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I enjoyed Carl Weissman’s recent article on Xconomy (one of my favorite sites!) in which he talks about (among other things) how venture capital has lost it’s taste for investing in “risky” innovation. There is a lot of truth in what he says, “VCs are demanding that these technologies be ‘de-risked’ before they warrant venture investment, and of course they think this should be accomplished using other people’s money.” But, if it’s true - and I very much think it is - then it begs the question as to why. What has changed? Have VC’s collectively lost their nerve?

VCs are Too Big
One problem is that many of today’s funds have simply become too large to invest in innovation. Bets on disruptive ideas or radical new technologies that are unproven tend to be smaller. Remember that being “unproven” is the attribute that both risk and innovation share - by definition. But if you have a billion-dollar fund, it’s impractical to make investments averaging less than $10m each. The sheer number of investments in the portfolio would be overwhelming to try to manage.

Performance
However, there is a more important problem, and that has to do with returns. The fact is that many VC funds of recent vintage did not perform as hoped. Too many investments that were “disruptive”, “radical”, and “game-changing”, simply turned out to be “game-ending” instead. VC’s have largely responded by moving their investments down-stream to the growth phase. Many have commented, and I think it is true, that VC’s have become just another player in the Private Equity world. That means that they invest in growth not innovation.

“De-Risking” Innovation
But the amorphic nature of the word “innovation” never ceases to amaze me, and these PEs in VC clothing continue to wield it liberally in defense of their post-innovation investments. As Weissman insightfully notes, VCs continue to talk big about investing in “innovations” as long as they have been “de-risked”. This simply means that they want to take the “unproven” out of both innovation and risk. Of course, when you do that all that remains is growth. That’s not innovation and it obviously isn’t risk.

The Funding Gap is Real
The interesting thing is that all of this seems to prove that there is a funding gap after all, which Weissman is arguing doesn’t really exist. He says it is merely an “expectations gap”. Although that may be true, that gap exists in a very important place: the minds of the investors. If there is a gap in their expectations, then I would expect that to manifest itself in their investments - which is exactly what a “funding gap” is.

I think what has happened is that the established VCs have sort-of “grown up” with their investments. I look at it as like an elementary school that changes to being a high school and then a university as their students progress, rather than admitting a new crop of kindergarten-ers. Over time, VCs seem to have lost interest in the fresh new faces. Certainly they invest in new companies, but many of them aren’t as “new” as they may appear. They invest in people they know, people that they have invested in before, or people who have a “proven track record of success”. Those are all acceptable things to invest in, but investing in your friends it isn’t the same thing as investing in innovation.

What Is Next?
I think that this has created a situation that is rife for disruption. Investors willing to make smaller investments at earlier stages are likely discover that the higher returns associated with things that are “unproven” are still out there for the taking. In fact, Weissman may be proof of that. To bolster his argument that there is no funding gap, Weissman provides his own company as evidence that VCs still make early stage bets on innovation, while criticizing other VCs for not doing so. So which is it Carl? Have VC’s mostly moved away from risk and innovation, or are they mostly like you? You can’t have it both ways. My own experience is mixed. I have certainly interacted with a lot of VCs that aren’t bashful about their departure from the rough and tumble world of early-stage venturing. But, I have also met several new VCs over the past year that are talking about filling this gap as a core part of their investment strategy. I think that the funding gap is real (as is Weissman’s “expectations gap”), but that innovation is not dead - it’s just hungry.

Managers tend to misunderstand the difference between what kinds of value patents can create (practice, license, litigate, and deter), and the kinds of business models and strategies that they can be used to support. In a previous post, I said that this is the difference between motivations and modes. In a recent article in the MIT Sloan Management Review, there is some research that demonstrates this. The author and colleagues conducted a survey asking managers to describe the “purposes that IP rights served for their business-area strategies.” What their analysis revealed was not purposes at all, but a series of 5 “IP strategy scopes” which really just described how far the company would go to pursue IP protection.

1. Full-fledged IP Protection
2. Patent and trademark control
3. Trade. IP is mainly to be licensed out or sold off.
4. Pure branding.
5. Support core R&D

What is interesting about this is that numbers 2 and 4 really don’t relate to patent strategy at all - but to trademarks and branding. Therefore, there really are just three distinct “scopes” for patent strategy here. The first basically refers to the method of trying to protect every possible thing in an effort to block entire spaces. Scopes 3 and 5 are coherent in that they clearly identify their motivations and the kinds of value they are trying to generate. For scope 3, it is Licensing, and for scope 5 it is Practicing.

So, I found all of this interesting for the way that it demonstrates how murky IP management remains, and just how rare it is for managers to think clearly about how to integrate IP into their business models and strategies. It’s also interesting that a major conclusion of the study is the strong shift toward scope 1 (trying to use IP to block entire spaces) as the new “dominant practice” in IP management.

In a previous post, I outlined four ways that patents create value for their owners. I realize that this can be confusing, because patents have become integral to so many different business models and strategies. In fact, there has been such a profusion of IP/patent strategies and schemes and a so many flavors of innovation management, IP management (IPM), and intellectual asset management (IAM), that it is difficult to believe patents create value in only four ways. On the other hand, many people correctly point out that patents only create value in one way: by blocking others from doing something. The question is: do patents create value in one way, four ways, or a whole bunch of ways? In my mind, the answer to this question is more than academic. It really ought to form the basis for how any company or organization deals with intellectual property, and particularly patents.

Luckily, finding the answer to this question is not as difficult as it might appear. We simply have to return to what we know. A friend of mine is a professor of engineering at MIT and an expert in metals and structural failure. He likes to recount a story to his students that illustrates what I mean. On September 11, 2001, as he drove home from work he was pondering why the World Trade Center towers had completely collapsed. His first thought was that he would need to examine and analyze the details of the engineering of the WTC buildings in order to answer this question. But, he quickly remembered that he already knew everything necessary to understand what caused the collapse (and what didn’t cause it). When he got home he wrote out those things (he calls them “fundamentals”) in a list - things like the temperatures at which aircraft fuel burns and steel melts, and the weight of the airplane relative to the weight of the building. The list was surprisingly short, and formed the basis for a paper he wrote that has become the most highly cited on the subject and of a subsequent NOVA program.

My point is that it is easy to become confused about how to think about intellectual property. But a review of the “fundamentals” can be very helpful. So, here is my attempt to return to what we know.

What We Know (the “fundamentals”):

1. MECHANISM: First, we know that intellectual property provides the owner with the opportunity to prevent others from using or doing something in business. This is literally how one goes about enforcing the rights of a patent and is fundamentally a legal process. I like to think of this as the mechanism by which IP delivers value.
2. MOTIVATION: Second, that opportunity can produce different kinds of value for the owner. In other words, there are different benefits that IP owners can receive by preventing someone else from doing something. In my mind, these as the motivations for owning IP. In case you are wondering, this is where my “Four Kinds of Patents Value” fit.
3. MODE: Finally, there are a lot of different contexts, business models, and strategies that these motivations can support or be a part of. To me, these are the modes in which IP owners leverage IP to pursue their business objectives. Although there have been a few traditional modes, there seem to be more and more lately, and they are probably limited only by the human imagination. Incidentally, this is really what most people are referring to when they talk about IP strategy (or “innovation” or “IAM”).

What it Means:

I believe that there are two conclusions from this that are of immediate and tangible value:

First, this clarifies why it is so important to involve different people with different skills, knowledge, and perspectives in IP management. Said another way, this makes it more obvious why companies that bring people from across the organization together to participate in IP management are consistently more successful.

Second, it is essential to remember that the mechanism and motivations of IP management don’t change over time (or, not much anyway), and they are not something managers have any control over. What managers have control over primarily are the strategies or modes they use to leverage IP.

The benefit of this realization is that it allows managers a relatively simple framework for evaluating any IP strategy. To produce value, an IP strategy (mode) must combine enforceable IP (mechanism) with the promise of generating at least one type of value (motivation).

Unfortunately, what I see too often is management that hasn’t identified its specific objectives (motivations). In other words, they haven’t decided specifically what types of value they want from their IP - usually they want to pursue them all. This kind of IP management is expensive and largely pointless mostly because it doesn’t provide any way to decide which IP to pursue (or not to pursue), or for that matter, when, where, and how much. And, isn’t making those decisions mostly what managers do? It is impossible to visualize effective management in this situation.

I also think that the failure to define the core motivations for IP strategy explains why we are seeing such a strong shift towards what Markus Reitzig calls the “Full-fledged IP protection” strategy. He defines this as the pursuit of IP for “every possible minor invention in order to block entire technology spaces”, and his recent research shows that nearly everyone is moving in this direction. In other words, this is what “IP Management” has come to mean to most corporations. I have a friend who calls this strategy, “spray and pray”.

This is not only expensive and unfocused, but it also shifts the competitive efforts increasingly toward speculation and guesswork. It is also one reason why many view IP strategy as a “dark art”. Personally, I am deeply skeptical about this as a viable IP strategy for any company. I strongly favor making informed decisions supported by knowledge, and that kind of IP management takes place where mechanisms, motivations, and modes converge.

I have just added the new Ideanomics Dashboard which is an interactive anlytical tool for exploring the relationships between the traditional economy and the idea-economy. Thanks to Google the whole thing animates and you can even sit back and watch the movie if you want. Please take a look and offer any suggestions you have and I will do everything that I can to make it even better by adding more countries and more indicators. I am particularly interested in ideas on what types of indicators we could find data for that speak to the emergent idea economy. Also, I am interested in hearing your thoughts on other “dashboards” that we could add that you would find interesting and useful. It is clearly a work in progress and I am busy readying new data to add as we speak, so come back often to see progress. Enjoy…

NOTE: This is the third and final part of a three-part series. (Part 1 | Part 2)

In order to understand what information we need to observe to derive useful market pricing information for patents, we need to have a basic understanding of the ways that patents create value. Only then can we understand what types of transactions we are interested in observing and the correct way to interpret their meaning. In addition to this, before examining the value of patents it is essential to be clear as to what kind of value we are talking about.

Private Economic Value

Most patent valuation techniques are hampered by a failure to be sufficiently precise on what kind of value they are attempting to measure. The problem partly arises from the almost universal failure to distinguish between the scientific significance of a patent and its economic value. Even those that have made this distinction have failed to adequately distinguish between the private economic value they generate for their owners/licensees and the public economic returns they create for society. To produce the kind of patent valuation metrics described above, it is essential to have information that measures the private economic value patents create.

IP Market Signals

It is also essential to understand the way different actors in the IP supply chain transmit market signals about the value of patent rights. It is the final market for goods and services that ultimately determines the commercial value of patent rights. Therefore, it is only when the products which embody patents are commercialized and sold to final consumers that economic value is established. This insight allows us to eliminate consideration of both litigation and deterrant value in searching for an optic on the market for IP. From this perspective, it is the “Practicing” value that is the most direct measurement of patent’s ultimate value.

However, this is not the specific type of value that we are most interested in observing. Remember that the need described here is for visibility on the market prices for IP. This is because all of our management tools and instruments rely on access to this particular kind of value. Thus we are most interested in the market-clearing price for patent rights. Only this particular definition of patent value can provide the necessary input to enable the adaptation of existing business skills and mechanisms to the ‘idea economy’.

Since market transactions occur between willing and knowledgeable parties, the market-clearing price for IP will also be influenced by the supplier. When the creator of IP is internal to the same organization that commercializes the final product, it is virtually impossible to observe “market” pricing. Therefore, it is only when patent rights are transacted between entities, as in the case of licensing, that we can accurately observe the sythesis of the influence of all of the actors in the IP supply chain.

Finally, in addition to the influence of the actors, market transactions also compound critical information about broader market forces and other external factors such as macroeconomic fluctuations, changes in regulation, the impact of key litigation, and many other influences that bear on the pricing of the transactions. This underlines the point that the most relevant and valuable IP valuation data are transaction prices between parties, or in other words, licensing transactions. The pricing of these market transactions alone reflect the true fusion all economic factors, and therefore, are the correct target of observation for measuring the market value of patents.

Conclusions

Four key conclusions come from this discussion of patent value:

1. Our ability to manage IP is limited by our inability to reliably measure its value.

2. Licensing value is the only type of patent value that can be measured consistently and reliably.

3. Only licensing transactions offer a valid measurement of the distinct economic value attributable to patent rights.

4. Only licensing transactions provide the opportunity to observe the “fair market value” of IP.

Based on this, the most viable solution is to gain access to observe a large number of licensing transactions as they occur and accumulate revenue over time. As noted above, the challenge is that these transactions are strictly confidential, and this is the reason that previous attempts to access this data have been unsuccessful. The need, therefore, is for a solution that provides a way to observe the market for IP transactions (or at least a statistically significant portion) which does not compromise the confidentiality of the transactions. Second, this data must be analyzed in such a way that the results can be accurately generalized to the larger space of patents. If you would like to learn more about this, my research on “Patent Citations and Licensing Value” examines the extent to which this kind of approach could produce meaningful metrics.