ABSTRACT The Adrenaline rushing sport of Formula One is not just a race among the…
The concept of Intellectual Property (IP) has not evolved over a decade rather, the origins of Intellectual Property can be traced back to the year 1623 when the British Law: Statute of Monopolies came into existence. Since then, the concept of Intellectual Property has grown significantly. The protection of ideas and inventions generated by an individual’s intellectual exercise is not limited to registration of Patents anymore. The field of Intellectual Property has been diversified into various branches like Trademarks, Patents, Copyrights, Designs, Plant Varieties, Trade Secrets and etc.
The distinct feature of intangibility makes the concept of Intellectual Property(IP) simple and complex at the same time. The nature of an IP is so simple that one can understand its importance just by looking around themselves. We are surrounded by IP’s; from our tooth brush to our car, from our laptops to a small pencil it’s all IP. Hence, to understand the value of something so important and useful becomes essential. It is now that the complex nature of an IP comes into play.
It is established that IPs are very valuable. An IP can be worth billions of dollars, like a patent in case of pharmaceuticals or in form of a trade secret for Coca-Cola. The complex nature of IP makes it very difficult for an IP owner to estimate the accurate value of his IP. It is the uniqueness of an IP that makes the assessment of its correct value so difficult because the primary feature of intangibility makes it pretty impossible for an evaluator to reach an accurate figure.The prominent feature of uniqueness makes it difficult to find a fair trade, there is no perfect scale to measure its value, lack of liquidity, absence of a market place where exchange of IP is possible and various other reasons why valuation of an Intellectual Property seems impossible.
No matter how impossible it may seem but there are some methods and parameters that different authors and scholars across the world have developed. The aim of this literature survey is to efficiently analyze and present those prominent methods and parameters that have been developed for value estimation of an Intellectual Property.
Purpose of IP Valuation
The purpose and objective of a project is directly linked to the desired outcome. Therefore, it is very important to know the purpose for which an IP is being evaluated. Clarity of the objective helps an evaluator to list out all the relevant factors and variety of parameters which might play a crucial role in the value estimation process. The link between the purpose and the value estimation has been demonstrated in the table mention below:
(This Table has been extracted from the Paper presented by Nick Bertolloti)
|Existing use value
|Value to the owner under the existing marketing operational and financial strategies. This ignores unexecuted plans to develop the intellectual property in new areas
|License Agreement Litigation Financial Reports Merger/Acquisition
|Amount that would be paid by a willing, but not anxious, buyer to a willing, but not anxious, seller adequately informed and acting at arm’s length in an open market.
|Transfer Pricing Merger/Acquisition License Agreement
|Assumes that the intangible are not operating as part of a going concern and that the assets will be soled is a forced sale situation.
|Security for debt finance.
Some of the purposes for which an IP’svalue is calculated are mentioned below:
- Licensing and Franchising:
Licensing and Franchising are one of the most common modes of exploiting an IP. The purpose of such transactions is to transfer the “right to use” that an IP owner enjoys either exclusively or non-exclusively (based on the nature of agreement) in exchange of some consideration (in the form of Royalty) for a specific period of time.
It is very important for a Licensor or a franchisor to know the exact value of their IP, if not exact than the nearest possible value that their IP is worth of. The value estimation of their IP will help them secure a royalty amount which they actually deserve. Similarly, it goes for the Licensee and the Franchisee. A franchisee wants to know the correct value of the IP he is taking the franchise of, to ensure that he is not paying more than the actual worth. Otherwise, he would suffer loss in the future.
- Merger, Acquisition, Joint Ventures and etc.
The value of IP plays a significant role in such transactions. Before a company gets involved in the operations of any other company or undertaking a detailed study of all the assets and liabilities of that company is done. In that process value the IP in a company plays a significant role. It is well-known concept that the mere name of a company like reliance is worth millions of dollars. In other words, the Trademark of the word ‘Reliance’ for Reliance Corporation is very valuable. A Trademark not only carries the identity but the goodwill of a brand.
Therefore, for accurate valuation of the assets in totality of the target company it is very important to find out the actual value of its IP. It is only then that a company can take a sound and informed decision about the cost of option, opportunity cost, share price, profitability of the decision, prospective benefits risk involved and other relevant factors.
- Corporate Financing
These are simple financial transactions in which the aim of the corporation is to procure funds and for that the subject approaches a financial institution. The borrower places his IP to be pledged as a warranty in exchange of funds. If an asset is to be deposited as a warranty, the correct value of that asset is very essential to the transaction because it is only the value of such asset that will determine whether the amount is to be sanctioned or not and if yes than how much.
There are different participants in these transactions and they all play a significant role. The purpose of this transaction also varies for each participant. The borrower’s aim is to find out the actual value of his IP to solidify his claim on the amount requested for, from the financial institution. If the value of the IP is satisfactory in comparison with the amount that is to be sanctioned then it will also reduce the warranty cost for the borrower. From the perspective of a financial institution the correct value of an IP is required to ensure that in case the borrower defaults in paying back the amount borrowed, the institution will be able to recover the amount back from the pledged IP easily. Financial Institutions are not only interested in the correct value of the IP but factors likeliquidity and possible markets for that IP are also considered.
The third participant actually plays the role of an umpire between the borrower and the creditor. The third participant in such transactions is the evaluating agency. Evaluating agencies are those agencies which actually perform the task of finding out the correct value of the IPpledged. They execute the common objective of both the first two participants of finding out the actual value of an IP.
- Strategic Guidance
It is very important for a business to re-evaluate its strategies and game plans time to time. In the modern era of cut throat competition, quick decisions, first mover advantage, and timely investment in R&D department of a business are the key to win over your competitors. It is fundamental that for a win-win business strategy the policy makers should have correct information about the value of all the assets and liabilities. Over estimation or under estimation of the IP can be fatal to the future prospects of a business. Hence, it becomes essential for an IP owner to know the correct value of such IP so that he can make suitable plans for its maintenance and development.
- Transfer Pricing
Government Authorities like Taxation Authorities keep a strict check on the valuation methods used to value an IP in a business. The expected value of an IP completely changes if the market conditions change. A change inn company’s IP value would impact the tax liability of that company. If there exists a substantial gap between the actual value and the expected value of an IP then it would certainly be reflected in the tax liability of that company which is a very dangerous pursuit for the health of a business.
- Financial Reporting
The increasing importance of IP as an asset has been recognized by the accounting standards. The International Accounting Standard Board (IASB) is not lacking behind in recognizing the importance of IP. The board specifically has started treating IP different from the category of goodwill in the column of assets. It is because of such changes that other important decisions like price of the share, important information that is to be shared with the shareholders and other decisions get influenced from the value of IP in a company. Other IP specific factors are also evolving and are given more weightage. For example, factors like expenditure on prosecution, marketing expenditure, policy to maintain an IP, periodical impairment tests and etc., are some of the factors which require accurate value of an IP.
- Insurance Purposes
Development of IP has opened up new horizons. Major players in the field of Insurance in developed countries have already started the practice to insure IP. Hence, in order to claim or even get the insurance protection for an IP it becomes more than necessary to know about the correct and accurate value of an IP.
- Litigation and amount of damages
In the world of IP infringement is something against which an IP owner has to work constantly and be aware about it all the time. It is a fundamental duty of an IP owner that if he/she wants to secure the value of their IP and do not want their IP to lose its distinctiveness, they have to sue all the infringers whenever they try to infringe their IP rights.
It is very important to understand that the Indian Judiciary is of the view that infringers should not only be abstained from infringing the rights of an IP owner rather, they should be punished monetarily to ensure deterrent effects on the potential infringers. It is clear that in order to ascertain what is the exact amount of damages that an IP owner has suffered due to infringement it is necessary that the owner should himself know the actual value of the IP that has been harmed in totality. Only then the plaintiff could pray for a sum for not only the actual and evident economic damages that the infringement has caused but also for the loss of value in IP which has tainted the reputation of his IP.
How to estimate the accurate of Value of an IP
In this literature survey, sufficient material has been presented to prove that IP is one of the most valued and essential type of asset. We have discussed the need, the different purposes and the multilayered difficulties that an evaluator comes across while finding out the correct value of an IP. Whereas, the important question of how to find out the correct value of an IP has yet not been answered. Therefore, now the I will submit the different methods, procedures, techniques and parameters that are available, have been used or have been talked about in different research papers of different authors across the globe.
Firstly, I would like to clarify that there cannot be a single checklist that can be prepared, which can be followed blindly to estimated the exact value of every IP. Rather, the methodology, pattern and parameters for every IP is very case specific. In other words, there does not exist a golden scale which can be used to find out the value of an IP simple, but, one has to study the purpose of evaluation and the nature of an IP to understand what method, which parameters would be suitable for that particular IP.
Different process and techniques based on various principles are classified into three broad methods. These three methods are Market Method, Income Method and Cost Method. These Methods have their own set of advantages and disadvantages.
|Valuation based on cost required to reproduce or replace an IP.
|Valuation is based on the Market Value of an IP.
|Valuation based on present worth of future income flow.
|Easy to calculate if cost data is available.
|Possible to calculate the most rational value if market data is available.
|Possible to capture present worth based on profit generating capacity.
|Ignore the future potential of an IP.
|Lack of market data on comparable IPs.
|Change of error due to subjective estimation.
In this method the value of an IP is estimated with the help of third-party transactions which are taking place in the market. There are very less instances in which a specific IP has been sold. Generally, an Ip is exchanged as a part of a transaction in which a whole enterprise is sold. In such a transaction, assets are labeled as Fixed Assets, Current Assets, Intangible Assets (which generally include the IP of an enterprise). This method is very easy to implement but the major drawback of this method is that information and data about third party transactions are often scarce.
Prerequisites for Successful execution of Market Method:
- Data pertaining to the amount paid in a transaction for an IP.
- Records and data pertaining to previous transactions of the same nature.
- Arm’s length transactions between independent parties.
- Existence of an active market where IP exchange transactions can take place.
This method tries to find out the correct value of an IP by comparing the price paid for a similar IP in an IP exchange transaction between a willing buyer and a willing seller. As simple as it may sound in reality even if data of third-party transactions is available the process will still be very complex because there are various parameters that influence an IP. These parameters have different affects on similar IP and also affect their value. Hence, a detailed analysis has to be done in order to find out the true nature of an IP. These parameters help an evaluator to locate the exchange transactions that have taken place in the market. These transactions are actually the exchange transactions in which a similar IP, which was subjected to the same parameters was exchanged for a price. Then such exchange transactions are used as a comparing factor to evaluate the value of subject IP. For a better understanding some of such parameters are mentioned below:
- Industrial Standard
Market Method suggests that one of the basic methods of calculating the value of an asset is to find out the value of other similar assets in market. It is simple to understand if you take an example of a flat. For Example, you want to buy a residential property and you are looking at different flats in different societies. If you like a 2 BHK in X society but you don’t know the price of that property. Then one of the methods is as simple as asking what is the amount that the previous owner has paid for that 2 BHK or even ask other residents of the same society living in 2BHKs about the amount that they have paid at the time of purchasing.
The principle that we are applying is similar to this example. An evaluator after finding out the nature of the IP can accordingly search in the industry in which similar IPs work or are exchanged. Thereafter, the evaluator has to find out transactions in which a similar IP has been exchanged. This would give the evaluator a rough idea about the figure which he is looking for. After that there are other filters that the rough figure estimated till now has to pass for refinement. These filters would indicate the similarities between the IP which was exchanged previously in the industry and the subject IP whose valuation is to be done. Considering the delicate nature of IP, these filters would include:
- Nature of Industry.
- Demographic factors.
- Purpose of exchange.
- Purpose for which the exchanged IP was utilized earlier.
- Nature of exchanged IP
- The government Policies and the legal environment in which the exchanged IP was being utilized.
- The quality of protection and maintenance protocols that were followed for previous IP.
These filters helpan evaluator to assess how accurate is the estimated rough figure.
- Brand Name and Profitability
A businessman builds reputation and goodwill over the period time. That reputation makes his brand popular among the existing and prospective customers. Popularity comes from the security that a customer experience while purchasing goods from that brand. This popularity and reliability proves beneficial to the businessman once he reaches that level of competition where every other competitor is providing the finest quality of product and the only way to win over competition is by good marketing skills and strong Goodwill.
There are many examples which demonstrate the functioning of this principle in our day to day lives. If we take an example of the sports shoe industry. One can easily notice that after a point of time it is difficult to compare on quality basis that which brand is offering the best quality of product. They all offer their products with simple strong designs which are capable to satisfy the need of a customer, are comfortable and up to date with the latest fashion. Yet there are some brands which are doing exceptionally well. It is reflected from the amount of profits that they achieve year after year. Their profit is higher than othermarket players. It is because of the reputation, goodwill, reliability, the security that a consumer feels while being associated with the brand.
Hence, reputation of the brand name (Trademark), goodwill and the image of the brand providing extra profit margins to a brand. Therefore, only those IP’s which have a similar popularity, goodwill and recognition should be compared with the subject IP. Otherwise, the purpose of value estimation would be defeated.
Every asset whether fixed or variable, large or tiny, tangible or intangible has a definitive period of life. In other words, after a period of time the machine is damaged or depreciated to the condition beyond repair and looses all its value. The same process happens with an IP. Every IP has a life, it can be very long or very short depending on how you take care of it. The remaining life of anIPis a very relevant factor if you are comparing exchange transaction of one IP to the subject IP. It is possible that two patents, the subject patent (whose accurate value is to be estimated) and the patent exchanged in the market are similar to each other on majority of the factors but there exists a significant gap between the life remaining of both the patents. In those circumstances the exchanged patent can not act as a reliable measure for comparison.
- Market Share
The share of market that a product entertains is very important for a business. The market share is directly related to the amount of profits that a company can generate. Greater the market share greater will be the profits. IP of a business play a very important role in maintaining that market share. As explained in other parameters, it is IP of a business that retains a customer and manage their loyalty to the firm. Value of 2 different IPs of same nature might differ, according to the share of market that they are catering. Value of a trademark which is used in domestic markets only, would be much lower than the value of a trademark that covers both the markets, domestic as well as international. Hence, for a reliable value estimation process,it is very important that only those transactions are considered that involve an IP which has covered the same extent of market share before the exchange happened. Otherwise, the value calculated would not be accurate.
- Value Acknowledged by the Judiciary
One of the primary drawbacks of this approach is that the data regarding transactional exchanges is not available easily. It becomes very difficult for the evaluator to gather significant reliable data.
Everybody knows that with great power comes great responsibility. An IP provides an IP owner with distinct and exclusive right to exploit that IP the way he wants to but, an IP owner has to take care of it. The remedy to the offense of infringement actually acts as a parameter that an evaluator can use to compare different IPs. In other words, the judiciary while awarding damages to the Plaintiff, in a way reaffirm or acknowledge the value of an IP. Hence, the amount of damages awarded in an IPR infringement suit, can act as a reliable parameter to compare the value of similar IPs.
- Market Dominance/ Market Entry
An IP is a kind of property that give its owner monopolistic rights to exploit the said IP. Monopolistic rights enable an IP to attain market dominance. There are many factors that help an IP to attain market dominance. One of such factors is entry to the market. If entry to the market in which an IP is functioning is not easy then, it simply means that the number of competitors which an IP has to compete with are very low. If there are less competitors then an IP can exploit larger share of the market. Larger share of the market eventually would lead to high profit margins and so on. All this cycle would function negatively if entry to the market is easy.
Entry to a market is easy or difficult according to the type and number of barriers that a potential seller has to overcome before competing in the market. The barriers can be of different types. Financial barriers (large amount of investment required), legal barriers (have to obtain different licenses and permits from government agencies), distribution networks and etc. Therefore, it is safe to assume that number of barriers to a market entry is directly proportional to the market value of an IP.
Hence, while comparing different IP’s it is important to compare only those IP’s with the subject IP which have previously functioned in markets that had the same nature of barriers as the market in which subject IP is functioning.
A value evaluation process will be void if it is blind to the technological advancements happening around theworld. Patents are a good example of the kind of IP that is gravely affected by the latest trends and technological updates in the market. A patent can be worth millions if it is unique and the same technology can run obsolete the other second if another technology which is more efficient than the patented one hits the market.
This is a well-known trend in the software industry. Generally, a software has a life span of couple of years only. After that it either gets updated or is replaced by technological advanced competitors. Hence, comparison of only those IP’s should be made with the subject IP whose value gets affected by the technological advancements happening in the industry otherwise, it would make no sense to compare them as the value generated after the evaluation process will be useless.
Every asset is purchased with an expectation of return in the future.The decision that whether an asset is to be purchased or not is totally dependent upon the percentage of return that an asset promises to offer in particular duration of time. If the amount of economic benefit does not exceed the cost of purchasing an asset, then an owner would not purchase that asset.
Income Method recognizes the importance of earning and the different economic benefits that an IP is capable of providing to the firm. This approach solely focuses on all those parameters that directly or indirectly are related to the earning capacity of an IP. This method works with an objective to find out the amount of earning and economic benefits that an IP is able to generate or will be generating. The amount of income generated by an IP acts as a base for value evaluation under this method. There are two major components in this method which are:
- Accurate estimation of the amount of cash flow that an IP can generate.
- The subsequent capitalization of these cash flows.
The financial capabilities of an IP under this method can be evaluated with 2 different approaches. The evaluator can choose the approach which best suits the IP he is dealing with. These two approaches are Cash Flow Approach and Royalty Approach. These two approaches help an evaluator to find out the exact cashflow generated by an IP. Different approach has their own set of features and serve a different purpose.
Discount Rate– Before we proceed with the two approaches mentioned above it is important to understand what is Discount Rate? The amount of earnings that these approaches will calculate, will be an amount which is to be received sometime in the future. An amount that is to be received sometime in the future involves a great amount of risk. Risk that whether this amount is real or not. Risk that whether this amount will actually be received or not. There is a great amount of uncertainty that the amount calculated via these approaches will ever be earned actually or not because there are a lot of factors that affect the earning capacity of an asset which is beyond the control of anyone like Inflation, unpredicted losses, bad debts, change in technology, change in consumer preferences and etc.
Hence, to find estimate the Net Present Value of the estimated future earning, a discount rate is applied to the figure calculated. This discount rate is highly subjective and is decided upon after considering different relevant parameters. Inflation that will change over the period of time is considered as one of the essential factors to decide upon the discount rate. Change in rate of inflation would surely affect the earning capacity of an asset in the future. Another important parameter is the liquidation capacity of an asset. The liquidation capacity of an asset changes a lot over the life span of an asset. So factors like inflation, liquidation, cost of capital, amount of premium associated with a project and other relevant factors are taken into consideration to establish a relatable discount rate.
There are certain objectives of this approach which are actually the significant factors for evaluation under this approach. The objective is to find the answers to below mentioned questions:
- What is the amount expected amount of cashflow that an IP can generate?
- For how long an IP can generate such expected cashflows?
- What are the possible risks associated with such expected future cashflows?
This approach tries to estimate the value of an IP keeping the amount of cash flow that it is and will be generating in the future. The value of the future cashflows are then adjusted as per the value presently. The future value of expected cashflows are adjusted with the help of discount rate. The discount rate applying the concept of time value of money and considering the risk associated with their eventual realization in the future, modify the calculated figure fit to present requirements. The amount of cashflow that an IP is able to generate is considered as the depiction of its value under this approach.
An IP owner can exploit an IP via different mediums. The owner can use an IP himself, can assign it or license it out, whatever an owner thinks is best for himself. In some cases, it is not feasible to estimate the value of an IP according to the Cashflow approach. As in cases where the data available does not differentiate among the amount of earnings due to IP and the earnings due to rest of the assets, Cashflow approach is not feasible. In such circumstances Royalty approach is best.
In this approach the value of an IP is calculated keeping the amount of annual post tax royalty that an IP can generate in future. The royalty is calculated keeping in mind a hypothetical licensing agreement. After that as it is in cashflow approach, the discount rate is applied to the amount of royalty calculated to calculate the correct figure as per present value of time and money. The rate of royalty can be assessed using the parameters mentioned below:
- A standard rate that prevails keeping in mind the IP and the purpose it is used for.
- Allocation of the economic benefits derived from the licensing of an IP.
There always exists a primary and fundamental cost attached to an asset that has contributed in its establishment. Similarly, there exist different types of cost that an owner has to bear in order to create an IP. The cost can be of different types, incurred at different stages in a life span of an IP. This method focuses on evaluating the value of an IP through the principle of cost incurred for its creation.
In order to simple the approach and easy application of the method the different scholars and have classified these costs into two broad concepts. These 2 broad concepts are Historical Cost Concept and Re-creational/Replacement Cost Concept. Further, we will look at both the concepts one by one analyzing the principle and the parameters they function on.
Historical Cost Concept
In this concept the amount of cost incurred for creation of an IP acts as a base for value evaluation. The amount of money spent for research and development, expenditure incurred for marketing of the IP, amount of money spent in prosecution of an IP and various other types of cost which contribute in the preliminary process of development of an IP are considered in this concept. The historical cost concept is very beneficial from the stand point that the data compared to other approaches is easily available for analyses. The data is primary or secondary in some cases but is reliable to an extent. Hence, the roots of this approach are strong. But, this approach is also not perfect there are various drawbacks of this approach which will be discussed later on.
The basic objective of this approach is to find out the cost of resources which were employed in the process of creating an IP in the past and then adjust the cost as per current scenario. The cost incurred in the past is modified as per the current scenario because of factors like change in the rate of return on investment, change in the figures of inflation and concepts like time value of money. This will eventually give the evaluator an estimate about the amount of money required to develop an IP of that sort. This amount of money is considered as the value of an IP under this method.
John Turner the managing director of the Flinders Technology Pvt Ltd in South Australia explained the approach of Historical Cost Concept with an example in his paper on Valuation of Intellectual Property Assets; Valuation Techniques: Parameters Methodologies and Limitations in the year 2000. The example used in the paper has been mentioned below:
From the company balance sheet, the book value can be obtained from Total Assets (A) LESS Total Liabilities (L). If any book value has been ascribed to any Intangible Asset (I) this is subtracted. Thus, Net tangible Asset (N). N = A-L-I.
The market capitalization (C) of a listed company is the price per share multiplied by the number of shares issued. This information is obtained from the stock market. An estimate of the unidentifiable intangible assets (U) (eg., Goodwill) can be estimated at 10% of the total capitalization (based upon experience) i.e., U= 10% x C.
Thus, the market valuation of the company is given from C= N+U+ IP Assets.
IP Assets = C – (N+U)
In effect, this the residual value of the company after deducting the value of the net tangible assets and a reasonable estimate for unidentifiable intangible assets.
Ford Motor Company Brand Example:
The Ford Motor Company has over 5300 US patents and Ford is a well-known Brand. The following figures are approximately correct from market data from Ford’s balance sheet:
Capitalization (C) = 48,400
Total Assets (A) = 276,230
Total Liabilities (L) = 248,700
Intangible Assets (bal. sheet) = nil
IP Assets = 0.9 x 48,400 – (276,230 – 248,700)
Market Value = 43,560 – 27,530
= $16,030 Million
As per this calculation, Fords IP Assets makes up approximately 33% of the Market Capitalization.
Recreational / Replacement / Reproduction Cost Concept
The Recreational Cost Concept advocates that the value of an IP can be estimated if an evaluator finds out what is the cost of regenerating that IP or a similar IP. In other words, under this concept whatever is the cost to rebuild an alternative IP which is as mature and developed as the subjective IP is, is taken as the value estimated of the subject IP. This concept is very useful is the record-keeping of an enterprise is not accurate because in that case, the evaluator cannot rely on the data available.
In order to estimate the exact value of an alternative IP all the requirements in terms of resources, time, cost, risk, and prospective benefits are taken into consideration. This approach is better than the historical cost concept as it does not depend on outdated data of the past that has to be first modified according to the present requirements. Also, this data takes the age and maturity of an IP into consideration while estimating the value of an IP, which is not considered in the historical cost concept. It is important to consider the maturity of an IP into consideration because it is possible that the reproduction of an IP is not so expensive but the goodwill and reputation that the IP has earned over the period is significant. It is exactly what happens with the brands which were first working in domestic markets and slowly-slowly expanded their business to international markets. If in such cases the factor of maturity of an IP is ignored then the correct value of an IP can never be estimated.
The production cost of an alternative IP would not be accurate till the time it has been filtered through some depreciating parameters which will bring the value estimated for an alternative IP in line with the value of subject IP. These Depreciating parameters will reduce the value of a brand-new IP down to the level of subject IP. It is through these depreciating factors that the value of an alternative IP which is as mature as the subject IP, can be estimated. The depreciating factors that are used in this approach has been mentioned below:
- Physical Depreciation– IP like any other asset goes through some wear and tear over the period of time. It can be due to infringement of an IP that have gone undetected, damages caused by the infringement suits that the IP owner has to defend in courts or a license agreement gone wrong, it can be anything. The point being that such wear and tear affect the value of an IP negatively to some extent and it is necessary to find out the amount of value that has been depreciated over the years from an IP due to such wear and tear.
- Functional Obsolescence- It is a possibility that the IP over the years has suffered some operating deficiencies or design issues or the technology that the IP is based upon has become obsolete with passage of time. In such circumstances the value of an old IP would be less than the brand-new IP available in the market place. Hence, it is important to depreciate the value estimated for an alternative IP by the amount of functional Obsolescence.
- Economic Obsolescence- The value of an IP is affected by various factors. one of such factors works on the principle that an asset attains the maximum level of market value on if the business to which it is devoted to is generating sufficient amount of earning. In other words, the value of an IP is directly proportional to the amount of earning a business is generating. Higher the amount of earnings higher will be the value of an IP. It is possible in some cases when the business is working in loss or is not generating sufficient amount of funds the market value of an IP gets depreciated. For evaluating the correct value of an alternative IP, the value reduction caused due to economic depreciation should be considered.
There are certain drawbacks of this method because of which some of the scholars have considered this approach as orthodox. Some of such disadvantages are listed below:
- Market Method totally ignores the significance of an IP to contribute in the earning capacity of a business. Which eventually neglects different relevant factors that affect the value of an IP both positively and negatively.
- This method ignores the possibility of a scenario where a business invests a lot of time and money in development of an IP but when it is launched in the market it is not able to recover the minimum cost of production. There are various examples, specially in the pharmaceutical industry where thesignificant amount of money is invested in a drug which fails to get permissions from the government agencies and face losses.
- The approach does not distinguish between the expenditure done for enhancing the value of an IP(R&D Department) and the expenditure done to maintain the value of an IP (Marketing Expenses).
- Market Method does not consider future benefits that are connected with an IP.
Authors Note: It is Author’s opinion that the Cost Method is very useful for those purposes where finding out the minimum value of an IP is sufficient because the parameters used in cost method does consider prospective aspects like development. The scope of this approach is limited to the past and current scenario.
It is easy to conclude that none of the three methods is perfect. Every method has their own set of advantages and disadvantages which makes them useful for a particular purpose. If value evaluation is done for the purpose to know what should be the amount of royalty in case an owner decided to license out his IP. Then Cost Method and Market Method should be applied. Cost Method would give the minimum value of an IP on the basis of amount spent on its creation and Market Method would let the owner know about the worth of an IP in existing market. It is smart to use a combination of different approaches entertaining different parameters under them because if a combination of methods is employed then it might include the advantages of all the methods eliminating major disadvantages of those methods.