Rembrandts in the Attic: Understanding Intellectual Property Licensing

Rembrandts in the Attic: Understanding Intellectual Property Licensing

1.0 Introduction:

In a span of two hundred years, the human race has entered the information age from the industrial age. Today, the majority of a company's assets may be in the form of intangibles. Approximately half the market capitalization of the Fortune 500 companies now is on account of the intangibles that they own. For e.g. Time-Warner has only 6.49% of its value attributable to tangibles; at Oracle Corps' tangibles account for only 4% of its value & unbelievably at GE tangibles account for less than 11% of its value1. The globalization of business, accelerated product life cycles, advances in technology are helping create an environment where the intellectual property component is expanding rapidly and must be strategically managed2.

Managing intellectual property (IP) till the very recent past meant defensive protection of a company's intangible assets designed to guarantee rights over the company's IP, to ascertain that there was no dilution of such IP rights and usually to stop others from infringing the IP. Very often IP created by companies was not commercialized or if done, it was at a very small scale. Even the companies that were very innovative looked at IP merely as a means to protect their technology. The philosophy that these IA could be licensed to earn substantial revenue was absent. Xerox, Bell-AT &T were invention generating powerhouses but they did not make a killing out of licensing IP. Quite literally their IP assets were the 'Rembrandts in the office attics'.

But the world has changed rapidly. Today to be competitive, companies must extract maximum value for their stakeholders from every available asset/ revenue generating opportunity. This includes creating value from their IP portfolio as well. Today in many companies (in developed nations) IP portfolio management is strategically linked with the overall business strategy. As we shall see, IP drives revenue against measurable business and financial goals. Fixed assets can be duplicated but "for a given firm, the combination of tangibles with its own unique, knowledge based assets will be the key differentiator3. Corporates look at their IP development and IP personnel as a profit centre than as a cost centre4.

1.0 Understanding Licensing terminology

1.1.1 Intellectual properties are those intangible assets that can be specified, protected and traded. They are the creations of human mind. Some illustrative examples are patents, know-how, brands, trademarks & content.

1.1.2 Licensing is "A permission to engage in a specified activity." It simply means granting a person specified rights related to a particular property without transferring ownership in the underlying property. A licensing agreement is essentially a contract. A license differs from a sale; in that ownership of the property is not transferred, and the licensor retains ownership rights to the property (e.g. Right to mortgage).

1.1.3 Royalty is the financial return (rent) received by the owner (Licensor) of the asset from the tenant (licensee) in return for granting the right to exploit (license) a particular right attached to a property.

1.1.4 Exclusive License is a license wherein the licensee is the only entity that is granted the licensed rights (excluding even the owner). No other entity has any access to those rights. In most legal situations, this is treated on par with a sale transaction.

1.1.5 Non-exclusive License is a license wherein the rights granted to the licensee may also be granted to others. E.g.. Commercially available software is "licensed non-exclusively" to the end-user, since there are numerous other licensees for that product.

1.1.6 Joint Development License is a scenario wherein one company enters into a joint development agreement with another in order to collaborate in development of a product calling for the special resources of each company. Both companies will need to use some of the technology of the other in the course of such development. A joint development license permits such limited use of each company's technology. When development of the new product is completed, the joint development license will grant each party whatever rights may be required to commercialise the product.

1.1.7 Cross License agreement is essentially two licenses combined into one agreement, and is used when each party to the agreement wants to obtain certain rights to the other party's property. The consideration for each entity is the right given by the other entity (usually) without any actual asset transfer.

1.1.8 Conditional License is a license where contracting parties agree that if one party fails to do something, a license will be created in favour of the other party granting it certain rights permitting it to do specified acts to protect its interests5.

1.1.9 Option based license gives the buyer a future right to use the technology at a later date, if he so desires on the payment of payments. It gives him the security to use the technology if it is accepted at some point in future without the burden of paying huge license fees up-front. (Like the Stock market "call option"). Reach-through licensing is licensing of IP with royalties based on percentage of sales, where the licensed IP is not incorporated in the end product. This scheme creates a license the value of which can be measured, and thus simplifies the problem of valuing basic IP per se.

1.2 Licensing Revenues

Now that we have understood the main terms in licensing, let us take a look the phenomenal revenues that IP pro-active companies have garnered by following diligent IP licensing programmes.

IBM collects upwards of US$1 billion annually from royalty payments6.

The Disney film 'The Lion King' earned more than US$1 billion in merchandising7.

Texas Instruments collected upwards of US$2.5 billion during 1994-99 from royalty payments8. It generated more than 20% of its revenues from royalties9 in 2000.

Pfizer paid US$ 225 million, including an up-front payment of US$ 85 million to Searle in 1998 for "Celecoxib" (anti-arthritis)10.

Synaptic Pharmaceutical Corporation has received US$ 2 million from Glaxo as payments for a non-exclusive licensing agreement11.

Johnson & Johnson's in-licensed products accounted for 54% of its pharmaceutical revenues in 199712.

In 1998, the top 10 US pharmaceutical companies derived 32% of their revenue from...