Volume 15, Number 4 Article by Prahlad Rao Laxman and Sandeep Aggarwal December, 2003
Patent Valuation Using Real Options :
In today`s knowledge economy, the use of patents is gaining popularity as a way of protecting the firm`s knowledge base. This makes it imperative to develop a framework for valuing patents. Valuation of patent applications is also crucial in case of a merger or licensing where the holder wishes to sell the monopoly rights to a third party. Such a valuation could well run into millions of dollars and hence needs a strong theoretical backing for its validity.
The various models of patent valuation generally followed by companies, such as the historical cost approach and the DCF approach, focus mainly on possible future cash flows. Prahlad Rao Laxman and Sandeep Aggarwal believe that the main value of an early patent application lies not only in the possible future cash flows but also in the various options of expansion and abandonment in the patent process itself. In this article, they explain the Patent Cooperation Treaty (PCT) process and develop a model that lists six call options including two decision nodes, and more accurately reflects the value of all the embedded options.
Laxman and Aggarwal strengthen the validity of their model by valuing a real 3G-telecom patent of Sasken Communication Technologies. Sasken has come out with a 3G protocol, which acts as an interface between the multiplexing and other transceiver circuitry in the mobile handsets that allows 3G transmission/reception. However, this technology will be used in practice, only if it gets included in the comprehensive 3G standard by the world body 3GPP, which is a low chance because of the many contestants in the ring. If it does get included in the standard, Sasken will get royalties for each 3G handset sold anywhere in the world for the next few years, until someone comes up with an improvement and the standard is upgraded to better technology. Applying the real option framework to value this patent application, the authors recommend the filing of the provisional patent since the expected value of Sasken`s provisional patent far outweighs the cost.
Reprint No 03405
