Intangible Assets: Major Risks, Major Rewards
We live in an information economy. Intangible assets, including data, trade secrets, content, software code, brand, industrial know-how, confidential information, design and patents, now represent over 87 percent of the value of the S&P 500—$15.8 trillion in wealth. These are the most important assets a company owns. They are also the primary source of company performance—with the exception of real estate, virtually all economic growth is driven by intangible assets.
Yet, most companies have only a limited grasp of their intangible assets and consequently overlook major risks and opportunities.
Hard To See
Despite being so critical, intangible assets still don’t feature on most board or company agendas. Many directors and senior management teams erroneously see intangible assets as being merely about patents and trademarks: a quasi-legal, administrative or R&D issue that, depending on the organization’s hierarchy, could variously belong to the CFO, CTO, head of R&D or general counsel. Sometimes, there is no direct owner at all, or responsibility is essentially farmed out to external attorneys with little understanding of the business or its strategic drivers. This seriously misjudges the critical importance intangible assets have now assumed in modern business.
In short, too often the company’s most important assets are not well understood by the company’s board. In over 750 client engagements across both private and public companies, we have seen intangible asset risk feature on only one board’s risk register. Yet, the consequences of not identifying and understanding intangible assets and their associated risks are extremely serious.
In over 750 client engagements across both private and public companies, we have seen intangible asset risk feature on only one board’s risk register.
The police arrive at your factory one day and confiscate a small but important machine producing the company’s primary product. On inquiry, it transpires that a staff member stole the machine from a competitor’s factory. The company now faces the loss of much of its revenue—a serious risk.
Now imagine, instead, that the staff member did not physically steal the machine but stole their intangible assets. Infringement of intangible assets is not only more probable but has the potential to be vastly more serious. Every day we see companies where staff intentionally, recklessly or naively use intangible assets they have no rights to. This varies from using confidential information belonging to previous employers to inadvertently replicating other products to deliberate copying and theft. The consequences are serious and include injunctions, product recalls, litigation and damages awards. In the U.S., intangible asset litigation costs start at approximately $1.5 million and rapidly climb. The median cost to first judgment alone is $4.8 million. Ensuring you have freedom to operate, that is, the ability to run your business without infringing on someone else’s intangible asset rights, is vital for all businesses.
A key step in avoiding these issues is an independent infringement risk review of key products and assets. It is particularly important before starting major R&D or product development projects. The cost of trying to change tack after a company has committed to a technology path or is in market is enormous. A rigorous infringement analysis will focus on more than patents, as many forms of intangible assets can be infringed: copyright, trademarks, design rights, data, software code or confidential information.
Major markets should be the primary focus, since the most serious infringement threats are likely to come from scale markets where margins, revenue or primary competitors are located. Best practice is to ensure that any infringement risk review is undertaken by someone independent—that is, not the team responsible for development of the product or the external firm responsible for filing patents or trademarks on the technology you are now checking. This is the same reason your accountant should not act as your auditor.
The CIO reports that the company’s bank accounts are at high risk of being hacked due to lax security. This is an extremely serious risk and one that any board or CEO should immediately move to address.
However, leaving your company’s intangible assets unprotected has the potential to be far more damaging. We were recently asked to assist a company which, under pressure to deliver on a product deadline, contracted a small external software developer to deliver the final stages of a key product. The company’s engineering team did not understand the true value of the intangible assets they were developing. Consequently, they took few steps to adequately protect or manage the assets, either contractually or through protection of the code itself. The external developer, however, very quickly realized the value of what they had been given access to. After completing the engagement, they shut down their company, restarted afresh and developed a rival (and far more successful) product, springboarding off the intangible assets they had access to. Their product subsequently stole a market share position worth hundreds of millions.
The company had no effective recourse: The horse had bolted. Neither the board, the head of R&D, the general counsel or the company’s external advisers had identified this major intangible asset risk. This could have been avoided had the company identified the critical intangible assets it owned and treated them accordingly.
Two Sides to a Coin
On the flip side of the risk coin is the potential reward companies can reap once they understand that intangible assets can be an extraordinarily powerful growth lever and ensure they have a robust intangible asset strategy.
There are potential rewards to be reaped by those companies which understand that intangible assets can be a powerful growth lever—and develop a robust intangible asset strategy.
Another scenario: Imagine finding your company owns a previously unrecorded warehouse, filled with a product that, with some minor modifications, will deliver a 25 percent increase in revenue for the next five years. Sounds fanciful? It’s more common than you might think.
For example, in the early 1970s Xerox identified 35 projects at its famous PARC facility that “did not have any value to Xerox.” Royalty-free licenses or the intangible assets themselves were given to various startups. Eleven of the 35 startups succeeded: the combined value of these cast-off companies was double that of Xerox.
There are many such examples of companies that allowed intangible assets to pass to third parties, which proceeded to convert these overlooked scraps into highly successful products or services.
Maintaining a Record of Intangible Assets
Ironically, while most companies have a fixed asset register listing desks, chairs and equipment, few have records of vastly more valuable intangible assets. An expert audit can help identify these nuggets of potential gold and turn them into revenue streams or strategic advantage before they are lost.
Intangible assets are the most important assets that companies own today. They are also the primary source of risk for most companies. Boards and C-suites have a duty of care to identify and manage their intangible assets and risks as seriously as critical machinery, key products or a bank account full of cash.