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A decade ago, Procter & Gamble’s paper-towel production line in Albany, Georgia, used to jerk to an unexpected stop more than a hundred times daily, costing the company thousands of dollars each time in wasted product and lost production time. To solve the problem, P&G developed a suite of sophisticated technical and statistical tools that not only helped managers predict such assembly line snafus but also prevent them. This “reliability engineering” technology has given the company an important competitive advantage over rivals, as it has helped P&G boost manufacturing efficiency by more than a third and save billions of dollars in the years since it was introduced.
It came as quite a surprise, therefore, when Procter & Gamble announced in the summer of 2000 that it would henceforth license this same technology to any and all bidders — including its own competitors. The company is known, after all, for being fiercely protective of its proprietary innovations (witness the forced bankruptcy of rival diaper-maker Paragon Trade Brands in 1998 after P&G won a patent suit against it). Yet suddenly P&G was offering (for a price) to share with other companies not only its reliability-engineering tools but its entire stock of 28,000 technology patents as well.
Although Procter & Gamble’s decision stumped industry analysts at the time, the company’s move is actually part of a larger trend (see also Henry Chesbrough’s article, “The Era of Open Innovation,” p. 35). P&G, in fact, is only one of a small but growing number of Fortune 500 firms such as IBM, BellSouth, Boeing, Rohm and Haas, and Motorola that are moving away from a strict reliance on the “exclusivity value” of their patents and other intellectual property — that is, their power to exclude or hinder competitors — and are instead seeking to tap the often-enormous financial and strategic value of their core technology assets by licensing them to other companies, including competitors. The practitioners of this strategic licensing, as it is called, are betting that any loss of market exclusivity that may result from making available their “crown jewel” technologies will be more than offset by the financial and strategic benefits gained.
Mining the Value of Intellectual Property
Strategic licensing is emerging against the backdrop of intensified efforts by corporate America to maximize the return on its intellectual property assets, which now account for 50% to 70% of the market value of all public companies.1 Patent licensing, for example, has become a growth business — revenues have skyrocketed from only $15 billion annually a decade ago to more than $100 billion today2 — as companies have sought to tap the value lying fallow in the 70% to 80% of corporate technology assets that typically never get used in core products or lines of business.3
Until recently, companies either limited their licensing to technologies that were not central to their main business or licensed core technologies only to companies in noncompeting industries. P&G’s licensing of an enzyme used in Tide to a contact lens maker for use as a nonabrasive lens cleaner is a good example of the latter. But with pressure mounting on companies to shore up their recession-battered bottom lines by any and all means, executives have now turned their attention to the stored value within their organizations’ crown-jewel technologies.
The strategy is not without risk. “It’s a delicate balancing act in which the business case varies in each situation,” says Daniel M. McGavock, managing director of intellectual-property consulting firm InteCap, which helps Fortune 500 companies execute licensing and other IP “value realization” programs. “On the one hand, you don’t want to abandon your patents’ ability to exclude competitors from your market. But on the other hand, you could be talking about hundreds of millions of dollars in new revenue from strategic licensing, not to mention a host of strategic benefits.” The challenge, he says, is to ensure that any strategic-licensing effort is undertaken only with the utmost care. “Companies must have a rigorous process in place,” says McGavock, “that enables them to evaluate quantifiably both the risks and costs as well as the potential benefits of any strategic-licensing initiative for the whole enterprise.”
To judge from the results of such initiatives to date, the most powerful benefits are economic. No company demonstrates this better than IBM, which earned an astounding $1.7 billion from technology licensing in 2000 alone.4 These revenues came with a 98% profit margin and accounted for roughly 20% of the company’s net income in that year. Although no other company can match IBM’s success in profiting from strategic licensing, others are certainly trying. Motorola, for example, launched its own program in July 2001 with the announcement that it planned to sell its most advanced cell-phone microchip sets, software and production tools to any company that wanted them — even to major rivals of its own handset unit. According to Ray Burgess, director of strategy and marketing for Motorola’s semiconductor operations, the licensing and other leveraging of this cell-phone technology could help to add as much as $10 billion to the company’s annual revenues by 2005. Purchasers of the technology, meanwhile, will be able to reduce their costs and design time and bring their own phones to market more quickly.
Of course, by forgoing the exclusionary barriers that its cell-phone patents could otherwise have erected against rivals, the company does risk some loss of market share. But as the New York Times noted, Motorola is betting that “any increase in the competitive pressures on its handset business, the company’s largest unit, will be more than offset by billions of dollars in new revenue and healthy profits for its chip business.”5
Pursuing Strategic Advantage
The benefits of strategic licensing are not just economic. Everyone interviewed for this article pointed out that licensing can also be a powerful means of transforming proprietary technology into an industry standard, creating a common platform that will help speed the growth of new industries and markets.
“Taking the traditional protectionist approach to your most valuable technologies doesn’t work if you’re trying to build a new industry around a common technology platform,” explains Janiece Webb, who heads Motorola’s Advanced Technology Businesses, the unit responsible for managing the company’s intellectual property portfolio. “We license [the cell-phone communication standard] GSM extensively, for example, and we license it to direct competitors such as Nokia and Ericsson. We want this industry to take off, and giving everyone access to a common technology will help build the industry more quickly, which is good for everyone.”
It’s especially good for Motorola, of course. By licensing GSM technology widely, the company is able to offset its own cost of development while generating significant new revenues. Strategic licensing, in fact, puts Motorola in the enviable position of essentially taxing its competitors for their help in building the industry.
But perhaps even more valuable than the licensing “tax” of this sort is the strategic advantage that can be gained from having a technology adopted as an industry standard. “Forget about that 5% to 6% royalty for a minute,” insists Mark Adler, chief patent counsel of the $6 billion chemical business Rohm and Haas. “The greater value lies in the fact that when your competitors license your core technology, you control the movement of the ball, so to speak. In fact, to an important degree, you get to control the direction of R&D for the whole industry, so you can move it in a direction that’s best suited to your own company’s long-term growth strategy. Plus, since you know the technology better than anyone else — you invented it, after all — you also have the edge in developing complementary technologies and products.”
If giving up monopoly rights to proprietary technologies can sometimes help companies dominate their existing markets more effectively, crown-jewel licensing can also enable them to forge partnerships with competitors that provide access to lucrative new markets. This was demonstrated last November when Procter & Gamble announced an unprecedented joint venture with one of its most powerful competitors, Clorox, to build a new bags-and-wraps business under the latter’s Glad trademark. Under the terms of the deal, P&G will give the new venture exclusive rights to its proprietary body of advanced bag-and-wrap technologies, while Clorox will contribute its existing Glad bags, containers and wraps business along with the manufacturing facilities and personnel needed to operate it. P&G gets a royalty fee and a 10% stake in the business, with the option to purchase another 10%.
The deal represented a significant departure for Procter & Gamble, which had never before engaged in a joint venture with a competitor as formidable as Clorox. The two companies are fierce opponents in several large markets. It’s only when Jeff Weedman, vice president of external business development and global licensing, discusses the internal decision-making process at P&G that led to this joint venture that one senses just how dramatically technology policy is changing in corporate America.
“Our company had for a long time maintained a strong core competency in high-speed, high-capital manufacturing of thin films and coatings for use in our diaper and feminine-care products,” Weedman recalls. “And when we looked for other applications where we could use that technology, the obvious answer was in the bags-and-wraps marketplace. So we developed what we believed was a superior wrap, one that did spectacularly well when we test marketed it. But then we asked ourselves, What’s the cost of establishing a new brand equity in a business where there were already some very talented and powerful competitors, Clorox among them? And we discovered that the economics were just not very attractive.”
Weedman sums up P&G’s dilemma: “We had this great technology that didn’t make sense for us to commercialize, given the market competition. Nor did it make sense to simply offer a onetime license, given that it was a core technology in our diaper and feminine products business, and we knew we’d continually be developing and improving it. So how could we extract the maximum value from this technology?” The answer was to go into business with a company better able to exploit the technology’s commercial potential, and Clorox had the manufacturing know-how and brand leverage to do that.
The lesson is that the company investing in research and creating new technologies isn’t necessarily the best one to commercialize every product opportunity that emerges from those innovations. Leaving such opportunities on the shelf, however, would be a tremendous waste of resources and potential shareholder value. Strategic licensing offers companies a new means of maxmizing the return on their R&D investments.
It can also create valuable new ways for a company to work with its suppliers, as Motorola’s Janiece Webb explains. “We developed a display capability for cell phones that made our phones cheaper and brighter,” she recalls. “The traditional approach would have been to hold on to that proprietary technology in order to develop it ourselves. But we’re not really in the display business; we just use them in our phones. We weren’t best suited to keep making improvements in the technology, nor were we going to have the volume of sales needed to make those displays at the lowest possible cost. So we licensed the technology to a supplier, which ensured that we’d always get the best displays at the lowest cost.”
Procter & Gamble took a similar approach with one of its suppliers. It designed new packaging for deodorants and took it to one of its suppliers to produce. At about the same time, a competitor approached P&G and asked if it could use the same packaging. Jeff Weedman recalls the decision: “The old Procter & Gamble would have said, ‘No, those molds give us a competitive advantage.’ But when we actually ran the numbers, we concluded that we wouldn’t lose much business from our competitor having the same packaging. In fact, by adding its volume of package molds to ours, we significantly lowered our own cost of producing them. Not only that, the supplier liked the packaging so much he asked us if he could also license the design and sell it to his other customers. So our competitor paid us a royalty. Our supplier paid us a royalty. And the combined volume of all those additional packaging molds saved us a lot of money in supply costs and lowered our capital requirements.”
The bottom line is that strategic licensing, if done properly, can spur a company to become more innovative and competitive in all sorts of ways. When a company licenses core technology to a competitor and can no longer rely on its monopoly patent rights to stay ahead in the market, for example, it must not only innovate faster and better but also execute its product development and marketing strategies more effectively. And it’s not just the increased market risk that motivates a company to execute better; it’s also the increased market opportunity.
“Strategic licensing is a great business-model enabler that has really helped us broaden the palette we can draw on to create innovative products and build profitable businesses,” Weedman believes. “It has opened up ways for us to bring products to market other than through our own sales and marketing organizations — we can now use those of competitors, too. This is extremely important, because historically only about 10% of our technologies ended up being commercialized in P&G products. This new approach really expands the opportunities to maximize the return on our R&D.”
Managing the Risks
Although Procter & Gamble, Motorola and other companies have derived important financial and strategic benefits from licensing their crown-jewel technologies, the potential risks of this strategy must not be overlooked. The most obvious danger is that a company might indiscriminately open up too much of its core technology for licensing and in so doing undermine its ability to enforce its intellectual property rights when needed. Strategic licensing should complement — not replace — the enforcement of patent rights, which should always remain an important weapon in a company’s competitive arsenal.
Companies must even be cautious about the way they present their strategic-licensing efforts to investors, shareholders and competitors. “You don’t want to sound like you no longer care about enforcing or seeking fair value for your intellectual property rights,” InteCap’s McGavock warns. “Because if you ever do take a competitor to court for infringing on your technology, he may try to use that against you.”
There are other concerns that companies must keep in mind. “Licensing and joint-venture relationships between competitors can raise certain antitrust issues if not handled properly,” Rohm and Haas’s Mark Adler points out. “You’ve got to make sure that there’s no question of market collusion or restriction of competition in these deals.”
But perhaps the most important caveat regarding the development of any strategic-licensing initiative is that it will succeed only if it has the strong and active support of the company’s CEO and other senior executives. One could say this about any corporate change initiative, of course, but it’s especially true in this case because the commercialization of intellectual property has traditionally been considered (if it’s been considered at all) a noncore activity of the firm and has rarely been any senior executive’s top priority.
Strategic licensing — indeed, any concerted effort to leverage intellectual property assets — also requires a strong independent organization or business unit empowered to make enterprisewide decisions about technology assets. “One business unit may feel it’s fine to license a technology, but another may disagree and believe its success depends on keeping that technology exclusive,” explains Gene Partlow, vice president of Boeing’s intellectual property business. “That’s why having an enterprisewide business unit to manage these assets — in our case, we’ve established a separate intellectual-property holding company — is so important. We’re able to make licensing decisions on the basis of the probability of economic benefit to Boeing as a whole.”
The most successful intellectual-property business units employ a rigorous set of procedures for making decisions. “Motorola has formalized its decision-making procedures in what we call the strategic-asset management process, or STAMP,” notes Janiece Webb. “Managers now have to come to us with a business plan that quantifies the dollars-and-cents, net present value of licensing versus not licensing a technology. We compare the exclusivity value of keeping a core technology in-house against the economic value of licensing it to other companies.”
Webb also believes that companies need to make their licensing policies explicit. “It used to be that you had to have permission from the CEO’s office in order to license a technology,” she recalls. “But last year we formally changed that. Now our policy says, ‘Thou shalt license.’ You still need to make a business case for it to the STAMP committee, but you no longer need a special dispensation from the CEO’s office to do a deal.”
Even with strong executive support and an independent licensing organization run along P&L lines, however, many companies initially will not have the skill sets needed to build an effective program; they will need to look outside the organization for help in identifying and exploiting licensing opportunities. And no matter how strong the support from the CEO, how effective the outside consultants, and how rigorous and well organized the decision-making process, cultural barriers to crown-jewel licensing will have to be surmounted in most organizations. “The unit managers and technologists are sometimes very resistant to strategic licensing,” InteCap’s McGavock points out. “Their attitude is, ‘Protect and don’t share’ — especially don’t share our technology crown jewels — and this attitude is deeply embedded in U.S. companies. One reason for this is that intellectual property has often been the responsibility not of business managers but of the corporate legal department, whose principal job was to guard technology, not leverage it.”
It was precisely in order to encourage a decisive break with such “protect and don’t share” thinking that Procter & Gamble promulgated a new policy two years ago. The policy requires managers to consider, on a case-by-case basis, licensing any of the company’s technologies either three years after its market introduction or five years after the patents for it have been granted — whichever comes first. In addition to patented technologies, other forms of intellectual capital — trademarks, brands, know-how and so on — are also candidates for “external commercialization.” Perhaps the spirit of P&G’s new policy is expressed in this company slogan: “We have no competitors, only potential customers.”
It’s an exaggeration, of course, to say that P&G has no competitors. The point is to get the company’s business managers and technologists to broaden their competitive outlook — to recognize that competitors can sometimes become customers as well.
Rethinking Competitive Advantage
Therein lies the broader significance of strategic-licensing initiatives: They are encouraging managers to broaden their understanding of what it means to create and sustain competitive advantage in business.
As P&G’s Weedman explains, competitive advantage used to be defined as “I’ve got it and you don’t.” But now it can mean “I’ve got it and you’ve got it, but I’ve got it at less cost” or “I’ve got it and you’ve got it, and if either of us didn’t have it, the market wouldn’t grow as rapidly and we’d both suffer.” But his favorite definition is this one: “I’ve got it and you’ve got it, and I make money when I sell it, but I also make money when you sell it.”
“Now if that’s not competitive advantage,” he concludes, “then I don’t know what is.”
1. D. McGavock, “Intangible Assets: A Ticking Time Bomb,” Chief Executive 183 (November 2002), http://www.chiefexecutive.net/depts/chiefconcern/183.htm.
2. J.J. Elton, B.R. Shah and J.N. Voyzey, “Intellectual Property: Partnering for Profit,” McKinsey Quarterly, 2002, no. 4, http://www.mckinseyquarterly.com.
3. D.M. Katz, “A Company’s Mind Is a Terrible Thing To Waste,” CFO.com, July 26, 2001, http://www.cfo.com/article/1,5309,4335|||1,00.html; H. Harreld, “Getting Your Buck’s Worth From Intellectual Property,” CNN.com, October 29, 2001, http://www.cnn.com.
5. B.J. Feder, “Motorola To Sell Inner Workings of Cell Phones to Rivals,” New York Times, Monday, July 23, 2001, http://www.nytimes.com.