Patent valuation methodologies: The cost based approach

An image of coins in a jar

Why is patent value important?

Monetising IP and patents is important for any company that wants to buy or sell their portfolio yet many companies struggle to value their patent portfolio because it is an intangible asset which can and will change over time. With certain IP, such as trademarks, the value can actually increase over time as the brand grows in stature.

However, with patents, determining value is trickier; some patents have a higher value if they serve a purpose and provide a valuable solution at a specific time but this can change if there are new developments, on that technology for example.

When companies want to license, acquire, merge, or invest in a company, they will look at the value of the patent portfolio. One of the most popular methods to value individual patents as well as portfolios is the cost-based approach.

What is the cost approach?

This approach implies that an investor will pay no more for an asset than the costs of purchase or creating an asset of equal utility. It considers the costs incurred during development of a patent and how much it may cost to recreate or develop a similar product. However, it doesn’t take into consideration the current market value of the product. This is usually considered in the market based approach.

What are the pros and cons of the cost approach?

Key factors considered are the various costs which contribute to patenting an invention including1:

  • Labour
  • Testing and trials
  • Materials and equipment
  • Regulatory approval and certification
  • Registering the patent
  • Overheads for utilities, accommodation and support staff

This approach has many benefits for the buyer:

  • Saves time - the buyer won’t waste time in R&D to develop a patent
  • Expenditure - the buyer won’t waste money on creating the invention and other patent related expenditure like commercialisation and resources.
  • Success - sometimes a buyer may not be successful in commercialising and selling their invention, buying a patent avoids this risk as they already know of its market success.

However, there are some disadvantages of this approach:

  • Usually there is no correlation between expenditure and its value because it is hard to distinguish between normal operating expenses and patent investment expenses.
  • Additionally, this approach doesn’t consider other factors such as future value of the patent. It mainly emphasises costs rather than future profit so the market potential isn’t fully recognised.

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Footnotes

1 https://www.gov.uk/guidance/valuing-your-intellectual-property#the-cost-method