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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.

Note: This is the second of a three-part post. (Part 1 | Part 3)

If there is such a great need for pricing information on the global IP market, then why has no one ever bothered to gather it together and analyze it? Unfortunately, this is a difficult question to answer, partly because different people give different reasons. Many understand that the fact that virtually all IP transactions are confidential makes it extremely difficult to gather this information. However, there are also a lot of misconceptions, particularly regarding patents, that are often cited as fundamental reasons why this kind of data wouldn’t be meaningful even if it were available.

One issue that has been widely blamed for the non-emergence of IP markets is the fact that IP assets are all unique by definition, and therefore transaction prices cannot be comparable. However, the attributes that distinguish patents within a definable group do not appear to have a distortive influence on the dimension of market value. Although patents within a specific technical area are all scientifically distinct in some dimensions, it is not evident that these differences are the driving factor in determining the market price. It is important to remember that what makes patents different scientifically is very different than what makes them different economically. The scientific and economic dimensions are less interconnected than most people think, and this is a major source of confusion about valuation.

More important, however, is this argument misunderstands the role of market data in many if not most contexts in which it is successfully used. First, it falsely assumes that other types of assets or products being traded in market are truly identical, or at least that their differences have a smaller impact on their economic value. In fact, there are very few products and markets where the products are truly homogeneous (sometimes thought of as “commodities”). Many things that appear to be commodities actually exhibit considerable variance along dimensions that have meaningful impacts on price.

Most market pricing data are aggregated, reported, and used in ways that obscure the impact of variability in attributes on pricing. An example of this is an automobile blue book. If you look-up the price for a particular car model and year you will see a high value (implying a car that has marginally higher than average value - usually associated with better condition or features) a low value (implying worse condition or features) and a mid point (implying typical condition and features). In reality, these numbers obscure the variability associated with these and a lot of other attributes such as where the transaction takes place, and even what color the car is. Obviously some variation in price is attributable to things like the color which are not visible in the market data (the blue book). Nevertheless this data is used to successfully enable what has become a very fluid market in used cars.

Looking at other types of assets such as real estate, industrial equipment, and labor reveals how much more variability is associated with other markets. Yet, the existence of the variability does not eliminate the usefulness of market data in negotiating transactions and providing the key input for sophisticated financing instruments such as securitization, insurance, and more. In fact, most market data that is used as the basis of a wide range of industries is aggregated, averaged, or summarized in ways that obscure significant variations in the attributes of the assets or products. Market pricing data are almost never generated in a context of perfect comparability. For this argument to be valid, one would need to demonstrate that the dimension of variation in the attributes within other markets has a proportionately smaller impact on aggregate market pricing data than it does in patents. However, there is really no evidence to support this.

Another version of this argument is that because patents are scientifically unique, only one or a few companies will be in a position to commercialize them. Therefore, as the argument goes, patents cannot exhibit a “market value” as the market for any given patent is too small to be generalizable. However, this demonstrates a misunderstanding of the concept of market value. Even if an asset has only one buyer, it will have a market value at which it will trade hands. In this scenario, the market may be small but this will only have the effect of giving the buyer more bargaining power in the negotiation. For all of these reasons, we can reject the argument that the dissimilarity of patents prevents their economic comparability.

Further evidence supporting this view is that there actually have been many efforts to aggregate comparables for IP transactions over the years, some of which are embodied in commercial services. A substantial amount of effort has also been invested in alternative ways of approximating market value. In a way, the legitimacy and comparability of the data have already been defined by the demand for it in specific contexts. This is not surprising as it has actually been the case in other areas where market data are now used actively. Ultimately, the valid interpretation of the data will always be defined by the use case and the need, and as I have already argued, there are a lot of valid potential uses for IP market pricing data.

The folks over at WorldMapper.org have some pretty fascinating maps of the world, including one that shows the size of countries proportional to their contribution to the world’s patenting (data are from 2002). Where is the Southern Hemisphere you ask? (You can see pictures of it in National Geographic of course!)

Obviously it is not exactly an “innovation map” but they also have a similar map showing contribution to scientific literature (data from 2001). Patenting and scientific literature have been shown to be useful proxies at least for scientific and technological innovation in many studies. Of course, what these both leave out is every other kind of innovation.

But it sure throws the disparity of participation in the idea economy into bold relief. And it raises the legitimate question of whether the idea economy will really have the flattening or leveling affect that is often claimed. To the extent that intellectual property is one of the most important economic assets of the new millenium, what can the southern half of planet Earth do to participate in the idea economy?