If You Can’t Measure IP, You Can’t Manage IP (1)

NOTE: This is the first part of a three-part post on the need for a new paradigm in IP valuation. More to come… (Part 2 | Part 3)

I have been pondering the wisdom of this classic quote by Peter Drucker, “If you can’t measure it, you can’t manage it.” (sometimes he is also quoted, “You can’t manage what you don’t measure”), and just how important the basic idea is to managing patents and other types of intellectual property. The implication is that you really can’t – manage IP that is – because we simply can’t measure the one thing that is most essential to management: VALUE.

I noted in my initial post on this blog, just how much the global economy has changed because of IP. The global economy has experienced a tectonic shift from a reliance on physical capital to intellectual capital. This tectonic shift is illustrated in the proportion of the value of corporations that is attributable to its intangibles – rising from around 20% 40 years ago to over 80% today.

It is fair to say that the world has not adapted to this new reality. Our current business infrastructure, practices, and regulations are designed across the board to support the tangible economy of the past. Accounting methodologies adequately measure and report physical assets. Business management practices offer powerful ways to strategically manipulate tangible, financial, and human resources. The financial world has evolved a rich variety of tools and instruments for capitalizing tangible businesses and activities. Government regulation and tax policies comprehend tangible assets and businesses. The problem is that none of these tools can be adapted to work with intangibles and intellectual property.

This is a major problem in the case of patents which have expressed, perhaps more than any other single economic institution, the dramatic nature of the ideanomic transformation. Patent applications have exploded by more than 400% over the past two decades, and patent licensing and litigation have grown even more dramatically. If innovation is truly the new “industrial religion”, then patents are now the cardinal virtue espoused and zealously sought by the faithful. Intellectual property has become one of the most valuable and important economic assets in the new ‘idea economy’.

The Challenge

The challenge in this new regime is that patents cannot be managed like any other kind of business asset. All of our business tools, practices, techniques, and instruments were designed to manage tangible and financial assets, and as a result they simply do not work with patents. The impact is that it is much more difficult to trade patents like other assets and as a result a global “market” for IP has not yet emerged despite predictions of its eminent arrival. In fact, it is virtually impossible to do anything with patents that we do with other assets.

We can’t manage them like a portfolio of any other kind of asset to accomplish even simple tasks such as optimizing the value of the portfolio or diversifying the economic risk in the portfolio. We can’t borrow against them, securitize them, insure them, or even audit them properly. It is a striking reality of the world economy that what has suddenly become perhaps the most valuable business asset is the one we are least able or equipped to manage successfully.

The fundamental reason for this is as striking in its simplicity as the era of ideanomics has been in its transformational sweep. The problem is rooted in our inability to know the economic value of intellectual assets. Virtually all business practices, techniques, and instruments – in fact practically everything we do that falls under the heading of “management” – requires knowing something about the value of the thing we are managing. Fundamentally, we need to be able to measure the things that we manage. It is true of physical assets like inventory, plant and equipment, real estate, and even human resources. It is also true of financial instruments. As the old adage applies very well to intellectual property: you can’t manage what you don’t measure.

In this context what is needed is a view on a very particular definition of value. Although we may be very interested in the intrinsic value, or the social value, or the scientific importance of IP for a lot of reasons, what we need most is to be able to use our accumulated set of business skills in managing IP is the “fair market value”. This is the price that the asset can be traded in the marketplace between willing parties (some times referred to as “fair value”) which is the universal gold-standard for defining the value of any asset, and upon which almost all management, auditing, and financial processes are founded.

The only way to know or measure this exact type of value is by observing the transactions that take place in the “market” for any given asset. In fact, it is obvious that one could not even pretend to effectively manage or trade in any kind of assets or resources without having up-to-date information about the market price. Ultimately, market pricing information is the key input enabling virtually all management capabilities, and is the catalyst enabling most of the processes and financial infrastructure of the modern business.

The Invisible Marketplace

The problem is that intellectual assets, and particularly patents, are not traded openly where the price can be observed. IP transactions are almost always confidential, and this is the reason that there has never been any systematic way to observe market prices. The absence of this critical information creates considerable friction in transacting intellectual property. As a result, fluid markets for IP have not fully developed. Though patent licensing has been growing at a very rapid pace, it remains small relative to the size of the asset base. Estimates of the value of un-utilized patents are in the trillions of dollars.

The lack of visibility on the markets for IP is one of the most significant challenges we face in our transition to the era of ideanomics. Companies need IP pricing information to focus their innovation investments, to maximize the value and quality of their IP portfolios, to reduce the cost of low-value patents, and to negotiate better license terms. Attorneys need it to craft more valuable patents for their clients and to facilitate negotiating infringement settlements. Auditors need it to more accurately measure and report corporate assets. Investors need it to analyze companies and sectors to inform their investment decisions. Financial institutions need it to be able to lend against and even securitize IP. Insurers need it to underwrite intellectual assets. This data is needed in evaluating assets and companies for mergers and acquisitions and for public offerings. It truly is the most important piece of missing data in the ‘idea economy’.