"If you don't have a competitive edge - then don't compete!" Jack Welch - CEO General Electric
I love this quote!
As investors and business owners you know that businesses need to maintain a competitive edge to give back far more than the original investment.
Most of that competitive edge is provided by intangible assets. When you compare market value to book value, the difference is the intangible assets sometimes referred to as intellectual property1 or intellectual capital. These assets on average account for 80% of the worth of a business.
Yet many business owners and investors do not apply the critical thinking needed to this crucial area with intellectual property (IP) being an afterthought - rather than an integral part of business strategy or valuation.
Applying appropriate due diligence involves asking many questions. Essentially the business model needs to be understood along with the "edge" that gives it sustainability.
Once I understand those aspects, I look at how the edge falls within four broad categories, intellectual capital (including barriers to entry), function, look and brand. Then I can look at what mechanisms are in place (or ought to be) to preserve and/ or make the most of the edge.
And these are considered alongside the business model, competitive environment and exit strategy.
From this, the relevance of the mechanisms (say patents, agreements) can also be evaluated. Are they there as
- a deterrent,
- to give leverage,
- defensive or litigation potential, or
- just growing the worth of the business for ultimate sale or further investment?
Or are they there at all?
To be blunt, the value of a business can be wiped out by an ill-timed impact with a bus.
As an example ...
Possibly a competitive edge arises from intellectual capital supplied by a skilled researcher.
Questions to ask include: How well are they being looked after? What happens when they leave? Can they take their/your knowledge with them? What does the employment agreement say? Is their knowledge well documented in the company? Is there succession planning? Does key person insurance cover them?
If intellectual capital is recognised as valuable, then there needs to be good systems (preferably documented) and agreements in place to provide a measure of control.
Maybe, a business' value arises because it has a product or process that looks or works better than a competitor's.
A question to ask is "How Quickly Can A Competitor Start To Compete?"
As soon as other players see another's success, it is very easy to come into the market with a cheaper or more profitable alternative.
It takes time, effort and money to develop a new product. That investment needs to be recovered and forms part of the price on the final product. If a competitor can short-cut the R&D process by copying a product, then they have no need to recover the full investment made in R&D in their pricing model. Therefore an identical product can be developed quicker, produced and sold cheaper.
If your investment feels vulnerable, then look at whether it has some IP2 protection – even if the intention is merely to use it as a deterrent for a period of time. The semblance of IP protection can give a competitor "cause to pause" and any time you have to gain more traction in the market is usually worth the initial expense of applying for it.
It should be noted that IP protection does not need to be continued with if the desired effect has been achieved, such as market dominance or sufficient revenue.
Importantly, in many cases IP protection (such as patents and design registrations) must be applied for before there is any public disclosure or business done in relation to the attribute to be protected.
If your investment relies on reputation to be sustainable, then make sure its brands are registered. Often these are the most valuable part of a business. Apple's brand for example is worth in the order of US$153 billion!
Finally, is there a robust IP strategy in place? If not, get one! Otherwise the sustainable potential value of a business cannot be realised.
Footnotes
1Refers to the ownership of an intangible thing - the innovative idea behind a new technology, product, process, design or plant variety, and other intangibles such as trade secrets, goodwill and reputation, and trade marks. Although intangible, the law recognises intellectual property as a form of property which can be sold, licensed, damaged or trespassed upon. Intellectual property encompasses patents, designs, trade marks and copyright.
2Refers to the ownership of an intangible thing - the innovative idea behind a new technology, product, process, design or plant variety, and other intangibles such as trade secrets, goodwill and reputation, and trade marks. Although intangible, the law recognises intellectual property as a form of property which can be sold, licensed, damaged or trespassed upon. Intellectual property encompasses patents, designs, trade marks and copyright.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
James & Wells Intellectual Property, three time winner of the New Zealand Intellectual Property Laws Award and first IP firm in the world to achieve CEMARS® certification.
