(P. Krishna Mohan) Date : Jan 5th,2019
Introduction
Intellectual property is generally understood to include patents, trademarks, knowhow and trade secrets, and copyrights. Each of these categories refers to an innovative development of something new and unique, something “non-obvious” that did not exist earlier. It can be a proprietary method or a technique, a name that confers a certain market value and position to a product, the right to use information exclusively or confidential information which is not available in the public domain. The intention of these IP categories is to create value for the developer. The value of each of the IP categories depends on its field of use. For example, patents and knowhow have high value in the manufacturing world while copyrights have high value in the media and entertainment industry. A trademark can have great value in marketing a product to a customer by differentiating it from the competition.
Instilling A Company Culture That Values IP
Companies that understand the value of their IP portfolios generally have a well-developed culture that places high regard on how to handle and protect confidential information. Beginning at the corporate leadership level, elaborate systems and processes are used to protect IP including restricting access to only those with a need to know. Also, periodic employee training, monetary rewards and recognition and career promotion are helpful in fostering a culture that values IP. Some companies also conduct annual surveys requiring employees to certify that they have read and follow company procedures for handling confidential information. If IP infringers are detected through monitoring by internal or external sources, they are dealt with appropriately and the results are broadly communicated both within the organization and externally via press reports. Such prompt action goes a long way to clearly signal a company’s stance on its IP protection philosophy.
Difficulties In Valuation Cause IP To Be Undervalued
While all these IP categories have intrinsic value to the holder, attempting to calculate their market value is a complex exercise and more an art than a science. This inability to accurately price IP may be a central reason why there is a tendency in some companies to undervalue their importance which in turn, creates an environment where employees do not treat confidential information appropriately. Compounding this problem is the fact that “home grown” IP is not usually recognized on a list of assets on its balance sheet like cash, plant and equipment. For example, when one buys a new machine for a factory, “Cash on Hand” decreases and the new machine is added to the “Property, Plant and Equipment” category. When a patent is purchased, “Cash on Hand” decreases and the “Intangible Assets” column increases. However, most of the patents owned by a company are internally developed and not purchased. The salaries and benefits of the employees who developed the innovation, the patent prosecution and filing fees are all expensed as part of regular business expenses, but no accounting transaction occurs when the patent is finally granted. Ideally, the value of these patent should be added to the balance sheet, but most are not.
Market Capitalization More Dependent Today On IP Portfolio Value Than Book Value
According to Bloomberg (1) , the tangible book value (total assets minus total liabilities) of the S&P 500 companies peaked in 2014 and has been going down ever since. Several trends have been converging to cause this situation to occur. Low interest rates have encouraged corporate borrowing, doubling debt loads which reduce book value. Stock buybacks, made popular due to corporate tax law changes, drain cash from balance sheets and reduce book values. And corporate earnings are not increasing sufficiently to offset these reductions. The result is that a good portion of the companies have effectively, a negative net worth. According to Bloomberg (1), there are currently about 191 companies in the S&P 500 that have net tangible book values below zero, up from 124 companies five years ago. The shares of many of these companies have continued to rise despite their negative book value most likely due to the economy being driven more by services and technology than manufacturing.
In this new service-oriented economy, Intellectual Property and other intangible assets are much more important in influencing market value than traditional book value. In fact, many companies generate their earnings primarily by extracting value from their IP (via licensing and sales) rather than manufacturing.
In future articles, we will continue to explore issues related to intellectual property and discuss creative ways to extract value from a business’ IP without disrupting its core operating strategy.
References
- “The S&P 500 Has a Tangible Net Worth Problem”. Stephen Gandel, Bloomberg Opinion. Sept. 17, 2018.
P. Krishna Mohan recently retired as Global Director of Licensing, E.I. DuPont de Nemours and Co., Wilmington, DE, USA. He can be reached at kitmohan@gmail.com.