Intellectual Capital: Software innovation and its role in national economies Gio Wiederhold Stanford University, Stanford CA http://i.stanford.edu/~gio 5/29/2016 Gio Wiederhold Germany 2016 1 Abstract Software has invaded all aspects of our world. It can no longer just be viewed as a fascinating technology. Software, and the products that depend on it, from watches to aircraft, social interactions, and sharing services, comprise a large fraction of modern commerce. The creators and the intellectual property they generate, exploit, and maintain comprise the intellectual capital of our hidh-technology industry, an asset that competes with the financial capital that traditional manufacturing industries rely on. I will present the flow of innovation into our national economics. Rights to profit from intellectual property are poorly documented and are easily transferred among countries. The importance of our intellectual capital is underestimated by economists and planners because the `Big Data’ they access is primarily from financial-oriented sources. As result, governmental policies to improve economic activity and the welfare of its people are often naïve and sometimes wrong. In this world computing experts have roles beyond the base technology. 5/29/2016 Gio Wiederhold Germany 2016 2 Gio’s Bio Gio Wiederhold was born in Italy, educated in Germany and The Netherlands, moving to the US in 1958. He started with numerical computing at SADTC in Holland and adapted his efforts as computing technology progressed into more areas. Gio obtained a PhD in 1976 and became a professor at Stanford University. During a three- year assignment at DARPA he initiated the Digital Library program, funding research that led, among others, to Google. After his formal retirement in 2001 he is serving as a government consultant on issues of software exports and their value. In 2011 Gio received an honorary DSc from the National University of Ireland in Galway. He stopped offering courses at Stanford in 2014. He has authored and coauthored 6 books on diverse topics and over 300 reports and papers and supervised 36 PhD theses. Many more details are at http://i.stanford.edu/~gio. 5/29/2016 Gio Wiederhold Germany 2016 3 Topics 1. Motivation & definitions 2. Intellectual capital and intellectual property (IP). 3. Value and sketch of valuation a. (Valuation based on expected income) b. IP generation: R&D and Marketing c. (Putting it all together in a simple business model.) 4. Income and allocation 5. Separation of IP rights from the property itself. 6. IP flow and IP rights flow. 7. IP data for valid economic models 8. Summary. 5/29/2016 Gio Wiederhold Germany 2016 4 The value of Motivation Computing 1. Software producers traditionally care about – Cost of writing software – Time to complete products – Capabilities 2. When the value is a concern life – Business people – Economists – Lawyers inconsistent – Promoters 55. A LISP programmer knows the value of everything, but the cost of nothing. [A.Perlis]] 5/29/2016 Gio Wiederhold Germany 2016 5 Definitions Intangibles ( IP) Product of knowledge by Cost of original >> cost of copies 1. Books authors 2. Software programmers 3. Inventions engineers 4. Trademarks advertisers 5. Knowhow managers 6. Customer loyalty – Interacts with long-term quality 5/29/2016 Gio Wiederhold Germany 2016 6 Definitions Intellectual Capital Assets of 5/29/2016 Gio Wiederhold Germany 2016 7 High-Tech Industry Definitions Economic Loop Taxes Profits Commodity Products Common Knowledge Public Inte- High-value Know-how gration & HTI’s . of HTI’s Products: Private Intel- .workforce Tech - Invest - nology Maniacs lectual .IP: HTI’s ments Intellectual Capital . Trade - Property marks Taxes Profits non-routine 5/29/2016 Gio Wiederhold Germany 2016 8 Value in a business Value water + sugar + IP `It’s one thing to sell Coke and another thing to sell the formula for Coke’ [Jay Flatley of Illumina] But you must make and sell Coke to profit from its formula. A commodity bottler makes the Coke for you. Where is the value? Who gets what profits? 5/29/2016 Gio Wiederhold Germany 2016 9 Value in a business Value gadgets + firmware `It’s one thing to sell iPhones and another thing to sell the embedded firmware’ [Jay Flatley of Illumina] paraphrased But you must sell iPhones to profit from the existence of the code in all those many chips. You design it, write, buy and integrate soft-and firmware usingSoftware A contractor builds the phones for you. A store sells the phones or plans that use it for you. Where is the value? What is an iPhone without Software ? Who gets what profits? 5/29/2016 Gio Wiederhold Germany 2016 10 Value in a business Value apps = software `It’s one thing to sell iPhone apps and another thing to sell the program codes’ [Jay Flatley of Illumina] paraphrased But you must monetize the software to profit from its existence. You or a distributor sells the software for you. Free + ads Where is the value? Fremium (free + $ for better) Who gets what profits? A price that allows quick decision-making 5/29/2016 Gio Wiederhold Germany 2016 11 Value in a business Value enterprise software `It’s one thing to build commercial SW and another thing to exploit that software in your business’ [Jay Flatley of Illumina] paraphrased But you must sell build enterprise SW to distinguish your business from all of your competitors. Your people or a contractor builds the SW for you. Your business depends on it. FedEx = Planes, trucks, & SW Banks = ATMs, managers, & SW Where is the value? Clinics: MDs, staff, medicines, & SW DoD = Soldiers, generals, guns etc, & SW Who gets what profits? Dept.stores: sales staff , buyers, inventory & GM: Designers & SW + marketeers & SW + plants & SW 5/29/2016 Gio Wiederhold Germany 2016 12 Value Tangibles / Intangibles In a business 3 parts have value (contribute to profit) 1. Tangible goods: buildings, computers, capital 2. Know-how of management & employees 3. Intellectual property: Designs, software, methods, trademarks, etc. 2. & 3. make up the Intangible Capital of a company. If owned then it is Intellectual Property or Intangible Property similar – distinction is source vs ownership 5/29/2016 Gio Wiederhold Germany 2016 13 Principle of valuation Valuation The value of an asset is the sum of all future income discounted to today (NPV) In a public company implicitly estimated by shareholders through the market cap Example: Market Cap value of a company (SAP, 2005) Largely intangible – like many modern enterprises Market cap = share price × no. of shares €31.5B 100% Bookvalue = sum of all tangible assets € 6.3B 20% Equipment, buildings, cash Intangible value per stock market €25.2B 80% Intangible/tangible = 4 x How much of the value is due to software at SAP ? 5/29/2016 Gio Wiederhold Germany 2016 14 Approaches to assess IP Valuation L $ • Technical alternatives 1. Income Prediction time Based on expected salesi * Lag + diminishing IP LifeL+i 2. R&D Roll-over ×1.? Based on experience of effectiveness of ∫ R&D from past investments m = 1.2 to 10 • Broader alternative approaches 3. Market Capitalization (Market Cap) Covers everything the shareholders value 4. Comparisons with another existing businesses Find other companies based on industry, operational similarity and then check their performance based on ratios as: margins, royalties gathered, costs/earnings, . 5/29/2016 Gio Wiederhold Germany 2016 15 Software is not stable (Valuation) ongoing IP generation • Corrective maintenance – Feedback through error reporting mechanisms • Taking care of bugs and missed cases, conditions • Complete inadequate tables and dimensions • Adaptive maintenance – Staff to monitor externally imposed changes • Compliance with new standards • Technological advances • Keeping with viruses, spam etc. Effort depends on number & volatility of external interfaces • Perfective maintenance – Feedback through sales & marketing staff • Minor features that cannot be charged for 5/29/2016 Gio Wiederhold Germany 2016 16 Maintenance → (Valuation) SW Growth Best Rule: V = V + V [see references] New software diminishes n+1 n 1 the value of prior software + Deletion of prior code = 5% per year Income is due to old+new software at 1.5 year / version 5/29/2016 Gio Wiederhold Germany 2016 17 Growth diminishes (Valuation) prior IP For constant unit price Same price ≈ effort X 5% at 1.5 year / version 5/29/2016 Gio Wiederhold Germany 2016 18 Lag delays benefits (Valuation) of R&D investments Estimate effective lag . growth limit ~37% → → @27.4% → ~14% → Testing Effort Effort growth limit Development Research 35%→ start 75% 50% 25% done 5/29/2016 Gio Wiederhold Germany 2016 19 Gestation period → Income Two sources of profits 1% - 8% of sales Common Knowledge Commodity Products Know-how of Intel- . workforce High-value lectual . Intellectual Products: Capital . Property 20% - 60% of sales 5/29/2016 Profits Gio Wiederhold Germany 2016 20 Future income has less Income value: Discounting • Standard economic accounting principle Getting €1 next year is less valuable than getting €1 today. 1. If no risk of getting it later, discount by available interest rate • Say 4%, 1-year off is 1/1.04 = €0.962, 5-year is €0.822, 15 year only €0.555 • Formally, use government bonds rates for that period 2. If there is a risk - likely in business – use risk experience • Say 15%+4%: 1-year is €0.84, 5-year is €0.42, 15 year only €0.074 • Tables per industry are available (at a price), based on past experience Discounting has a large effect on income estimates Makes looking