The pros and cons of 4 patent valuation approaches

By valuating patents one can choose between several approaches. The paradox is that the most of approaches named in norms were basically not made for patent valuations. Some valuation methods are derived from company valuation (i.e. income approach) or accounting rules (i.e. cost approach). This can lead to problems in applying the methods to all patents.

Different approaches may also lead to completely different results for the same patent – so what approach to prefer?

There are 4 typical approaches that are currently used in patent valuation:

Income approach
Cost approach
Market approach
Indicator based approaches

In following we describe these approaches and show the pro and contra of these methods. We also mention what scope´s types these approaches are appropriate for.

Income approach

Income approach has its roots in valuation of companies, valuing their annual income and applying an industry-specific multiple. For patent valuation it measures the (prognosis) of the income of a patent. The income approach can be applied also without any patent that means that the income approach strictly spoken is the difference of the earnings that can be done without a patent and the earnings that are achievable with having the monopole advantage of the patent.

There are several types of income. Direct income includes e.g. licenses or revenues associated with products that are protected by the patent. Indirect income can be determined e.g. by cost savings or additional revenues by locking out competitors with alternative solutions.

What is the income approach usable for?

Patent applications and granted patents valuation
Single families valuation

Pro

Full transparent process
Different scenarios can be used
The approach becomes much easier when a patent is already utilized

Contra

The shares of a patent on a certain product must be known, also cost must be directly linked
Difficult if a product contains multiple patents
Difficult when blocking patents are valued
Indirect income difficult to value
Uncertainty of future (prognosis risk)
Income value is difficult to transfer to another owner (i.e. market access may be different)
Expensive, time consuming valuation process
Assumptions that are done are always vague

Cost approach

This approach is derived from accounting standards, where the replacement value of a certain good is valued. In terms of patent valuation, here all direct associable costs are considered, e.g.:

Development expenses (only development, not research) for this invention
External expenses for
Development, prototype
Patent search
Patent application (attorney, translation, fees…)
Maintaining (fees, attorney, trials…)
The total sum of cost is the cost value

What is the cost approach usable for?

Patent applications (difficult) and granted patents valuation
Single families valuation
Portfolios valuation

Pro

When a process and cost accounting is settled once, costs can be easily added together

Contra

Cost is not proportional to inventive success
Worthless patents are valued too high
High value patents are valued too low
Cost assignment is not always precisely possible i.e. when multiple inventions were created within the same project
According to cost approach, the value rises with age and external cost

Market analogy approach

This method compares an object with another similar object in the market. It determines the price. Market analogy approach determines the value based on the references that were found, e.g. an average value of the similar objects that were traded in the past. This approach is normally used in real estate valuation.

What is the market analogy approach usable for?

Patent applications and granted patents valuation
Single patent families valuation
Valuation of the similar patents

Pro

No prognosis risk in terms of future income
Also blocking patents can be valuated using this method
„Fair value“ is according to all norms and also accounting standards (e.g. IDW S5)
Market value is a potential trade value

Contra

Major problem is to find out, what price was the alternative patent sold for?
Key idea of patents is to protect a principle (unique) – that’s why finding corresponding patents may be difficult
Alternatives may lead to completely different values e.g. when a standard is involved
This method is usually expensive and time consuming

Indicator-based market analogy

By this approach each patent is abstracted to a set of characteristics/indicators, each of them will be analyzed separately. These indicators determine certain „patent-features“. The key figures themselves are the result of statistical research and experience, examples such as “A big patent family size indicates a high family value” (Lanjouw et al, 1998; Harhoff et al, 2003) or “The number of citations that a patent receives indicates technological importance “(Trajtenberg, 1990; Hall, et al., 2005; Harhoff et al., 2003).

Indicator based models deliver a qualitative picture of a patent, this means it can indicate a high or low quality of a patent. It is well-suited to compare patents with each other, e.g. own vs. competitor patents (Squicciarini et al., OECD Science, 2013).

Assigning a monetary value is possible by applying the market analogy to indicator model.

Market analogy with abstract indicator models compares not the object with similar object in the market but only the indicators, determining the object. This method determines the value of certain patterns of objects that were traded in the past and calculates the value based on the reference patterns that were found.

Therefore each patent is reduced to a set of key figures and indicators (see general indicator approach). It means, patent is not directly compared to another, just its model with other models. The approach is very popular in real estate valuation for assigning a value range (e.g. square meters, location, equipment, year of construction are often used indicators).

The more indicators can be used, the more precise the model and the value prognosis becomes. Indicators can be sourced automatically - as long as they are available - or manually. There are software solutions available in the market.

What is the indicator-based market analogy approach usable for?

Patent applications and granted patents valuation
Single patent families valuation
(Big) patent portfolios valuation

Pro

All kinds of patents can be valued
„Fair value“ is according to all norms, standards, guidelines, even accounting standards (i.e. IDW S5)
Market value is a potential trade value
Very low effort to valuate (big automation potential)
Low failure rate (empirical data)
Automated patent value data is already available in the market as well as software solutions
Approach is a scientific trend