Licensing as a Growth Strategy LM

1. Licensing as a Growth Strategy LM

2. The following slides provide background on Growth Strategies for Firms including JV’s, Alliances and of course Licensing.

3. Inter-Firm Relationships • Inter-firm relationships are paths to value enhancement along with internal growth, M&As, etc. • Analysis of relationships should be done within the context of firm’s overall strategic planning • Alliances and other arrangements between firms have become more important since 1985 legislation eased antitrust barriers

4. Multiple Strategies for Growth Growth Strategies are Based on Many Factors

5. Joint Ventures • JV characteristics • Combination of assets from 2 or more parent firms place into a separate business entity • Limited scope and duration • May not affect competitive relationships • Examples: R&D, joint production of single product • JV timing similar to M&As (correlation over 0.95) – driven by same factors affecting total investment activity

6. Joint Ventures • JVs and business strategy: • JVs a part of multiple paths to value growth (Geis & Geis, 2001) • Used over 782 JVs and alliances to: • Develop new product markets • Cable TV – NBC alliance – • Online gaming – JV with Dreamworks to produce games – • Expand into new geographic areas (ex. deals to expand in Japan) • Participate in new technologies (ex. wireless deals with Qualcomm, Ericsson)

7. Joint Ventures • JVs and restructuring – JVs can be used as transitional mechanism in broad restructuring (Nanda & Williamson, 1995) • Buyer can better determine value of seller's brands, personnel, etc. • Risk of making mistakes is reduced through direct involvement with business • Customers moved to buyer over a period of time in which both firms are involved in JV • Buyer builds up expertise in JV • Seller is able to realize higher value from sale following JV due to increased buyer knowledge of assets

8. Joint Ventures • Other benefits • Knowledge acquisition is goal of at least 50% of JVs – best for “learning by doing” with complex processes • Risk reduction – expansion of activities with smaller required investment • Tax aspects – contribution of patent or technology may be more tax effective than licensing (depreciation may offset revenues) • International aspects – reduces risk of foreign expansion (some nations require firms to take a local partner)

9. Joint Ventures • Reasons for failure (70% disbanded early) • Technology never developed • Inadequate preplanning • Disagreement over basic objectives • Managers refuse to share expertise with counterparts from other firm • Requirements for success • Participants have something of value to JV • JV should be carefully preplanned • Agreement should provide flexibility • Should include provisions for termination • Key executives involved in implementation

10. Joint Ventures • Empirical tests • Business and economic patterns (Berg et al, 1982) • Industry JV participation increases with: firm size, capex, profitability • Technologically oriented JVs: substitute for long-term R&D more often than short-term • JVs and R&D are complements at industry level • Event returns (McConnell & Nantell, 1985) • Value of gains evenly divided between firms • No change of mgmt. – gains must be from synergy

11. Joint Ventures

12. Strategic Alliances • SA characteristics • Informal or formal agreement between two or more firms to cooperate in some way • Created due to industry uncertainty and ambiguity – value chains, new technology, etc. • Need not create new entity • Relative size of firms may be highly unequal • Difficult to anticipate consequences – relationships evolve, firm boundaries blur • Firms pool resources and expertise hoping for synergy from learning capabilities, etc. • Allow firms much flexibility

13. Strategic Alliances • Examples Cooperation on system for voice commands for the internet (VXML) Joint offering of international 2-day delivery Combined research and purchasing in 6 JVs • AOL followed strategy of providing subscribers with many benefits through alliance • Partnerships with brick & mortar retailers • Deals with software developers Sumitomo Rubber

14. Strategic Alliances • 2.6% of SAs result in M&As – more likely in mature industries (Hagedorn, Sadowski, 1999) • Types of alliances (Bleeke & Ernst, 1995) • Collisions between competitors – tensions cause failure • Alliances of the weak – weak grow weaker • Disguised sales – strong competitor buys weak • Bootstrap alliances – weak firm improved by strong until alliance becomes on equal footing • Evolution to a sale – successful SA becomes sale when tension emerges • Alliances of complementary equals – SA succeeds due to compatibility

15. Strategic Alliances

16. Strategic Alliances • Requirements for success • Well defined strategic themes • Organization relationships should facilitate communication to share decision making • SAs viewed in real options framework – allows portfolio of potential growth opportunities • High level management should be involved • Must be positive incentive to overcome tension • SA governance must adapt to different types of alliances • SAs must seek out growth opportunities to augment core capabilities

17. Relative Roles • Acquisitions • Rapid augmentation of firm capabilities • Consequences are long lasting • Often costly due to takeover premium • Challenges of combining organizations • Joint ventures • Reduce relative size of investments and risks • Create new entities and relationships • Can develop learning and new opportunities • Strategic alliances • Broaden range of potential opportunities • Relationships are more ambiguous – greater need for communication

18. Minority Equity Investments • Actively employed by successful high technology firms with substantial cash balances • Rationale for investor • Investments in promising startups can yield high returns and substantial long term benefits • Information source about growth opportunities • Method for learning about industries and firms • Identification of new managerial talent • May expand markets for investor’s products • Rational for recipient • May gain knowledge from investing firm • Increases financing resources • May bring visibility

19. Franchising • Contracts between franchisor (parent) and franchisee that grant rights to use name, brand, etc. within specific area • Widely used in geographically dispersed industries (Mail Boxes Etc., McDonald’s) • Reduces monitoring costs – franchisees returns are tied to performance • Potential conflicts • Franchisor has risk of franchisee not conforming to standards • Franchisee may prefer to use different vendors • Disagreements with respect to size of franchisee’s exclusive area exclusive

20. Technological and Marketing Agreements • Exclusive agreements • Enable firms to combine complementary strengths more quickly and at lower costs • May develop into other forms of interdependence between firms • Licensing agreements – licensee may use the knowledge or processes of licensor for a fee • Method of expanding market for firm’s product, or gaining acceptance for new product • Licensee may gain by adding successful product • High immediate returns for licensor in market, but may create future competitor

21. Licensing Arrangements • Exclusive versus nonexclusive rights • Field(s) of use – geographic, market • Economic terms – royalty, sublicense royalty, performance payments, annual fees and/or equity • Diligence terms – development and commercial • Rights to future intellectual property prescribed • Patent prosecution and control • Warranties, termination and dispute resolution

22. What Does A Firm Want from a Licensee? • A true commitment to further commercialize and/or enhance the technology. • A fair price, uncomplicated royalty terms and an opportunity to share in the upside. • Reasonable terms for acquiring new IP. • A role for the firm. • To retrieve the IP if licensee doesn’t produce.

23. How We Assess Technical Feasibility? • Maturation of the technology – where is it in the reduction to practice to market ready continuum? • What does the data say? - from suggestive to proven in fact. • What do non-biased experts say? • Can it be validated and replicated, in what context? • What is the product? How long will it take to develop and at what cost?

24. Assessing Technical Feasibility (cont’d) • How complete is the technical asset? What is necessary in the production and product infrastructure so it can work? • Can it scale to the size necessary for economic success? • What are the technical alternatives, and their IP, economic and market implications relative to the subject IP?

25. How Do We Assess Commercial Potential? • How can a licensee make money from this IP? • Need to have a sense of the product and the context in which it could be used. • Is it a continuous innovation vs. discontinuous innovation? • What is the value proposition for the product – replacement and benefit economics? Some call this the “pain threshold”, what pain will it cause a competitor and relief to a user? • How do you extract economic value for the pain/benefit, i.e., what are the transaction points where value is attributed and exchanged?

26. Assessing Commercial Potential (cont’d) • How much money can a licensee make? • This is a market size issue. • Three primary factors – numbers of users, frequency and intensity of need • What may impinge on market entry and/or growth? Typically regulation, standards or acceptance patterns. • How does the firm make money from the licensee? • We do a broad-aim analysis of commercial potential to determine if we want to patent and who might adopt

27. Valuation Approaches • Market Approach • Comparables, databases, articles, TTO experience • Cost Approach (set up-front fee) • Research $ • IP Prosecution $ • Discount Factor • Income Approach • Discounted sum of future cash flows, i.e. NPV • Option pricing, Black-Scholes formula, decision points increase value relative to NPV • Rule of thumb – 25% Rule

28. Discount Factors RisklevelDiscountrateDescription Nearly Risk Free 10-18 Existing product Very low risk 15-20 Improved existing product Low risk 20-30 New product, new technology, existing market Moderate risk 25-35 Same as above with competition High risk 30-40 New product, new technology, existing market Very high risk 35-45 New product, new technology, new market Extremely high 50-70 New company, unproven technology, new market

29. Product Life Cycle Licensee would like to neglect research costs and risk, and emphasize development cost and riskSolution is to analyze mature operation; if consider development costs, then amortize over the product life Research Expenses Sales Revenue Sales, Cost & Profit Profit * Cashflow Loss Time Introduction Growth Maturity Decline “cash cow”

30. 25% Rule • A fair return is 25% of Operating Profit= revenue less cogs less overhead • Empirical • Retrospective study indicates 25-33% of profit is commonly observed across licenses in many markets • Robert Goldscheider (late 1950s) • Starting point for courts in infringement suits

31. Valuation VariablesGeorgia-Pacific V. US Plywood Relevant factors for determining a reasonable royalty Established royalty 10. Benefits Infringer comparable royalty 11. Extent of infringing use Degree of exclusivity 12. Industry-accepted rate Licensor’s established position 13. Infringer comb. credit Degree of competition 14. Expert opinion Synergistic value 15. Hypothetical negotiation Patent life Established profitability Market advantage

32. Exits • Difference between exit and termination • Termination of a license • At will by licensee, upon breach by Licensor • Breach terms and cure periods • Treatment of sublicensees • Monetization of a license asset • Why, how, and who • Equity as partial consideration for a license • Common v. preferred stock • Member shares in an LLC • Dilution • Liquidation

33. Appendix

34. Basic licensing models Product IP Typically exclusive, rarely a start-up Platform IP Start-up or existing company, sometimes divided uses Process IP Often nonexclusive to existing companies Research tool IP Typically non-exclusive for broad use

35. Patent costs Simple, mechanical application = $8-12k Complex chemical or software = $20-25k Pharmaceutical = $30k + Prosecution = $4k per office action Issue/maintenance fees for life of US patent $1.4k + $0.9k + $2.3k +$3.8k = $8.4k

36. Marketing strategy Know the channels that fit the technology Look for the partners that will develop or use the product/technology Follow inventors inquiries Summarize the critical info Get in touch with the right people in the right company Publication exposure can lead to critical mass Seek feedback, refine the pitch