Competitive Advantage is an advantage over competitors gained by offering consumers greater value than competitors offer. The key reason for competitive advantage is the incremental value creation from IP (Intellectual Property) Assets. IP Assetsincludes patents, research and development investments, and patent licenses. In today’s business environment, IP Assets have become the currency of business, used not just to protect technology rights, but also to gain competitive advantage and drive new revenue opportunities. IP Assets are part of the Total Intangible Assets of the company and part of the total enterprise value of the business. Global equity market has witnessed tremendous growth in the value of IP Assets during the last 20 years. Today nearly 80% of S & P 500 company’s market value is attributable to Intangible Assets.
A strong brand, big pockets, network effect, patents, and trademarks are few other competitive advantage strategies businesses use to outdo their competitors. … Apple is a perfect example when it comes to brand-related competitive advantage
The generic use of the CAV method is to value patents, research and development investments, and patent licenses. Following are the basic steps for CAV calculation.
A. Calculate present value of total market profits in technology’s (IP) target market over time (5 Years). The discount rate to be used is the SumTotal of Risk-Free Investment Return and Inflation. The discount rate does not include other risks including investment risk.
B. Disaggregate present value of total profits into portion attributable to technical intellectual property assets. All of the target company’s assets contribute to total market profit of the company. These assets include: Tangible Assets, Intangible assets (Goodwill, Management skill, Customer and Supply Chain relationships) and IP assets. Profits are disaggregated using financial models. The financial models can be based on the assumption as Intangible Assets (SG & A Expenses), Revenue generating IP Assets (Advertisement Expenses-AD) and Technical IP Assets (R & D Expenses). This is based on the assumption that assets contribute to profits in proportion to amount the company investees in assets. The calculation for the percentage f profits attributable to Technical Intellectual Property (TIP%) is as:
TIP%= $R &D/ ($SG&A+ $R&D+ $AD)
C. Define the price/performance parameters that determine success in the intended market. Compare IT (Investigated Technology) to average substitute technology on price and performance parameters.
D. Calculate competitive advantage of the investigated technology by comparing it to an average substitute technology on the price/performance parameters: Example: To calculate the Competitive Advantage-%
Average Technology Price- $40
IT Technology Price- $30
IT Competitive Advantage= ($40-$30)/$40= 25%
E. Extrapolate from investigated technology’s competitive advantage to its predicted market share in intended market. Market share predicted from analysis of sales/or customer focus groups or Market share predicted from default correlation. i.e. Intended Technology (IT) competitive advantage relative to average substitute technology=IT predicted market share relative to average market share. If IT has 50% greater CA than average substitute technology, default correlation predicts IT will have 50% greater market share than average market share.
F. Calculate the present value of investigated technology from value of technical IP profits and predicted market share in intended market. IT present value is calculated by multiplying technical IP portion of market profits and IT predicted market share. Example is as below:
- Present Value of total market profits= $200M (5 Yeas)
- Assume TIP-% of total market profits= 30%
- Present value of TIP% pf total profits= $60M($200M*30%)
- IT competitive advantage= +25%
- Average market share= 10%
- IT predicted market share= 12.5% (125%*10%)
- Predicted present value of IT= 7.5M(12.5% *$6M)
G. Adjust for technical, market and intellectual property risks: Value of IT is net of adjustment of TRD (Technical risk discount), MRD (Market risk discount) and IPRD (Intellectual property risk discount.). Total risk discount is the product of technical, market and intellectual property risk discounts.
(1-TRD) X(1-MRD) X(1-IPRD). No risk can be > 95% and <5%.
Assume TRD, MRD and IPRD as 25%, 15% and 60% respectively.
Hence, Total Risk residual discount factor is= 25.5%
(1-25%) X (1-15%) X (1-60%) =75%X85%X40%
- From our example(F) Predicted present value of IT-Unadjusted present value of IT- $7.5M
- Risk adjusted present value of IT= (25.5% of $7.5M) = $1.92M
Calculated Competitive Advantage Valuation of IP Asset (Intended Technology is $1.92M. This s the risk adjusted present value. Company can increase IT present value by increasing IT competitive advantage over substitute technology and decreasing total risk discount.
The Market multiples approach is a comparative analysis method that seeks to value similar companies using the same financial metrics. The companies must be similar for a comparison of multiples to be meaningful. We can’t compare companies of vastly different sizes in different industries.
Business Value is in the eye of the beholder. There are many ways to quantify value. A valuation analyst looks at a variety of Valuation methods to quantify Value. No valuation method is definitive and all Valuation methods have appropriate uses. Valuation methods should be used in combination based on respective valuation assignments. The real value of applying various methodologies is applying them to value negotiations. Following are the multiple valuation methodologies and their attributes.