Visibility On The Invisible - Intangible Asset Insurance: Part 2

Visibility On The Invisible: Intangible Asset Insurance - Part 2

This is part two of a three-part series of “Visibility On The Invisible: Intangible Asset Insurance”.

What are Intangible Assets?

Tangible assets are physical assets; intangible assets are the opposite and account for assets that are not physical. This simple definition has unfortunately been misconstrued, leading to a misunderstanding of what an intangible asset is.

The term “intangible asset” is a broad umbrella that includes many different types of assets. Intellectual property is a term often used in place of intangible assets, but it is important to realise that intellectual property is only one type of intangible asset.

In its broadest sense, intangible assets can be grouped into two: intellectual property (IP) and intellectual capital (IC). IP and IC are illustrated below in Figure 1.

Figure 1. High-level overview of the different types of intangible assets.

The above breakdown is generalised and depending on context some of these assets may differ. In particular, trade secrets are shown as a form of IC, but can also be considered as a form of IP. For example, instead of protecting technology using patents, an organisation may elect to protect the technology using trade secrets.

IP can be broken down further into registered and non-registered IP. This is illustrated in Figure 2 below. Registered IP includes patents, trademarks and designs, and unregistered IP includes copyright and unregistered trademarks. If trade secrets are considered as forming IP, trade secrets are an unregistered form of IP. Depending on the jurisdiction, trademarks can be protected through other avenues, such as under the Australian Consumer Law for passing off.

An important distinction with registered and unregistered IP rights is the onus of proof during infringement. In general, for registered IP rights, the burden of proof is on the alleged infringer to show they do not infringe the right, but for unregistered IP rights the burden of proof is on the owner to show that a third party infringes the right. This subtle but significant difference can affect how the IP is enforced.

IC can also be broken down into structural capital and human and relational capital.

Figure 2. The breakdown of IA into the different forms of IP and IC.

An outline of the different types of IP and IC are provided in Table 1.

Table 1: Summary of each type of IP and IC.

IA Type	Afforded Protection
Patent*	Protects an invention which can be a physical thing, the way something works, a way of doing something, a composition or formulation, the way something is made or prepared, or the way things are combined.
Trademark*	Identifies the brand owner of a product or service by using a recognisable sign, design or expression.
Design*	Protects the visual form of a product, such as the shape, configuration, pattern or ornamentation of an object.
Copyright	Protects original expression of an idea in the form of a creative work, but not the idea itself, and gives its owner the exclusive right to make copies of the expression.
Trade Secrets	Any confidential information, including secret formulas, processes, and methods used in production.
Proprietary Software	Software for which the software's publisher retains intellectual property rights, which is usually copyright of the source code but can sometimes patent rights.
Brand and Reputation	How a brand is viewed and perceived by customers, stakeholders, and the market as a whole, and it is the culmination of ideas and emotions associated with the brand.
Research and Development	Activities undertaken in developing new services or products or improving existing ones.
Critical Suppliers and Customers	Key relationships and agreements. Exclusive Government contracts for example.
Organisational Knowledge	The collective knowledge and abilities possessed by the people who belong to an organisation.
Strategy and Market Intelligence	Knowledge attributed to decision making in positioning the organisation in a market and knowledge of the market. Market intelligence can include datasets and consumer information.
Know How	Practical knowledge on how to accomplish something and is a component in the transfer of technology, co-existing with or separate from other IP rights.

^{* denotes the IA is a registered IP right.}

One of the biggest benefits of capturing and owning IA, such as IP, is that its value does not necessarily depreciate like tangible assets. Because IAs do not always follow a linear relationship between cost and value, it’s possible to generate a higher return for a smaller investment in comparison to traditional tangible asset classes. The value of an intangible asset can increase dramatically over time with extra usage, due to the benefits of networking and expansion. For example, the most successful companies which have scaled tremendously while being primarily founded on intangible assets include Google, Uber and Facebook. These companies have radically transformed the traditional business model to a modernised version where most the company value can be ascribed to its intangible assets.

It’s important to realise that the development of a new product often involves the use of IC but that the product may be protected using IP. For example, an organisation may decide to develop a new product based on market intelligence, and a research and development (R&D) team using know-how and organisational knowledge develops the product that can then be protected by a patent. Part of the research and development may include licencing in technology (think critical suppliers and customers). This interrelation of the various types of IA often makes it difficult to delineate the perceived value of each type of IA, and interactions within an IA network can often lead to an unconscious devaluation of the IA.

To determine what type(s) of IAs an organisation may have, IA identification is required. Identification of IAs can be an involved process which goes beyond the scope of the subject of this paper. Suffice to say the identification of IAs can be difficult – if it were not, organisations would already be recording and valuing their IA. IA identification often requires more than one specialist to examine what assets a company may have. For example, a patent attorney is best suited to determine what technology (i.e. inventions) can be protected by patents, a trademarks attorney is best suited to determine how best to protect a brand, and an intangible asset manager may be best suited to codify and leverage organisational knowledge.

Irrespective of how the IAs are determined, they need to be valued to assess their respective risk exposure. The three main approaches to valuing IA are the income approach, the market approach, and the cost approach. This is further outlined in Figure 3 below. Placing a value on IA often requires consultation with the entities that first identified the IAs.

Income approach	Estimates for future cash flows and discounts them. An issue with this approach is that it can be hard to distinguish IA cashflows from overall cash flows.
Market approach	Uses recent transactions of similar or identical assets. An issue with this approach is that it can be difficult to find suitable comparisons, if at all.
Cost approach	Estimates based on the cost to replace or develop the asset. An issue with this approach is that it often ignores the amount, timing and duration of future economic benefits and the risk of performance.

Figure 3: Three broad approaches for estimating fair values.

Although the process of IA identification and valuation can be involved, its outcome provides a much clearer picture of what assets and organisation has, their value, and most importantly how to protect and leverage these assets for commercial gain. Kodak invented and patented the original digital camera, yet they filed for bankruptcy in 2012 due, in part, to the rapid rise of digital cameras. Understanding what IAs an organisation has and how to leverage them sets up future revenue streams and growth.

Associated risks of IA

Much like tangible assets, intangible assets have associated risks. This risk profile depends on the type of IA and how it’s used. Risks associated with IA can be viewed from an owner or a third-party perspective. For example, an owner may lose ownership of an asset, such as a patent being found to be invalid, or a third party could infringe a registered IP right.

Brief explanation of the risk for each type of IP and IC:

IA Type	Explanation
Patent	Owner: If found to be invalid it cannot be enforced, which means the monopoly right is lost. Any licensing of the patent also falls away as a license cannot be used to control the use of an invalid patent. Third-Party: Infringement of patent rights resulting in litigation.
Trademark	Owner: Poor management means the trademark is not “used” and registration is revoked, or the trademark has become a term of the trade to describe the brand, product, or service. Third-party: Infringement of registered trademark, or proceedings for passing-off and misleading and deceptive conduct for non-registered trademark.
Design	Owner: If found to be invalid it cannot be enforced, which means the monopoly right is lost. Any licensing of the design then falls away as a license cannot be used to control use of an invalid design. Third-Party: Infringement of design rights resulting in litigation. .
Copyright	Owner: Loss in ownership means others can replicate or use the expression. Third-Party: Infringement of copyrights resulting in litigation.
Trade Secrets	Owner: Once a trade secret is no longer secret, for example by unauthorised disclosure by an ex-employee, it is irrevocably lost and cannot be further protected e.g. by patents. Third-party: Unauthorised acceptance and use of third-party confidential information, either knowingly or unknowingly, such as from information disclosed by a new employee.
Proprietary Software	Owner: Like a trade secret, closed source proprietary software can be kept secret. Third-party: Unauthorised acceptance and use of third-party proprietary software, either knowingly or unknowingly.
Brand and Reputation	Owner: Public opinion can change how a brand and reputation is perceived. In the digital age, public opinion can quickly cause permanent damage to a brand and reputation. Third-party: If associated with the damaged brand, the brand of the third party may also be damaged by association.
Research and Development	Owner: Information about past and future R&D activities, what works and what does not and why, is all confidential information that could be used by a competitor if information about the R&D was disclosed. Third-party: Unauthorised acceptance and use of third-party confidential information, either knowingly or unknowingly.
Critical Suppliers and Customers	Owner: Information about suppliers and customers is typically confidential information that could be used by a competitor if information about the suppliers and customers was disclosed. Third-party: Unauthorised acceptance and use of third-party confidential information, either knowingly or unknowingly.
Organisational Knowledge	Owner: Information about an organisation is typically confidential information if it pertains to trade secrets and how they are managed, proprietary software, R&D, know-how strategy and market intelligence, and is confidential information that could be used by a competitor if information about the suppliers and customers was disclosed. Third-party: Unauthorised acceptance and use of third-party confidential information, either knowingly or unknowingly.
Strategy and Market Intelligence	Owner: Confidential information about a market, what the market drivers are, how the organisation and their competitors fit within the market, and where the organisation strategy and market is heading could be used by a competitor if the confidential information about the strategy and market intelligence was disclosed. Third-party: Unauthorised acceptance and use of third-party confidential information, either knowingly or unknowingly.
Know How	Owner: Know-how is often organisation-specific and is part of confidential information and is of value to competitors. Loss of know-how is like loss of trade secrets. Third-party: Unauthorised acceptance and use of third-party confidential information, either knowingly or unknowingly.

Infringement of IP occurs when a third party uses the right without authorisation. IP rights need to be enforced by the owner, so the owner should keep a watch out for any infringing activities. Once an infringing activity is identified, the allegedly infringing party is put on notice which is either followed by a cease and desist notice or a letter of demand. Depending on the parties, the next step is generally a period of back-and-forth, negotiation and/or mediation. If the parties cannot arrive at an agreeable outcome, court proceedings are commenced.

Contrary to popular belief, only a small number of patents (i.e. < 2%) are ever litigated. For example, from 2006-2012, in the US there were 23,014 patent litigations, which represents only about 0.7% of the number of patents filed (3,331,170) during the same period. However, despite the relatively low number of patents litigated compared to the number of patents filed, the costs of being a party to infringement can be significant, even if the dispute is settled before reaching the courts. In some instances, the cost of defending accusations of infringement can be material enough to present issues of bankruptcy.

Figure 4: Patent Litigation by territory 2006-2012.

IC is not formally infringed per se and instead is generally only lost. For example, once a trade secret is made public the secret is lost and, in principle, the value associated with the secret is also lost to the public. The key with IC is understanding where risks can arise from. The two main avenues of risk with ICs come from either within an organisation, or from the outside.

The Inside Threat

One of the biggest risks to IC is not from the outside, but from within. Most companies constantly leak key intangible assets, such as confidential information.

As the world becomes more open and connected, information is becoming harder to keep secret without proper protocols and controls. Trade secrets are examples of lucrative knowledge or know-how that is not available to the public. Two common examples of trade secrets are KFC’s secret chicken recipe and Coca-Cola’s recipe.

One of the difficult decisions a business needs to make is determining when and how to use trade secrets – the alternative to trade secrets is often patents which by nature requires full disclosure to the public.

Despite the value of trade secrets, they are susceptible to being lost. If a trade secret is made public, it is no longer confidential and protectable. Ex-employees carry a wealth of knowledge about their previous employer’s IC and non-disclosed IP. If employment contracts do not clearly outline ownership of confidential information and how confidential information is to be treated, this may allow for leakage of confidential information to external parties.

An example of leakage of confidential information is Anthony Levandowski who was ordered to pay US$757,000 in restitution and a fine of US$95,000, and who has also been sentenced for 18 months imprisonment, for stealing trade secrets in relation to a self-driving car technology from Google and distributing this knowledge with Uber.

Conversely, any employer who recruits and hires an employee away from their competitor should also be wary of any confidential information the new employee may bring across with them. The new employee may distribute confidential information to the new employer in breach of their previous employment contract, and this may expose the new employer to risks of unauthorised use of confidential information.

The Outside Threat

Threats from within are potentially the riskiest but also easiest to manage. On the other hand, threats from the outside can be harder to manage, though on average they are likely to be less risky.

Counterfeiting	Counterfeiting has become a significant problem and is steadily growing. Counterfeiting has become a US$917 billion industry per year for the exchange and trade of illegal goods. Counterfeiting can have serious implications on an organisations ability to maintain a positive reputation and generate revenue due to diluted market shares.
Draining Capital via Litigation	Competitors initiating litigation to drain the company’s capital reserves so they can merge and acquire the enterprise for its technology is another type of threat. Hostile takeovers are a strategic way for large companies to access newly developed technology from smaller companies in the same field without developing the IAs themselves
Agreement Exploitation	Companies with high demand for their IAs may license their technology out to third parties to manufacture, use and sell. This is often done in exchange for a royalty payment. One of the risks with licensing out IP rights is that the third party may use the technology outside the scope of the agreement. This can result in the owner of the IA having to initiate litigation against the third party, such as for patent infringement..
Agreement Exploitation	Companies tend to have key employees in various roles to support company structures. The value that these key employees have in the company needs to be understood and protected. If the role or contribution a key employee makes is not identified and documented, especially if the employee is erroneously not identified as a key employee, this may make it easier for a competitor to poach the employee. Such a situation could have adverse effects on company structures, for example, the cost of recruiting and training to replace the employee to maintain the company structure.

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