UNCITRAL, IP and security interests

The most recent issue of the Uniform Commercial Code Law Journal, Vol. 43, No. 2 April 2011, published in coordination with the Penn State Dickinson School of Law, contains at p.601 a most interesting article by UNCITRAL Senior Legal Officer Spiros Bazinas, "Intellectual Property Financing Under The UNICTRAL Guide". To give readers some idea of its contents, the IP Finance blog quotes from the article's conclusions:

"The Guide and the Supplement are designed to facilitate intellectual property financing, without interfering with intellectual property law. This result is achieved by commentary and recommendations that deal with the creation, third-party effectiveness, priority, enforcement (even within insolvency) of a security interest in an intellectual property right, and the law applicable to such matters. 

The commentary of the Supplement explains how the recommendations of the Guide and the Supplement would apply in the context of an intellectual property financing transaction. They do so in a way that ensures better coordination between secured transactions and intellectual
property law. With the same goal in mind, the recommendations of the Supplement modify the general recommendations of the Guide as they apply to security interests in intellectual property
rights. 

The Supplement is intended to provide guidance to States as to issues relating to security interests in intellectual property rights. It is not intended to deal with purely intellectual property law issues. However, it includes mild suggestions as to how States that may wish to enact the recommendations of the Guide and the Supplement could coordinate their intellectual property laws with their enactment of the recommendations of the Guide and the Supplement. 

The integrity of intellectual property law is preserved through a general rule that gives precedence to intellectual property law where it deals in an asset-specific and different way with a matter addressed in the Guide and the Supplement. 

The creation of a security interest in an intellectual property right is simplified by requiring only a written security agreement. At the same time, the rights of third parties are protected by third-party effectiveness requirements that refer to the registration of a notice of a security interest in an intellectual property right in the general security interests registry (or, if there is a specialized intellectual property registry, in that registry). 

Similarly, the interests of competing claimants are protected by a set of rules according to which priority among competing claimants is to be determined on the basis of the time of registration of a notice of the security interest in the general security interest registry, with appropriate exceptions (for example, giving priority to a security interest registered in an Intellectual property registry over a security interest registered in the general security interest registry). 

A comprehensive set of enforcement provisions in the Guide and the Supplement is designed to ensure certainty as to the remedies of the secured creditor in the case of default with due protection of the rights of the grantor and other parties with interests in the encumbered intellectual property, and with due recognition being given to the basic principles of intellectual property law. 

Discussion of applicable law issues completes the treatment of security interests in intellectual property rights in the Guide and the Supplement in a practical way that is consistent with intellectual property law. The recommendation adopted breaks new ground and should enhance
certainty of the law applicable to security interests in intellectual property rights and thus facilitate intellectual property financing. 

Finally, the discussion of insolvency-related issues is intended to supplement the regime of security interests in intellectual property with an analysis of the impact of the licensor's or licensee's insolvency on a security right in that party's rights under a licence agreement. It can be reasonably expected that the Guide will become a common reference tool in all secured transactions reform efforts. The reference to the Guide in the Australian and South Korean secured transactions law reform initiatives, as well as the use of the Guide in the Draft Common Frame of Reference and in World Bank secured transaction law reform documents justify such an expectation. 

The expectation of the Supplement can be no less, in particular, as it is the first text of its kind that deals with the issues at the intersection of secured transactions, insolvency, conflict-of-laws and intellectual property law, and cuts in an Alexandrian way many Gordian knots in that respect or even breaks new ground with rules that attracted a great deal of consensus among experts who initially were not of one mind".

Meanwhile, preparations for next week's Commission session (Vienna, 27 June to 8 July 2011) are going well. You can find the provisional agenda (A/CN.9/711) is here.  This blog is indebted to Spiros for letting us know that

"On security interests, we have just a brief report on the progress of WG VI and on the coordination with: (i) the security interests texts of Unidroit and the Hague Conference; (ii) the WB in preparing a joint UNCITRAL/WB set of standards on ST; and (iii) the EU Commission on the law applicable to the proprietary effects of assignments (the BIICL is preparing a study). Security interests will probably be discussed between 4 and 6 July".

Long-standing readers of this weblog will recall that it was UNCITRAL's first efforts regarding the IP-security interests zone of interest which triggered its being founded in January 2008.  The blog and UNCITRAL have both grown through the experience which, initially filled with friction, suspicion and misunderstanding, has brought a good deal of benefit to both the IP and the finance communities. Thank you, Spiros and UNCITRAL, for taking our comments, and our commitment, so seriously.

IP – the value and risks to a fast growing business

- was the title of a seminar recently held at the London office of insurance company MunichRe.

In addition to launching a new IP insurance product, the seminar also presented the findings of a survey of attitudes to IP insurance recently carried out by Morwenna Rees-Mogg, proprietor of AngelNews, a media business focused on business angels, VCs and early stage funded companies.

One interesting conclusion of the survey was that “investors should and will pay for the right insurance”, with over half of the investors surveyed agreeing that a company’s valuation would be enhanced by having IP insurance in place. Around 75% of those surveyed also felt that they would be more willing to do business with an SME having IP insurance.

UK R&D – more consulation

In addition to the patent box paper, the Treasury also published the next round of R&D consultation – this is rather more a summary of responses to the last consultation than new information.

In summary:

• not ruling out ‘above the line’ R&D relief/credit but the Government still needs to be convinced
  
• large company subcontractor costs to qualify for the subcontractor only where the subcontractor is aware that it is qualifying R&D and has evidence to this effect
  
• no plans to extend qualifying expenditure to cover (eg) rent of premises used for R&D
  
• draft legislation in the Autumn to allow a wider range of externally provided workers to qualify
  
• no plans to restrict internally created software from being qualifying costs
  
• improved guidance on whether prototypes will be qualifying R&D – whether the ‘uncertainty’ principle applies
  
• plans for a pilot scheme will be brought in during the Autumn so that small companies and start-ups can get advance assurances that can be relied on in making R&D claims for several years
  

The Government is looking for specific responses (by 2 September 2011) on:

• qualifying indirect activities: should the relief be retained? (QIA are hard to define and harder to get relief for)
  
• should there be some form of certification or election process to provide certainty for subcontractors as to whether the work they are doing is R&D?
  
• does the removal of the PAYE/NICs limit on the repayable credit require any safeguards?
  
• does the ‘going concern’ definition need to be reformed, to make it closer to that for other tax reliefs?
  

The UK Patent Box - more details, not necessarily much more clarification

The Treasury has published (a few days later than originally advertised) the
next round of consultation on the patent box (pdf).

In summary:

• extended to plant variety rights, data exclusivity and supplementary protection certificates
  
• will apply to UK and EPO patents only
  
• will apply to all UK and EPO patents, no matter when commercialised or granted
  
• to be phased in over 5 years, from 2013/14 – full benefit not until 2017/18
  
• a seriously complex round of computations will be involved, with analysis of income and expenses across the company and possibly by division required
  

Responses to the consultation are requested by 2 September 2012.

The consultation paper builds on the previous round of consultation, with more detail on the proposals following the responses to that round. There is still no draft legislation to consider, as the paper focussed on the high level principles involved.

Qualifying IP

The patent box proposals are to be extended to income from: data exclusivity (regulatory data protection), plant variety rights, and supplementary protection certificates (for pharma and agrochemical patents) as these are considered to be appropriately subject to external scrutiny before being granted.

Qualifying patents will be those granted by the UK Patent Office and the European Patent Office only – the UK is usually quite accommodating about foreign IP but the wider range of patents granted in (say) the US is clearly a step too far for the UK Revenue. The consultation indicates that the Government is open to the idea of including patents granted by other national
authorities where the local examination process, and scope of patentable ideas, is similar to that in the UK. However, it will not include non-UK/EPO patents that could have been protected by patent in the UK but have not been so protected – the consultation paper notes that HMRC is not in a position to judge whether the UK Patent Office would have granted a patent. This may lead to an increase in patent registrations in the UK; I doubt whether anyone has considered the additional resource issues that might arise for the Patent Office as a result.

Outright ownership of the patent will not be required: the patent box will be available to UK companies with an exclusive licence (as to field or territory) to a licence, where there is effective market exclusivity. It appears that the licensor (if a UK taxpayer) will have the advantage of the patent box for the royalty income, and the licensee could (presumably) have the advantage of the patent box on the 'embedded income' in profits from manufacturing.

This is fairly theoretical because it is also proposed that – to be able to claim the benefit of the patent box – the taxpayer must be actively involved in the ongoing decision making in respect of exploitation of the patent. In addition, the taxpayer must have performed "significant activity" to develop the patented invention or its application. It's not impossible, as a result, that
neither the licensor could claim the patent box (where it is not actively involved in the ongoing decision making once a licence has been granted) nor the licensee (where it has not performed significant development activity). Legal protection and management of a financial investment won't count as activity or involvement.

Qualifying income

Qualifying income will be that earned worldwide by a UK company on such patents – this is perhaps likely to be more important for embedded income relief under the patent box (that is, income from utilisation of the IP rather than income from licensing).

When considering embedded income (the profit on sale of product that relates to the patent underlying the product), the patent must genuinely contribute to the product producing the income (it's not enough to simply say it's protected by patent).

Compensation and damages for infringement of a patent will qualify as income from patents.

Income from products made using a patented processes may qualify where an arm's length royalty can be imputed for the use of the patent.

Income from the sale of patents will qualify for the patent box rate (although if the patent is held in a separate company, and the company's shares are sold rather than the patent, the substantial shareholdings exemption could mean a 0% tax rate on the gain instead ...)

The patent box rate won't apply to income between application and grant of the patent at the time it arises but, once that patent has been granted, the company can claim the benefit of the rate for that income (up to four years). Rather
than having to re-open the previous returns, this will be done by way of reduction of tax in the year the patent is actually granted.

Calculating the profits

The patent profits (for tax purposes) are to be calculated on a three-step basis which I'm not even going to attempt to explain, beyond saying that it will involve analysing the income and expenses of the company, possibly by division, and separating out the qualifying income, reducing it for a fixed percentage of 'routine' profits and rinse and repeat as necessary.

Commencement date

The November consultation suggested that all patents first commercialised after 29 November 2010 would qualify; this consultation paper now considered that this sort of cut-off date might not work all that well – the date of initial commercialisation can be hard to define (no kidding!), and a single date would require transitional rules for up to 20 years until all older patents have expired.

So the suggestion is now that the patent box will apply to all UK/EPO patents, but phasing in the benefits over the first five years of the patent box – effectively, 60% of the benefit would apply in 2013/14, then 70% in 2014/15 etc until 100% is available in 2017/18. It will still only apply to profits arising after 1 April 2013.

The latest IAM is the earliest

Issue 48 of Intellectual Asset Management (IAM) magazine is now available online and in digital format. The cover date is July/August, but don't let that worry you.

Editor Joff Wild has a few things to say about this issue:

"For six weeks during January and February this year, IAM and the IP Solutions business of Thomson Reuters offered readers of the magazine and the IAM blog the opportunity to take part in our second annual benchmarking survey. The 700-plus in-house and private practice IP professionals who agreed to do so answered detailed questions that focused on issues such as patent quality, portfolio creation and management, litigation, licensing and the alignment of IP with overall business strategies. The results of the survey – along with comments on its findings from a number of well-known individuals in the IP world – form the cover story of this issue.

IAM 48 is also special for another reason. It marks the first time that we have invited a highly regarded chief IP officer to guest edit the magazine. The person in question is Damon Matteo, from the Palo Alto Research Centre (PARC). ...  Our thanks go to him and to the authors he selected to write for us: Vincent Pluvinage, formerly of Intellectual Ventures; Peter Holden of Coller Capital; Nader Mousavi of Sullivan & Cromwell; and Dan Figueroa of Sony Computer Entertainment America. Look out, too, for the profile of Damon and PARC written by new IAM reporter Helen Sloan.

... In a very full issue, we also have our regular IAFS contribution and a fascinating insight into the developing IP transactions marketplace in China. In addition, we carry a management report on IP issues in the life sciences industries.. ..".

You can check out the contents of this issue in full here.

The British Patent Box: consultation advances

The Patent Box comes
out of the closet ...

In November 2010 the United Kingdom announced its intention to establish a 'Patent Box'. As the Treasury explained at the time,

"The Government is consulting on a preferential regime for profits arising from patents, known as a Patent Box. The intention is to introduce rules in Finance Bill 2012.

The Patent Box will encourage companies to locate the high-value jobs and activity associated with the development, manufacture and exploitation of patents in the UK. It will also enhance the competitiveness of the UK tax system for high-tech companies that obtain profits from patents ...".

Last week the Government released the next stage of the consultation on its Patent Box proposals. You can read the consultation document here.  The Government now seeks views on the points raised in the consultation document.  These must be received by 2 September 2011.  Between now and that date, the Government will be continuing to consult businesses on its proposals.

This blogger's colleagues at Olswang LLP have taken quite an interest in these proposals and plan to respond to the consultation after seeking views on the proposals from business and interested parties. A summary of the firm's response to the first stage of the consultation, following discussions with clients and contacts in the high-tech, pharma and life sciences sectors, runs like this.

"Olswang's consultees were generally supportive of the Patent Box proposal.  However, a number of suggestions were made regarding the design of the regime, some of which were considered would be critical to its success. 

Appropriate conditions for a patent to qualify 

Eligible Patents

• It is understood the Government intends to limit the regime by reference to patents registered in particular jurisdictions.  The Patent Box regime should recognise patents from EU member jurisdictions, the United States of America, Japan, Australia, Korea and the BRIC countries (although income subject to corporation tax from products sold in/ licences to any jurisdiction should fall within the regime if a relevant patent is registered in only one qualifying jurisdiction).

• The Patent Box should apply to acquired patents, not just those based on technology developed by the patent holder. 

Ownership Criteria

• Beneficial ownership should take precedence over legal ownership.  Exclusive licensees should also qualify for the regime.

Commercialisation Condition (the Government has proposed that all patents first commercialised after 29 November 2010 will qualify for inclusion in the Patent Box)

• Initial commercialisation could be the date that a product protected by a patent is first offered for sale to end-consumers.  Similarly, for patent licence income from easily identifiable patents, the date of initial commercialisation could be the date that the patent was first licensed. 

• A number of representations were made that, in order for the UK Patent Box regime to be both practicable and competitive, it should apply to all embedded patent profits and licensing related profits received from eligible patents from 1 April 2013.

Determining patent income

• Receipts from disposals of patents and other receipts of a capital nature should be included within the regime.  This is to reflect (and avoid distortion of) commercial actions.

• A simple formulaic approach to determine the proportion of income that falls within the regime is to be welcomed.  However, companies should be given the option of using transfer pricing methods to determine the correct amount of income.

Commercial alignment

• The Patent Box should not result in a narrowing of the Research & Development (R&D) tax credit regime, nor should it claw back the benefit of R&D tax credits or enhanced deductions.

• For the regime to reflect commercial reality it should apply to income generated prior to the grant of a patent; the date of publication may be appropriate.  However, we understand the Government may take the approach that the regime should not apply unless and until a patent is granted and that, once a patent is granted, credit for pre-grant profits be given by way of an enhanced corporation tax deduction in the tax year in which the patent is granted.  We have suggested that any such approach should be carefully considered as it may undermine the competitiveness of the UK's Patent Box regime.

• If a patent is granted and then revoked there should be no claw-back of the benefit of the regime on the pre-revocation profits.

Preventing artificial tax avoidance

• We would expect that the high costs of obtaining and maintaining a patent would, in itself, deter artificial behaviours in relation to the Patent Box regime. 

• If the Government insists on including an activities based restriction, it should be the case that historic R&D activity should also be taken into account (rather than only ongoing R&D or manufacturing which the Government stated it was considering).

Further general views

• It is understood that the Government will not at this time introduce a regime that applies to income deriving from IP generally; it is suggested that the Government review this position in due course.

• It is suggested that all IP income deriving from R&D activity should be included in the scope of the regime.  At the very least "know-how" that is inextricably linked to a qualifying patent should be included within the regime.

• Income obtained whilst a product is protected by a supplementary protection certificate should be included within the regime. 

• Income connected with services related to qualifying patents should be included within the regime.

• The regime as currently proposed would appear to be easier to apply to products that are protected primarily by one or only a few patents and for companies that licence easily identifiable rights.  In particular, it would appear to be much more challenging to apply to complex technology products and licences of patents relating to complex technology.  The regime should be structured such that it provides a sufficient tax incentive for innovative companies across all high-tech sectors in order to achieve its stated aims.

• The regime must be easily accessible and simple to apply.  Procedures for obtaining advance clearances should be introduced. 

• The effectiveness of the regime should be reviewed on a regular basis and its terms adjusted to deal with perceived and practical difficulties".

Anyone wishing to comment on the consultation document, or on the views expressed above, should email Natasha Kaye or my SPC Blog colleague Robert Stephen.  IP Finance is also pleased to hear from other bodies, firms and individuals who are seeking comments or intending to make submissions: just email me here with the subject line 'Patent Box'.

Patent Licensing Fees Modest in Total Cost of Ownership for Cellular

In this, the third in a series of features written for Keith Mallinson (WiseHarbor) for IP Finance, Keith addresses the claim that the aggregate of patent licence fees paid by anyone buying into patented mobile handset technology is prohibitive and stifles competition (Nb if you can't read Exhibits 1 and 3 clearly on-screen, try clicking them).

"Patent Licensing Fees Modest in Total Cost of Ownership for Cellular 

Patented technology is the lifeblood of today’s advanced mobile handsets, network equipment and operator services. As mobile services become increasingly sophisticated, manufacturing of handsets and network equipment represents a declining share of value compared to investments in innovative mobile technologies and software. There is no inherent maximum value share for the IP created with such investments. Aggregate IP fees are a small proportion of handset costs and are very modest compared to operator service charges. Handset costs as a percentage of total ownership expenditures including operator services are 17% in the US and Canada and 13% in Western Europe. 

My previous IP Finance posting showed markets for mobile phones and operator services have flourished with outstanding growth, technological innovation, significant competition and tumbling prices on the basis of (Fair) Reasonable and Non-discriminatory licensing for technologies required to implement mobile communications standards. Despite all these positives, some still complain IP fees are excessive in comparison to other costs. In this article, I evaluate fees paid upstream in technology licensing in comparison to downstream expenditures in supply of handsets and provision of operator services. 

Caps to fix IP charges 

There are concerted attempts to limit licensing fees in standards-essential IP.  For example, downstream equipment manufacturers seek to minimize out-payments for licensing standards-essential IP by promoting aggregate royalty caps.  In 2008, Alcatel-Lucent, Ericsson, NEC, NextWave Wireless, Nokia, Nokia Siemens Networks and Sony Ericsson announced their agreement that aggregate royalties for handsets implementing the 3G/4G LTE standard should be capped below 10% of handset prices. Similarly, mobile operators, who in many cases subsidize handset prices to consumers, also seek to limit these licensing fees.  A common proposal from several mobile operators is to limit aggregate essential-IP charges by establishing an LTE patent pool. Patent pooling will be the topic of my next IP Finance posting. However, one immediate and obvious observation is that if a patent pool is designed to limit aggregate license fees for the benefit of downstream licensees, then it will be unattractive to upstream licensors that depend on licensing revenue to fund continued investments in R&D and earn a return on prior investments.  Also, the major vertically-integrated companies have mostly preferred to enter into bilateral agreements with other vertically-integrated companies in order to be able to negotiate cross-licenses with trade-offs between their business interests and patent portfolios. 

Unproven suppositions of licensing excesses by some technology licensors and resulting harm abound by predominant voices downstream and their cheerleaders. For example, an August 2009 contribution to the European Competition Journal by Philippe Chappatte of Slaughter and May argues that: 

·         There is likely to be an upward spiral of royalty claims for many standards including telecoms standards resulting in higher costs for handsets and other standardised products; and

·         Operators will be reluctant to invest in new technologies or upgrade their networks to endorse faster and higher quality networks and the quality and range of services that will be available to consumers may be prejudiced. 

Contrary evidence is that handset prices and royalty costs have actually fallen—with handset prices, upon which royalty fees are based, declining 77% on average since 1993—despite the addition of many new technologies and increasing demand for advanced features and functionality. 

Estimates for “cumulative royalties” vary widely. In 1998, International Telecommunications Standards User Group (representing some operators and manufacturers) complained to the European Commission that “when GSM handsets first appeared on the marketplace cumulative royalties amounted to as much as 35 percent to 40 percent of the ex-works selling price”. Much lower estimates for the cumulative GSM royalty rate paid, by companies that do not have any patents to trade, include 10-13 percent (IP Law and Business reporting PA Consulting Group estimate, July, 2005). In September 2005, CSFB’s “3G Economics” report estimated cumulative royalties had fallen to single digits and predicted 17.3% cumulative royalties in WCDMA “for those vendors without an IPR position to trade off”. Whereas ABI Research described average WCDMA cumulative royalties of 9.4% in 2007 “a most challenging barrier... ...to the development of more affordable devices”, the market-leading handset manufacturer with 37% share was paying much less: Nokia stated that “until 2007 it has paid less than 3 percent aggregate license fees on WCDMA handset sales under all its patent license agreements”. 

In addition, there have been various attempts to determine aggregate fees sought by licensors for new technologies. In 2007, the Next Generation Mobile Network (NGMN) Alliance, an industry group led by mobile operators and including major 4G equipment vendors, established a confidential process for the ex ante disclosure and aggregation of expected licensing fees for a number of upcoming 4G standards including LTE. The process concluded in 2009 and the results are confidential. However, commentators have suggested the individual disclosures of expected licensing fees—which were in several cases accompanied by public disclosures on company websites—produced misleading and unrealistic figures.

Aggregate figures derived are not actual prices paid including cross-licensing and do not reflect other realities in negotiations such as identification of patents that are weak or inapplicable. Patent strengths and “essentiality” were not validated. In 2003, the 3G Patent Platform Partnership (including 19 telecommunications operators and equipment makers) estimated “that several hundred different patents, among several thousand publicly claimed as essential, will actually be determined to be ‘essential patents’ in implementing 3G standards”. Some candidate licensees would rather risk being sued than pay “rack rates” in these circumstances. Licensors prefer to negotiate settlements than litigate and subject their patents to invalidity and non-infringement claims. Vertically-integrated licensors are particularly concerned about their product revenues with the risk of being counter-sued for infringement. 

Mobile operators are as eager as ever to invest in new technologies to improve performance and lower total costs. New technology cost savings outweigh licensing fees. For example, while mobile operators spend billions of dollars on spectrum, technological advancements have mitigated this cost with 20-fold spectral efficiency increases and much improved voice encoding since 1G analogue cellular. Operators worldwide are investing extensively in advanced technologies HSPA+ and LTE that have increased network capacity and maximum end-user data speeds 1,000-fold since the introduction of 2G technologies around 1993. In the US, for example, all the major operators (and smaller ones too) claim to have introduced “4G services” over the last couple of years. Operators are also making major investments in associated devices by significantly subsidising end-user prices. With demand for HSPA+ and LTE so strong, IP cost issues can be no more significant than they were with previously and currently successful 2G and 3G technologies. 

Increasing value share in software and patents 

There is no reason why any arbitrary percentage limit should be imposed on IP costs. It is widely accepted that when one pays, for example, $25 for a hardback or $10 for a paperback book, production costs in printing account for but a small proportion of these figures. Royalties to authors, illustrators and agents as well as costs in distribution, marketing and the publisher’s profit margin account for the vast majority of these prices. Similarly, other IP-intensive products, as illustrated in Exhibit 1, have a significant proportion of costs in the intangibles. 

Exhibit 1: Manufactured content value varies substantially by product category

                    Source: WiseHarbor

I have predicted a marked trend of increasing value with the intangibles in mobile devices—including embedded and aftermarket software predominating over hardware—since Apple’s 2008 3G iPhone launch. The success of the iPhone including its Apps store proves my point. The iPhone leads the smartphone market and has a manufacturing cost around just one third of its $600 average wholesale pricing (before operator subsidies to consumers). Gross profit margins approaching 60% provide a significant return on investments in software, brand and distribution, while Apple largely relies on the essential IP developed and contributed to mobile standards by others. 

Handset, network and services-essential IP 

Mobile phones are inextricable from the networks and operator services with which they are used: licensing fees should be considered in this broader context. In contrast to technologies that can be used offline, such as in audio and video players, standards-essential IP is implemented end-to-end in handsets and network equipment with the provision of cellular voice and data services. In addition to increased speeds and network capacity, end-to-end innovations include voice encoding, encryption, automatic roaming and location tracking. A handset in isolation from a network cannot make calls or receive data, let alone exploit any of these capabilities. By convention, licensing fees are charged on wholesale mobile phone prices. Whereas this royalty base is simple and convenient to administer in licensing, it overlooks where most ecosystem value is generated—in operator service revenues. In fact, phone prices are commonly subsidised—to substantial extent in many cases—by operators in anticipation of these revenues. 

The average service life of a phone from purchase until retirement is around 20 months in the US where postpaid contracts predominate and 34 months in Western Europe where most users have prepaid or SIM-only service with unsubsidised phones. Exhibit 2 shows that during a handset’s service life, consumers spend on average around five or six times more on service fees than they or their operators spend on the handset. Handset costs in the US/Canada and Western Europe represent 17% and 13% respectively of total ownership expenditures including handset costs and operator service charges. 

Exhibit 2: Handsets, a small proportion of total ownership expenses

	US and Canada	Western Europe
Average service revenue per user (per month)	$50	$32
Service life (in months)	20	34
Total operator services expenditures	$1,001	$1,087
Average unsubsidised wholesale phone price	$207	$167
Total lifecycle expenditures	$1,208	$1,254
Handset cost/total expenditures	17%	13%

       Source: WiseHarbor, based on 2009 and 2010 market figures

Royalty rates expressed as a percentage of total ownership lifecycle expenses are therefore much lower than rates based on handset prices. Exhibit 3 shows that converting aggregate handset cost-based royalty rates to rates based on total ownership expenditures reduces the rate to 13% and 17% of the rate based on handset costs for Western Europe and US/Canada respectively.  More frequent handset upgrades in the US account for most of the differences between the two regions. 

 

Source: WiseHarbor Research   * For companies with no IP to trade

Competitive advantage with IP 

It is not the average level of IP charges that affects competition; it is the different rates paid among competitors. Aggregate royalty rates are significantly less than European Union VAT rates that have mostly ranged from 15% to 25% in recent years.  Applied uniformly among competitors, taxing phones and services at these VAT rates has not significantly impeded their sales versus nations where consumption taxes on phone sales are much lower. 

The asymmetry in licensing costs between manufacturers with IP who can cross-license to minimise their licensing expenditures and manufacturers without essential-IP patents who must pay more is a significant competitive factor. Manufacturers are faced with a business choice: bear the up-front costs and risks of investing in technologies with the aim to cross-license for much of the essential IP required, or pay to license others’ IP. Investing up to several billions of dollars per year in R&D in the hope that some of it will prove effective enough to be accepted in leading mobile standards merits competitive benefits and commercial returns. Nevertheless, latter-day cellular market entrants including Research in Motion, HTC, Apple and others succeeded with little or nothing in the way of essential IP at the outset".

Keith Mallinson‘s recent clients include several mobile phone technology IP owners. His work includes various other commercial issues as well as IP. He provides advisory services including market analysis and forecasts for operator services, network equipment and handset. He also has significant testifying expert witness experience in the cellular sector, but has not yet testified on matters relating to standards-essential IP.

The Groupon IPO: Where Does IP Fit In?

No sooner had the successful LinkedIn IPO settled into becoming yesterday's news than the spectre of the even more massive projected Groupon IPO returned to the headlines. Groupon is the fabulously expanding online daily coupon company that features discounted gift certificates usable at local or national companies. Readers may remember that Groupon rejected last fall a reported acqusition offer by Google of more than $5 billion dollars, making the likelihood of an IPO only a matter of time. That time has apparently arrived, as Groupon has notified the SEC of its intention to float its shares.

The numbers for the projected Groupon IPO are eye-popping. The company seeks to raise amounts that I have heard range from $750 million upwards, the most ever in the social-media space, based on a valuation that has ranged in recent reports between $20 billion and $30 billion dollars. Groupon has been described as one of the fastest growing companies in history since its founding in Chicago 2008. In light of all of this hoopla, the article by Ari Levy, which appeared on 3 June on Bloomberg.com entitled "Groupon’s $540 Million in Losses May Leave Investors Leery of Share Sale" here, is noteworthy.

The gist of the reservation expressed by Bloomberg.com is that the fact that the company has had "operating losses of $540 million dollars in operating losses since 2008 may leave some investors leery of buying shares in a company with a business model so easy to copy that it has spawned 482 imitators.... Sales surged more than 14-fold to $644.7 million last quarter, making Chicago-based Groupon bigger than established technology companies like Citrix Systems Inc. (CTXS) and Autodesk Inc. (ADSK) Yet, with marketing costs rising faster than sales, Groupon may not make money fast enough to warrant the $25 billion valuation it was said to be contemplating. .... [This so so], despite that]gross profit, or the revenue left after sharing sales with merchants, jumped to $270 million in the first quarter from $20 million a year earlier."

Lets add a bit more granularity to these data. Groupon has increased its subscriber base to 83.1 for Q1 2011 (up to 3.4 million subscribers for the Q1 2010). The number of deals has increased from 1.8 million in Q1 2010 to 83.1 million for Q1 2011. The company provides coupon offers in more than 500 markets throughout the world, nearly in twice as many markets as its closest competitor.

With these kinds of numbers, what could be the concern? In a word, the problem is marketing costs. As reported in Bloomberg,"[t]o handle the growth, Groupon bolstered its workforce to 7,107 employees as of March 31, from 37 in June 2009. Revenue per sales representative in the first quarter was $172,000 a month, up from $87,000 two years earlier, the company said. The company had marketing costs of $208.2 million in the first quarter, resulting in a net operating loss of $117.1 million. Groupon spent $179.9 million on subscriber acquisitions, as it tries to build its lead ...."


And so to the question: can Groupon reach scabilility whereby profits will at some point consistently exceed marketing and manpower costs? This is especially so, given the low barriers to entry and fact that, while the service is online, the service is at the end of the day local. To reach profitability, Groupon has to ensure repeat custom. In the words of Espen Robak, president of Pluris Valuation Advisors LLC, a New York-based adviser to investment funds,“It all depends on how sticky those customer relationships are. 'If they become subscribers forever and you can harvest those relationships for a long time, the money you spent up front is money well spent.' ”

Notable in the discussion up to now is nary a mention of IP. Whatever success Groupon may enjoy, IP would seem to be a minor factor, at best. Let me suggest, however, that at least regarding trade marks/goodwill and trade secrets, IP considerations may be more crucial for Groupon than appear at first glance.

With respect to trade marks/goodwill, in a crowded field of competitors and low barriers to entry, the successful building of the Groupon brand may well be crucial to enable the company to continue to stand out from the rest of the pack. A killer brand may provide the ultimate leverage that will enable the company to achieve the kind of repeat custom that it needs to reach profitable scalability. The company's continuing marketing expenses suggests that it well recognizes the centrality of branding in determining its ultimate success.

Less certain is the value of trade secrets about the manner by which the company organizes and operates its business. I have no way of determining the extent to which the company's overall creative and operational "DNA" is a unique contributor to its current success. A direct measure of this will be attempts by competitors to poach current Groupon employees and the extent to which the company will then seek recourse in the courts to prevent such employees from disclosing valuable company trade secrets going to the heart of the company's operations. Even if such defections do not occur, the existence of such valuable trade secrets will presumably be expressed in the ability of the company to build its brand.

The claim is being increasingly made (including by myself) that the two pillars of IP that have driven entrepeneurship for 30 years--copyright (think software) and patents--will be of lesser importance in the social media space. If so, however, the upshot may not be that successful social companies will be bereft of IP, but that other forms of IP will become more central. Groupon may be an excellent test case to prove the correctness of this supposition.

Animal brands as intellectual assets

Much has been written about the fate of polar bear Knut, writes guest blogger Birgit Clark, whom IP Finance thanks for this fascinating contribution.  Says Birgit:

This bear grossed more than
US$ 140 million during his brief
life as a live brand

Regular readers of the MARQUES Class 46 and IPKat blogs will recall Knut's rise to global fame and the various trade mark issues surrounding the marketing of Knut and other high profile (polar) bears (see obituary here and links cited therein).

Sadly, Knut passed away earlier this year and, like so many events in the bear’s short life, it happened in public. Knut, weakened by an undetected brain disease, drowned at Berlin Zoo in front of shocked zoo visitors. Knut's short life was not an easy one: born in the Berlin Zoo at the end of 2006, Knut was hand-reared by his keeper Thomas and became a global celebrity after being rescued when his mother rejected him. Knut became so famous that he even made it on the covers of the US and German editions of Vanity Fair. He was also the German government's mascot for its climate change campaign and even inspired the Class 46 blog’s logo.

Now you would be forgiven if you thought that this might be the end of the exploitation of the Knut brand. But no: shortly after his death there were rumours about plans to have Knut stuffed and displayed at a Berlin Natural History museum. Knut’s fans and the German public mostly reacted with bewilderment to these plans. In light of Knut’s sad fate, these plans sounded too much like a distasteful exploitation. However, to be fair, while the Berlin Zoo had its only profitable years while Knut was alive, the zoo had strict guidelines as to who was allowed to take a licence to use the Knut trade mark: Knut products had to either be environmentally friendly or raise awareness for climate change. That there is still much interest in the Knut brand can be shown by the fact that the media still report about Knut and speculate on the worth of his brand, most notable Peter Savodnik in his recent article for Bloomberg Businessweek.

Gerald Uhlich, the former chief executive of the zoo, told Bloomberg Business Week that in his short life Knut generated more than US$140 million globally -- a staggering amount. And while there is a good argument that the Knut brand will have survived his death, I would naively argue that consumers would somehow wish to see Knut’s fate reflected in whatever products are now marketed under the Knut trade mark. However, it appears that I got that one slightly wrong. Reading Peter Slavodnik’s article, I have now learned that publishers, film makers, advertisers, as well as “manufacturers of stuffed animals, lunchboxes, and coffee cups” are planning to launch new Knut products. Porcelain manufacturer KPM even plans a commemorative Knut statue and there are already plans for a television documentary in Germany. Uhlich is also as having said that the Knut brand should not necessarily be limited to environmentally sensitive goods: “there is still greater potential to use it for further products or services", a view that appears to be shared by the chief executive officer of the Berlin Club of Merchants and Industrialists. No surprise then that Uhlich is himself writing Knut biography, covering Knut’s “untold story”.

The idea of branding celebrity zoo animals appears to have caught on, as the recent examples of the now deceased psychic octopus Paul and cross eyed opossum Heidi have revealed. Bearing all this in mind, it is a relief to hear that Flocke, a polar bear cub born at Nuremberg Zoo in 2008 and who was the centre of widely publicized trade mark dispute, is doing well at a French zoo. Wilbär, another German celebrity polar bear, whose name was registered as a trade mark, appears equally happy at a Swedish zoo.

Somehow, however, I have this inkling that this iss not the last we shall have heard about the exploitation of polar bear and other celebrity zoo animal trade marks.

Entrepreneurs beware

A recent newsletter from the WIPO SME Unit highlights the “Top Ten Legal Mistakes Made by Entrepreneurs” as identified by Harvard Business School professor Connie Bagley. Three of the top five mistakes relate to IP.

At #5 is “Waiting to consider international intellectual property protection.” In fact, the example given by Prof. Bagley relates to waiting to consider IP protection per se, pointing out that in the US, “if an invention is sold or made public, there's a year's grace period to file a patent application. Everywhere else, if the invention is sold or publicized prior to filing the patent application, the invention is unpatentable in that country.”

At #4 is “Disclosing inventions without a non-disclosure agreement.” “Is it wise to get potential venture capitalists to sign a nondisclosure agreement?” she asks, suggesting that “In the best of all worlds, yes, but most won't. Before disclosing to anyone, one must learn who has a reputation for integrity in the industry.”

And at #3 comes “Starting a business while employed by a potential competitor, or hiring employees without first checking their agreements with the current employer and their knowledge of trade secrets.”

But top of Prof. Bagley's list comes “Thinking any legal problems can be solved later”. “Many of the points made here are problems that can't just be patched up later” she explains.

Valuing a diluted brand: the Pierre Cardin challenge

In a piece for the Wall Street Journal last month, "Pierre Cardin Ready to Sell His Overstretched Label", Christina Passariello gave an account of the exercise in which still-active designer and hyperactive licensor Pierre Cardin is currently engaged in selling his business.  In brief:

".... Ever since luxury-goods giant LVMH Moet Hennessy Louis Vuitton paid richly for Italian jeweler Bulgari SpA in March, valuations of fashion houses have been on the rise. The industry is entering an acquisitive phase for the first time in a decade. ... The price Mr. Cardin wants — €1 billion, or $1.46 billion— is a stretch, industry watchers say.

Bankers estimate it could be worth about €200 million—but even that is a guess because of a lack of financial information. ... Mr. Cardin doesn't have a clear idea about his company's annual sales, which are garnered by some 400 license partners world-wide. ...

Says Mr. Mallevays [ex-LVMH executive, founder of boutique investment advisory Savigny Partners], "From a due diligence perspective it's an absolute nightmare, and goes contrary to the fact that he wants a lot of money for it." ...  

Like other fashion companies such as Dior and Gucci, he parlayed his cachet into licensed products far removed from fashion. But he went much farther, starting from a first license for porcelain crockery in 1968. There are Cardin toilets, strollers and heating units. Some 20 years ago, however, fashion labels began to realize that too much licensing harmed their global reputation. Now, fashion houses carefully handpick their licenses in areas that are related to the core business: Gucci has a perfume license with Procter & Gamble Co.; Swiss watch giant Compagnie Financière Richemont makes Ralph Lauren timepieces.

Not Pierre Cardin. He continues to farm out his name to thousands of products world-wide....

In recent years, sales and profits at several of Mr. Cardin's subsidiaries have continued to slowly increase, according to the company's public records. Still, there is no global picture of his finances. Making his financial empire more nebulous, he claims to owns a 5% to 10% stake in each of the companies he licenses his brand to, as part of the royalties he collects....

Asked how he came up with the billion-euro valuation, [Cardin] takes out an old greeting card and, scribbling, says, "If I ask €10 million per product, which is nothing at all, per country, multiplied by 1,000, that makes one, two, three...." Dismissing the profusion of zeroes, he concludes, "One thousand products, 100 countries, that's how it calculates. It's nothing." ...".

The question for readers is this: how does one approach the valuation of an IP portfolio which contains a bundle of copyright and design rights which is likely to defy organised attempts at due diligence, and which is underpinned by a brand which is (i) extremely diluted through decades of apparently promiscuous licensing but (ii) highly recognisable and attached to a large number of product sectors in a correspondingly large number of countries?

A second question relates to the prospects of turning such a brand around by jettisoning some of its excesses and refocusing it by creating a new, fresh image to tie to the brand recognition and which promises a prospect of a good return: is this exercise feasible and, if so, how should it be tackled?