There is a much-quoted statistic that 80% of market capitalisation now resides in intangible assets. I have often wondered about the origin of this statistic and what sort of inference we should take from it. Certainly, many presenters imply that these intangible assets are intellectual property and in that way legitimise the dramatic importance of intellectual property in the 21st century. But is this a realistic analysis?
There are many reasons why fixed-asset heavy businesses no longer predominate in Europe and the United States – for example, the growth of pure software businesses such as Oracle, Google and Microsoft. But the picture is more complex: looking deeper, many businesses have simply moved their assets off balance sheet and only appear to be asset light.
The predominance of sale and leaseback arrangements for capital-intensive assets is one reason. This is driven by tax planning (lease payments are deductible) and accounting, since the return on assets is higher in companies with lower asset bases. Further, markets tend to reward management focus on operations and fail to recognise any value for static assets such as real estate or aircraft.
Another reason is the ability of companies to reap economies of scale by outsourcing manufacturing. This trend has transformed many industries, from semiconductor to automotive. Even pharmaceutical companies outsource a large percentage of production. This outsourcing of plant, machinery and often labour management does not imply that the business is now an IP business (actually not much has changed), but simply breaks up the model into pieces that optimise returns.
Ironically, some studies show that the divorce of manufacturing from conception results in a reduction in innovative capability – it turns out that innovation is iterative and learning from the factory floor is invaluable for product development.
So what does the 80% number mean and has it established a paradigm that we accept too readily as the basis for other assertions?
Half-life of ideas
I recently read Tom Brakke’s investment blog, where he discusses Samuel Arbesman’s 2012 book The Half-life of Facts: Why Everything We Know Has an Expiration Date. It led me to Shane Parrish and made me think about the half-life of our ideas about intellectual property. Much of what follows below is taken directly from the thoughts of these two investment professionals.
Brakke states that there is a disintegration of accepted knowledge across all disciplines. In certain fields, the body of knowledge changes pretty slowly; in others, much more quickly.
What is the half-life of an investment theme such as intellectual property as an asset class? Or of an investment belief, such as that intellectual property comprises 80% of market value? Brakke states that their lengths depend on the economic actors who recognise, characterise, capitalise, organise, sensationalise, fantasise and ultimately marginalise the concepts in play. The IPBC is a hotbed of such participants and, judging from the proliferation of conferences for investors, the community is growing.
Brakke also states that there are few universal truths when it comes to markets. But there are certainly dominant beliefs that drive the pricing of securities and the behaviour of markets. Gauging how sustainable those beliefs are, what will cause them to change and how quickly they might change is a valuable and elusive skill. Timing is everything.
As a relevant example, we can look at the formation of large multi-portfolio non-practising entities (NPEs). The two pioneers of this model are Acacia and Intellectual Ventures (IV), founded in 1993 and 2000, respectively. When they started, the economic and regulatory environment supported their thesis and IP owners and investors poured assets and money in. Further money followed, validating and reinforcing the concept. But it looks less attractive now. IV has changed its business model and the Acacia stock price is trading near a five-year low. Where was that turning point? What were the signs that the change was afoot?
Dealing with conceptual change
These kinds of conceptual change – regarding individual investment vehicles and themes/strategies – are the province of active managers and others trying to 'play' the market in real time, which is one reason why hedge funds have been quite active in the IP space. Other shifts happen more slowly. Sometimes the tectonic plates are moving for quite a while before the earthquake occurs. Even if we notice a few signs along the way, it is the earthquake that gets our attention. In other cases, it is as if we awoke to a new world, even though we felt nothing in our sleep. I wonder whether Alice v CLS is such an event.
Parrish uses a chart that shows how accepted facts about something as critical as hepatitis and cirrhosis can change over time (below).
He also goes on to explain how knowledge that evolves improves as a result of the iteration. In quoting Zen and the Art of Motorcycle Maintenance, Einstein and Isaac Asimov, he makes a vivid and persuasive argument.
Brakke notes that because of the decay across all levels of knowledge, assessing the nature and pace of change should be a core competency of investment organisations, yet most are not structured or oriented to deal with the transformations in an organised way. I think that this is one reason why convincing investors of the global shift towards intellectual capital and the consequent value of intellectual property is so difficult.
But what does all this have to do with the 80% quote? For IP professionals seeking to interact with the mainstream financial markets, what we say is important. As Brakke says, the ways that our beliefs about intellectual property are marketed as truths can lead to a “truthiness” that appears valid until it does not. I for one will be more careful in what I say going forward.
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