Demonstrating ROI from your IP portfolio
This is an Insight article, written by a selected partner as part of IAM's co-published content. Read more on Insight
KPIs for IP portfolio management
In today’s ever-increasing competitive landscape, the link between a firm’s knowledge assets and intellectual property and the firm’s overall competitive advantage and business success has become a key area of focus for the C-suite. This is seen in the way in which companies are paying greater attention to making the right investments in intellectual property and managing the resulting portfolio of IP assets effectively and efficiently to create and maintain these business advantages and revenue and profit opportunities.
However, it is still often the case that IP rights are viewed as legal rights rather than managed as strategic business assets. Unsurprisingly, in such environments, IP programmes are usually assessed through secondary metrics, such as the number of patents in the company’s portfolio, which may provide no useful insight into the portfolio’s economic value to the firm. In contrast, most business asset management frameworks use metrics that provide clear insights into the value of the assets being managed. For example, in financial portfolio management, portfolios are evaluated on the returns that they generate, their risk profiles and management cost efficiency, among other things. These metrics provide direct insight into the comparative performance of investment and resource-allocation decisions.
The difficulty of measuring IP value can be attributed, at least in part, to the fact that intangible assets are a complex class of assets to manage. Intangible assets are hard to identify and track, are easily lost, volatile in value and high-risk, notwithstanding their high value and critical role to the enterprise. In addition, they require cross-functional expertise to manage well. These attributes do not, however, preclude applying sound portfolio and business management principles. In fact, given that intangibles constitute the most of a firm’s value in today’s economy, it is critical that these assets be managed within a business value and operational efficiency framework, using key performance indicators (KPIs) that provide useful insights to the business.
As a full discussion of the conceptual underpinnings of such a framework is outside the scope of this chapter, we shall instead focus on one KPI that we use to help clients develop a robust IP management programme, namely, return on investment (ROI). ROI is a powerful and sound decision-making tool because it is relatively simple in its derivation and application.
What does ROI measure?
As with any capital allocation decision, companies seek to evaluate the benefits against the costs associated with various IP decision options. The benefits can take multiple forms. For instance, IP investments may allow for the development of differentiated products that yield new market and growth opportunities, ability to price products higher, lower costs and improve margins, among other things. When assessing the payoffs from an investment, firms often miss the tax benefit that may accrue from strategic tax planning around key IP decisions. Similarly, the cost associated with the decision may also be many-layered and include direct costs (eg, R&D investments) as well as more operational or indirect costs (eg, support functions).
ROI is a commonly used metric to encapsulate the cost-benefit trade-off. The benefits of the investment – the ‘return’ – is assessed relative to the costs – the ‘investment’ – by computing the ratio as follows:
While the appeal of the metric is its conceptual simplicity, it also has other attractive attributes:
- its logical foundations are consistent with the economic investment decision frameworks such as net present value and internal rate of return often used in strategic planning;
- it is understood by key decision makers on the business side of the organisation; and
- it can be adapted to support decision making over long horizons and when outcomes are uncertain.
In addition, just as it can be used to evaluate future investments, it can be computed to assess the performance of prior investments. Further, an ROI assessment can be complemented by advanced strategic options or decision tree analysis in high-stakes decision making.
In other words, ROI is a measure that can be powerfully applied to provide historical perspectives or to evaluate prospective decisions. Perhaps even more importantly, it provides IP departments a way to communicate with a language and vocabulary that is familiar to business leaders and to generate greater support for securing the resources that they need.
Applying ROI to IP decisions
One of the challenges of applying ROI in an IP context is the measurement of IP benefits. This chapter uses patents to illustrate, even though the ROI assessment can be applied to all forms of intellectual property.
The benefit of patents (ie, the return) can be characterised in many ways (eg, protecting competitive advantage or hedging against third-party claims of infringement), all of which are difficult to measure. While these benefits are clearly relevant, as a practical matter, it may be worth considering a more quantitative measure, such as the ‘revenue protection’ aspect of patents. Patents serve a basic function of protecting firm revenue. If a firm generates revenue from a product that is patent protected, that revenue should be more resilient against competitive attacks compared to that of a non-protected product. The non-patent scenario is well known:
- Firm A introduces a new product;
- it establishes market dominance; and
- competitors introduce similar products that reduce Firm A’s market share and revenue over time.
In our simplistic scenario, had Firm A’s product been patent protected, the market share and revenue would likely have been less affected and remained stable for a longer period. Therefore, in this example, the additional revenue that patent protection provides can serve as a measure of the benefit, the numerator in an ROI analysis.
If taken further, ROI can support other, more nuanced approaches. For example, it can be expanded to consider such question as:
- What portion of a product’s revenue is attributable to the patent or patent portfolio? Can it be quantified and, in turn, serve as a discounting factor in the analysis?
- Does the patent allow the firm to charge a premium? Is that premium an appropriate input for the ROI discussion?
- How might we model our patent-protected revenue streams as a function of time? What can we assume about competition, technical obsolescence and shifting market preferences, among other things?
- What costs can the firm avoid by virtue of its patents? Do the patents, for example, allow the firm to avoid paying a royalty to a third party (eg, this may result if two firms avoid confronting each over due to the deterrent effect of each firm’s portfolio)? Is the avoided cost a suitable basis for assigning return to the patent?
- What is the incremental or marginal value of securing additional patents for a given product?
We might factor into the analysis the probability of prevailing in patent litigation. Litigation history often demonstrates a measurable correlation between the size of a patent portfolio and the odds of success in litigation.
It is challenging to discuss the specifics of how the numerator (the benefit) and the denominator (the cost or investment) should be accurately measured without detailed information about the facts and circumstances surrounding the business assessments being made. In this chapter we present a few examples of IP portfolio management situation regularly faced by IP professionals to give the reader a chance to recognise the power of applying ROI as a KPI.
Firms can use ROI as a basis for assessing the extent (ie, portfolio size) of patent protection needed for a given product. The benefit of a protected revenue stream (the ROI numerator) may be assessed against the costs of securing patent protection (the ROI denominator). The benefit may vary depending on the market conditions. For instance, in a rapidly changing technology landscape or one in which substitute or alternative technology options are available, the benefit of protections may be significantly lower than for other products or markets.
Once the ROI is computed around a specific patenting decision, the next step would be to compare it against internal benchmarks for return expectation to provide a basis for decision making. In addition, it is helpful to benchmark the resulting conclusions against external market data as a test of reasonableness. For example, if the ROI analysis is supplemented with an analysis that compares the ratios of patents held by competitors for a given level of revenues, say $10 million, it allows the IP department to assess individual patents decisions at the micro level and at the patent-group level, and thereby enable the IP team to present a stronger and more rigorous case to business decision makers for funding.
ROI can also be used during the strategic resource-allocation decision process. A firm may face the decision to file another patent or instead invest the cost of patenting in additional research and development. A comparative analysis of the benefits – higher revenue over time from a known product with a well understood risk profile protected by a patent versus potentially higher but uncertain revenues from future products – can be assessed relative to, in this case, the same cost base. This of course requires greater communication with and information flow from the finance department, but it also provides an improved basis for informed decision making.
ROI can be used to make patent maintenance payment decisions. For example, the USPTO requires a payment of $7,400 to keep a patent alive at the 12-year, post-grant date for a large entity. ROI can help the firm decide whether that payment is economically sound. Clearly, this requires an analysis of whether the patent is core to the business but also, when it is not core, whether it has value in the market to third parties. The ROI analysis allows the IP team to convey a sense of analytic rigour but also increases connectivity to and better engagement from the business. It enables discussions around strategic business questions, such as:
- What is the anticipated future revenue stream of the protected product, particularly because the product has been on the market for at least 12 years?
- Is it still generating licensing income?
- What is the risk of competitive threat to that product at this stage in its life (ie, is the patent still necessary to deter competitors)?
Introducing risk considerations into ROI analysis
Risk is an important consideration in the decision-making process. Yet, it would appear that there is no room to consider risk in analysis where the ratio that is computed has only return and cost as drivers. The limitation is further compounded by the fact that high return or high ROI alternatives typically have higher risks associated with them.
Fortunately, there are ways to incorporate risk into the analysis to allow for better decision making. One of the easiest ways to implement such an approach is to perform ‘what if’ scenario analyses. Scenario planning is similar in some respects but also different from contingency planning, where the question focuses on one source uncertainty. For example, a typical contingency question may focus on the ramification of not getting a patent, whereas a scenario analysis may consider various uncertainties, and the inter-linkages between the scenarios.
Armed with an understanding of the outcomes in various scenarios, it then becomes possible to estimate expected benefits or returns, and to weight the benefits under the various scenarios by the likelihood of them being realised. Further, a scenario modelling exercise can also allow the IP team to go beyond quantifying risk – it allows for the clear mapping of decision trees and for the consideration of strategic options that create opportunities to manage, or even mitigate the risk. In fact, many patent decisions can be analogised to purchasing an option. For example, filing a provisional patent application is like buying an option, the right to file a more expensive patent application later. Similarly, a comparatively inexpensive Patent Cooperation Treaty patent application buys the option to pursue much more expensive patents in other countries at a later date.
In short, a scenario analysis allows for the consideration of risk in an ROI assessment, by providing insight into the range of possibilities, thereby encouraging decision makers to consider options that would have otherwise been missed. It has the added benefit from a communication standpoint that it can help the IP team develop narratives that are easier to grasp for the business.
The ROI assessment can be applied to many forms of IP decision making. While it is conceptually simple and robust in its theoretical underpinnings, it is not trivial to apply. It involves a deeper examination of economic and business questions and requires greater communication with the operating business and teams, such as financial planning and analysis. Still, the discipline that ROI thinking brings, even when the ratio itself is hard to compute, improves the business decision-making process and allows the IP teams previously frustrated by their inability to communicate the value proposition, to communicate with the business in a language that they understand. This puts the IP team in a much better position to secure the resources necessary to optimise the management of the IP portfolio and create organisational value.