Patent Valuation revisisted

An insurance policy is an example of a defined benefit. When some defined and unwanted incident occurs the policy holder gets a defined financial benefit. These are relatively easy for the insurance companies to price although they do seem to make a meal of it sometimes.

A patent on the other hand is an option to receive an undefined benefit.

Let me explain; like an insurance policy a patent has significant costs that are ongoing. However, unlike an insurance policy, when something goes wrong (say a competitor copies a product), all the patent owner has is the right but not the obligation to attempt to enforce their patent rights, at great cost. When a patent owner attempts to enforce their patent rights they have no idea what the outcome will be, hence the term ‘undefined benefit’.

The results can be wildly different; for example, a patent owner’s patent can be invalidated in court so, not only do they receive no upside, they may be well out of pocket in costs. They can also be penalised for unjustified (patent aligned) threats against a competitor.

Alternatively, they may win and get large punitive damages (in the US) and get rid of some competition thereby going on to receive more financial benefits from increased market share and/or gross margin (after they put prices up to exploit their monopoly).

In another example, a competitor may choose not to compete with a patent owner. The patent owner normally has no idea this has occurred and therefore no way of valuing this benefit.

There are dozens of scenarios for future undefined benefits that flow from owning patents. And only one of these has a defined benefit and that is when a patent is licensed by contract to a third party with guaranteed cash flows to the patent owner. In this sole scenario an ‘option to receive a undefined benefit’ has been converted to a defined benefit.

So you might be able to see why it is so hard to put a value on patents except in the case where a patent already has guaranteed licensing revenue. If the insurance companies and their actuaries have a hard time pricing scenarios for defined benefits can you imagine how they would go if they were pricing an option for an undefined benefit?

On a global basis my gut feeling tells me that there is more money going into the patent system than defined benefits flowing out. That is, I suspect that all the patent costs and enforcement costs of patent owners, and lost opportunity costs for competitors, add up to more than all the increased profits to patent owners. But I can’t prove this. The beneficiaries of these global private sector losses in the patent systems are the governments (and related agencies) and the patent service providers.

What I do know is that ALL patent valuations models, apart from Discounted Cash Flow calculations on patents with licencing revenues, are pretty much useless. As a result there is no consensus as to what patents are worth except that many parties have decided that they are worthless, which is a consensus of sorts. How do I know this? Well being the part owner of a patent broker I can tell you that most large operating companies are very, very reluctant to acquire patents at any cost. In fact in most cases you can’t give patents away. And this mood is spreading rapidly.

The crux of the problem is this. Only a small fraction of patents can be lucratively enforced or used to create a useful monopoly but no one knows ahead of time which fraction this is. Patent valuation models that include scenario analyses just highlight that there is no good way to assign a probability to any particular future for the economic value of patents.

To put this into plain English; no one has yet found a good correlation between any of the quantitative or qualitative aspect of patents, and the two cohorts of patents – that tiny fraction that end up being worth a lot of money to their owners and the majority that create losses for their owners.

Part of the problem is also that the value of patent enforcement option rights is relative to who owns the patents. The same patent might be worth much more in the hands of a large segment-dominating corporate compared to a backyard inventor. So the valuation problem is compounded by the relative value of the assets. The qualitative factors such as those described here that impact the value of patents also happen to very hard to measure.

I have an idea as to what we can do in attempt to elucidate what patents are worth before the option to exercise an undefined benefit is executed, and it is this…

When something is way too complex to value, as patents are, the very best way to value them is to create a market. Human markets somehow manage to get to an equilibrium where the market is profitable and hence the assets are properly priced. Human society with it’s inherent drive to consume and it’s social intelligence somehow represents one big learning algorithm. I don’t think there is a pricing challenge for assets that we haven’t yet conquered by turning to the market solution.

So what we need to do with patents is to create a real market as free as possible from unnecessary government constraints. We need to let the ‘business model’ for patent systems float until a profitable and measurable system evolves.

One way we can do this is to remove the monopoly of the patent offices and their fixed cost-plus pricing models. If we had competing and privately owned patent offices, operating under license from a government and free from any specific pricing model, then the costs of attaining a patent would float until the market was profitable. Then and only then would we know what patents are worth and which model for patent systems makes sense.

You might think that a privately owned patent office would be inclined to grant every patent so as to increase their revenues. But maybe not because after a while those patents would be worth less as they were known to be readily invalidated in courts.

Indeed the situation might arise where one of the privately owned patent offices actually paid patent owners to get their inventions patented for a profit share. Or everyone might drift to the low cost utility patent model where examination of patents only occurs when they are enforced or challenged. Whatever would happen I can assure you this, it would look very different to the patent systems that we have today.

Many government functions are outsourced to private entities and I can see no reason why this shouldn’t extend to patent offices. After all, a patent office doesn’t actually grant any monopolies; they just grant an option to receive an undefined benefit via a implied future monopoly which is usually adjudicated upon by another government monopoly agency – the courts.

In summary, today we have a bloody awful situation where patents are granted by an inflexible government monopoly agency with a fixed and outdated business model, and where there is no probabilistic means to value the options implied in a patent to receive an undefined benefit.

This is very silly because we are under-utilising the incredible asset that patent systems represent. If patents could be valued by a proper market mechanism via new ‘business model’ then we might see a lot more investment into technology. And give some of the challenges we are facing on this planet we are going to need all the technology investment that we can get.