Skype woes raises questions

One of the reasons I am so fascinated with the Skype saga is that it hinges on the management (or mismanagement) of a key intangible asset. Joff Wilds over at his IAM blog asks the yet unasked question about the Skype deal:

If I were an eBay investor, I would be asking the company’s board some very hard questions about all of this. And if I were sitting on that board, I would be thinking very carefully about how to ensure something like it never happens again.

Joff’s answer to the latter question is the creation of a Chief Intellectual Property Officer (CIPO). That person would go beyond the IP council’s role in the legal department to encompass all of the aspects of IP – “from strategic development and prosecution, through to litigation, exploitation and value creation.”

I have some sympathy for the CIPO idea. But I think it too limiting. It could end up treating IP as something outside of the company’s normal operations rather than a key asset. It also ignores the broader sweep of intangible assets. In truth, the job of fostering and exploiting company’s intangible assets is the job of the CEO (and the COO). Intangibles needed to be baked into the company’s DNA. The danger of the CIPO is that IP becomes seen as something over there that is someone else’s responsibility. A CIPO could help the CEO and COO; it could also become just another corporate silo.

And as Joff points out, it is also part of the oversight job of the Board. Should the Skype deal fall about because of mismanagement of a key intangible asset, I think eBay management (past and present) and the Board will have a lot to answer for.

Shiller on complexity in financial products

And speaking of securitization, Robert Shiller makes an interesting point in his a recent piece in the Financial Times “In defence of financial innovation”:

New products must have an interface with consumers that is simple enough to make them comprehensible, so that they will want these products and use them correctly. But the products themselves do not have to be simple.

Intangible asset backed securitizations are likely to be complex. As we noted in our report Intangible Asset Monetization: The Promise and the Reality, such deals require a number of backstops. For example, a securitization of a trademark/brand needs to have an active management and marketed entity to ensure that the assets are protected and utilized to their fullest extent. Such deals are also likely to be “covenant-heavy” (in contrast to the covenant-lite deals of the recent bubble).

Thus, deals themselves are likely to be complicated. They don’t have to be opaque, however. Those who structure the deals should take Shiller’s point to heart. The deals need to be comprehensible. That will be the key to market acceptance: investors understand what they are buying.

Going after toxic assets — again

It looks like there will be another attempt to clean up the financial system’s toxic asset problem. According to a story in this morning’s Washington Post (More Help Coming To Clean Up Crisis):

Since July, the Treasury Department has been working with a group of private firms to build investment funds that would combine public and private resources to buy troubled bank securities. The firms plan to buy the assets at bargain prices in hopes that they will turn profitable over time.
This week, the first round of financing from the Treasury is slated to go out the door, sources familiar with the program said. The department plans to commit more than $2.5 billion to match dollar-for-dollar what has been raised by the private firms, the sources said. The investment funds can then borrow another $5 billion from the Treasury in a form of leverage intended to provide a further incentive to the private firms.
The total size of the program is expected to eventually reach $40 billion and can be expanded if needed, administration officials have said.

As the reader of this blog know, I have long advocated such a step. If the program can take the assets off the books, it will go a long way to restarting the securitization market (see earlier posting). And that will help the financial markets for intangibles.

But, as I’ve also said, watch for the flood of red ink as the banks are finally forced to write off those assets at the prices that the markets set for them, rather than the assumed value of the mark-to-myth models.

UPDATE: According to a story in the Wall Street Journal, the IMF estimates that banks still have $1.5 trillion to write off. However the US is ahead of Europe in the process: “Banks in the U.S. have recognized about 60% of anticipated write-downs, the IMF calculated. Banks in the Britain and continental Europe have recognized only about 40% of their potential losses.”

Restarting Securitization

Last week, the IMF released an advanced chapter from its Global Financial Stability Report (the full report is due out on Oct 1). The released Chapter 2 of that report was on Restarting Securitization Markets: Policy Proposals and Pitfalls. According to the IMF, the secutization process remains a useful means of mobilizing illiquid assets, reducing credit costs and spreading risk. The problem, as has become widely recognized, was the slicing and dicing of the securities into highly complex transaction where the risk became almost unknowable, and then hiding that risk in off-book entities.

The report goes on to discuss various proposals to reform and restart the securitization market. These include the now standard items of credit rating agency reform, improving transparency, realigning regulatory capital requirements, and originator retention requirements. On this last point, they argue for careful implementation of policies requiring more “skin in the game” as those “can have dramatic effects on the incentives
to improve loan screening, in some cases with the unintended effect of making some types of securitization too costly to execute, effectively shutting down these markets.”

On the issue of transparency, the reports notes that American Securitization Forum has a Project on Residential Securitization Transparency and Reporting (Project RESTART) which is focused mostly on the mortgage backed securities process. That is a good step, but I strongly believe that such efforts are not enough.

There is another recommendation called for the report that would greatly strengthen the market: more simplification and standardization:

Most products could usefully be standardized at least to some extent. This should increase transparency as well as market participants’ understanding of the risks, thus facilitating the development of liquid secondary markets. Although there will always likely be investors that demand bespoke complex products, securitization trade associations and securities regulators should encourage standardized building blocks for securitized products. It would also be useful if some standardization could be imposed on the underlying assets to maintain higher quality pools or at least verifiable pools (see the covered bond discussion below).
Valuation difficulties could also be alleviated if securitization products were simplified. Some of the product complexity was well intentioned, such as excess spread traps and triggers designed to bolster the creditworthiness of the senior tranches. Others, such as micro-tranching, were designed to game rating agency models. In any case, this product complexity has made some securities extremely difficult to value and risk-manage, and to the extent that regulation or market practices encourage such complexity, these components should be eliminated.

Those are good objectives: “facilitating the development of liquid secondary markets” and “alleviate valuation difficulties.” The IMF report notes that the American Securitization Forum is also working on legal documentation standardization, but not on product standardization. Maybe they should.

For the intangible asset securitization process, simplicity is the key. Intangibles are already view with suspicion. As I have argued before, we need some plain vanilla transactions to make that case that these are not overly risky. With patents are becoming more accepted investment asset class (see earlier posting), maybe a few basic patent securitization deals could help get the market going again.

Basic, plain vanilla, uncomplicated. That is a formula for re-starting a market previously see by many (and with good reason) as rather dubious.

Jon Low on reputation

Jon Low (full disclosure alert and shameless plug: Jon is a member of Athena Alliance’s Board) has a new three part series on reputations and brands as intangible assets over on Jonathan Salem Baskin’s DimBlub blog:

From Pitchforks To Profits

Public Actions; Private Realities

Social Media In The Post-Crash World

As Jon notes:

Trust and reputation are intangibles; frequently taken for granted and not accounted for on traditional balance sheets or income statements. And yet, research suggests that as much as 50 percent of a company’s market value may be attributed to them.

And they are fragile and in constant need of management attention – as these essays explore.

Commerce to create new office on innovation

This morning Secretary of Commerce Gary Locke announced the creation of a new office for entrepreneurship and innovation. The announcement was first made during a CNBC interview (see below – note that the interview covered a number of other issues as well, including G-20 protesters and health care).

The official announcement will come this afternoon when Secretary Locke gives the keynote speech to the Council on Competitiveness’s National Energy Summit the Inc. 500/5000 Conference.

UPDATE: Here is the link to the press release Commerce Secretary Locke Announces New Commerce Initiatives to Foster Innovation and Entrepreneurship.

What happened to Pittsburgh

Every G-20 Summit (formerly G-8 Summit) has two side stories. The first side story is about the protesters. The second side story is about where the meeting is happening. In this case, the story is about Pittsburgh’s transformation from steel to the knowledge economy. For example, this morning’s Washington Post has a story on Pittsburgh Shows How the Rust Belt Can Be Polished Up. The emphasis of these stories has been the rise of the educational and health care sectors of the city’s economy. (See also this blog posting on the coverage.)

But that focus may be misleading. A report from OurFuture – Pittsburgh: The Rest of the Story – offers a more detailed analysis:

First, manufacturing did not disappear entirely. In addition to steel, Pittsburgh industry diversified into products ranging from advanced metal alloys to surgical implants and sophisticated robotics. With roughly 100,000 workers, or 10 percent of the area workforce, manufacturing remains a vital part of the regional economy. Manufacturing jobs are generally unionized, so they pay well and generate economic activity beyond the company payroll.
Second, these changes didn’t happen automatically. This wasn’t an unstructured evolution from gills to lungs. It was the result of deliberate plans, of partnerships between government and private industry to achieve shared goals. It involved public investment in infrastructure, private and government subsidies, and express plans to “pick winners” and support them until they gained a lead. It is a story of industrial planning, a piece that has been missing from our national economic equation for the last 30 years.

Interestingly, that transformation includes metals:

The manufacture of steel grew and transitioned into the manufacture of specialty metals and sophisticated alloys. Allegheny Technologies Incorporated manufactures titanium, hafnium, tungsten, and cobalt. With 9,600 full-time employees and $5.3 billion revenues in 2008, the company forges custom fittings for the defense, aerospace, and nuclear energy industries. Over 300 other metals technology service firms provide steel production equipment, engineering services, parts, and supplies.

In other words, manufacturing in Pittsburgh is part of the knowledge economy.

That is a lesson we need to remember.

IP management and SMEs

Duncan Bucknell – over at IPThinkTank – has an interesting posting The biggest issue in IP management? He argues that the biggest pool of IP and therefore the biggest challenge for IP management is in small and medium size enterprises (SMEs). As he notes, “The vast majority of IP management is done where there is no IP function.” He call for the development of tools for IP management that can be applied to all size firms, like accounting.

Neil Wilkof over at IP Finance counters with the comment

that if we are to go about the “development of tools” correctly called for by Bucknell, we will first need to address the prerequisite question: What is the relationship between IP and innovation? Only after we have created a structured approach to answering that question can we then proceed to the “development of tools.”

I’m not sure that I would go as far as Wilkof in that we have to spell out the precise relationship between IP and innovation. But he is correct in that we have to take a broader perspective. SMEs often don’t just lack capacity for IP management, they don’t have the capacity for any form on intangible asset management. The broader framework needs to go well beyond IP to embrace all their intangibles.

There are some models for developing the tools that Bucknell calls for — and for disseminating those tolls to SMEs. In Scotland, for example, there is the Intellectual Asset Centre. Their mission is threefold:

  • to raise awareness and understanding of intellectual assets among Scottish organizations
  • to help those organisztions identify and exploit their intellectual assets
  • to work with independent intellectual assets management specialists and encourage their sector to grow

The Centre provides direct support to companies as well as undertaking research and developing tools. There is a similar program in Hong Kong – the Asia Pacific Intellectual Capital Centre and the Intellectual Capital Management Consultancy Programme.

This is somewhat similar to the US manufacturing Extension Partnership (MEP) centers in the US. MEP, however, is limited to manufacturing firms and focuses on issues of quality and productivity. In my posting yesterday, I noted that as part of the next wave of innovation policies we need to expand MEP’s services to include intangible asset management. But we need to do more.

We need a dedicated institution(s?) on the Scottish IA-Centre model with the sole purpose of intangible asset management. Placing IA management specialists at MEP centers is a good step. But MEP has a number of activities they need to focus on – and its narrow target is helping manufacturing companies. The focus of the IA Centre is both narrower and has much more broader target. It focuses on intangibles but goes beyond helping companies to also raising awareness and fostering expertise in the field. A US IA Center could undertake the same activities. It could feed into the MEP activities – as well as into other business assistance programs run but the federal, state and local governments as well as those by other organizations, such as universities. Such a center could be the catalyst for IA management activities.

Something worth considering.

Grand challenge prizes?

I did want to draw special attention to one part of the Administration’s new innovation strategy report (see earlier posting). At the end of the paper, there is a list of possible “Grand Challenges” of the 21st Century:

•   Complete DNA sequencing of every case of cancer; smart anti-cancer therapeutics that kill cancer cells and leave their normal neighbors untouched; early detection of dozens of diseases from a saliva sample; nanotechnology that delivers drugs precisely to the desired tissue; personalized medicine that enables the prescription of the right dose of the right drug for the right person; a universal vaccine for influenza that will protect against all future strains; and regenerative medicine that can end the agonizing wait for an organ transplant.

•   Solar cells as cheap as paint, and green buildings that produce all of the energy they consume.

•   A light-weight vest for soldiers and police officers that can stop an armor-piercing bullet.

•   Educational software that is as compelling as the best video game and as effective as a personal tutor; online courses that improve the more students use them; and a rich, interactive digital library at the fingertips of every child.

•   Intelligent prosthetics that will allow a veteran who has lost both of his arms to play the piano again.

•   Biological systems that can turn sunlight into carbon-neutral fuel, reduce the costs of producing anti-malarial drugs by a factor of 10, and quickly and inexpensively dispose of radioactive wastes and toxic chemicals.

•   An “exascale” supercomputer capable of a million trillion calculations per second – dramatically increasing our ability to understand the world around us through simulation and slashing the time needed to design complex products such as therapeutics, advanced materials, and highly-efficient autos and aircraft.

•   Automatic, highly accurate and real-time translation between the major languages of the world – greatly lowering the barriers to international commerce and collaboration.

The list is generally a free standing section of the report tied only indirectly. Tom Kalil, Deputy Director of OSTP and also on the staff of the NEC, has long been a proponent of incentive prizes as a research funding mechanism (see his posting earlier this year on the White House blog). Could we be seeing the list of soon to be sponsored research prizes?

Obama Innovation Strategy

Yesterday, President Obama gave a speech on his innovation strategy and the National Economic Council released a white paper A Strategy for American Innovation. The speech reiterated the importance of increasing investments in education, infrastructure and scientific research – and of health care technology and clean energy/green technology. In his posting on the White House blog, Larry Summers stressed the importance of entrepreneurship (and lauded Schumpeter).

The plan itself lays out the case for innovation-led growth – as a sustainable (non-bubble) economic path – and the role of government in the process. In terms of specifics, the paper reiterates policies and programs already proposed or underway, as part of the Recovery Act , the FY 2010 Budget submission or as previous Presidential actions. One of the new actions was the President’s support for FCC Chairman Julius Genachowski’s pronouncements on “net-neutrality.” Thus, rather than a new set of initiatives, the paper seeks to promote current proposals by tying them closely into a package to boost growth through innovation – and thereby remind everyone why the proposals are important.

While it is important to keep the focus on enacting these proposals (as Congress has not yet acted on the FY2010 appropriations bills), it is also not too early to be thinking of the next set of actions. Let me suggest a couple ideas from our earlier Athena working paper from last December Crafting an Obama Innovation Strategy:

•   Rename the Baldrige Quality Award the Baldrige Quality, Productivity, and Innovation Award. Over the years, the criteria for the Baldrige Award have changed with the times. As these criteria have shifted and broadened, the award has become much more productivity and innovation focused. Much of this shift, however, has not been recognized. The change in the name would both better advertise the broader nature of the award and provide an opportunity to review and modify the criteria to reflect this broader view. In addition to changing the name, the award should be given greater visibility by the President. By presenting the awards personally, the President could use it as an opportunity to showcase innovative American companies and collaborations. The National Science and Technology medal criteria could also be broadened to recognize a small number of individual contributions to innovation that are not solely technology based. .

•   Expand the Manufacturing Extension Partnership (MEP) program. The MEP program has been a successful mechanism for increasing quality and productivity in small- and medium-sized manufacturing companies. We should build on that success by expanding the scope of MEP’s services to include innovation activities, including intangible asset management. Doing so would require a phased expansion of the program’s budget and staffing into areas of marketing, finance, and business model development beyond simply new product development and process adoption. .

•   Enable the National Science Foundation’s (NSF) Engineering Research Centers program to support the creation of Design Research Centers as well as promote research and teaching of integrated design thinking. Innovation success is heavily reliant on design as a key component but not simply involving the physical appearance of products. A new approach to applied problem solving and innovation is emerging under the rubric of design thinking. Successful models include the Stanford Design School and the Institute of Design at the Illinois Institute of Technology (IIT), among others.

•   Implement the America COMPETES Act call to study of how the federal government could support research and teaching related to the services industries and service functions in the manufacturing sector. Some suggest that there is already a well-defined discipline of “service science” that merits support and replication across more higher education institutions. Whether or not that is the case could be answered by such a study, which, like other provisions of the 2006 Act, has not been implemented.

•   Endorse, operationalize, and fund the recommendations of former Commerce Secretary Gutierrez’s Advisory Committee on Innovation Measurement in the 21st Century. Among other things, this means supporting and accelerating efforts of the DOC’s Bureau of Economic Analysis to revise the national economic accounts by converting intangible business assets (R&D, software, intellectual property, human capital, brand identification, and organizational capacity) from expenses to investments with future returns. Although Federal Reserve Board staff studies–corroborated by similar analyses in the UK and Japan–find that intangible investments exceed spending on plants and equipment and account for a significant portion of economic and productivity growth, that fact is unlikely to be given full weight in economic policymaking until reflected in the nation’s official accounting.

•   The Securities and Exchange Commission (SEC) should be asked to undertake a study examining barriers to disclosure of intangible assets on corporate financial statements, assess past disclosure requirements (such as the 2003 guidance on the Management’s Discussion and Analysis [MD&A] section in financial statements), and the merits of a safe harbor for limited disclosure of financial information on intangibles not currently allowed in financial statements.

•   As proposed at a June 2008 conference sponsored by the Bureau of Economic Analysis (BEA) at the National Academies, a broader study of intangibles could include (1) a survey of efforts in other countries to advance the understanding of intangibles and their role in corporate performance and economic growth, promote financial investments in intangible assets, and foster the utilization of intangibles; (2) an inventory of federally owned intangible assets and how to exploit them for economic growth; and (3) recommendations of policies to accelerate private investment in and management of the types of intangible assets most likely to contribute to growth.

•   To foster best practices for management of intellectual assets and intangibles in the United States, the relevant federal agencies–such as SEC, Department of the Treasury, and DOC–should establish an advisory committee to make recommendations on ways of providing investors with an improved method for assessing the impact intangibles have on the accuracy of a company’s financial picture and supporting industry trade associations in an effort to adopt guidelines for intellectual asset management and intangible disclosure appropriate to particular industry sectors.

•   Undertake a budgetary cross-cut of government investments in intangible. The federal government is a major investor in intangibles, but we don’t know the size of that investment or even where it really goes. For some time the federal budget, as prepared by the Office of Management and Budget (OMB), has included a capital budget that includes physical capital, R&D, and education and training. The budget documents also include a separate analysis of funding of statistical agencies, which is not included in the investment budget. These and other budget analyses already undertaken by OBM can serve as the starting point for a cross-cutting budgetary analysis of federal investments in intangible assets.

•   As part of the effort to enact a permanent R&E tax credit, adding an incumbent worker training tax credit that would transform the provision into a knowledge generation and acquisition incentive. We already support training of unemployed workers, but not for those who have a job. A corporate tax credit would reduce the incentive firms now have to lay off workers in a recession and rehire different workers with higher skills when the recovery comes, with an attendant loss of company-specific knowledge. Instead of sending some workers to the unemployment line in a recession, we could be sending them to the classroom.

Longer term actions might include:

•   establishing an analyze capability for reviewing regulatory activities with an innovation impact;
•   better managing the allocation of R&D spending among and within federal agencies through a joint OSTP and OMB review agency spending plans in key areas with an eye to making mid-course adjustments;
•   strengthening the White House role in reviewing and balancing intellectual property policy as broadly defined;
•   consider establishment of a National Foundation for Science, Technology, and Creativity patterned after the United Kingdom’s National Endowment for Science, Technology and the Arts (NESTA);
•   greater use of government procurement to push new business models, including use of new collaborative work tools, such as Virtual Worlds.

These short and longer term actions would move the innovation agenda to the next level and bring in the element missing so far from the Administration’s proposals: intangible assets.

One somewhat disturbing note. When the speech was given, Senator Orrin Hatch, chair of the Senate Republican High Technology Task Force, immediately attacked it (see also Obama Innovation Plan Gets Mixed Reviews). That the Senator felt compelled to issue an attack is of concern. Innovation policy should be a bipartisan activity. If it gets caught up in the current raw politics that has seemed to grip the nation, then the chances of any meaning full action are greatly diminished. And we all lose.

In another side note, it was interesting to see the media’s coverage of the speech and the report. There have been a number of online stories, but not much in what I would call the general print media. For example, the Washington Post ran an online article Monday afternoon but didn’t have anything in the Tuesday morning print edition. Much of the coverage was on the Letterman appearance and the how the President and the New York Governor were getting along. Looks like those two stories, and Genachowski’s statements, trumped coverage of the speech.