Four Kinds of Patent Value
Patents create value for their owners in a variety of different ways. One of the biggest problems with nearly all patent valuation techniques is a failure to be explicit about what kind of value they are attempting to measure. It is essential to have an accurate model of value types in order to identify the source of the information that is needed, and also to formulate the correct approach for interpreting that information.
The Four Kinds of Patent Value
Patents basically allow the rights holder to pursue legal measures to prevent others from practicing the subject matter. This is the reason why many people are quick to point out that patents are only valuable in the way that they act as a blocking mechanism, and this is certainly true. However, although it is very important, it is not accurate to say that the value of a patent is purely a function of its enforceability. In practice, there are different ways to use patents to create value, and people are getting more creative about it all the time.
I group the major ways patents create private economic value into four dimensions.
1. Practicing
The first and most obvious method for realizing economic value from patents is by producing and selling products which embody the patent. This is what is known as “practicing” the patent. Value derives from the producer’s ability to exclude competitors and therefore earn monopoly profits. In practice, this type of value is virtually impossible to measure directly particularly because it is nearly impossible to determine exactly how much value is attributable to the patent’s exclusionary rights versus all other factors such as superior design, branding, timing, market power, other intellectual property, and existing manufacturing efficiencies. Another problem is that the value that a company may ascribe to a patent in this context will not normally be the same as the price at which the patent would transact in the market.
2. Licensing
An alternative to practicing a patent is to license its rights to another entity. Licensing value is realized when the licensee pays royalties and other fees to the licensor. Thus, value is created through royalties on the sales of any products that embody the product and therefore can be viewed as a function of the ultimate value from practicing the patent. This provides at least one way to observe directly the value specifically attributable to the patent in its ultimate application, and therefore addresses the problem with measuring practicing value. Licensing transactions also offer the opportunity to observe prices that occur in the market between willing entities. In practice, these are virtually impossible to observe because patent licenses are always confidential.
3. Litigating
An entity that does not practice or license a patent can sometimes receive value by leveraging the special legal status of patents. Recently, some patent holders (often referred to as “patent trolls”) use patents as an asset in a threatened or real patent infringement suit. In this case, the patent holder does not intend to practice the patent, but seeks value primarily through settlements and court awarded damages. The majority of patent disputes are settled out of court and are confidential. But, even if known, settlements and awards cannot represent the “market” for IP as they do not occur between two willing entities and amounts are distorted by legal rather than commercial considerations.
4. Deterring
“Defensive” patenting is the practice of filing patents for the purpose of providing a basis for counter-infringement claims in patent litigation. In a sense, it is the opposite of litigation value. As patent infringement litigation has accelerated, many companies have filed defensive patents to serve as a deterrant by increasing the cost to opponents of asserting patent rights. Obviously, measuring this kind of value is virtually impossible as its economic benefits are unknown except in rare cases.
One of the purposes of this taxonomy is that it helps us to understand the roles that IP plays in business strategy and therefore helps us to construct more coherent and effective IP management practices. Another benefit, is that it provides a way for better understanding patent valuation. Most patent valuation techniques suffer from a lack of clarity on this point. Because patents can create different kinds of value, we have to be clear which kind we are estimating when we do patent valuations otherwise our results will not be valid. In addition, being clear about the kind of value we are estimating makes it obvious what types of data are relevant.
The Four Kinds of Patent Value
Patents basically allow the rights holder to pursue legal measures to prevent others from practicing the subject matter. This is the reason why many people are quick to point out that patents are only valuable in the way that they act as a blocking mechanism, and this is certainly true. However, although it is very important, it is not accurate to say that the value of a patent is purely a function of its enforceability. In practice, there are different ways to use patents to create value, and people are getting more creative about it all the time.
I group the major ways patents create private economic value into four dimensions.
1. Practicing
The first and most obvious method for realizing economic value from patents is by producing and selling products which embody the patent. This is what is known as “practicing” the patent. Value derives from the producer’s ability to exclude competitors and therefore earn monopoly profits. In practice, this type of value is virtually impossible to measure directly particularly because it is nearly impossible to determine exactly how much value is attributable to the patent’s exclusionary rights versus all other factors such as superior design, branding, timing, market power, other intellectual property, and existing manufacturing efficiencies. Another problem is that the value that a company may ascribe to a patent in this context will not normally be the same as the price at which the patent would transact in the market.
2. Licensing
An alternative to practicing a patent is to license its rights to another entity. Licensing value is realized when the licensee pays royalties and other fees to the licensor. Thus, value is created through royalties on the sales of any products that embody the product and therefore can be viewed as a function of the ultimate value from practicing the patent. This provides at least one way to observe directly the value specifically attributable to the patent in its ultimate application, and therefore addresses the problem with measuring practicing value. Licensing transactions also offer the opportunity to observe prices that occur in the market between willing entities. In practice, these are virtually impossible to observe because patent licenses are always confidential.
3. Litigating
An entity that does not practice or license a patent can sometimes receive value by leveraging the special legal status of patents. Recently, some patent holders (often referred to as “patent trolls”) use patents as an asset in a threatened or real patent infringement suit. In this case, the patent holder does not intend to practice the patent, but seeks value primarily through settlements and court awarded damages. The majority of patent disputes are settled out of court and are confidential. But, even if known, settlements and awards cannot represent the “market” for IP as they do not occur between two willing entities and amounts are distorted by legal rather than commercial considerations.
4. Deterring
“Defensive” patenting is the practice of filing patents for the purpose of providing a basis for counter-infringement claims in patent litigation. In a sense, it is the opposite of litigation value. As patent infringement litigation has accelerated, many companies have filed defensive patents to serve as a deterrant by increasing the cost to opponents of asserting patent rights. Obviously, measuring this kind of value is virtually impossible as its economic benefits are unknown except in rare cases.
One of the purposes of this taxonomy is that it helps us to understand the roles that IP plays in business strategy and therefore helps us to construct more coherent and effective IP management practices. Another benefit, is that it provides a way for better understanding patent valuation. Most patent valuation techniques suffer from a lack of clarity on this point. Because patents can create different kinds of value, we have to be clear which kind we are estimating when we do patent valuations otherwise our results will not be valid. In addition, being clear about the kind of value we are estimating makes it obvious what types of data are relevant.
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