what had been Motorola Mobility including the team which developed Motorola’s high-end phones. In combining that intellectual capital with Lenovo’s existing technology and low-end know-how, Lenovo gained the ability to move into a new product market, potentially making new patentable inventions along the way, despite not having the Motorola patents themselves.

This example illustrates an important issue in considering the value of patents: like a plot of land, which may be used for grazing sheep or turned into a highly profitable shopping centre, it is something which depends as much upon the user as upon the pure legal right granted. A set of highly technical communications patents can only be of use to a company which understands the vision behind them: what product, or aspect, were they developed to protect? Without that vision the purpose of a patent can be difficult to deduce, so that buying and selling patents as if they were bonds, for instance, will never make commercial sense. There may be a bargain basement price at which any given portfolio can be guaranteed to find a speculative buyer, but there are few buyers who will be in the position to understand and fully exploit the true potential value. Google’s sale of the Motorola team was an assertion that its own people will be able to assess and implement all of the know how that went into the technologies selected for patenting. Whether that is correct, or whether a few nuggets of gold slip out of the pan and downriver, remains to be seen. But Lenovo, too, have taken a gamble, since unlike patents legally owned, the Motorola team may fracture and dissipate to new employers over time, leaving Lenovo with neither rights nor know-how.

What value do patents give?

The classic justification for patenting is to protect the investment made in researching and developing new products. Without a legal barrier, any successful new product will rapidly be copied and its market share and profit margin eroded accordingly. Putting numbers to this value is difficult; but worthwhile as a counter to the ordinary accounting approach of treating patents as a pure cost.

Patents can also be licensed out, once a strategy has been decided as to what technology should be available for licensing or not. One again, it will be the combination of pure patent rights giving potential licensees comfort in selecting a licensor, with the sharing of technical know-how to enable the licensee to get up to speed implementing the technology expeditiously, and a vision of the commercial possibilities, which will be the most attractive package. Even a patent for the most technically advanced solution is of no value if the market does not see that potential. The zip fastener, for instance, was patented in the 1920s but not adopted until after the patent had expired, when World War II created a need for clothing which could be fastened rapidly and effortlessly compared to the buttons, buckles and belts of the preceding era. Less disastrously, the truly innovative development of liquid crystal displays was offered for licence for several years before Sharp eventually led the way and a market for the technology began to develop.

Conversely, in any negotiation which begins with a third party assertion that the company’s products infringe, the company’s bargaining position will almost certainly be far stronger if it has its own set of rights which can be asserted in response – and potentially cross-licensed by way of settlement. If there is nothing with which to meet an allegation of infringement save for argument about the strength of the infringement claim, the negotiation is fundamentally more one-sided.

But there are more subtle advantages to be gained. A company with a strong research track record can leverage that know-how by selling research services to others in collaborative research – but may only maintain that access to the research market as a result of being able to protect its background IP from each new collaborator. And just as potential licensees may draw comfort from the exclusivity provided by patents, so too consumers may be seduced by the knowledge that a particular product is protected by patents into believing it represents the most cutting edge device. As Dyson and Audi have both demonstrated, truthful claims of patent protection can be effective marketing tools. (Untruthful claims, on the other hand, can amount to a criminal offence in the United Kingdom.)

In the public sector, different factors such as the contribution of the patented technology to improving public health (and saving healthcare costs) will also apply.

How to come up with a number?

There are numerous techniques on offer, but the best approach is to use several techniques to identify a value range with a high level of confidence.

The potential cost of a licence for the technology, if the company did not own it, is one technique. Another is to identify if possible the price paid for comparable patents – always assuming that the figures are public and the real extent of comparability of the patents in issue (strength to withstand challenge; breath of products potentially affected; remaining lifespan) can be assessed. If reliable figures can be estimated, the net present value of future revenue streams (whether licensing, or increased market share and profit margin) attributable to the patents over the remaining lifespan is also a useful valuation approach. Values can also be ascribed to patents based on the tax benefits they can bring.

Confidence in the strength of an individual patent is likely to be greater, and therefore its value higher, if it has been subject to attack either through the patent office (European oppositions, for instance) or in the courts. The fact that a third party wishes to use the technology (an assumed reason for the attack) and has been unable to revoke it suggests that the technology is indeed innovative and has near term commercial relevance and value. Another useful measure is forward citations – the number of times third parties’ later patent applications have referred back to the patent; although this only starts to accrue 6-7 years after publication.

Of course, a weak patent is not necessarily valueless. Revoking a patent in one or more territories is a costly exercise and will not make economic sense if the patent is available for licence at a level below the likely revocation costs.

But purely physical measures – length of patent description or of claims, number of patents in the portfolio – sometimes adopted because of their simplicity of measurement, bear no real correlation to the commercial value and should be avoided. An excellent counter-example was the exceptionally important original patent for the drug interferon, claim 1 of which simply stated “Interferon”, and claim 2 “human interferon”.

Maximising returns

Whichever source of value may be targeted, keeping the patent strategy aligned with the business strategy is key. Patents are expensive, both to obtain and to maintain, since renewal fees increase with every year of patent life. So no company should include in its portfolio any patents for which it cannot identify a business need. This is not a once-for-all exercise to be done and then shelved. On the contrary, any company with a portfolio of reasonable size needs to have a patent manager, whether full or part-time, whose task is to own the portfolio, make filing, licensing and abandoning decisions, and ensure that the portfolio’s relevance and usefulness in helping the Board to deliver shareholder value is clearly presented to management.

One solution long argued for is that patents should, like other capital assets, appear on a company’s balance sheet. But although this certainly gives patents as an asset a higher visibility, it may also engender an undue focus on the immediate numbers, and a year-on-year expectation of increased returns. As discussed above, patent value arises from a range of sources some of which – potential future market access, for instance, or defence against as-yet unidentified competition – are dependent on future development and therefore fundamentally uncertain. Some of the associated costs can only fairly be treated as a gamble on markets over the next 5-20 years; and a fair management assessment should accept that despite the undesirable uncertainties that entails, nonetheless, a portfolio of patents represents an insurance policy well worth having.