Finance concepts and applications

Finance

Intellectual property has become an increasingly important source of value for corporations. Traditionally, companies were valued for their fixed assets and their potential growth. Yet there is a growing body of evidence that the true value in many companies -- especially in high tech industries -- comes from the intellectual property they possess. Rivette and Klein (2000) note that executives became increasingly focused on the value of the intellectual property they possessed in the late 1990s. Value derives from patents, trademarks, copyrights and brands. That IP is a primary source of value in many firms is confirmed in the Hewlett-Packard purchase of Palm, which was done primarily to secure Palm's patents (Bettiol, 2010). Palm has a manufacturing business and millions in fixed assets, but these were irrelevant to HP. The purchase was akin to buying a run-down house simply for the value of the land -- IP is now the base upon which all businesses are built and even when the business is a shambles the IP still has value that can be extracted.

In traditional manufacturing operations, it was manufacturing equipment and processes that helped a firm turn raw materials into finished goods. Without the means of production, the firm had no value. The shift to an information economy is not simply symbolic -- manufacturing capacity has largely been moved overseas. This implies that manufacturing is an activity that may once have provided firms with competitive advantage, but that no longer applies. Reduced trade barriers and globally-standardized production methods mean that sustainable competitive advantage seldom derives from fixed assets. Sustainable competitive advantage can only derive from that which cannot be easily replicated. As most forms of intellectual property receive some form of legal protection, they cannot be easily replicated. Thus, firms seeking a source of sustainable competitive advantage can really only focus on IP.

The price of something only reflects its value on the open market. Intellectual property always had value -- it is hard to argue that the McDonald's brand is any more well-known or powerful today than it was in the 1980s -- but the increase in the emphasis of IP on balance sheets and in merger & acquisition activity rests on the increased recognition of the value that IP has.

Yet, it is difficult to quantify the true value of intellectual property. In theory, the value of intellectual property derives from the degree to which the firm can convert that property into wealth. In some cases -- pharmaceutical patents, for example -- this can be relatively easy to calculate. In other cases -- the good vibes consumers get from seeing the Geico gecko -- quantification becomes more challenging. Yet that gecko character does have value for the insurance company, and if the character was licensed to another firm there would be a high cost attached. Kossovsky (2002) proposed a valuation method for IP loosely based on the Black-Scholes model of option pricing, and the FASB has also issued guidelines with respect to IP valuation. Yet in practice, valuing IP remains one of accounting's dark arts.