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!

Innovation in construction – an example

We tend to think of construction as not very innovative. But, as this story from today’s Washington Post (“Why National Gallery’s East Building shed its pink marble skin”) illustrates, construction can face some daunting technical challenges:

In 2005, the pink marble panels that envelop I.M. Pei’s stunning museum [National Gallery’s East Building] started to show worrying symptoms. Excess mortar and lead shims had inadvertently tied the stones together. Instead of each being able to float freely over the brick and concrete wall behind, they were locked to one another. As temperatures rose and fell over 30 years, the fastening system failed. Stones started to pull away from the building.
It is a bad thing to have stones pulling away from a building. Flatten a single tourist with a 450-pound slab of falling marble and people talk. And so a challenge was issued: Who can fix this?
The response came from people such as Lenny Pagliaro, a mason and one of a team of contractors who have come together to take off all 17,000 stones, refinish them and put them back in exactly the same places. It’s an $85 million project that won’t be finished until 2014.
. . .
Then there’s the little matter of making sure what happened once doesn’t happen again. The marble cladding is attached with various anchors, and each panel is supposed to be free to move independently. Engineers came up with a sophisticated set of components to replace the old method, along with a soft silicone gasket that won’t stress the stones. Then they built a training facility in Bowie just to test the technique and teach workers how to use it.

Necessity really is the mother of invention/innovation. The next question is whether this technique will be used elsewhere or whether it is a one-off. This is where invention becomes innovation.

Economic Report of the President – includes intangibles

The Economic Report of the President was released last Friday. Understandably much of the focus by the press/pundits/blogsphere is about the macro economy outlook (for example, see “How the Economy Looks From the White House”). But within the document there are a number of interesting references to intangibles and innovation.
First of all, let me draw your attention to the document’s specific discussion of investments in intangibles (on page 56). This discussion not only talks about current BEA efforts to include intangibles, such as R&D, as investments in the GDP calculations. It also argues for a broader view of intangibles, such as human capital:

Some researchers have argued that investment in intangibles should be defined even more broadly (Corrado, Hulten, and Sichel 2009; Corrado and Hulten 2010). In addition to research and development that builds on a scientific base of knowledge, for example, there is an argument for treating as investment the money firms spend on other sorts of new product development, such as the development of new motion pictures or new financial services products. Businesses also spend money on strategic planning, the implementation of new business processes, and employee training, all of which may add significantly to future productivity and thus arguably should be treated as investment as well. Taking an even broader perspective, time and money devoted to formal education add to the human capital of the American workforce and thus to its future productivity. While accounting accurately for the value of these investments poses some difficult measurement challenges (Abraham 2010), their importance to future economic growth should not be overlooked. According to some research (Krueger 1999), returns on human capital generate the lion’s share of national income.

I welcome this attention — and hope it might be the groundwork for the creation of a crosscutting look at investments in intangibles assets in the Federal government’s budget (see earlier postings).
I should note that the Report raises a number of data questions, such as the discussion on pages 52 and 53 about measures of the service economy. See also a WSJ piece on “White House Highlights Need For New Data Based on Changing Economy.”
The Report also includes a discussion of trade in services — highlighting the importance of royalties & license fees and business services. To its credit, the Report talks about the contribution of trade in intangibles without falling into the all too common trap of “services will save us.” In addition, in a footnote the Report references the issue of companies locating their intellectual property “in low-tax jurisdictions, minimizing their global tax liability as well as measured U.S. royalties and license fees.”
Interestingly, the discussion of innovation is tucked in the section on “Improving the Quality of Life” (Chapter 8). Here the discussion is, predictably, on technology-focused issue: measuring technological innovation; IP; funding of R&D; commercialization of university research; wireless and spectrum. Unfortunately, we still can’t seem to get beyond our narrow policy thinking on innovation.
BTW – the Report also has a section on modernizing unemployment insurance, including an endorsement of work sharing programs (see earlier posting) and use of UI funds to support entrepreneurship.

Work share included in tax bill – with a reference to training

In an earlier posting I noted that the sale of broadcast spectrum (an intangible asset) is being used to fund the extension of unemployment insurance (UI) benefits in the Middle Class Tax Relief and Job Creation Act of 2012 (H.R. 3630). But also tucked inside the bill is a modification to the UI program to create a “work sharing” program — including a training portion as I have advocated in the past. Subtitle D of Title II of the bill authorizes the use of UI funds for “short-term compensation programs” for workers who have had their hours cut back. Since UI is a State-run program, the States will have to create job sharing programs within their specific UI program.
This is a major step forward in re-orienting our UI system. As a story in the Wall Street Journal (“Tax Bill Passed by Congress Broadens Jobless Program”) notes:

The bill will expand a program known as “work sharing” that uses unemployment-insurance funds to supplement the paychecks of employees whose hours have been reduced as part of a company’s cost-cutting. Supporters credit the program, used in Rhode Island and several other states, with encouraging companies to keep workers in part-time jobs rather than resort to layoffs.
“Right now, we have a UI system that is biased toward laying people off rather than cutting hours,” said Betsey Stevenson, a former chief economist in the Obama Labor Department and currently a visiting professor at Princeton University. With the changes, she said, “you’re not only spreading out the pain but you’re actually minimizing the pain, because we know that when people go through a spell of unemployment, there are actually long-term consequences.”

But more than spreading the pain, the program specifically includes training as part of the package. The bill (in Sec. 2161) states that “(6) eligible employees may participate, as appropriate, in training (including employer-sponsored training or worker training funded under the Workforce Investment Act of 1998) to enhance job skills if such program has been approved by the State agency”. This allows those receiving the fund to be treated the same as anyone else receiving UI benefits. I would have liked to have seen the words “shall participate” instead of “may participate.” Better to pay workers to sit in a classroom than sit at home. But this is still a step forward.
As I have argued before, the UI system needs an overhaul. The need for a UI overhaul and the shift from simply job search to training is illustrated by a recent story in the Washington Post (“U.S. manufacturing sees shortage of skilled factory workers”). That piece describes the problem perfectly:

Much of the demand for skilled workers arises because the automated factories demand workers who can operate, program and maintain the new computerized equipment. Many of those who have been laid off can operate only the old-fashioned manual machines.

As skills are constantly changing, workers need help in keeping up. Rather than laying those workers off, a work sharing program tied to training would give those workers the skills they need be more productive and keep their jobs in the first place. And if they do get laid-off, to quickly find a new job.
When we had this debate last summer, I called the UI extension bill a wasted opportunity. I’m glad to see that Congress has seized on this opportunity in the form of creating the work sharing program. I hope the States also seize the opportunity and move forward quickly with its implementation.