Intellectual Property as an Asset and a Driver of Development

The market approach asks what comparable rights have sold for. Reliable when comparables exist, which for a patent is rarely.

The income approach asks what future income the right will produce, discounted to present value. This is the method actually used, and its two hard variables are the royalty rate and the discount rate.

A rule of thumb the profession uses, and it should be stated as a rule of thumb rather than as law, is the twenty five per cent rule: a licensee expects to keep about three quarters of the profit attributable to the licensed technology.

A worked example

Sanjay Bhat's firm in Coimbatore holds one patent on a water pump seal, a registered design for the pump housing, a trade mark, and a secret list of two hundred distributors.

The bank will not lend against the pump factory alone, which is leased.

Valuing the patent on the income approach. The pump sells 40,000 units a year. The seal permits a price 60 rupees higher than an unpatented pump, so the attributable profit is 24 lakh rupees a year. Twelve years of the patent term remain. Discounted at 15 per cent, the present value of that stream is roughly 1.3 crore rupees.

Valuing the trade mark. It has no term limit, so the stream is longer but the discount and the risk of the brand fading make the tail worth little; the practice is to value ten to fifteen years and add a terminal value.

Valuing the distributor list. Almost nothing on a balance sheet, because it can be destroyed by a single disclosure and cannot be insured against that.

What Sanjay actually does. He licenses the patent to a Gujarat manufacturer for a 5 per cent royalty on net sales, retains the trade mark, mortgages the patent to the bank subject to the licence, and keeps the list secret because registration would publish it.

One firm, four rights, four different commercial treatments. That is what "asset" means in this subject.

The evidence, stated honestly

The claim that intellectual property boosts development is contested. Cross country studies find a positive association between protection and growth in middle and high income countries and little or none in the poorest.

The mechanism matters more than the level. A strong system with no capacity to use it produces royalty outflows and nothing else, which is the argument developing countries made throughout the Uruguay Round.

India's own record supports a qualified answer. The generic pharmaceutical industry was built under a weak patent regime between 1970 and 2005 and now exports to more than two hundred countries; the software industry grew under copyright, which India already had.

What it does NOT mean

It does not mean stronger protection always produces more development. The relationship is not linear, and the evidence does not support the claim.

It does not mean an intellectual property right has an objective value. It has a value to a particular holder in a particular market at a particular time.

A trade secret is not a worthless asset. It is an unbankable one, which is different.

Quick revision

• Intellectual property is an asset because it is transferable (section 68 Patents Act, section 19 Copyright Act, sections 37 to 45 Trade Marks Act) and divisible by territory, field and period.
• Four channels to development: direct earnings and exports; investment and technology transfer (TRIPS Articles 7 and 66.2); finance, since intangibles can secure a loan; and reputation, which is the case for geographical indications.
• Three valuation approaches: cost, market, income. The income approach is the one used; its variables are the royalty rate and the discount rate. The twenty five per cent rule is a rule of thumb, not law.
• The evidence is mixed: a positive association in middle and high income countries, little in the poorest. Capacity matters more than the level of protection.
• A trade secret is valuable but unbankable, because a single disclosure destroys it.

Test yourself

1. In what sense is intellectual property an asset? In the ordinary commercial sense: it can be owned, identified, valued, sold, licensed, mortgaged, inherited, taxed and recorded on a balance sheet. Two features of the statutes make this possible. Transferability, provided for by section 68 of the Patents Act 1970, section 19 of the Copyright Act 1957 and sections 37 to 45 of the Trade Marks Act 1999, each of which requires an assignment to be in writing because there is no delivery to mark the transfer. And divisibility, which allows one right to be split by territory, by field of use and by period, so that a single patent can be licensed exclusively to one firm for India, non exclusively to another for Africa, licensed for a different application to a third, and simultaneously mortgaged to a bank subject to those licences. That combination is what turns a legal power to exclude into a tradable asset, and it is the reason a small inventor need not build a factory and a small author need not become a publisher.

2. Through what channels does intellectual property contribute to economic development, and how strong is the evidence? Four channels. Direct earnings, through royalties, licence fees and exports of protected goods and services, of which India's software services and pharmaceutical exports are the domestic examples and both depend on recognition in the importing country. Investment and technology transfer, since a firm deciding where to manufacture asks whether its technology will be protected, and TRIPS names transfer of technology as an objective in Article 7 and obliges developed members to provide incentives for transfer to least developed members in Article 66.2. Finance, since intangible assets can secure lending in an economy where a knowledge firm may own no land. And reputation, since a geographical indication allows producers in a region to capture the premium their region's reputation earns, which is the economic case for the Geographical Indications Act 1999. The evidence is mixed and should be stated as such. Cross country studies find a positive association between the strength of protection and growth in middle and high income economies and little or none in the poorest, and the reason usually given is capacity: a strong system in an economy with little ability to generate protected subject matter produces royalty outflows and little else, which is the argument developing countries pressed throughout the Uruguay Round.

3. How is an intangible asset valued? By one of three approaches. The cost approach asks what the asset cost to create, or what it would cost to recreate, and is simple but usually misleading, because what something cost has no necessary relation to what it is worth. The market approach asks what comparable rights have changed hands for, and is reliable where comparables exist, which for trade marks in an active sector they sometimes do and for a specific patent they almost never do. The income approach asks what future income is attributable to the right and discounts it to present value, and this is the method actually used in practice. It has two difficult variables, the royalty rate that can be attributed to the right rather than to everything else the business does, and the discount rate that reflects the risk that the income will not arrive, including the risk that the right is invalidated. A rule of thumb widely used in negotiation, and it should be quoted as a rule of thumb rather than as law, is that a licensee expects to retain about three quarters of the profit attributable to the licensed technology, leaving about a quarter as the royalty. A trade mark presents an additional problem, because its term is indefinite, so practice values a defined period and adds a terminal value; and a trade secret presents the opposite problem, since a single disclosure destroys it entirely, which makes it valuable but very difficult to finance against.