E.J. Reedy and Bob Litan at Kauffman Foundation have written a new report on start-ups and job creation — Starting Smaller; Staying Smaller: America’s Slow Leak in Job Creation. The report highlights the fact that the job creation slowdown predates the beginning of the Great Recession.
Interestingly, the problem has not been a lack of start ups. In fact, the report notes that the 2010 Kauffman Index of Entrepreneurial Activity was at an all time high. The reason for the job slow down has been a decrease in the average number of jobs being created by new firms:
BLS data show that new establishments opened their doors with about 7.5 jobs on average for much of the 1990s, a figure that has since declined to 4.9 jobs per new
. . .
the most recent year of data shows a cohort of new business that was smaller in number and in jobs created than in any cohort since 1994 and, in most cases, than any previously measured cohort in data dating back to 1977.
And the problem is not just that new companies start out small. They also have stayed smaller.
The average rate of employment growth from birth to age two and then age two to age five has been decreasing in all the data series, with only moderate yearly variation. So, while the levels might vary slightly in the different data series, the trends appear similar: Businesses that survive their early years of existence have been adding jobs at a slower pace than the historic norm in recent years. (emphasis in original)
So the problem is not start-up, but scale-up.
To me, this calls for a different approach to public policy. The recent focus has been on the start-up process, for example the President’s Startup America (see this posting on the Kauffman blog for an update of the program). This new look at the data tells me we need to focus more attention on the growth phase. There are a number of things we could be doing to help established business grow faster. For example, we could expand the Manufacturing Extension Partnership (MEP) programs to encompasses a broader range of business assistance services (including management of intangible assets) to a broader range of companies. We could also increase funding for high-growth intangible-rich companies by allowing intangible assets (such as patents and other IP) to be used as collateral for loans. Creating a pilot program on IP backing lending at SBA would be the first step.
Bottom line: entrepreneurship is good; scaling up from start-up to high growth is better. Time we start paying more attention to the latter part of the process.
Innovation needs to be a verb. Unfortunately, most people think of it as a noun. Innovation is a thing, an outcome. As Webster’s defines it: a new idea, method or device. But we also need to think of innovation as a process.
Case in point is the recent history of Motorola. As everyone now recognizes, the proposed takeover of Motorola Mobility by Google is based on access to the Motorola patent portfolio. The acquisition has little to do with Motorola’s hardware technology. In fact, as a story in today’s New York Times (“Motorola’s Identity Crisis”) points out, Google may have difficulties figuring out what to do with Motorola’s hardware activities. Google already has close relations with other hardware manufacturers, such as Samsung and HTC. Getting into the hardware business could disrupt those relationship.
This is far cry from Motorola’s reputation as an innovative leader. Motorola pioneered wireless communications, starting with the first “carphone” (a radiotelephone) in 1946 to the first commercial cellular phone (the DynaTAC 8000X) to the breakthrough flip phone StarTAC and the hot selling RAZR. Motorola also led in process technologies in the late 1980 with the development of the Six Sigma quality improvement program.
The acquisition could be a huge positive step for Google if it can find a way to harness the innovation processes in Motorola. Controlling the previous innovations (noun) in the form of the patents is far different from exploiting innovation (verb) capacity latent in the Motorola Mobility organization. That capacity in embedded in a variety of intangibles — from the innovation tradition and culture to the skilled workforce.
On the other hand, maybe all that changed with the split of the company last year into Motorola Mobility and Motorola Solutions. It could be that all that innovation capacity now resides in Motorola Solutions. If so, then Google has only bought itself some innovation-as-a-noun. Innovation-as-a-verb may continue somewhere else.
If you want to understand what is happening with the recent patent boom, here are two stories to read: Steve Lohr’s “A Bull Market in Tech Patents” in the New York Times and Jia Lynn Yang’s “Four titans of tech are racing to be king of digital age” in the Washington Post.
It is not as if companies just realized the value of IP and innovation.
It is about dominating the next technological platform.
Not that this is necessarily a bad thing if it brings greater attention to intangible assets. As a NY Times Dealbook story (“Quest for Patents Brings New Focus in Tech Deals”) relates:
“Before, nobody really paid attention to patents. Now patents are emerging as a new currency,” said Alexander I. Poltorak, chief executive of the General Patent Corporation, a patent licensing and enforcement firm. “I’ve recently received several calls from financial analysts and bankers who want to know how to value patents and what does it mean.”
Unfortunately, it may be a bad thing if it only feeds the litigation mindset. The concept of intangibles asset monetization easily be dismissed as only an innovation-blocking defensive strategy. Yet the utilization and management of intangibles can be a powerful positive and innovation-inducing business strategy (see earlier posting). It would be a major lost opportunity if we can’t make the positive case for intangibles right now.
And by the way, for the latest on the patent wars behind all this, check out these two stories in the Wall Street Journal — “Cellphone Patent Disputes Piling Up” and “Founder of Priceline Spoiling for a Fight Over Tech Patents”.
Get ready for the next patent auction. Kodak is the latest company to sell its patents, according to the Wall Street Journal:
Investment bank Lazard Ltd. began marketing the portfolio this week, reaching out to companies that may be interested, said a person familiar with the matter. The auction will be conducted over two stages, according to a person advising a company interested in buying Kodak’s digital-imaging patents.
This person says the interested company is a large, strategic buyer in the wireless industry looking to use the patents for defensive protection.
The news apparently sent Kodak stock up by 24%.
The sale is the second part of Kodak’s IP strategy. The company has already licensed a number of their digital imaging patents to mobile phone companies. According to the Journal story:
The licensing strategy brought in $1.9 billion from 2008 to 2010, but the flow of settlements dried up this year, prompting the company to look more seriously at selling patents, one board member said.
One wonders how many boards are asking the same questions and how many other companies are now scouring their patent portfolios looking for anything remotely associated with wireless technologies.
The near-frenzy over wireless patents has also sparked action in another area. The Journal also reports that Canadian patent licensing company Wi-LAN has launched a hostile bid for another Canadian technology company, MOSAID Technologies:
“Combining the patent portfolios will provide a more efficient and rapid path to establishing a larger and more valuable aggregate portfolio given the combined management team’s expertise and increased business scale,” Wi-Lan said in a statement. It will also allow the combined entity to access capital to grow the business and fund litigation to enforce its patents, if necessary, Wi-Lan said.
Who will be next?
In a couple of recent postings, I mentioned that for an intangible asset acquired from outside, accountants try to separate out the value of particular intangibles from the overall sales price. Here is a study from Ernst & Young – Acquisition accounting: What’s next for you – that describes exactly how intangibles get counted. Published in February 2009, the study looked at over 700 acquisitions across a variety of industries as reported in 2007 annual reports.
In general, the story is not necessary very flattering. The report begins but noting the difficulties in getting the data, noting that “many companies were reluctant to fair value tangible assets bought and to provide detailed information on intangible assets they acquired and how they were valued.” That insight is borne out by the fact that “goodwill” continues to be the convenient catch all category for acquired assets. Goodwill accounted for 47% of total enterprise value, compared with 23% for recognized intangible assets and 30% for tangible and financial assets. In other words, almost half of the total value of the acquisitions and over two-thirds of the intangible portion of the acquisition where labeled as goodwill. So much for accountants making process in accounting for intangibles. In almost a quarter of the transactions, goodwill was the only type of intangible — no other type of intangible was reported.
On the other hand, the report seems to indicate that the category of goodwill is used extensively to capture the value of intangibles that GAAP accounting rules do not allow. For example, descriptions of goodwill include brief discussions of workforce skills and business processes.
The uses of goodwill versus GAAP recognized intangibles varies by industry. Not surprisingly, the patent heavy industries of biotechnology and pharmaceuticals have a larger percentage of intangibles in GAAP recognized categories and less in goodwill. The consumer products industry has the largest percentage of total value (and of intangibles) in goodwill at 65%. Interestingly, this is followed by the technology industry at 60% goodwill. Telecommunications had 48% in goodwill.
A breakdown of the telecommunications industry’s recognized intangibles shows that 40% of recognized intangibles were in customer contracts and relationship. For consumer products, the largest recognized intangible was brands and trademarks, at 39% of recognized intangibles (which was only 27% of total enterprise value — meaning brand and trademarks accounted for only 10.5% of total enterprise value of the acquisitions).
All in all, an interesting look at how accountants are allocating among intangibles. And a clear indication of how far we still need to go in accounting for and reporting of intangible assets.
In a posting last month I noted that Carl Icahn wanted Motorola Mobility to sell off its patents which he apparently estimates have a higher value than the $4.5 billion paid for the Nortel patents. Well, Motorola Mobility decided not to sell of their patents, but to sell the entire company to Google for $12.5 billion (see stories in the Wall Street Journal and New York Times, as well as Larry Page’s official Google blog posting on the deal).
Given that the accounting rules require companies to account for intangibles purchased from outside, we might actually get to see what they assign as the value of the patents.
One of the nagging issues about intangibles is the valuation problem. How can you assign a value to an intangible asset? In the case of a market transaction — i.e. an intangible acquired from outside, accountants try to separate out the value of particular intangibles from the overall sales price. For internally generated intangibles, they don’t even try. It is easy to simply dismiss valuation of intangible assets as not precise.
I would argue, however, that precision is a function of the valuation process itself not just the nature of the asset. Take, for example, that most tangible of assets — real estate. It has been claimed that inflated valuations were a contributing factor to the housing finance bubble. Now come the concern from the other side, as illustrated in this piece in today’s Wall Street Journal – “Judgment Call: Appraisals Weigh Down Housing Sales”.
William Maxwell is an expert in finance. He’s a professor at Southern Methodist University’s business school, has co-authored a book on high-yield debt and spent years calculating values of financial markets.
Yet there’s one valuation he can’t understand: the appraisal of his Dallas home.
In August 2010, Mr. Maxwell’s home was appraised at $790,000 as part of a mortgage refinancing. Yet this past spring, when he tried to sell the four-bedroom home for $756,500, the appraisal commissioned by the buyer’s lender, Bank of America Corp., came up with a value of $730,000. Mr. Maxwell said the appraisal killed the sale.
The conclusion: the appraisal system is broken. Of course, not everyone agrees. As the article notes:
The Mortgage Bankers Association, an industry trade group, concedes that appraisals are conservative but says they need to be, partly to protect the banks from future problems with investors who buy mortgages. “There’s an extra note of caution,” said Steve O’Connor, a senior vice president at the association.
And some appraisers say homeowners are just having trouble facing reality. “It’s the market. It’s not the changes” in the appraisal process, says Charles MacPhee, a partner with Buttler Appraisals LLC.
The article goes on to cite a number of concerns with the appraisal process: less experienced appraisers; using distressed sales as part of determining comparable prices; use of automated valuation models; processes that don’t capture all of the specific features of a property.
As we look at the issue of intangible asset valuation, let us keep in mind the lessons from real estate. Valuation includes a degree of judgment. The system will never be totally precise. We need to understand and accept that fact and move on.