Managing intellectual assets¹ used to be a backwater, consigned to research laboratories and to dusty file drawers in the offices of patent attorneys. Insofar as such assets were managed at all, they were mostly managed defensively: after a company’s labs developed something new, the legal department would get a patent and try to ensure that third parties didn’t infringe on or otherwise misappropriate it.

Too often, hugely promising inventions were unused by the companies that owned them and, at the same time, off-limits to third parties that understood their true value. Moreover, some companies developed and patented devices and technologies less to exploit them commercially than to prevent competitors from doing so or to avoid undermining current businesses. Although the filing of a patent gave notice to third parties that might have been interested in using it, there was no intellectual-asset market where companies could buy what they needed or sell what they couldn’t commercialize themselves.

Most companies with research labs have produced valuable intellectual assets that languished because their creators didn’t recognize their value or lacked the ability or incentive to extract it. Perhaps the most notorious example is the Xerox Palo Alto Research Center (PARC), which in the 1960s and ’70s developed many fundamental aspects of today’s computing environments, such as the mouse, graphical user interfaces, and object-oriented programming. But Xerox failed to market these innovations seriously, because it didn’t think of itself as a computer business. Stringent antitrust laws made companies like Xerox, IBM, and AT&T wary of licensing their innovations to others.

Since then, of course, the value of intellectual assets and, more broadly, of intangible assets in general has greatly increased—at least partly because information technologies have diffused throughout the economy. Meanwhile, as the return on investment in physical assets has declined, the return on intangibles has soared. Along the way, many obstacles to commerce in intellectual assets have been overcome. For one thing, it is easier for companies to find and manage what they need thanks to the emergence of the Internet, intellectual-asset databases such as Lexis-Nexis, and intellectual-asset management software from Aurigin Systems and other firms. What is more, the availability of data on many deals involving intellectual assets helps sellers and buyers set the terms for licensing and acquiring them. As a result, marketplaces for intellectual assets have begun to emerge (see boxed insert, "Market makers in intellectual assets"). They promise to simplify the negotiating process and to promote low-cost deals, including many too small to justify the large set-up costs buyers and sellers face today.

As the market for intellectual assets becomes fluid and transparent, an ever-broadening spectrum of industries—ranging from entertainment to pharmaceuticals to semiconductors—is being transformed: the intellectual-asset value chain, traditionally vertically integrated within corporate boundaries, is disaggregating, and successful focused creators and exploiters are starting to emerge. Although most companies will go on playing both roles, any business that tries to exploit as well as develop a particular intellectual asset runs the risk of not realizing its full value. Even companies that successfully generate and commercialize substantial numbers of intellectual assets must begin to think of themselves as sellers or buyers as well.

The value of the seller’s role is evident from the nearly $1 billion a year in royalties that IBM collects and from the stratospheric valuations of start-ups, with minimal or no revenues, that are being acquired almost daily by technology and Internet giants such as Microsoft, Amazon.com, and America Online. Texas Instruments, one of the companies that pioneered the idea that licensing should be treated as a profit center, has collected more than $2.5 billion in royalties over the past five years. In each of those years, analysts estimate, licensing income has represented between a third and a half of Texas Instruments’ total profits.

For buyers, too, intellectual assets can represent a powerful stream of revenue. Many leaders in the pharmaceuticals industry generate a substantial part of their sales by marketing products licensed from other companies. For instance, Johnson & Johnson’s in-licensed products accounted for 54 percent of its pharmaceutical revenues in 1997, up from 48 percent in 1992. In the technology arena, companies like Cisco Systems and Microsoft, acknowledging their inability to develop all the innovations their businesses need to grow, have acquired or struck licensing agreements with many smaller creators of intellectual assets. (The main text of this article focuses on three strategies for selling intellectual assets. For a discussion of buy-side strategies, see boxed insert, "The buyer’s side.")

Strategic positioning

Companies unable to maximize the value of their technologies would be wise to license those assets to all key market players

Companies that can’t maximize the value of their own core technologies would be wise to license those assets to all key market players—including dangerous competitors—to create de facto standards or to accelerate times to market when windows of opportunity open briefly.

The positioning of the compact disc is a successful example of this approach. Philips Electronics and Sony developed CDs in the early 1980s by pooling their intellectual assets in optics, lasers, and electronics. But the two companies soon recognized that while CDs offered better sonic clarity, greater durability, and longer playing times than vinyl records or cassette tapes (then the entrenched media), CDs would have to become the new standard to be more than a niche phenomenon. Most of the material already on vinyl and cassettes would have to be transferred to the new format, and the new playback equipment would have to be broadly affordable.

Philips and Sony therefore licensed the CD technology to other manufacturers of stereo equipment—mostly direct competitors—at rates that wouldn’t put them at a disadvantage. Meanwhile, record companies, having concluded that consumers would replace their records and cassettes with CDs, agreed to move content to the new medium, thus swelling sales of recorded music.

Before long, CDs had almost eradicated vinyl records and surpassed cassettes in sales, not only because of public demand, but also because record companies could earn wider profit margins by selling them. Since the mid-1980s, Philips and Sony have collected an estimated $2 billion in royalty revenues while building significant businesses in CD drives and components and extending the format (through CD-ROMs) to computers.² By licensing the CD technologies to competitors at an early stage, Philips and Sony prevented them from developing alternative standards, which could have provoked a long and draining format war like the one between the video formats VHS and Betamax. In short, Philips and Sony focused on expanding the market, not just their own share of it.

Lateral revenue

When a company develops a valuable intellectual asset it can’t use in its core business, it can often license the asset to others that can. Moreover, the very same company might also want to license intellectual assets that do have value for its core business, and not only for the reasons Philips and Sony had when they licensed the technology for compact discs.

In 1977, for instance, Lucasfilm saw an opportunity to generate revenue from the marketing of toys based on characters in its first Star Wars movie. But it badly underestimated their value when it granted perpetual rights to Kenner, a toy manufacturer, for only $100,000. Luckily, Kenner defaulted on the contract, and this gave Lucasfilm a chance to renegotiate it with Hasbro (which had acquired Kenner) and Galoob Toys. The new agreement called for variable royalty payments based on toy sales—a deal that produced more than $500 million in royalties. Announcements indicate that toy-licensing deals for the recently released "prequel," Episode I: The Phantom Menace, involved both a higher royalty rate and guaranteed licenses worth at least $400 million and as much as $600 million—sums that would more than offset the production costs of even the most extravagant Hollywood blockbuster. The prospects of any new movie are uncertain, so the variable-payment scheme has the advantage of minimizing the licensees’ up-front risk for these toys while preserving the earnings potential both for the licensees and for Lucasfilm.³

Lucasfilm’s income from licensing doesn’t stop with toys. The company has collected billions of dollars from apparel, books and other printed materials, sound track recordings, and comarketing deals—and, of course, videocassettes of its movies. Furthermore, it has continually added new sources of lateral revenue, such as the Star Wars bed and bath linens that WestPoint Stevens has manufactured since 1998. These licensing deals have changed the economics of movie production so dramatically that it is hard to remember just how innovative they once seemed. Most major studios now expect licensing to provide a significant share of the revenues and profits of major productions. For some recent films (such as Disney’s The Lion King) with high production and marketing costs, licensed products like merchandise and videos accounted for a larger share of the profits than did box office sales—record-setting sales at that!

Of course, there is always a risk that a licensee’s actions could damage the licensor’s core business. Ralph Lauren’s Polo brand captures premium prices for apparel and home furnishings, so products from third-party manufacturers are permitted to carry the brand, for a price. But the company insists that they comply with its quality and presentation standards or lose their licenses.

Minimizing risk

Companies that can’t market intellectual assets competitively can try to extract their value by finding suitable partners

Some creators of intellectual assets don’t have what it takes to bring them to market at a competitive cost. Such companies can reduce their exposure to risk and extract the value of their creations by finding suitable partners.

When a start-up in life sciences or computing, for example, creates valuable intellectual assets, it must decide whether to build the infrastructure for bringing them to market itself or to piggyback on the infrastructure of a scale player through a licensing, joint-venture, or merger agreement. The piggyback approach has two advantages. The first is a faster time to market, which frequently translates into faster cash flows, increased market share, premium prices, and reduced competition. The second is a significant diminution of the risk involved in execution: the need to build entire capabilities (such as a manufacturing and logistics infrastructure, a sales force, a brand image, and a channel presence) from scratch.

Of course, the greater the investment, the greater the risk. Companies in the semiconductor business, for example, need billions of dollars to build manufacturing facilities. Lacking that sort of money, a number of pure intellectual-asset companies have emerged in specialized parts of the industry. Rambus, which develops interfaces connecting memory chips to microprocessors and microcontrollers, is the best-known example, having licensed its technology to Intel and to memory producers. Within two years of a deal with Intel, Rambus had expanded its revenues to nearly $40 million, and by the end of 1998 its market capitalization had reached more than $2 billion.

Despite this initial success, Rambus, as a pure intellectual-asset player, faced unique risks. Early in 1999, memory producers, themselves under very strong financial pressure, forced Intel to reconsider its endorsement of the Rambus technology, thus sending the smaller company’s stock tumbling by nearly 50 percent from its previous peak. Although Rambus may yet emerge as a winner in the memory interface market, its experience highlights the importance of giving licensees a win-win value proposition.

One company that took a particularly creative approach to minimizing risk was Amgen, when it commercialized Epoetin alfa, its first treatment for anemia. Lacking the ability either to manufacture or distribute the drug, Amgen launched a 50-50 joint venture with Kirin Brewery, which had manufacturing expertise and a distribution presence in major Asian markets. The joint venture, Kirin-Amgen, retained the intellectual assets related to the drug and licensed them to Kirin, F. Hoffmann-La Roche, and Amgen itself. With help from Kirin, Amgen rapidly built manufacturing and distribution capabilities in North America while also entering into distribution agreements with Roche and other parties.

Intellectual-property alliances helped Amgen increase its revenues from $44 million in 1987 to $1 billion-plus in 1992, a rate of 90 percent a year

These alliances helped Amgen increase its total revenues from $44 million in 1987 to more than $1 billion in 1992, an extraordinary rate of 90 percent a year. As the company developed new drugs, it extended its distribution partnerships—for instance, by entering into an agreement with Ortho Pharmaceutical (a Johnson & Johnson subsidiary) to distribute Epoetin alfa as a treatment for renal disorders. It also has broader codevelopment agreements to continue improving the products it markets together with partners.

Such deals exemplify many key elements in a successful strategy of minimizing risk. Kirin, Amgen’s first partner, had complementary assets and capabilities. In exchange for the sizable portion of the Amgen intellectual assets that Kirin received, Amgen secured Kirin’s strong commitment to the success of the Epogen program. By pursuing a number of distribution arrangements, Amgen ensured rapid coverage of its target markets and freed itself from dependence on any single licensee. Finally, its codevelopment agreements committed licensees to promote even drugs whose patents were approaching their expiry dates.

Almost every company has exploitable intellectual assets, but few companies systematically explore the opportunities they create. Companies that do take advantage of them share three characteristics.

First, they make their executive teams aware of the importance of exploiting intellectual assets. Second, they continually assess their use of those assets and have formal processes for identifying internal and external opportunities; for example, they look beyond registered patents for sources of valuable innovation. Finally, they build strong organizations—a point that cannot be overemphasized—attracting skilled and motivated people to discover opportunities, negotiate intellectual-asset transactions, and manage the ensuing relationships under the supervision of at least one senior business executive.

This is no easy formula to implement. But the rewards can more than justify the effort.