Will patent auctions open up bank IP lending?

Over at the IAM Magazine Blog, Joff Wild has an interesting posting on a new patent auction based on Article 9 of the Uniform Commercial Code (UCC). Article 9 of the UCC deals with default of a loan and the recovery of collateral. The case in question deals with the auction of 12 registered patents and patent applications the defunct company SemiQuest Inc. on behalf of 3M Innovative Properties — the only secured creditor of SemiQuest’s debt (see press release).
One question about this auction is why this mechanism hasn’t been used before. In a comment to Joff’s posting by Patrick Anderson notes, there have been lots of cases where patents have been directly or indirectly assigned as collateral. And as the press release states “Bank lenders typically use Article 9 all the time to enforce their rights as creditors, but this case is groundbreaking because a nonbank lender [3M] is credit-bidding its debt in the form of a competitive auction.”
I think what is interesting here is the increased trend to breaking out the IP from the rest of the business. While banks use Article 9 as a mechanism to recover losses from defaults, it has never been clear to me that banks think there is a way to use Article 9 for IP. They know how to liquidate tangible assets (real estate and equipment). They don’t know how to liquidate intangible assets. Therefore, while intangibles such as patents may be included in the collateral package, they are not valued very highly. Use of Article 9 might be a step towards making banks more comfortable in lending based specifically on IP (rather than treating IP as a side thought).

Business use (or not) of Intellectual Property Rights protection

There is a new report out from the National Science Foundation (NSF) on “Business Use of Intellectual Property Protection Documented in NSF Survey“. This InfoBrief looks at data collected in the NSF/Census 2009 Business R&D and Innovation Survey (BRDIS). Taken at an aggregate level, the report is somewhat surprising. Only 5% of businesses say that utility patents are either very or somewhat important. Only 12% said copyrights were very or somewhat important. Only 14% said trade secrets and only 15% said trademarks were very or somewhat important. In other works, 85% of U.S. businesses don’t think trade secrets are important and 96% don’t think patents are important.
But, once you start getting into the details, at least some of this begins to make sense. Certain industries believe certain types of intellectual property rights (IPR) are of importance. Copyright in the publishing industry is an obvious example. A not-so-obvious examples is that, according to the report, “98% of businesses in the semiconductor machinery industry (NAICS 333295) reported trade secrets as important–no other NAICS industry reported a higher share of any type of IPR as important.” One would think patents rather than trade secrets would be of key importance.
The difference is also stark when it comes to business who conduct R&D and those who do not (self-defined). Not surprising, those who say they do not undertake R&D overwhelming rate IPR as not important. On the other side, however, only about half of those businesses that do have R&D activities rate some form of IPR as very or somewhat important.
A couple of questions jump out at me from the survey. First is the most obvious. Do companies really understand intellectual property?
But thinking about it more, another question emerges. In the text is this note: “Only about 3% of the estimated 1.9 million for-profit companies represented in the survey performed and/or funded R&D in 2008.” So the issue is not necessarily IPR. Regardless of whether they utilize IPR or not, do companies understand that they are selling knowledge? They may very well understand this point and we have failed to capture that understanding. The long standing problem here is that many companies are creating and selling knowledge that is outside of the traditional definition of R&D.
So, maybe some of these companies get it — that their intellectual capital/intangible assets are more important than their formal IP. Maybe IPR is not as important as we think. Or maybe the companies are just clueless.
Obviously, more needs to be done before we can understand what is going on here.

Are non-compete agreements bad for innovation?

Non-compete agreements are a standard mechanism that companies use to try to protect what they see as their intellectual property. They are so standard that they are recognized by the accountants as an intangible asset. Yet, the question remains whether they are effective and enforceable. As I noted in Intangible Asset Monetization, non-compete agreements are considered illegal under California’s Business and Professions Code Section 16600 as a restraint of commerce. A number of other states also tend not to enforce non-compete agreements or limit their scope. For example, last November the Virginia Supreme Court once again ruled that an overly broad non-compete agreement could not be enforced (see earlier posting).
But the real question is whether such restrictions can harm innovation. The standard counter-argument to non-compete agreement is Silicon Valley. Many have argued that the lack of such restrictions on the free flow of information and people is a hallmark of the Valley’s innovative culture.
Recent work by Matt Max of MIT and his colleagues describe a different problem: the impact on human capital. In one study, they found that enforcement of non-compete agreements drives away inventors to locations that do not enforce these agreements (see “Regional Disadvantage? Non-compete Agreements and Brain Drain“. Another study shows that non-compete agreements waste human capitol by forcing knowledge workers to switch fields, thereby losing the ability to utilize their existing skills and knowledge base (see “Non-compete agreements create ‘career detours”.)
The issue is beginning to get more attention in policy circles. For example, the Kauffman Foundation’s new report StartUp Act for the States specifically mentions the problem of non-compete agreements restricting labor mobility and cites the work done by Professor Marx and others. While not calling for the elimination of non-compete agreements, the report lays the case for why a state might want to relax enforcement:

What we recommend is that each state look hard at its legislative policy and judicial doctrine on the matter and make a calculated decision as to whether lax or vigorous enforcement will better serve its objectives. If a state seeks to promote higher entry by new businesses and help them hire and grow, then perhaps more relaxed enforcement is called for. If a state seeks to bolster the economic health of its existing businesses–perhaps because the state’s economy relies heavily on sectors with larger and older companies–then non-compete enforcement might remain appropriate policy.

This was elaborated on in response to a question I asked during panel discussion at the Kauffman State of Entrepreneurship event – see video at 38:00 minute. In that answer Bob Litan of Kauffman made it very clear that there are other ways to protect intellectual property – specifically through trade secrets.
It seems to me that the trade secret route could be a much more effective mechanism. It would be interesting to see work on the application of trade secrets in places like California and Colorado where non-compete agreements are not allowed. The problem is that maintaining trade secrets is more difficult and takes more work on the part of the company. I wonder if companies simply default to the easier action of using non-compete agreements. If that is the case, then the restriction or elimination of non-compete agreements might force greater attention to trade secrets.
Given this new attention – and the availability of alternatives, I would not be surprised to see at least some states begin to take a hard look at their position on non-compete agreements.

Manufacturing/service fusion explained

Here is a great description of the fusion of manufacturing and services by Henry Chesbrough. This is taken from an interview of Chesbrough — “At the Court of King Henry.” Of course, most the interview is about open innovation (and worth reading for that discussion). But Chesbrough is interested in the broader question of value creation and he said about manufacturing and services was especially interesting:

“Xerox now gets more than 25 percent of its revenue from services. IBM is another classic case. A lot of its revenue is generated from services. Company after company is getting more and more of their business from services. In some cases what’s really happening is the business model is shifting. So for example, a GE aircraft engine can be sold for tens of millions of dollars to an airframe manufacturer. That same engine can also be leased on a so-called “power by the hour” program to that airframe manufacturer. In the first case it’s a product transaction. In the second case it becomes a service. And with the latter what benefits GE is all the aftermarket sales and service, spare parts, etc., that accrue during the 30-year life of the engine and operations. So now all that comes back to GE, whereas with the first case, when GE sold the engine, they were in competition in the aftermarket with all the former GE technicians that spent 10 years at GE and then decided to go out on their own. They’ve got all the tools. They’ve got all the manuals. They’ve got all the equipment, the training, but they don’t have GE’s overhead. So they’re undercutting GE, 20, 30 percent on price, and it’s the same people. So this is the way to kind of bring that 30-year aftermarket back into the fold of GE.”

Its all about selling off of your knowledge base — as a product, a service or both.

Restaurants seek to profit from an intangible asset: wait staff

Some of the major restaurant chains have figured out that they run a business based on intangible assets — including their wait staff. This was made clear in a recent “living” section piece in the Wall Street Journal — “How Waiters Read Your Table”. While meant to be a guide for diners, it explains the companies’ strategy:

“We asked what can we do that will set us apart from the scrum,” besides discounting and coupons, says Wayne Vandewater, vice president of learning and development for Applebee’s, owned by DineEquity Inc. “Food is easy to copy, a building is easy to copy, but it’s not easy to copy our people.”
. . .
“We changed ‘suggestive selling’ to ‘situational selling,’ ” says Rene Zimmerman, senior director of training and development for Bob Evans Farms Inc., a family-style restaurant and food maker. Instead of offering every breakfast guest one additional item, say biscuits and gravy, waiters are taught to adjust their offer depending upon the guest. For a diner who places a lighter order, like a bagel and fruit, the waiter might suggest a cup of coffee or tea.
. . .
Reading a table happens within seconds of a waiter coming to a table. By asking for a cocktail menu or smiling and making strong eye contact, “they are saying ‘hey, I want to engage with you and I want you to make me feel really important,’ ” says Mark Maynard-Parisi, managing partner of Blue Smoke, a pair of barbecue restaurants in New York, owned by Union Square Hospitality Group. If people seem shy, “you want to put them at ease, say, ‘take your time, look at the menu.’ ”
Blue Smoke does seven days of training with new waiters, five days of trailing an experienced waiter and two days of being trailed by the experienced waiter. Each day includes a quiz and a focus such as greeting guests.

I love the fact that Applebee’s has a “vice president of learning and development.” I know that McDonald’s has its own training facility (often referred to as “Hamburger U”). But, as I understand it, their emphasis is still on uniformity and efficiency – based on their well-known factory type methodology. These other chains seem to be moving away from the mass production model to emphasizing the customized model. But then again, the customized model was the dominant model in the restaurant business forever before McDonald’s industrialized it. As any trip to your favorite local diner will confirm.

Obama proposal for corporate tax reform

Today, the White House and the Treasury Department released The President’s Framework for Business Tax Reform. The main focus of attention is on the proposed reduction of the corporate tax rate to be paid for by eliminating many tax incentives (aka loopholes). This follows the “cut and broaden” strategy advocated by a number of sources.
However, the President’s proposal does not eliminate all incentives. In fact, it has an entire section on strengthening incentives for manufacturing and innovation, including expanding the R&E tax credit. But nothing about a “patent box” or a “knowledge tax credit” for on-the-job worker training.
It also refers to the previous proposals on transfer pricing of intangibles being shifted to low tax jurisdictions (see earlier posting).
Interestingly, Appendix II of the document lists the effective marginal tax rates on new investments. According to this analysis, the effective marginal tax rate for a new investment in intangibles is 6.2% for a corporation and -3.1% for noncoporate businesses. This seem to poster the claim by the Treasury Department of some years ago that intangibles are already favored under the tax code (see earlier postings). However, since the analysis specifically notes that intangibles include R&D, I assume that most of this low effective tax rate is due to the R&E credit. It would be interesting to see the full analysis on all forms of intangibles. And the economic impact of those rate on investment decisions!