27 May 2007

Patent Auctions, Where Are the Buyers?

When the first patent auction by Ocean Tomo was held in San Francisco, it caused a huge media hype in the US. It looks that the next one, in London on June 1, will receive the same attention from European media (if by then, we do not have an overdose of hype already because of the Michael Jackson auction on Wednesday and Thursday). The reason it will is, no doubt, because of the esoteric nature of the goods being auctioned. We can imagine old cars, antique books, art, wines and other “tangible” goods being sold on an auction. Even 3G wireless licenses. But patents?

Trading products of the mind, like an invention embedded in a patent, or “intellectual assets” (or “intangible assets”) are much harder to imagine when it comes to putting value on it. “Value” makes most intangible assets indeterminate. But how come we can value 3G wireless licenses (be it too high) but we have trouble valuing patents? There are over 100 methods of putting a value on patents[1]. What is the “value” of a patent, or more broadly, value of intangible assets? In case of the 3G the value must have been driven by market (and profit) expectations. But what profit can be made from patents?

These and other problematic issues make the auction of a patent a daring event. Or are we too much of an iconoclast to take issue with conventional wisdom that a patent is by itself and stripped from its application of the patented invention has no value at all?

Intangibles represent “immaterial” value, such as relationships of companies with its business partners, and its ability to innovate (R&D capital). Stripped from its context, however, the “value” of a patent is nothing but a assertion of a right to an invention, a monopoly right granted by the government for an innovation that is both new, inventive and contributes to the “art”. It is a long way from a “right” to “value”. For some the sole right to exclude others to use the same invention for which a patent has been obtained is what the real value of a patent is. Contrary to this view, licensing officers, business development and financial people interested in monetizing IP, see the real value of patent in its potential to add value to the organization (e.g. by shorten its own R&D time), or by establishing relationships in open innovation projects or by using it to realize financial value (e.g. lowering the cost of capital by securitization the license income stream that (some) patents generate.

So a smart buyer will ask himself some tough questions. Am I really interested in buying a right without the product that is the result of the patented invention, or the certainty that what is being described in the patent actually works for you? What is the value of that (paper) right that is being auctioned? Is it the right it conveys to exclude others and how sure can you be of that (have you not misread the claim, do you have a full overview on the closest prior art and did you do your due diligence on validity of what is being claimed? Or, do I buy to enlarge my own portfolio and to what extent? Does the offered patent grant me access to other players in the market by leveraging this new patent against the rights other companies have whose cooperation I seek? Although patents are meant to be useful, studies show that almost 95% of all patents have never been used in any product and have created no economic value. They are being filed as a guarantee (actually rather an expectation) that it deters competitors from copying the invention. Patent as a “freedom to operate” mechanism. But how does that confer value to any other party than the originator of the invention?

So, one wonders, who is interested in a patent without some proof attached to it that the invention has potential applications or is capable of rendering a commercially viable product? Yes surely patents are being traded, actually in quite large numbers. These patents are being traded (either sold or exclusively licensed) after detailed negotiations and careful due diligence on behalf of the buyer, in private dealing rooms.

But how about auctions? Tim Harford, in the Financial Times Magazine (“Under the hammer”) cites economist Paul Klemperer, Europe’s best known auction expert, who showed that trivial seeming features of an auction can have big (and sometimes disastrous) effects by repelling bidders. Take the question whether there should be an open or secret reserve. Auction theory offers an argument that a secret reserve price is better (IPA did that during the Munich patent auction, however, no bidders). The idea behind it is that bidders, confronted with gradually ascending bids will draw confidence that a bidder is not alone in valuing the item, even if the bids are too low to reach the reserve. In 2001 Katkar and Reily put this theory to the test by selling 50 matched pairs of collectible cards, 50% open and 50% secret reserve of the same level. They concluded that secret reserve is counterproductive. Far from stimulating interest they seem to put off bidders, fearing that a secret reserve is secret because it is far too high.

A further misconception is that small inventors or SMEs when seeing the figures for which patents in total have been auctioned (as Ocean Tomo did), might be lured into thinking that having a patent will make them rich. As we wrote earlier, there is a lot more needed to make money out of a patent than selling it on an auction.

In that respect IP auctions will not be the value driver of IP that some will make you belief it is.

[1] Relief from royalty, Excess profits or notional maximum royalty payable, Capitalization of earnings, Net present value of incremental cash flows, Gross profit differential, Premium sales price , Comparable market transactions, Cost based, etc. etc


Anonymous said...

All of your very rational comments are very rational.

But what you left out (and I can speak from experience having attended one of the Ocean Tomo patent auctions), is that auctions are fun!

IPEG said...

all true, there needs to be something to laugh, I agree! So let's go on with this fun events, do not get me wrong on that.