Will Myhrvold’s Model Work?

Let’s consider the idea of funding the creation of patents.  This type of transaction system will only work if the amount the funders are willing to pay inventors to generate inventions is no less than the amount inventors are willing to accept to generate those inventions.  So, how much are funders willing to pay for the generation of patents, and how much are inventors willing to accept?  The answer lays in the expectations both funders and inventors have about the contribution of patents to the stream of profits they end up generating.  If both parties are in agreement about the portion of the final expected profits associated with a commercialized or licensed invention that is attributable to the underlying patent, then the model should work.

How might expectations between the parties differ?  I describe a couple of possible points of contention below.

First, in his HBR article, Myhrvold indicates that “Statistics on the true risk of investing in inventions are sketchy, but government reports suggest that just 1% to 3% of patents generate a profit for their inventors.”   Detached funders will discount the expected value of any given patent by 97 to 99 percent to account for the fact that only a small portion of patents end up being valuable.  However, inventors are much more inclined to believe that their patents fall into the 1 – 3% portion of profitable patents.  As such, inventors will be more inclined to discount the expected value of their patents by much less than will the funders.  In other words, inventors will be inclined to believe their patents are worth more than will funders of those patents.

Second, the value of patents is context specific.  Given its repository of patents and products, its know-how, its relationships, and such, IBM may be able to generate greater profits from a particular patent on a computer technology than, say, Cisco.  In this case, the patent at issue will be more valuable to IBM, that is, IBM will be willing to pay more for the patent, than Cisco.  A detached funder will be much more likely to understand this issue and discount the value of the patent to account for the fact that the patent might not end up with its ideal commercializer.  An inventor, on the other hand, will tend to focus more on the possibilities of his patent in its most valuable context, and thus value his patent more than the funders do.

Third, these days, most technologies are systems that combine patents and know-how from many different sources.  As a case in point, Steve Jobs has made a point of noting publically that the iPhone incorporates technologies from 200 patents (see for example this article). What can we then say about the portion of the iPhone’s value that is attributable to any one of those 200 patents?  It’s tough to say.  However, the inventor of one of those 200 patents will be more inclined to believe that his patent is the make-it-or-break-it piece of the system and thus value his patent more than would a disinterested funder.

Finally, in his HBR article, Myhrvold notes that patents are a lot more valuable when they are aggregated into portfolios:

One way to extract the full value of patents is to aggregate them intelligently so that the whole is worth more than the sum of its parts…

Any one of the patents would have some value, but as a package the value is much more compelling, because customers save the time and expense of tracking down all the patent holders and negotiating separate deals. Customers can easily get all the patents they need to roll out an innovative product faster and at the same time reduce the risk that theyʼll miss a necessary license and get blindsided by an infringement suit.

Most of our large customers understand this approach and want to license our patents in bundles of 1,000 or more…That said, constructing such portfolios is far from easy. One of the biggest challenges we face is discerning which kinds of inventions are most valuable to our strategic investors and other customers. Companies are not used to talking about such needs with others. And sometimes they just havenʼt thought that far ahead.

When patents are aggregated into portfolios, it is the aggregators who realize the extra value created, not the inventors.  Suppose, for example, that a licensor would pay $10,000 for each of 1,000 patents licensed separately (for a total license fee of $10M), but he would pay $20M to license the portfolio of 1,000 patents.  The inventors of the individual patents will be inclined value their patent based on the $20M generated from the portfolio licensed as a whole, rather than the $10M generated from individual licenses.  As such, the inventors will be inclined to place higher values on their patents than do funders.

Given the large discrepancies between the value inventors are apt to place on their patents as compared to the value that the funders are likely to assess for any number of reasons, it would not be surprising if Myhrvold’s capital markets don’t attract as many inventors as the funders would like.