Over the past few years audit committees and boards have increasingly sought assurance that a company’s intellectual property is being properly managed and appropriately protected. The need for that assurance has never been greater. For one thing, we’re in an era when IP is being bought and sold for record amounts – in May, for example, Google paid $12.5bn for Motorola Mobility’s 17,000 or so patents.
Companies are also now thriving on IP alone – a prime example being ARM Holdings. ARM dominates the global mobile phone chip market, yet has never manufactured a single unit. Instead, it supplies the IP and to date has sold 800 licences to over 250 companies.
Meanwhile, and in fact because of the booming value of IP, the growth in IP crime is also record-breaking. European customs seizures in 2010, for instance, were almost double those of 2009.
All of this is making IP management more important than ever for many organisations. In this environment, where should internal auditors be focusing their attention?
The role that IP plays will depend on the type of organisation and internal auditors will always take that into account. Nevertheless, when it comes to managing IP, good housekeeping is the right place to start. This means ensuring that the organisation is scrupulous about its administration, documentation and record keeping. Among other things, the documentation should establish ownership of all IP in the organisation and when actions such as registration and patent renewals are due. Understanding what your organisation owns and in particular what is protected by a UK or European patent is a crucial first step in being able to elect into the new Patent Box tax regime (see panel, at end of article).
Organisations also need to have sound decision-making processes in place to determine how best to protect IP – for example, whether to apply for a patent and disclose IP or to keep it as a trade secret.
Processes need to be established and followed to ensure that prior patent searches are conducted to protect investments in R&D. Organisations should be clear about who is responsible for making key IP decisions at the appropriate time internally and for undertaking key actions.
“We always find that people think it’s the legal function that is responsible,” says Lara Quelch, a senior manager in KPMG Forensic’s intellectual property services team, “but they don’t create IP and they don’t decide what IP to acquire, so the management and protection of IP should not be the responsibility of the IP legal team alone. The team interacts with other functions: R&D, strategy, marketing, finance and even HR in managing IP risks.”
Businesses should also assess, on a regular basis, whether IP assets continue to be worth the investment in patent renewals. Or conversely, whether IP is protected enough.
“You may have instances where people think they have a patent protecting a particular production line, but the product has moved on,” says Keith Hodkinson, a partner in Marks & Clerk, the largest firm of patent and trademark attorneys in the UK and one of the largest in Europe. “I’ve seen instances where the company is still renewing a patent without realising that it’s no longer protecting what they are doing,” he says.
Organisations also need to be vigilant in looking out for infringements of their IP rights. Counterfeiting and piracy are becoming more prevalent (see panel, at end of article) and organisations need to work to minimise the impact on revenues and brands.
Acting robustly on patent infringements can reap rewards. Hodkinson says that the about 90 per cent of disputes are settled long before they get near a courtroom – simply because the potential legal costs for both sides are punishingly high.
Instead disputes are settled with licensing agreements, or rivals’ products being modified, or by competitors exiting the market altogether. Whatever the solution, it’s worth pursuing.
Last but not least, under the “good housekeeping” heading, organisations should to be paying close attention to how they are handling other people’s IP.
“When I have been asked to do internal audits of IP”, recalls Quelch, “the use of third-party IP is actually of great concern. People don’t have systems and processes in place to track what they are using and if they are using it in compliance with the terms of the licence. I think that across the board this is a very weak area.”
Sweating the assets
However it’s become clear in recent years that good housekeeping is only half of the equation when it comes to managing IP. The role of IP as a protector of market share has been superseded by an imperative to make it pay.
To this end, as Hodkinson points out, IP is now being deployed as a tradable asset. He lists the ways it can be used: to secure bank funding; to win equity in joint ventures; to generate cash flow through licensing; to generate one-off cash injections by selling IP when cash flow is an issue; and to replace cash as a contribution to reducing pension fund deficits. TUI Travel concluded a deal to do just that last year, using the £234m valuation of its Thompson and First Choice brands as collateral.
IP should also be managed tax efficiently. In this regard, as of next year, it can be used to reduce your firm’s tax burden through the government’s Patent Box regime.
Hodkinson adds that many internal auditors come from an accounting background where there are established rules for handling IP.
“Those rules are fine,” he points out. “But they’re not the only way of accounting for IP. For purposes other than published accounts, there are other approaches to valuation.”
For example, with trademark portfolios, you are unable to put a value on the books for the rights that have been grown organically, as opposed to rights that have been acquired.
“But in fact, these trademarks can be extremely lucrative with an independent value that could be incredibly important,” he notes.
Taking it outside
It looks as though the importance of IP management is set to continue growing and the landscape will continue to evolve. For example, David Eastwood, a partner in KPMG Forensic’s intellectual property services team, observes that some organisations are now more focused on acquiring IP through licensing or outright purchase rather than on developing their own IP in-house.
Moreover, in a world where knowledge is widely distributed, many companies can’t afford to rely solely on their own R&D efforts. Eastwood notes the rise of “open innovation”.
“You get to the stage where you just can’t invent everything internally and it doesn’t make sense in terms of managing your costs,” he says, “So companies increasingly buy or license the IP of others to plug their own gaps.” An example is Facebook’s acquisition earlier this year of Instagram – a company with a neat photo-sharing technology that Facebook lacked.
Meanwhile, and particularly in the highly competitive technology sectors, more and more organisations are adopting cross-licensing strategies – a sort of “you show me yours and I’ll show you mine” approach. This has evolved into patent pools, especially in telecoms where the compatibility and interoperability of devices is paramount. These have given rise to industry standard technologies such as 3G and 4G where whole batches of patents are pooled into standards under cross- licensing arrangements.
With all the permutations available, IP management is becoming increasingly complex and many organisations are outsourcing professional expertise to handle it.
For their part, internal auditors should maintain an awareness and understanding of the issues involved. In particular, Hodkinson believes that, for many organisations, the rights that they hold are not at all well understood, with the top of the organisation grasping the notional value of IP but not what IP they actually hold; and the technical people understanding the detail of what they have but not its value. A key role for internal auditors will be, as ever, to see the bigger picture.
>> Patently important
Internal auditors should be aware that, from April 2013, a new tax regime will come into force. Called Patent Box, it will give organisations using patents the chance to reduce their UK tax burden significantly.
Conceived as a means of encouraging innovative businesses to remain or locate in the UK – and ensuring that UK tax laws remain competitive – Patent Box means any UK company with interests in qualifying patents can opt into the regime. Once in, the corporation tax on qualifying profits will be at ten per cent, rather than 26 per cent.
Companies that could benefit should act early to find out what business changes might be to their advantage. For further information visit www.hmrc.gov.uk/budget2012/tiin-0726.pdf
>> The rise of IP crime
IP crime is on the rise. The European Commission, for example, noted “an amazing upward trend” when it announced its most recent customs detention statistics in July 2011. The commission reported that the number of cases – that is to say individual interceptions on the EU’s external borders – almost doubled between 2009 and 2010. Over the longer term, the number of cases rose steeply from 6,253 in 2000 to 79,112 in 2010 – a growth of some 1,265 per cent.
The increase is partly because counterfeiting and piracy provide high returns at low risk for professional criminals. Estimates suggest that cybercrime – of which some IP crime is a component – is a more profitable “business” now than running illegal drugs. This is also largely a result of technology. The internet provides a ready marketplace for trading illicit goods. Moreover, a great deal of IP is stored electronically, making it very easy to steal, copy and distribute. Consequently, the music industry expects to have lost £1.2bn to online piracy between 2007 and 2012, while the business software industry believes it loses £1bn every year.
Meanwhile, the Alliance Against IP Theft found that nearly a quarter (23 per cent) of SMEs have had their businesses significantly affected by IP crime. That said, 40 per cent of businesses surveyed by the IP Crime Group admitted to taking no practical action, such as trademark registration or employee training, to look after their own IP or that of other people.