10,000+ patents, spending $10M’s per year, cross-licenses, and license potential with dozens of companies, what’s the value of the portfolio to the business? Is your patent strategy valuable to your company? How? OK, tag you are it, what is the answer? The problem seems intractable. In previous articles, we have discussed how to determine your general patent risk and how to put a number on it. But where do you start when you are trying to estimate the value of your patent strategy?
Our client had built an impressive patent portfolio which they used extensively for cross-licensing. Every year, they spent millions of dollars on their patent program and the IP department had begun investigating their patent spend. But now, they needed to value what they were receiving from that patent spend. For the IP department, this was problematic since the CFO wanted quantitative arguments for the high expense. This article describes how we helped the client develop a value model that resonated with the rest of the organization.
Our client’s main patent value stream was cross-licenses
In our previous article, Patent Quality Isn’t the Question. Patent Value is the Question, we discussed how companies can receive value from their patents through different value streams. In the example we are discussing here, the client extracted the most value from their patents through their cross-licenses. (We have discussed the dynamics of cross-licenses in detail in another article, Finding Your Way from Patent Value to Return-on-Investment). Briefly, cross-licensing removes both the patent risk exposure you create against an asserter and the patent risk the asserter creates for your company. For our client, modeling the value of their patent program meant understanding the potential risks and benefits of their current and future cross-licenses.
The patent portfolio provides different value to each business unit
Because a large company may have distinct business units (BUs) with distinct patent portfolios it is necessary to consider the value to each BU separately. Additionally, for our client, some cross-licenses were BU-specific while others were company-wide. These company-wide cross-licenses contribute value to the entire company on a corporate level. The total counter-assertion value provided by the patent strategy is thus the value provided to each business unit and the company-wide corporate value.
We started out with one business unit by mapping that business unit’s patent landscape
We initiated the project by looking at only one business unit (BU 1). In this way, our models could be developed and their effectiveness with the finance team tested before we assessed the entire company.
As discussed in Finding Your Way from Patent Value to Return-on-Investment, mapping the patent landscape is a prerequisite for the value model.
Our client had previously linked or tagged, all of their patents to the relevant BUs. This allowed us to use the group of patents tagged to BU 1 as a reference group for finding similar patents. Two primary approaches were used to find similar patents: (i) machine learning to scan the full patent databases for similar patents or (ii) patent classification overlap (e.g. CPC codes). Our goal was to identify the primary patent holders and the size of their respective portfolios both in aggregate and the portion relevant to BU 1.
We now knew who the main companies with BU 1-related patents were, and the size of their patent portfolios. We also knew with which of those companies we already had a cross-license. Our next task was to set up a model to calculate the value of the cross-license independent of the amounts paid for the cross-license itself.
The net-adjusted exposure model
The model itself is set up as follows. Assume our client has 5% of the world’s patents relating to BU 1 and $100 million in revenue from BU 1. OpCo 1 has 10% of the world’s patents relating to BU 1 and $1 billion in revenues from BU 1-related products. In this case, our client has a relative outbound exposure of $10M ($100M ? 10%) to OpCo1. Our client also creates a relative inbound exposure of $50M ($1,000M ? 5%) for OpCo1. This gives us a net exposure of $40M ($50M – $10M). Thus the net exposure measures the proportion of revenue that is connected to the relevant patents. To be clear, exposure is only an approximation; however, it is logically linked to how assertions work (see Figure 2-3 in Finding Your Way from Patent Value to Return-on-Investment) and generally aligned with the principles of proportionality (e.g. if you have X% of patents on product Y it’s hard to get a massive multiplier on that in claiming revenue).
The next step was to apply a royalty rate (in this case, we used 3%). To be clear, we are not advocating that 3% is the right royalty rate for any given product/patent, in fact, the vast majority of high-tech patent licenses close for a small fraction of that amount. However, this is not a single product/single patent we are modeling, rather a broad portfolio license, thus a higher benchmark number was used for the royalty to reflect the increased value transfer. The rate is industry and company size dependent.
The net exposure is then multiplied by the royalty rate to compute the adjusted inbound and outbound exposure. In this example, the next adjusted exposure would be a positive return of value from our portfolio of $1.2M. In other words, while our client might “owe” OpCo1 $0.3M, OpCo1 “owes” our client $1.5M. Our client’s patent portfolio thus contributes a net $1.2M of value through this particular cross-license. We use “owe” in quotes because we are not calculating an exact royalty rate or a trying to determine the exact exchange of value; “owe” really represents a balancing offset estimate of payments that might occur in negotiations between the two companies.
This can be repeated for each of the cross-licenses for BU 1 with a major patent owner to get the total cross-licensing value shown in Table 1:
While this model is somewhat simple, it has a number of virtues. First and foremost, it provides a uniform perspective on per BU-risk from 3rd party patents and the risk your own portfolio creates for those same companies. This model of value can be shared with other people in the organization and used as a general guideline for evaluating future cross-licenses. The model also highlights where portfolio development is most likely to reduce the client’s risk.
Possible model adjustments
Many adjustments can be made to further increase the precision of the model, such as:
- Patent quality weight adjustment. As of now, the model only accounts for the number of patents in the analyzed BU, but does not take into account the quality of those patents.
- Add time dimension. The model does not differentiate between a license 1 year from now and one 5 years from now. By not taking the time aspect into account, the numbers are also not discounted to their net present value.
- Patent litigation success weight. If a company has a better litigation success rate, they might act differently, which could motivate an adjustment in litigation aggressiveness.
- Asserter’s patent aggressiveness. If an asserter has shown higher patent aggressiveness in the past, it might suggest something about their future behavior.
- Licensing caps/minimums. In our experience, an asserter will, in most situations, make a request within a “normal” range of cross-licensing rates and total cash. The model has not been adjusted according to such minimums and caps on royalty claims.
The IP department used our model successfully to show the CFO a key component of the value the company receives from its patents. Even though we only modeled the cross-licensing value, in this case, it was sufficient to justify a significant patent spend by providing a sound return on investment (ROI).
Importantly, the model incorporates simplicity and high communication impact. In creating models, the challenge is often is reducing the complexity to the point that the key business drivers are clear. We removed complexity by selecting the largest value drivers for the patent portfolio and only modeling explicit cross-licenses. This is despite the fact that our client receives additional value from their patents through deterrence, and recognition/distinction.
Ultimately, the model helped our client communicate their business strategy. From here, resources can be allocated or reallocated, success metrics can be defined, and broader buy-in from other executives can be obtained and maintained.