A CEO's Guide to IP

You don't have to be an IP professional to understand the importance of intellectual assets in today's information age. The old industrial 'bricks and mortar' era has been replaced by a powerful knowledge-based economy, with ideas and innovation as the new currency. In this environment, IP is no longer just a means of protecting innovation - it's also a potent business asset and a means of capturing value.

By Jeff Maddox, CEO of CPA Global North America LLC

White Paper Contents

• What is IP?
• How Valuable is My IP?
• 10 Questions Every CEO Should Ask

IP Rights have become the most important form of competitive power that any company can own; they are the foundation for a product's market dominance and continuing profitability, the basis for an almost unrivalled method of revenue-generation, through licensing or merchandising, and are often the key objective in mergers and acquisitions (M&A).

Where the core of a company is its IP, it's important for executive management to understand the extent of these rights and what IP can do for them. However, the management of a company's IP Rights is a challenging, fast-moving and, often, unpredictable task. So long as intangible assets continue to play a pivotal role in bolstering a company's bottom line, the methods in which IP Rights are created and enforced will also continue to fluctuate and expand. Already, the growth in importance of IP Rights has created new, previously unthought of methods of exploiting and using it. This in turn has generated an unheralded surge in filings and registrations, created new challenges in terms of accounting, taxation and valuation (many of which are still to be resolved) and placed added pressure on the systems in place to record and monitor IP Rights, causing them to be assessed and often overhauled. At the same time, it has produced a much-needed and successful IP management industry, where companies outsource to off-shore services and tax havens to better exploit and protect their IP.

Of course, it hasn't traditionally been part of a CEO's role to track the management of the company's IP; this has previously been considered a legal issue, the domain of corporate lawyers. IP is just one of many concerns to be factored into overall corporate policy, along with more obvious short-term topics, such as cash flow, customer retention, supplier sourcing, tax reporting and recruitment.

Yet, as IP has become a business driver, it's becoming imperative for CEOs to build a basic knowledge of the rights the company owns in order to properly direct its future and account for its worth. Just as IP experts are not CEOs, CEOs are not necessarily IP gurus; however, each needs to know and understand the position of the other if they are to meet each other's needs. After all, IP, well-nurtured, can provide the bedrock of a company's security, as well as enhance its identity and brand value.

What is IP?

Intellectual property, or IP, is a loose term for the property that exists in the things people create (such as inventions, medicines, music and movies), as well as the information that becomes valuable because not everyone has access to it or can use it (trade secrets, customer or supplier databases and business and product names). Some IP is protected by statute law (most countries have special enactments governing patents, trademarks, designs, copyright and domain names). Copyright is protected by default, but all other rights need to be registered, monitored and renewed. Other IP is protected almost by chance, through the courts applying their own judge-made case law; for example, to protect confidential information or the 'passing-off' of another person's rights.

new products, processes, marketing ploys and in its relationship with its customers. The current economic climate provides immense rewards: a music group that is popular in one country is increasingly likely to be successful in many. Similarly, products as diverse as fast food, technology and automotives do not depend on a specific geographical location, but can be sold and marketed everywhere.

Secondly, the formal IP Rights system that protects a company's intellectual output renders the IP a valuable commodity. Patents, trademarks, copyright and domain names are powerful competitive advantages because individuals and corporations own them and can enforce them in the courts.

IP Rights protect the results of creativity once they hit the marketplace. For example, the cost of mass-producing a finished medicine is derisory in comparison to the billions it takes to create and test a typical pharmaceutical product. If it weren't for patent protection, many organisations would think twice about embarking on the expensive R&D needed to produce new product research in the first place. IP allows them to justify the initial expenditure because it provides them with a guarantee that they will at least have the opportunity to regain their investment once the product has hit the marketplace.

In many areas (eg fashion, software and pre-recorded music) copying is rife, even where IP Rights are in place. Even so, imitators who enjoy a life which is both profitable and untroubled prefer to copy products that are ill-protected by IP Rights or whose rights owners pay less attention to enforcement.

With a properly maintained IP portfolio in place, a company can develop, acquire and use its IP Rights as competitive weapons to capture and defend markets, outflank rivals, and increase market value and revenue. Companies that ignore the growing value and power of IP do so at their peril.

IP audit shows CEOs what intellectual assets are at their disposal and how useful they are likely to remain. This is vital. For example, a company may rely on a patent to keep competitors from copying its product, but the maximum life of a patent is quite short. If that company does not have a strategy for maintaining the product once its patent has expired, how does it expect to retain its market share once other non-brand products enter the marketplace?

As well as tracking the patents close to expiry, an IP audit shows the CEO how much he depends on IP that is owned by others. The company's software, its mailing lists - even the music played in its public spaces - may all be licensed in from other IP owners. Few businesses are entirely independent of 'third party IP', so the CEO should know which bits of his operation are subject to the continued co-operation of outsiders. Similarly, companies will often work together to co-produce IP. A study of patenting trends in hybrid technology produced by CPA Global in 2006 revealed a considerable amount of co-assignment activity among the world's leading automobile manufacturers: 'We found several examples of crosscompany collaborations, in order to get hybrid products to market,' said Christian Bunke, Product Manager, CPA Global . Both share the IP and should profit from the associated rights equally, but this can only be ensured if a succinct IP strategy is put in place to monitor its use.

In addition, an audit of patent rights will reveal the patent rights that can be licensed to generate revenue to the business itself; it will also uncover deadwood - patent rights that the business is paying to maintain, but which are not used. Rather than being abandoned, these too, could be licensed to generate a potentially lucrative revenue stream, but only if they are of use to someone else.

An audit focusing on trademarks, on the other hand, will help a CEO to chart the future of the company's products in its marketplace, and plot a path for future expansion. Senior management needs to be informed of the extent of a company's trademark rights before it decides to move into new markets or territories. Trademark rights need to be put in place first, in order to ensure that the company has the freedom to trade in the new areas.

As with patent rights, a study of trademark rights will also reveal those unused rights that can be licensed or sold on to save the cost of maintenance. If you've invested time and effort to build a brand, why let it lapse? The trademarks that support an existing brand can easily be sold or out-licensed. They can also be used to encourage other businesses to co-operate with you in developing your own. For example, if you work in retail and you think your shop format may succeed in other locations, you can take the capital-intensive route of buying or renting properties in other locations, equipping those premises, recruiting and training local staff. Or you can register a trademark, assemble a confidential and copyright-protected operational manual on how to run the shop, then get people to pay you to use this IP package. That's how IP-based business format concepts, such as Starbucks, McDonalds, KFC and, more recently, hairdressing salons, such as Toni & Guy, have spread. The idea's yours, but the investment risk belongs to your licensees - and the better they do, the more valuable your IP becomes.

Equally, the results of the audit of trademark rights should always be compared with the company's domain name strategy. Are domain name registrations in place to support the marketing of the brand in all relevant territories? Are defensive registrations in place to ensure that others aren't using your brand for their own gain?

Knowing what you own is key to building a successful IP strategy; one that will allow you to exploit maximum value from your company's creativity, while ensuring you can chart your future in the marketplace without fear of infringing or being infringed.

How Valuable is my IP

Just like any other property, the value of IP is flexible: it all depends on whether the company is buying or selling it; what it is being securitised for; whether the valuation is subject to accounting standards or financial reporting conventions; whether the right's validity has been tested following a contested court action or is only presumptively valid; and whether it is free from encumbrances or subject to licenses, charges or other equities.

'The context of the valuation is critical,' explains Danny Ryan from LECG Corporation. 'For example, patents can be worthless if they don't come with the necessary knowhow or trade secrets to apply them. At present, there is no standard method, but as CEOs and financial institutions begin to understand more about IP valuation, it will result in an increased belief in balance sheet values of IP as a result.'(Source: presentation at IP Review Live in February 2006.)

Until that point, those IP valuation experts who practise their profession agree on one thing: given the different reasons why IP Rights get valued and the different methods of valuing them, companies should consider carefully what purpose a valuation exercise is intended to achieve before embarking on it. Bearing this in mind, CEOs should adopt a mindset of sensible constructive scepticism when dealing with any value-related issue and should not allow themselves to be seduced into accepting a single sum as representing the 'true' value of any item of IP.

This is not to say that a directional understanding of IP's value contribution to a product cannot already be estimated. The valuation of IP has become a necessary business skill, particularly in mergers and acquisitions where management may be required to determine how much of the purchase price should be attributable to intangible assets. Management should start by first asking whether the overall product is value producing, followed by an assessment of IP's contribution to that value. General areas of examination include:

As IP becomes an integral part of business strategy, its value should be understood before it is granted, not just when it is bought or sold. Companies need to understand the link between IP and market share if they are to retain their competitive advantage, as one US science and technology giant discovered when it decided to cut back on its R&D spending as part of a larger company-wide series of cuts in 2003. Unsurprisingly, the reduction in R&D investment also led to a decline in the number of patent disclosures, applications and grants. Concerned that the short term cost savings in R&D and IP were coming at the expense of long term value, a project team was established to try and measure the value of its R&D. What they actually did was measure the value of its IP.

The balance sheet showed that the company was investing approximately 4% of its sales in R&D, in excess of $500 million annually. The project team assumed that the value of R&D could be partly measured by the value of the IP that it produced. In its case, IP generated income in two main areas: licensing (a revenue that would be lost without IP protection) and the profit from higher margins charged for IP-protected products. They found that licensing revenue accounted for about £100 million (or 20%) of annual R&D spending. They also found that a significant share of the R&D investment was earned back through the higher margins earned on the IP-protected products. This was calculated by linking the company's current patent rights with the company's financial database, allowing for the measurement of margins for IP-protected versus non-IP protected products. In fact, on average, IP-protected margins were 8% higher than their non-protected counterparts.

This helped to reinforce the importance of IP (and R&D spending) in the company. However, it didn't serve as a push to increase R&D spending; rather it prompted them to analyse how to get more from the R&D investment that was already being made through IP registrations. As a result, extra investment was dedicated to building the company's team of patent attorneys and the company's business unit managers were asked to incorporate the potential advantages of IP into their strategic planning. After all, if IP conveys a competitive advantage, companies should be asking whether they are getting the most from that advantage in terms of price and/or revenue growth.

Can IP protection reduce commercial risk?

Every statutory IP Right can blow up in your face, if it turns out to have been invalidly registered. This frequently occurs for patents, but also for trademarks and designs. That's why it's so important to properly protect a company's creativity in the first place.

But for as long as you have those IP Rights, you still have some comfort based on its deterrent effect and the cost faced by your competitors in attacking it. Even an invalid patent can ward off competitors for as long as it takes to invalidate it. For example, Viagra is one of the most successful products of our generation. Pfizer's patent was eventually held invalid in the UK, but not before the company had built up a massive market presence based on its powerful trademark.

But IP can only be protected commercially if it is properly monitored. In the field of brands, for example, counterfeiting provides a real and growing threat to trademark registrations. According to some, counterfeit goods account for 7-9% of world trade and rising (Toe Su Aung, General Counsel at Batmark Ltd and chair of the International Trademark Association's Anticounterfeiting & Enforcement Committee. Source: IP Review, issue 15, summer 2006). No branded goods are safe, nor any country immune, but at present it is up to the individual company to monitor protection of its own brands. Counterfeiting erodes brand values and product integrity and damages a company's market share for genuine brands. They can also cause injury and defraud both governments and the general public. 'Companies need to be vigilant in defending the integrity of their trademarks and urge regulators to enforce IP protection laws vigorously,' advises Toe Su Aung. A market-aware CEO will not determine his business strategy first, later considering what IP Rights are at his disposal. Nor will he contemplate his IP Rights before deciding how he can blend them into a business strategy. Successful companies are aligning IP and business strategy to use their IP Rights to maximise their market presence.

For example, when Nokia decided to enter the US telecoms market, an immediate problem was that the players already there, Motorola and the Japanese tele-giants, were well entrenched. Those players had cross-licensed the use of one another's patents and Nokia was afraid to infringe. Those patents were so many in number, and so complex, that even the act of reading them to see what they covered would have been a slow, uncertain and extremely expensive activity. By the time Nokia discovered whether it infringed them, most of them would have lapsed or become obsolete, to be replaced by new ones. So Nokia developed its own portfolio of patents. It was then able to say: 'Here are our patents. You may or may not be infringing them, but if you let us into the club we'll cross-license to you, too.' In doing this, Nokia gained admittance to their target market.

IBM's long-term business strategy reflects a different approach to patent protection. When Big Blue made boxes, it wanted computer users to be able to get hold of as much software as possible. That's why, when the debate over software patents arose in the 1960s and 1970s, IBM fought long, hard and unsuccessfully to ensure that computer software was as unprotected as possible. Later, IBM's own huge segment of the hardware made it so powerful a monopolist that it couldn't enforce its IP Rights against cheap PC clone-makers without risking antitrust suits. Recognising the potential power of software patents against the weakness of machine patents, the company switched to software development and is currently the most profitable software developer in the world. It has since altered its approach again; announcing at the end of 2006, a new patent policy to promote innovation. 'We are now the biggest supporters of the open source development project,' explains David Kappos, IBM's Vice President and assistant general counsel for IP law. 'Admittedly, this policy is not easily reconcilable with our traditional IP strategy, but we are convinced that it is the way to go for the future.'

Microsoft, in turn, is pushing for amendments to international systems to better reflect the rising demands for patents. Part of this is to help technology-rich companies, such as its own, better use patent registrations as a means of capturing value, but it also wants to open up the procedure to companies who have, to date, been unable to utilise the patent system due to its prohibitive cost.

Using IP knowledge to beat the competition

IP is not only a legal and protective mechanism - by looking at other people's IP you can determine where you need to invest money in R&D. IP profiling can give a CEO not only the low-down on their own patents, but also on those of their competitors, distributors, suppliers and takeover targets. Patent analysis uses the information provided by the registrars of statutory patent rights, as well as information that appears on the face of patent applications, to measure activity in the marketplace. However, unless you're an experienced patent examiner or analyst, it can be difficult to decipher the results. Fortunately, services already exist to assess the available information on your behalf.

The information available from these services isn't dull nor difficult to utilise. It includes such valuable information as: the names of inventors on your competitors' patent applications; the fields in which your competitors are spending money trying to develop products and services; the split of research activity between different product sectors; and even data concerning professional representatives.

Similarly, if you track which trademarks other companies are registering, you'll be able to assess if they're moving into new markets, potentially threatening your business model. In the domain names arena, conducting a WHOis and reverse WHOis investigation will also enable to you to check which URLs are available and what others have done before you to launch a campaign in your key territories.

Conclusion

As all CEOs should now be aware, ours is no longer a culture of bricks and mortar assets; we are operating in a knowledge-based economy in which the ownership and management of intangible assets, such as IP, is directly linked to corporate success and failure. In such an environment, protecting, developing and exploiting IP assets should be at the very forefront of business strategy; however, for many companies, this is not yet the case.

Ultimately, the growth in value of IP necessitates a step change in the manner in which companies and, by extension CEOs, view and utilise the IP assets that they own. Properly managed, IP can be a source of innovation, creativity and corporate growth. But to succeed, it needs to be understood at boardroom level. Trademarks, patents, domain names, design rights and other forms of IP interlink with every aspect of a business - from the way in which it markets its products and services to the way its assets are reported financially. Companies need to recognise this importance if they are to maximise the benefits to all sides of the business, and to ensure that any move into a new market or business area is supported by the requisite IP. But this needn't be as complicated as it first sounds. Once a CEO recognises the value of its corporate IP, there are some important questions they need to ask their IP department. These are summarised on the next two pages.

10 Questions Every CEO Should Ask

1 Can we profit from our IP?

'Twenty-five years ago, IP was simply registered as a defensive tool,' said Bruce Berman of Brody Associates. 'Today we know it as an asset that can be exploited for financial return.' This is certainly true when it comes to selling or licensing unwanted IP, which may be very good in itself, but not related to any goods or services the business is trading in. IP Rights can also be mortgaged or securitised, but individual industrial rights are likely to be highly valued if they are not secured as part of the business as a going concern. An exception here is copyright, where 'Bowie bonds' give the IP owner the chance to borrow a large sum, repayable through relatively stable and predictable royalty income over a long period of time.

Further reading: 'Closing the innovation value gap', Jeff Maddox, IAM (January 2006)

2 How much is it worth?

The answer depends on the reason for asking the question. A wise CEO will hold his company's IP in high esteem privately, but remain cautious about putting a high figure to its value in public. That way he won't encourage inflated expectations among shareholders, speculators or employees. 'Value your IP as any other asset,' advises CPA Global's Jeff Maddox. But remember, it's difficult to value IP, so seek expert advice in order to tailor the valuation to the IP Rights in question; for example, as they can be renewed, trademark and domain names are valued in a completely different way to a company's fixed-term patent rights.

Further reading: 'A capital market approach to IP valuation', Jeff Maddox, IAM (June 2005); 'What your domain name is really worth', Dominic Speller, MIP (June 2006); 'How to value your IP', Robert Wulff, IP Review

3 Can we make money out of IP licensing?

You can if you create products that lots of people want to pay for. Where there is no demand, there's no big money. That's why companies spend so much time marketing their brands. Look how Intel, by advertising direct to the public, were able then to charge manufacturers for using their 'Intel inside' brand. 'Non-core licensing is like playing the lottery,' explains Peter Spours, formerly Vice President at Thinkfire and now head of IP at TomTom. 'Winners are the rare exception. For the best chance of success, companies need to align their corporate and IP strategies, focusing on the lucrative rights they own.' You need to understand your assets, quantify them as strategic business aims and understand your market to generate revenue through licensing. Beware of the 'illusion of exclusion'; licensing valuable technologies brings greater profit than keeping them to yourself.'

Further reading: 'How to exploit patents for profit', Peter Spours, IP Review

4 What is the tax position of our IP?

In a word, complex. Transfer pricing rules and withholding tax can affect transactions between companies in the same group when, for example, a tax-efficient IP holding company in the Netherlands Antilles licenses the use of 'its' IP to companies elsewhere in the world. On the plus side, IP development costs can reduce the tax bill. 'Careful tax consideration throughout the life cycle is key,' says Isabel Verlinden from PriceWaterhouseCoopers. 'R&D, corporate partnering and licensing all have an impact on the tax status of IP, yet many companies only consider their tax position as an afterthought, which can often be a costly mistake. Rules and responsibilities must be defined in agreements with third parties.' Keep your accountants informed and watch for major shifts in direction. Only by properly recording and auditing the value of your IP will you be able to assess your tax position.

Further reading: 'A Haven for Tax?', Isabel Verlinden, IP Review

5 What is the most efficient way of managing our IP?

Obtaining, enforcing and exploiting IP is not a party trick - it's a skill that is acquired through patient study, professional qualification and on-the-job training. Some businesses outsource all their IP work and it looks a lot cheaper. For many businesses this may be the best course, particularly those that are not IP-intensive (the retail clothing sector, for example). However, businesses can usually find something useful for their IP department to do if the IP work doesn't fully occupy them, while some companies that outsource their IP work find that they fail to budget for unexpected contingencies, such as having to defend an expensively acquired patent. Ultimately, the IP department needs to raise its profile in the company, by showing its value in terms of revenue and by explaining the importance of IP to the business as a whole.

Further reading: 'A recipe for success', Paula Nelson, IP Review

6 Are we doing enough to combat IP crime?

IP crime should nnot be ignored since it generates illicit income that cannot be easily laundered and is thus best 'invested' in further IP crimes. Information sharing with competitors and co-operation with the enforcement authorities are both strongly recommended, though they will always be disruptive and often initially futile. Bring private prosecutions if the authorities are unwilling or under-resourced: even a token sentence following a conviction will pave the way for the recovery of the proceedings of crime.

Further reading: 'Does crime pay?', Toe Su Aung, IP Review

7 Is IP litigation the only option?

No. Arbitration is often favoured as a means of getting a binding decision where two sides fall out, while mediation has become increasingly popular as a means of enabling the warring factions to talk their problems through and reach their own decision. In short, arbitration is good at dealing with problems attached to the past ('did we act outside the scope of our IP license?'), while mediation is good for disputes that reach into the future ('this license isn't working and makes no business sense, so how can we patch it up?').

Further reading: 'A strategy for enforcement', Samantha Frida, IP Review

8 Should we have IP insurance?

If you are in a sector in which your competitors neither sue nor are sued, or if you are so large and wealthy that you can absorb any amount of IP litigation expense without noticing it, IP insurance is not for you. If your business is very small, you probably can't afford its fairly steep premiums (which are tailored to the risks borne by the underwriters). If you're somewhere between the two, you may well want to consider it seriously. Case-studies have illuminated both the virtues of IP insurance and its shortcomings - for both companies and attorney firms. The best advice is not to let your mind be made up once and for all - revisit the issue regularly, on the basis of what your business needs at any given point in its trading cycle.

Further reading: 'Made in Canada', Rob Macdonald, IP Review; 'Going Global', Margaret Briffa, IP Review

9How can we monitor our competitors' IP?

Statutory IP Rights create a trail of both electronic and paper information that you can use. Warning note: much 'current' information is out of date. A patent filed by a competitor today will often tell you what it was spending its R&D cash on three or four years ago, but not yesterday. However, in many industries it can take years to get a product to market. Assessing patent filings in such instances provides an indicator of activity. It can also help you to assess your business model in comparison to industry trends.

Further reading: 'Reveal your competitive advantage', Jason Resnick, IAM (January 2006); 'The secret of our success', 'Unlock your IP', Jason Resnick, IAM (CHECK); Marc Kaufman, IP Review

10 I understand IP, but what is IA and IC?

The honest answer is that they're all the same thing, viewed from different angles. IP addresses the fact that intellectual property behaves like property: you can buy it, rent it, exclude other people from it. IA (intellectual asset) focuses on the fact that it's an asset rather than merely a liability: it can create value through strategic deployment, through growing a thicket of IP Rights that competitors cannot penetrate or (in the case of so-called 'patent trolls') by laying down IP Rights that earn rent from passers-by who chance upon them. IC (intellectual capital) describes the ability of IP to influence the capital value of its owner and to act as a mechanism that triggers the release of capital when it is securitised. 'There is value to be derived from non-IP intangibles, or "I-Stuff"', says Suzanne Harrison. 'Only a small percentage of "I-Stuff" can be protected, but quantifying it can help companies better understand the value of their assets and extract financial return from them as a result.'

Further reading: Edison in the Boardroom, Suzanne Harrison (2004); 'Backing the ideas generation', Dr Caroline Sincock, IP Review

About CPA Global

With clients in over 100 countries, CPA Global is a leading provider of legal process outsourcing services and the world's top intellectual property (IP) management specialist. Founded in 1969, CPA Global provides lifecycle management services for intellectual property such as patent, design and trademark searching, watching, renewals, and portfolio strategy in over 181 jurisdictions. CPA Global is also a leader in the growing market for outsourced contract management and litigation support services, helping law firms and corporations to realize value by managing risk, cost and capacity. CPA Global employs over 1,000 people in 16 offices in 8 countries. www.cpaglobal.com