Innovative groups including companies of all sizes, universities and individuals seek to maximise the value of their intellectual property by investing in R&D activities and pursuing patent protection. Medical device companies are particularly focused on converting R&D efforts into patent-protected products. However, these companies and innovators face constant challenges resulting from numerous changes in regulations, pricing coverage, tax regimes and IP rights. As a result, corresponding IP values within the medical device industry appear to be declining based on a study of identified licensing transactions and royalty rates. To improve IP value, licensors must focus on demonstrating product and technology value to differentiate their licensing opportunity from others on the market and to command higher royalty rates, better deal terms and potential multiple licensing opportunities across different end markets and licensees.
Significant changes in regulatory and tax policies are expected in 2017 and beyond as Donald Trump begins his term as president of the United States alongside a Republican-led House of Representatives and Senate. A driving message in Trump’s campaign was the repeal and replacement of the Affordable Care Act, a critical component of the US healthcare systems. At present, the act includes an excise tax of 2.3% on certain products sold by medical device manufacturers based in part on the corresponding increase of patient procedures. This tax policy, effective January 1 2013, potentially stripped billions of dollars of financial benefit from innovative companies focused on developing and commercialising intellectual property. On December 18 2015 the Consolidated Appropriations Act 2016 (Pub L 114-113) was signed into law and included a two-year moratorium on the medical device excise tax. As 2017 emerges with numerous fronts of political discord and uncertainty, there are a number of proposals and discussions set to repeal the medical device tax, including the Medical Device Access and Innovation Protection Act and the Protect Medical Innovation Act of 2017. So what is the connection to IP value?
IP licensing transactions data
One method of better understanding the market and the effect of the factors mentioned above on IP value is to analyse relevant IP licensing transactions. Using KTMine, an industry-leading source of IP-related data, 84 IP licensing transactions were selected for this analysis. The criteria used to determine the applicable transactions included:
- transactions with effective dates between January 1 2010 and December 31 2016;
- transactions that included a patent element; and
- transactions related to the field of “Healthcare: Products and Samples”, which is believed to generally relate to medical devices.
The analysis does not include outcomes of litigation-based licensing transactions or settlements.
The observations can be summarised as follows:
- From 2010 to 2016, the average royalty rate of licensed intellectual property was 9.41% of net sales.
- Royalty rates peaked from 2010 to 2012 at an average of 10.02% and dropped considerably to 6.57% from 2013 to 2016 (a decrease of approximately 35%).
- The 2016 data confirmed the downwards trend on an annual basis with an average royalty rate of 3.54%.
- The number of reported transactions decreased significantly in each analysed period.
|Year range||Deal count||Average||Median|
While the passage of the Affordable Care Act and its subsequent taxation (and the two-year moratorium) on the medical device industry is a likely factor for driving down the number of IP licensing transactions and corresponding royalty rates in the medical device industry, it is unlikely to be the only factor. Other factors that may negatively affect IP transactions and corresponding IP value include:
- the changing IP litigation landscape;
- regulatory and market challenges; and
- declining early-stage investment funding opportunities and direct investments in device and diagnostic companies as a percentage of overall venture capital funding (see here).
Further, this analysis is limited to data that is publicly available and data that was included in the search as queried. The chart below further illustrates the historical decline in royalty rates from 2010 to 2016.
Exemplary impact on IP value
Illustrating the decline in potential IP value is informative when considering the impact of declining royalty rates. Using the US Department of Commerce’s findings on the global medical device market for 2014 and 2015, the value of medical device exports in 2015 were estimated to be approximately $43.1 billion (based on the North American Industry Classification System (NAICS) codes selected for the Department of Commerce report). For illustration purposes, it is assumed that 25% of market revenues were generated from in-licensed intellectual property (versus internally developed innovations). The table below presents a calculation for the 2014 and 2015 period for seven selected NAICS codes.
The 2015 export revenue multiplied by 25% (an estimate of percentage of revenues derived from in-licensed intellectual property) equals $10.8 billion.
To illustrate the impact of royalty rates on annual royalty stream from a licensing transaction and resulting overall IP value, royalty rate averages from two periods were compared and analysed. The first royalty rate is the 2010-2012 average of 10.02% of net sales, and the second royalty rate is the 2013-2016 average of 6.57% of net sales.
According to the analysis below, innovators licensing intellectual property with the average royalty rate of 6.57% based on adjusted 2015 export revenues would have lost approximately $370 million in annual IP value compared to licensing their intellectual property at the historical average royalty rate of 10.02%. While the IP value decline for the licensor on an annual basis may be a significant loss of compensation, this cost saving allows the licensee to save money and continue to expend more funding into R&D and product development. The table below calculates the difference in values to the licensor of the licensed technologies.
Conclusion and actions
The number of publicly available IP licence transactions related to medical devices and corresponding royalty rates have been declining due in part to regulatory, tax and market uncertainty. These factors are directly related to IP value and are critical to consider when negotiating IP transactions. Additional detail and analysis can be provided, but below are key points of consideration and potential action.
- The process of repealing and replacing the Affordable Care Act will continue to deliver market uncertainty with respect to regulatory burdens, pricing and patient coverage, but transactions are expected to continue with greater technology convergence and consumerism through, for example, wearable health technologies.
Licensors seeking to license their intellectual property in an environment of declining royalty rates should:
- demonstrate and maximise product and technology value to differentiate their licensing opportunity in order to command higher royalty rates;
- seek to package the economics of a transaction such that the partners share the appropriate balance of risk to return; and
- consider adjacent projects or technologies in order to span multiple licensing partners for a technology platform.
- Few licensors reported multiple licence agreements either with different intellectual property or with different licensees. Those companies that reported multiple licence agreements generally commanded above-average royalty rates compared to companies that reported only one licence agreement.
- To drive royalty rates higher and to differentiate from industry norms, innovators should diligently investigate the attributes of the licensable intellectual property, including the prosecution stage, geographic coverage and the technology development stage.
- Companies seeking in-licensing opportunities may have a potential advantage negotiate favourable deal terms compared to years past.
For further information please contact:
Adapt IP Ventures LLC
Tel: +1 828 737 1600
This is a co-published article whose content has not been commissioned or written by the IAM editorial team, but which has been proofed and edited to run in accordance with the IAM style guide.