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In our intellectual property valuation practice, we are often asked by patentees how they can get a proverbial back-of-the-envelope assessment of the value of their patents. What at first blush sounds like a reasonable request, its proper answer is not as easy as most would like to think. In this continuing series of blog posts, I will strive to address the question from a practical perspective. In the end, I believe we shall see that not only is there no simple answer, but the question might not be the right one to begin with.

General Principle No. 2

“A patent’s use is a key arbiter of its economic value”

Patents can have several uses in practice, and each alternative brings characteristics and contextual parameters that affect economic value in specific ways. Once a patent holder is in possession of an issued patent it can be put to economic use in at least one of the following ways:

• INTERNAL – The patent holder may make use of the patent internally in an existing business (or firm). The patent may cover a specific aspect or an improvement of the manufacturing process use in the firm, or it might cover a specific feature of a product. In addition, the patent could be a method patent and claim a specific mode of operating the business, or implementing a procedure in software for example. Internal users typically supplement new patents with existing resources, trade secrets, and knowledge assets to put them in practical use. For example, Apple, Inc regularly obtains patents on its own future product designs or for product features that it plans to incorporate into its products [See e.g. the Patently Apple Blog].
• LICENSING – The patent holder may focus on licensing the patent to third parties, with the goal of developing a royalty income stream by relying on the licensees to bring together any additional resources to practice the claimed invention. IBM has been granted more patents than any other US company during each year since 1993 [IBM Patent Licensing]. It maintains a broad portfolio of patents in the computer industry specializing in the areas of display, storage, network computing and software. Yet, IBM does not manufacture products in these areas anymore; it licenses its technologies to third parties that do engage in manufacturing. One technique increasingly used to establish a licensing program has been the threat of litigation. This strategy has been the choice for companies described as “non-practicing entities” or, less charitably, as “patent trolls.”
• BLOCKING – The patent holder might not use the process, manufacture a product, or license third parties, but rather hold on to it in order to block competitors from developing specific products or benefiting from some innovations. This use is typically not publicized for obvious reasons, but imagine a car manufacturer had been the first to patent fuel injectors but did not use them in their vehicles nor licensed them. The competition would have to continue using carburetor-based engines as long as the threat of patent infringement was perceived as real, and the patent-holding car company could buy a head start in developing a better fuel injection system for the future, thus staying two-steps away from the competition.
• MIXED LICENSING – A patentee could have a patent on, for example, a way of compressing and decompressing video to facilitate its transmission over the Internet. The main way in which it can profit from this is if the whole industry uses it and, specifically, if it licenses everyone to use it (even at very low royalties) along with its own internal use.
• CROSS-LICENSING – In many industries that are host to active patenting, such as telecommunications or pharmaceutical research, patent holders often use patents as bartering pieces to cancel out the threat of infringement litigation form competitors, by licensing some of their patents to the holders of patents it needs to compete, or is likely to be found infringing. A case in point is a recent agreement [Cross-Licensing Report] whereby Intel Corp. (the company famous for its microprocessors) received a license to Nvidia Corp.’s patents, while Nvidia (the company famous for its graphics processors) got a license to some of Intel’s patents, thus resolving outstanding litigation between them. As part of the deal, Intel will pay Nvidia $1.5 Billion in royalties over the next five years.
• SLEEPING or SUBMARINE PATENTS – Sometimes, patent holders do not apply, license, cross license, or litigate their patents; they lie in wait until a suitable target appears, or they are simply shelved (sometimes forgotten) as a consequence of an overly active patenting drive or bad management.

How the actual pool of patents is divided among these uses is hard to ascertain. Nevertheless, relatively recent survey data from the European Commission indicates that the most frequent use is Internal, at 51%, followed by blocking, at 19% (See Chart below) [2005 Patent Study Report].

Chart 1: Patents and their uses

From the same European source, we have found that the distribution of the value of patents differs for its different uses (See next Chart). Relative to the value of the average patent surveyed, the most valuable uses by far are, not surprisingly, internal use and cross-licensing. Both of these uses allow patent holders to opewrate in a more profitable protected environment. Blocking, while popular and profitable, is a slightly inferior use of a patent because, one may expect, competitors invest in non-infringing alternatives and defeat the purpose of blocking. The other licensing uses are naturally less valuable than average because licensing involves sharing a portion of the incremental profits with the licensees. It is no surpise, finally, that Sleeping patents are the least valuable.

Chart 2: Patent values and uses

In conclusion, from the perspective explored in this post, a follow-up question to correctly approach the valuation of new patent would be simliar to: What is the intended strategic use of the patent?

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You can follow the rest of The Patent Value Guide on its dedicated website (www.PatentValueGuide.com) and continue to read up on patents and other Intellectual Property valuation topics on the IPmetrics® Blog.

In our intellectual property valuation practice, we are often asked by patentees how they can get a proverbial back-of-the-envelope assessment of the value of their patents. What at first blush sounds like a reasonable request, its proper answer is not as easy as most would like to think.

In this series of blog posts, I will strive to address the question from a practical perspective. In the end, I believe we shall see that not only is there no simple answer, but the question might not be the right one to begin with.

General Principle No. 1

“A patent has no intrinsic value independently of the value of a business”

At the risk of repeating what must have been replied myriad times by patent attorneys and IP professionals, a patent is only the temporary right to exclude others from a specific market delimited by a written description of an innovation [USPTO Patents Portal]. It does not represent the right to practice an invention, or title to a royalty income stream; several factors are co-determinants of the economic value of the opportunity the patent represents.

For example, if an inventor is issued a patent on an innovation which he/she cannot implement directly and no one else needs such invention to operate their business and satisfy actual consumer demands, then no actual market segment exists for the invention. That patent is not simply worthless, rather it represents a net cost to the patent holder as obtaining a patent in the first place requires one to cover drafting, drawings, filing fees, and other prosecution costs which, realistically, are no less than $1,500 and could be as high as ten times that amount [Current USPTO fees].

By contrast, consider a situation where there is market demand for, e.g., an accessory that props up touchscreen cell phones because: (a) a large number of such cell phones are in use; (b) the phones must be held at an angle for confortable viewing of videos; (c) the cost of manufacturing the accessory is low relative to the phone at the appropriate volume levels. In this case, the value of this limited accessory business would be proportional to the net profits of the venture.

Phone Accessory (www.theGlif.com)

Then, a patent that claims that invention would likely have economic value because the patent holder can exclude others from making, importing, using, and offering for sale, or selling that invention throughout the US and sell the product at a monopoly price. This price would be greater than the competitive price and, thus, the patent holder would effectively be reaping an economic rent: the incremental profit at the monopoly price over the net profit at the competitive price. Only this portion of incremental profit would be attributable to the patent and would therefore be the value of the patent.

Patent Effects on Market Price

Thus, it is because the phone accessory business has value that a patent on the device would have economic value and, furthermore, the value of the patent is different from the value of the underlying business (and always smaller if the business is profitable in a competitive environment).

Consequently, at this initial level of the inquiry, the right question would be closer to: What is the value of the underlying business, and how much can a patent contribute to that business value?

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We shall cover additional principles in the IPmetrics® Blog, and dig deeper into useful tools for estimating the elusive patent values.