CXO

Accurately pricing your intellectual property

Placing a monetary value on an idea--your intellectual property--is part science and part voodoo. Several consultants shared their methods for calculating the worth of intellectual property. Find out how their approaches compare to your own.


Once you’ve settled on an hourly fee, billing your clients is as easy for you as it is for an auto mechanic. You simply multiply the hours worked by your fee and add the price for purchased equipment. Quantifying the value of original ideas is another thing altogether.

So how do consultants calculate the worth of creativity and invention, as in the case of intellectual property (IP)? We found several answers to that question—one from a TechRepublic member and others from the consulting trenches. After you’ve seen their methods for valuing IP, tell us how you assess the value of your ideas in the discussion below.

What is intellectual property?
When asked in a poll, 45 percent of TechRepublic member respondents said their firms owned the intellectual property rights to anything they created (see Figure A). It’s important to be able to place a monetary value on those rights in order to calculate an estimate of your firm’s worth.

Figure A


What does that IP include? According to Gartner, IP has traditionally included assets that are protected patents, copyrights, and regulatory licenses. However, IP has been expanded to include software and business processes when they can be proven to be innovative and original. Customer intelligence and business intelligence may also be considered IP, depending on its value to business in terms of competition and its necessity to the basic business processes, according to Gartner.

Pricing proprietary software
TechRepublic member cegum was trying to attach a dollar value to a program she designed for a client. She asked our members for guidelines to determine a fair market price in the Technical Q&A.

In response to cegum’s query, member xgenius suggested the following equation to calculate its worth: T + R (H) + V+V (E), where:
  • T=The total costs involved for development
  • R=The hourly rate
  • H=Hours worked on the project
  • V=The value of a similar product plus an undetermined percentage based on the new product’s uniqueness
  • E=A client’s expected use and number of users

While that may be a valid way to come up with a value for your intellectual property, it seems to raise more questions than it answers. For example, what is the “undetermined percentage,” and how do you estimate a client’s expected use?

Xgenius also suggested that cegum “think twice about selling outright.”

“In the long run, it will always be better to license your product because not only do you still ‘own’ it, but future income can still be derived,” he said.

What the experts say
Typically, valuation consultants use three general approaches to determine a fair market value of IP, said John D. Emory Jr., vice president of Emory Business Valuation in Milwaukee. The three methods are:
  • Income approach
  • Cost approach
  • Market approach

The income approach, which is the most commonly used method, considers the present value of future cash flows to the IP's owner, Emory said. The cost approach considers the cost to replace or re-create the IP, and the market approach considers the prices obtained in sales, licensing, or royalty agreements for comparable assets in the marketplace.

Another approach
“Valuing intellectual property is an interesting mix of art and science,” said Brian W. Napper, a partner in Intellectual Asset Management Consulting at Deloitte & Touche in San Francisco. He suggested a similar approach called the relief from royalty method, a version of discounted future cash flows, which uses specifically comparable transactions information, like licensing and acquisitions. For example, when estimating the value of software, you should consider the costs that would be incurred if the software had to be licensed from a third-party vendor.

Napper said the advantages and benefits of the intellectual property to the user—the so-called “value in use”—should be carefully identified and considered in intellectual property valuations.

Your view on IP
How do you value your intellectual property? Do you use one of the methods described above? Send us an e-mail describing your process or post your comments below.

 

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