The demise of Borders and other firms whose business model has collapsed in the face of innovation is one side of the story. On the obverse, according to NACD Director's Daily (25 July), the Economic Times (July 24) quotes a new Ernst & Young study, which has found that "domestic companies are innovating in an unprecedented manner to beat competition and remain relevant to their target customer base" after the recent economic downturn.

Ram Sarvepalli, E&Y's India leader for risk advisory services, notes that this is markedly different from how companies responded in the past two recessions. He states, "The study confirms that, today, businesses look before they leap. They don't just seek opportunities, but focus on making sure they have the capabilities and innovative strengths to make a real impact in their chosen markets."

E&Y's survey of non-executive directors and operational heads was conducted between this past December and February among 733 companies in 15 countries.

Meanwhile, this past week, Forbes magazine published its list of the 100 most innovative companies. If you read the methodology text closely, you will appreciate that the list is really of companies with a reputation for innovation. As described by Clayton M. Christensen, along with colleagues Jeff Dyer, a professor at Brigham Young University, Hal B Gregersen, a professor of leadership at INSEAD and Michael McConnell, a senior advisor at HOLT, a division of Credit Suisse in Forbes magazine, (20 July):

Imagine leading your company so differently that investors bid up its stock price by 50% because they expect innovations—incremental and disruptive—far into the future. Significant market premiums typify the most innovative companies. You can, in fact, quantify that predictive extra kick in something we call an “innovation premium,” a metric we worked out with Michael McConnell, a senior advisor at HOLT, a Credit Suisse unit. It is defined as the proportion of a company’s market value that cannot be accounted for from cash flows of its current products in its current markets. Put another way, it’s the premium the stock market gives a company because investors expect it to launch new offerings and enter new markets that will generate even bigger income streams. We use the innovation premium to rank the world’s most innovative companies.

On Monday 14 February, Barron’s released its list of the world’s most respected companies. Apple (NASDAQ:APPL) tops the list at #1 yet again. And lest your curiosity be left hanging, finishing off the top 5 are Amazon (NASDAQ:AMZN), Berkshire Hathaway (NYSE:BRK), IBM (NYSE:IBM) and McDonald’s (NYSE:MCD).

And then there is Nokia (NYSE:NOK), the world’s biggest telephone handset-maker. Quotes the Economist, “We are standing on a burning [oil] platform,” Nokia’s CEO, Stephen Elop, wrote in a memo to all 132,000 employees. If Nokia did not want to be consumed by the flames, it had no choice but to plunge into the “icy waters” below. In plainer words, the company had to innovate -- quickly.

The value of Apple’s reputation for innovation, earned by actually being innovative, is that while the most respected company in the world only commands 4% of the telephone handset market, it commands 50% of the profits. That's pricing power, a benefit of a superior reputation, in the extreme.

Turning to the reputation metrics, Apple’s popular standing is reflected in its stable top ranking in the Steel City Re Corporate Reputation Index. Over the trailing twelve months, it has made the jump from the 97th percentile to the 100th percentile among the 51 companies in the Electronic Data Processing Equipment sector, and over the past six months, it hasn’t budged from that spot. Its corresponding trailing twelve month return on equity is 58.63% greater than the median of its peer group, its EWMA volatility is 1%, its trailing twelve week reputation velocity is 0.0, and its trailing twelve week reputation vector is undefined.

Its peer group shows a U-shaped drop and recovery in reputation standing relative to the market as a whole, and the intra-sector volatility is at the upper end of average. Significantly, the intangible asset fraction of the group has been progressively rising these past 12 months.

Nokia should wish for such metrics. Over the trailing twelve months, it has dropped from the 36th percentile to the 19th percentile among the 30 companies in the Diversified Electronics sector. Its corresponding trailing twelve month return on equity is 52.22% below than the median of its peer group, its EWMA volatility is 2%, its trailing twelve week reputation velocity is -10%, and its trailing twelve week reputation vector is -.8% which is a material level.

Its peer group shows a slight rise is reputation standing relative to the market as a whole, and the intra-sector volatility is at the low end of average. Last, its intangible asset fraction has dropped from 86% to 78% of market capitalization while the median of its peer group now stands at 88% of market cap.

Mr. Elop believes that one advantage Apple has over Nokia that he believes he can overcome is its access to the innovative genius that is resident in Silicon Valley. Stay tuned, as Finland comes to California.

Palm, Inc. (NASDAQ:PALM) is on the block. E & Y reported that in 2007, only 30% of the value realized in M&A deals was tangible. While a smart phone is a discrete, countable, physical asset, its value is mainly intangible With the above in mind, what are the prospects for Palm?

Using the 3-element accounting-like framework favored by Society member and Member News Committee chair Mary Adams of Intellectual Capital Advisors, those intangibles are as follows:
1. Human capital – the founders, who left the company in 1998 to start Handspring, maker of the Treo, which Palm then purchased for $240 million in 2003
2. Relationship capital – agreements with cellular carriers (Sprint/Nextel initially) through which most cell phones are sold.
3. Structural capital – the business processes, patents, and methods comprising the innovation activities and marketing activities behind the solution

Using the six-element Roman arch model of reputation value as defined in the Society’s book, Mission: Intangible, the two key intangible asset drivers of reputation value for Palm are innovation and quality. Palm’s reputation is abysmal. According to the Steel City Re Corporate Reputation Index, Palm’s reputation ranking in the Computer Hardware and Peripherals sector has not been above the 33rd percentile for the past 16 months. This ~60-member sector, which includes the monotonously #1 ranked Apple, Inc., recently saw Palm drop to the 4th percentile.



Reputation is important because among other things, it confers pricing power. It is not surprising, therefore, that Palm’s two current carriers, Sprint and Verizon, heavily discount Palm’s phones. And even in the face of these discounts, Palm’s global share of smart phones has declined from a peak of 4% in 2004 to only 1.5% in 2009.

Cutting to the chase, Shaw Wu of the Kaufman Brother’s equity research firm opines, according to the Wall Street Journal, that “the company should be worth at least the $600 million to $700 million it has spent on research and marketing…” Valuing a company based on expenses related to innovation and building a brand? That’s intangible asset finance at its best!

Act on your intellectual curiosity!

If the above discussion piques your interest, here are several things you can do right now:

1. Register free of charge for the next IAFS Mission Intangible Monthly Briefing set for Friday 7 May. The conversation will feature Scott Childers from Walt Disney and Bob Rittereiser from Zhi Verden on “Process-driven reputation risk in supply chains”
2. Purchase the book, Mission: Intangible. Managing risk and reputation to create enterprise value, at the IAFS Store (or any online book retailer) 
3. Become a member of the Intangible Asset Finance Society.
4. Join our community on Linked-In.

The Intangible Asset Finance Society is absorbed with issues at the interface of finance, risk, and the six major business processes that drive reputation: ethics, innovation, quality, safety, sustainability, and security. Today's note, courtesy of Society member Bruce Berman, CEO of Brody Berman Associates, Inc., a specialized management consulting and communications firm, is exemplary of core Society interests. Bruce writes,

In a story that received surprisingly scant media coverage, an appeals court has decided that two insurance companies must provide defense coverage to Hyundai against patent infringement claims by a non-practicing entity (NPE), also known as a patent troll, because the company’s policy covers advertising injury. As reported by the Courthouse News Service and IP Law 360 on April 7, the federal appeals court reversed a lower court decision when it ruled that Hyundai Motor America (SEO:011760) is entitled to defense coverage by National Union Fire Insurance Co. of Pittsburgh, Pa.,  a unit of AIG.

The case involved a patent infringement suit over an advertising method that ended with a $34 million verdict against the automaker. The U.S. Court of Appeals for the Ninth Circuit ruled Monday that Judge James Selna of the U.S. District Court for the Central District of California erred when he granted summary judgment to National Union and American Home Assurance Co. on the grounds that patent infringement does not constitute “advertising injury” for the purposes of an insurance policy.

As reported in IPL360 “ Gene Schaerr, a partner at Winston & Strawn LLP who represented Hyundai, called the ruling a ‘tremendous victory.’ Schaerr stated that the ruling is significant not only for Hyundai, but for a large number of other companies with similar policies that cover advertising injury. "The insurance industry has been taking the position that such policies don’t apply to patent infringement and other alleged wrongs involving Web sites,” he noted. The case began in 2005, when Hyundai was one of 20 automakers sued by patent-holding company Orion IP LLC, now known as Clear with Computers LLC, in the Eastern District of Texas over a patent for a method of generating customized product proposals.

Bruce adds, "I wonder how many companies are aware that some of their existing insurance coverages may fund IP defense if not liability?"

Ken Jarboe, President of Society partner Athena Alliance and Chair of the Society's Public Policy Committee has given us permission to share the following post from the blog, Intangible Economy.

As the U.S. economy evolves, intangible asset investments are becoming vital to economic growth and sustainability. But, as our new paper "Intangible Assets: Innovative Financing for Innovation" outlines, intangible assets can also be the source of financial capital. As industry has invested capital in research and development (R&D) to create new technology and advance other creative activities, a niche market of firms specializing in intangibles-based financing is springing up. Some intangible assets--traditional IP consisting of patents, trademarks, and copyrights--have been used in sale, leasing, equity, equity-debt, debt, and sale-leaseback transactions to finance the next round of innovation.

The paper outlines a number of public policy actions that can be taken to foster the use of intangible asset financing. These include streamlining the technology transfer process, developing underwriting standards to cover the use of intangible assets as collateral and making financial statements more transparent with respect to intangible assets.

The deals that have been done demonstrate that IP and other intangibles are viable assets to secure capital. Unlike other "exotic" financing vehicles, however, intangible-asset financial products are built on some of the most basic financing mechanisms. Far from exotic, they use traditional techniques in new ways to help companies innovate and grow. As the paper shows, there is plenty of opportunity to harness the power of intangibles.

The paper is a summary of our two reports: Intangible Asset Monetization: The Promise and the Reality and Maximizing Intellectual Property and Intangible Assets: Case Studies in Intangible Asset Finance. Published in the Winter issue of Issues in Science and Technology, the paper is also available on the Issues website.

Among the educational resources offered by the Society are the Mission:Intangible® Monthly Briefings. These one hour events, moderated by Mary Adams who chairs our Member News Committee, comprise about 45 minutes of prepared remarks backed up by presentation materials, and 15 minutes of responses to questions submitted by listeners. Often, because of time constraints, there are questions leftover.

The 8 January 2010 Mission: Intangible Monthly Briefing comprising a robust panel of Society committee chairs evoked many questions. As promised, here is the third and final potion of leftovers.

QUESTION TO JUDY GIORDAN: You talked about capturing the value from open innovation. When companies do this, do they see it in terms of the relationship with IA management? Does the question matter?

ANSWER: The concept behind Open Innovation (a term promoted by Henry Chesbrough, a professor and executive director at the Center for Open Innovation at UC Berkeley) is that companies can and should use external ideas as well as internal ideas and paths to market. As described by Chesborough and others, central to open innovation is that in a world of widely distributed and ever increasing information and knowledge, companies cannot afford to rely entirely on their own internal research, but should instead buy or license processes or inventions (e.g. patents) from other companies as well as find opportunities for internal inventions not being used in a firm's business to be commercialized outside the company (e.g., through licensing, joint ventures, spin-offs).

Explicit to all of this is the IP question – who owns the rights to the IP of the technology – and this is the aspect being focused on by companies. What is implicit and is an opportunity that is not being capitalized upon is for reputation enhancement from the standpoint of IA around open innovation. That is – demonstrating that the ability to creatively and facily interact in the open market for innovations creates a competitive edge for a company –by capturing value through the process of bringing in technology, aligning it well to corporate goals and monetizing as well as process of spinning out unused technology.

Judith Giordan.
Steel City Re

QUESTION TO DAVID HETZEL: You talked about the market for patents maturing. Is this something that will happen organically or can it be speeded up? If so, how?

ANSWER: The re-institutionalization of the public, real-time live auction ala Ocean Tomo would assist. Now that OT auction are under the umbrella of ICAP, we'll have to see what they do. ICAP, as you may know, has tremendous resources. I'm sure standardizations around patent quality and valuation would go a long way to accelerating the market's development.

David Hetzel
Motorola

Among the educational resources offered by the Society are the Mission:Intangible® Monthly Briefings. These one hour events, moderated by Mary Adams who chairs our Member News Committee, comprise about 45 minutes of prepared remarks backed up by presentation materials, and about 15 minutes of responses to questions submitted by listeners. Often, because of time constraints, there are questions leftover.

The 8 January 2010 Mission: Intangible Monthly Briefing comprising a robust panel of Society committee chairs evoked many questions. As promised, here are some more of the leftovers.

QUESTION TO JON LOW: You talked about how we shouldn't look to the accounting profession for support on intangibles yet you also call for comparability. If we don't get this from financial data, where will we find it? What will it look like?

ANSWER: Useful, comparable data supporting the growing economic importance of intangibles will most likely come from practitioners who perceive a financial benefit to themselves. Historically, this is where such innovations have come from as opposed to regulators or stolid, conservative and internally conflicted practitioner groups like the accountants. In the case of comparable data for intangibles we are already seeing growing interest in certain segments like reputation, brand and R&D as a proxy for innovation. Sustainability in its various manifestations is also gaining as a topic of interest.

From these basic roots, successive branches will grow as more factors become important to more industry segments. For instance, once M&A activity revives, data on post-merger integration success or failure – already a subject of considerable research – will probably also blossom.

It would be nice to think that some supra-national organization like the UN or OECD will take the lead, but they see no financial incentive or moral imperative to do so. Self-organized groups like WICI might have been able to lead had they adopted a more open-source approach, but they appear to be pursuing the secretive ‘let’s corner the market and see how much we can charge for our insights’ approach that has failed repeatedly in the past. Any group wedded to a particular technology or set of what they hope will be patented-able processes are similarly doomed because the market is simply too dynamic and unmanageable at this stage. Again, this is not a philosophical, political or doctrinal point of view, it is simply a reflection of natural phenomenon based on historical experience.

When comparable data emerge I believe they will look like the sort of ratios and benchmarks that managers use as a practical means of evaluating their performance. This is in contrast to the increasingly ambiguous or obfuscated metrics served up by GAAP or international accounting standards. The basis of intangibles importance to managers is their usefulness in evaluating and predicting performance, not in enabling arcane acts of financial sleight of hand. It is this usefulness that has prevented their oft-predicted demise and will support their ultimate adaptation.

Jon Low.
Predictiv

QUESTION TO NIGEL PAGE: You predicted a convergence of IP and IA/IC. I agree with you although in my experience, many folks in the IP space have a very strong prejudice that leads them to think (and often say) that intangibles outside of traditional IP (patents, trademarks, copyrights and trade secrets) have limited value. How do we cross this chasm?

ANSWER: I suspect that the events of the coming few years will see this prejudice start to disappear. Most organisations are likely to refocus their priorities as they emerge from recession and, as they do so, they will begin to pay far greater attention to the whole range of intangible assets they own, as well as the potential for monetising these assets. At the same time, CIPOs (or equivalent) will increasingly realise that the best way to secure C-suite attention for their efforts will be to make sure that they incorporate IP into a broader reputation-based 'package'. CEOs will sit up and pay attention to IP if and when they can be made to understand that it is a cornerstone of their corporate reputation, and not a techy side-avenue that's best left to in-house counsel.

Nigel Page
Intellectual Asset Management Magazine

As financial intermediaries, brokers play a crucial role of matching buyers and sellers. Central among those role is facilitating price discovery. This is especially true in markets for bespoke, less liquid products. Having a reputation for ethical behavior is valuable—as are the underlying business processes that foster ethical behavior.

Faking trades to distort pricing could threaten the commercial viability of a broker were the practice found to be widespread. At the very least, it is fraud. On Friday 18 December, ICAP Securities USA LLC reached a settlement with the United States Securities and Exchange Commission (SEC). The company, a US subsidiary of ICAP plc (LON:IAP) and winner of a Queen’s Award for Enterprise, is alleged to have posted fictitious trades in 2004 and 2005 on some Treasury brokers’ screens to encourage trading by attracting those brokers’ attention.

ICAP is active in the wholesale markets in interest rates, credit, commodities, FX, emerging markets, equities and equity derivatives. ICAP has an average daily transaction volume in excess of $2.3 trillion. In June 2009, ICAP purchased the intellectual property markets division of Ocean Tomo thus becoming one of the largest market makers in a class of bespoke intangible assets. Intellectual property markets have suffered chronically from price discovery challenges.

ICAP Securities has agreed to pay the SEC disgorgement of $1 million and a penalty of $24 million as settlement to end the investigation. The settlement includes the concept of non-intentional fraud. ICAP Securities has also agreed with the SEC that ICAP Securities will appoint an independent consultant to review the improved control environment that is now in place. Shares of ICAP ADRs fell 46 cents or 3.37% in Friday’s session in New York to close at $13.19 a share. The S&P 500 index was up 0.58% and the financial services sector average was up 0.68%

The Society's mission is to increase the visibility, transparency, and positive impact of intangible asset finance through education, the promulgation of standards, and advocacy. The Athena Alliance, a friend of the Society, specializes in advocacy. Its President, Ken Jarboe, provided us with the following:

As innovative companies struggle to raise funds, intellectual property and intangible assets are providing alternative ways of financing innovation. But greater awareness of them as an asset class is needed. Raising that awareness is the focus of a new report from Athena Alliance, Maximizing Intellectual Property and Intangible Assets: Case Studies in Intangible Asset Finance by Ian Ellis, a former U.S. Department of Commerce official specializing in intellectual property and international trade.

The report outlines increasing, but still nascent, means of financing innovation based on these assets in public, private and venture capital markets. As industry has invested capital in research and development to develop new technology and advance other creative activities, intellectual capital has become a valuable asset class, according to the paper. In response, firms specializing in intangible-based financing are springing up, using them to raise capital for the next round of innovation.

The paper details equity, equity-debt, debt, and sale-leaseback transactions, both private and public, that have helped companies raise capital, based on careful, rigorous analysis and conservative underwriting standards. For example, the author notes that in 2000, there were two public deals using royalty securitization, raising $145 million. In 2007-08, $3.3 billion was raised in 19 deals.

Unlike some of the exotic financial vehicles, however, the financial products discussed in this paper are some of the most basic financing mechanisms in business. The innovation is in recognizing the value of intangible assets for corporate finance. These new financial firms are using traditional financial techniques in new ways to help innovative companies.

But more should be done.

One important step would be developing sound, industry-wide, underwriting standards, according to the report. For example, Small Business Administration (SBA) rules permit its loans to be used for acquisition of intangible assets when buying on-going businesses. Rules are unclear on whether those assets can be used as collateral. The paper recommends that SBA work with commercial lenders to develop standards for using intangible assets as collateral.

The report builds on earlier Athena Alliance papers, notably Intangible Asset Monetization: The Promise and the Reality.

During the 6 February 2009 MISSION:INTANGIBLE Monthly Briefing, Fish & Richardson’s Cathy Reese, who chairs the Society’s IA Corporate Governance Committee, indicated that under Delaware Law, Directors and Officers had a Duty of Care to oversee the management of the business processes that help establish reputation. She noted that absent oversight systems, Members of the Board could be personally liable to shareholders for adverse events that impaired a company’s reputation.

Cathy’s warning of shareholder-driven exposure is just the beginning. Now companies are seeking restitution, too. According to the newspaper Deutsche Welle, after spending nearly 2.5 billion euros to cover legal bills and fines stemming from an international bribery scandal, Munich-based Siemens AG (NYSE:SI) is seeking payments from its former leadership team. Siemens was investigated for paying 1.3 billion euros in kickbacks between 2003 and 2006 to potential buyers in 12 countries, including Italy, Greece, Russia and Nigeria. In Germany and in the United States, the company was found guilty of corruption and ordered to pay combined fines of just over a billion euros. After the 2006 investigation, Siemens then accused some of its former managers of having failed to stop illegal practices and wide-ranging bribery.

It gets more interesting. The Financial Times reports that some of Siemens’ investors have threatened to sue the company if it did not claim damages from its former managers.

The value of risk and reputation management at the board level should be painfully obvious. The consequences of failing to manage a firm’s business processes for ethics, sustainability, innovation, quality, safety, security, etc. – the drivers of reputation – can place officers and directors at great personal peril. Yes, it’s personal.