Chapter 3

Technology Transfer

Phyllis Speser, JD, PhD, RTTP

How You Make Money—the Framework

Today, technology is almost a commodity. There is a lot of it around. If a small and medium enterprise (SME) is looking to in-license or buy, it often is a “buyers’ market.” It is a good time to be cherry picking or just building a portfolio to scare off and fend off competitors.

Most of the technological inventions out there will never make it to market. There are all sorts of reasons why. The most common reasons are:

1. (1) The inventions are immature, which means they suffer from high technical risk (will they work?); and
2. (2) The market is uncertain (will products and services based on them sell?). This technical and market risk increases the discounting in a net discounted cash flow analysis, making it appear financially risky to invest in licensing the technology.

Exacerbating matters is

1. (3) Intellectual property (IP) risk (can it be patented, was it already invented and disclosed, is it not protected in critical countries, etc.?); and
2. (4) Firm-specific risk (does the inventing organization know how to commercialize it or does the potential licensee know how to absorb it, adapt it for the market, and sell and support it?).

Ironically, all these risks create a business opportunity for SMEs, if they have the technical skills to mature the technology themselves (internally or by contracting) and to bring it to market and support it, once there. The reason for the business opportunity is that governments around the world have pots of money (gap funding) for maturing technology for which only small firms can compete. If an SME can either (1) gain access to the technology under a no-cost research license with an option to license to make, use, and sell, or (2) obtain a low-cost license to make, use, and sell, that SME can compete for government funding to mature the technology. Maturing the technology increases the value of the technology. The result is a classic buy low, sell high. The irony, of course, is the more risky the investment, the lower the price of acquisition. Yet if the small company can be paid to mature the technology, it has very little risk from the activity of spinning up the technology. Instead, if the SME is paid to mature the technology by the government, it may even make a profit. At worse, assuming there is a market for the technology, it is laying part of the costs of product development off on the government.

Because out-licensing these inventions is often a problem for research institutions like universities, research hospitals, government labs, and nonprofit institutes, most research institutions now have special offices called technology transfer offices (TTOs). These offices have the authority to sell and license technology for the institution. Usually, they also do cooperative research and development (R&D) agreements. As part of their job, they collect, document, and evaluate inventions. They determine which ones should be protected via patent or copyright and frequently manage that process. They also do the deals, as already noted. These offices can help you find what you are looking for. Just remember they are also the ones who will negotiate with you the terms of any deal.

Figure 3.1 depicts how technology transfer looks from the perspective of a TTO. Note there are two primary ways institutions make money off technology transfer: licensing or obtaining sponsored research funding in exchange for an option to license the resulting technology. Everything else is a variant of one of these two themes. For example, if professors or postdocs form a new company (a spinout), the TTO still licenses institution-owned technology to that new company. If the institution sets up a cooperative research center, then the companies involved pay a membership fee in exchange for option right to exclusively or nonexclusively license technology developed.

Here is how it plays out on the SME’s books. When the SME acquires the technology, there is a series of expenses. These include licensing up-front fees (if any) plus any milestone payments, the cost of finding the technology and doing due diligence on it, and the cost of negotiating and closing the deal. These expenses show up on the income statement as expenses. Depending on how the chart of accounts is structured, these expenses may be part of the cost of goods sold or in the overhead or general and administrative accounts. At this time, there is most likely no revenue, but the SME’s intangible asset value increases on the balance sheet regardless of whether the technology goes to market or not. It increases because any technology relevant for future products is an intangible asset and, assuming the company is good enough to win government R&D awards, goodwill is higher. Government awards are a sign the company is technically competent, which reduces both technical risk and firm-specific risk associated with the SME’s IP. Hence, two bumps in intangible asset value. If the technology actually makes it to market, revenues will go up and the revenues minus associated expenses will increase the gross profit on the income statement. Furthermore, if the technology is significant enough to cause fluctuations in the value of the company’s stock, the option value of the stock also goes up. That means the company can make money by selling stock options if it so chooses.

Of course, the devil is in the detail.

What You Need to Make Money—the Details

To make any significant money at open innovation, you need four things: technologies worthwhile to acquire, a way to acquire them, the ability to bring them to market, and customers who will buy them. Please note whenever we use the term “technology” or “technologies,” we will include as part of the technology the invention, know-how, and any products or services or processes based upon them or significantly utilizing them. We include both in-licensing and buying all the rights to a technology (also called assignment).

The method we use to figure out these four things is called backward chaining. You start with the desired end state, and then you determine what is needed to have it. Then, having thought backward, you plan forward—starting from where you are today. You move from there to where you need to be. In open innovation, backward chaining leads us from customers to technologies to acquire, to negotiating to acquire them. The ability to bring them to market is addressed as part of determining what to acquire.

Backward Chaining With Customers

People want new technologies for all sorts of reasons. But for open innovation, the best reason is a pressing need that cannot currently be adequately met. This need drives the features and functionality customers will desire in a product or service and the price they will pay to get it. Businesses that talk to their customers and listen to them usually have some ideas of where market opportunities lie.

Let us illustrate this with an example; suppose you are a farmer with a lot of acreage under cultivation. Let us also suppose you are in California’s Central Valley—one of the great food-growing regions of America. Ideally, you only want to give your plants water when they need it. The same is true for other inputs (e.g., fertilizer). In both cases, eliminating the unnecessary application of inputs reduces expenses and, assuming solid revenues, increases profit. In the case of California, four years of drought has created a situation where limiting the amount of water may make the difference between staying in business or bankruptcy, because water is scarce and wells are running dry. The problem is that limiting inputs to only what is necessary for crop health requires good data about soil moisture, plant respiration, disease, and so on.

On a large farm of thousands or millions of acres, collecting that data can be time-consuming and expensive. The U.S. government has recently issued rules governing the use of unmanned aerial vehicles (UAVs) in civilian airspace. For large acreage farms, using UAVs to collect data is now a viable option. As more data becomes available, new approaches to data analysis also become viable.

At the major trade shows, like Commodity Classic, which focuses on corn, soy, wheat, and sorghum, there were lots of interest in both UAVs and space-based data to support precision agriculture. Not surprisingly, the major vendors of crop management software are now highlighting how they can incorporate aerial data. These product enhancements result from vendors talking with, and listening to, their customers. Smaller firms were introducing UAVs and data or image analysis packages that either are stand-alone products or designed to work with one of the major vendor packages. It is an area ripe for open innovation as there is a lot of defense and earth observation software that could be (and already is being) repurposed for use in precision agriculture. (Which is why the National Aeronautics and Space Administration’s [NASA’s] Goddard Space Flight Center’s TTO has an initiative focused on precision agriculture. Goddard is the world’s largest earth observation center.)

Listening to customers and talking with stakeholders and experts is a good way to find out what customers in your market might buy. Your market can be one your SME already services. It can also be one you are interested in penetrating. In either case, the first step is to identify and understand needs.

Needs always can be quantified on scales.

Ordinal scales are constructed on the basis one is more than two, two is more than three, and three is more than four. We do not know if the interval between one and two is the same as the one from two to three or three to four. We also do not know if zero makes any sense as a measurement on this scale. We just know it is about more and less. An example is love. You tell your spouse, I love you more than words can tell. Desirability of a product is measured by an ordinal scale.

Other scales can also be used. Interval scales have equal intervals, but zero is arbitrary. An example is years. The year zero on a calendar does not mean there were no years before that.

Ratio scales have meaningful zeros. Absolute zero is where there is no heat energy left in a substance. Zero celsius is where water freezes. Distance is a ratio scale as is power consumption.

What we want to know is needs on three dimensions: performance, ease of use, and price.

Performance consists of the hard, measurable engineering specifications. Usually it is measured on ratio scales or interval scales. It uses this much power. It is this big. It blocks this much radiation. Whatever. A good way to think about performance is to think about the patent claims you would make for a technology. Efficacy in attaining those claims is the performance. An inhalable flu vaccine works if it gives the user some percentage of certainty that a person will not have the flu for some period of time.

Ease of use consists of factors that make a technology easier or harder to adopt. Usually it is measured on interval or ordinal scales. If a technology requires extensive training to know how to use it, special infrastructure, and so on, then the hassle of adopting and implementing it rises. Obviously, ease of use is context sensitive. A computer easy for you to use may not be so for your 93-year-old grandmother.

Price is what something costs. It is measured in currency, which is a ratio scale. There cannot be “sticker shock” or no one will buy the technology. What if sticker shock varies from application (field of use) to application. In each arena, buyers are used to spending some level of money. A quick way to estimate how much is to look at multiples of 10. One dollar, 10 dollars, 1,000 dollars, 10,000 dollars, and so on. When I buy a new car, a price in the $20,000-to-$30,000 range is reasonable. When I buy a used car, however, a price in the $5,000-to-$10,000 range seems reasonable unless the car is only a year or two old and has low mileage.

The final reason is UMPF. UMPF is a made-up term, which means there is some imperative to buy this good now rather than later. UMPF is measured on an ordinal scale. When water is scarce, home gardeners are more likely to buy drip irrigation systems. When it is plentiful, they are less likely to.

The point is, if we collect data about needs, we are also collecting data on what a technology must do to be attractive to buyers. We can then assess the attractiveness of technologies for acquisition in terms of how well they fit the needs of customers in markets of interest (see Figure 3.2). Ideally, these needs will endure over time long enough for the SME to run through the process of acquiring it, bringing it to market, and making money off it.

Finding Technology to Acquire

Usually, a technology is not a perfect fit with a set of needs. So when doing due diligence on a technology, we want to know more than what it does today on relevant metrics and what it is anticipated to be able to do when R&D is completed. We also need to understand the flex (flexibility) of the technology to be adapted better to the needs of potential customers. Typically, changing yield on one metric will adversely affect yield on another one. The trick is to be able to degrade trade-off yields on low-priority metrics to improve yields on high-priority ones (see Figure 3.3).

As the old adage goes, there is more than one way to skin a cat, and typically, there is more than one technology that can address end user needs. Just as customers have choices, so also do companies acquiring technology. By comparing yields on high-priority metrics (i.e., customer needs), an acquirer can compare the competitive advantage of various technologies. There is a large pool of empirical research that validates the commonsense view that competitive advantage is the critical factor in market success. Be aware that competitive advantage has to exist at the time the product or service will be introduced to the market. There is a dynamic system here, with both technology and customer needs having trajectories over time.

You can use a spreadsheet to model current or potential competitive advantage and portray it graphically. Each column represents a metric. You plot the customer’s desired values for the yields. Then you plot the yields of the various technologies that can address those needs either in their current state or after further development to optimize them for end user needs (see Figure 3.4).

If you want a single value to represent competitive advantage, you can normalize the values for the yields. If the significance of metrics varies significantly, you can weight them. The result is an ordinal number on a scale from 0 (the worst) to 10 (the best).

Competitive advantage mitigates market risk. Lower market risk means lower discounting and thus higher value on the balance sheet. This higher value, in turn, reflects a greater likelihood of downstream net positive cash flow from sales or licensing of the technology.

Another factor to assess when determining whether to in-license or buy a technology is IP risk. If the technology infringes the rights of others, it will be difficult to introduce. An inability to obtain strong IP protection, or any at all, may be less of an issue depending on the nature of the technology and the field of use in which it will be applied. That said, in general, obtaining an exclusive license to the IP rights can give you a monopoly position in the market or at least give you a monopoly for a specific technical approach. Good patent, copyright, mask IP, or a combination of these protects technologies from being made, sold, or used by others. Patents protect inventions; copyrights protect creative works, including software code. Masks protect the layout of the lines on chips and circuit boards.

Critical for determining the strength of IP protection is determining three things. The first is the claims made in a patent or the work submitted in a copyright or mask filing. The claims or work determines what is to be protected. The second is the priority date. In general, it is a first-to-file world. The priority date establishes who is first to file if more than one application is submitted. The third is how much time is left on a patent. If a patent has not issued, the issue becomes what is necessary to secure one. Other factors, such as whether the technology is only protected by one patent or by a group of patents (or a group of patents plus a trademark, trade secret, etc.) strengthen the IP protection. In general, IP protection in more of the jurisdictions in which customers are found is stronger than where fewer jurisdictions are covered.

Process technologies can be protected through trade secrets if they are easily copied to make products, but the products cannot be reverse engineered to determine if infringement occurred. Several years back, we worked with a university that developed a new and less expensive way to make a specialty chemical. We advised against patenting it as the chemical was a commodity and patenting would disclose the process. Since there was no way to know if the process was used or not used by manufacturers of the chemical, we recommended licensing the technology as a trade secret.

In general, there are four requirements for a patent to issue.

First, the subject matter must be protectable. By law, machines and processes are almost always patentable, while laws of nature are not. Whether software, results of genetic engineering, and so on are patentable depends on whether they are seen by the legal jurisdiction as closer to machines and processes or laws of nature.

Second, it must be novel (i.e., a new bona fide invention). We once were hired by a Fortune 500 company to out-license surplus patents. One was for an electric outlet with a 120-volt and a 240-volt socket. As electric cars were about to be introduced, we determined there was a market for this technology. However, we recommended abandoning the patent because we discovered a firm had been selling these dual-voltage outlets to the public for several years before the patent held by our client had been filed.

Third, the invention must be novel, which means it is not obvious to a practitioner in the field of the invention.

Fourth, it must not have been previously disclosed to the public.

These four traits are sufficient for a design patent. Design patents protect nonfunctional, purely ornamental designs. A “spork” is an eating utensil that is both a fork and a spoon. A variety of design patents cover different looks for sporks.

Plant patents protect asexually reproduced plants and sexually reproduced plant seeds. Such plants and seeds are usually the result of a scientific experiment involving genetic engineering or crossbreeding.

What people normally think of when they hear the word patent is a utility patent. These patents have, as the name indicates, an additional requirement that the invention be useful for some human endeavor. Usefulness has to be proven through an actual or constructive reduction to practice. Theoretical utility does not count. Anyone who has seen a Star Trek TV show or movie knows what a teleporter is. With the discovery of quantum pairs, it is theoretically possible to see how one might be constructed. It is much more than a simple matter of engineering to build one; because the teleporter is still just an idea and not reduced to practice, it cannot at present be patented.

When evaluating technologies for their current or potential IP protection, there are a number of free and fee-for-service patent and copyright servers you can use. (You also can easily find search copyrights, trade and service marks, and masks.) My favorite free ones are the U.S. Patent and Trademark Office (www.uspto.gov/patent) and the European Patent Office (www.epo.org/searching.html). The latter includes a worldwide patent search engine. The World Intellectual Property Organization (WIPO) (https://patentscope.wipo.int/search/en/search.jsf) can also be searched for applications under the Patent Cooperation Treaty (primarily patents seeking protection in more than one country) as well as patents from member countries of WIPO.

When assessing the potential patent protection for a technology, what counts are the claims. Using a spreadsheet, you can create a tool for comparing claims of other patents and patent applications with the technology you are interested in acquiring or in-licensing (see Figure 3.5). In addition to the “closeness” or similarity of each claim, it is also important to look at content of the claims in terms of how broad and seminal they are and whether they constitute major technological breakthroughs or are more like variations of a theme.

Note that if only summary values are desired, begin by examining the first claims on their own. These claims are usually the most significant, and combining the spread from the baseline here with the spread from other claims would distort the results. As the other claims clarify and extend the first claim, next weigh and average them on their own. Place greater weight on those claims related to higher-priority needs (metrics) in the eyes of your customers.

We are now in a position to determine which technologies look most interesting, all other things being equal. The most important element of “all other things” is alignment with capabilities and resources of the firms, a topic we shall address next. Where we are is presented in Figure 3.6.

The final thing to assess is firm-specific risk for the SME if it acquires the technology. Interestingly, once we have the yields customers seek on performance, ease of use, price, and UMPF, we can use those to garner insights on what we need to make and support the technology in the market. That is because the desired yields constrain the materials and parts and the production process that can be used to make the technology, and these, in turn, constrain how the technology can be transported, maintained, and repaired (see Figure 3.7).

Ideally, what you want is a strong alignment with materials, parts, and components you already use and R&D and production processes you already utilize. That makes the technology easier for you to adapt and introduce to the market.

As an example, a small firm was looking for a better way to detect cancer cells in mammography and other images. Using an open innovation approach, the firm found an image-processing technology at NASA’s Goddard Space Flight Center. That technology had been originally developed to better assess the depth of lakes from space. It was based on an invention called “Recursive Hierarchical Segmentation” (RHSEG)—a new way of combining the pixels in an image to do better recognition of features of interest. Although proven, the technology had been only used by NASA and was still too immature for commercial introduction. The small firm, Bartron Medical Imaging (www.bartron.ws/) had the absorptive capacity to recognize the value of RHSEG and to adapt it to a new use, after in-licensing it. As part of the adaption process, Bartron entered into a cooperative R&D agreement with NASA Goddard and also won a variety of government R&D awards. The product, MED-SEG, won the R&D Magazine R&D 100 Award for being one of the most significant new products of 2011.

Porter’s value chain is another way to identify potential leverage points. Figure 3.8 in the following text, from Wikipedia (http://en.wikipedia.org/wiki/Value_chain), displays these leverage points. The primary activities depict what is needed to make, deliver, sell, and support a product or service in the market. The support activities provide the back end for the primary activities. Technology includes both the acquisition of IP and maturing it for the market.

What you are seeking are technologies with strong alignment for your company, as that reduces firm-specific risk. Reducing firm-specific risk increases the value of the technology for you on the balance sheet. For example, can the same manufacturing process be used? If you can make toilet paper, you can probably make paper hand towels. If you have a strong brand name that pulls supermarket sales of toilet paper, you probably have a good shot at getting some shelf space to try selling paper towels. However, assume your only market is consumers and your only distribution channel is supermarkets; if you want to sell paper towels to institutions like airport, restaurant, school, and other commercial and industrial bathrooms, you need to become part of a different supply chain. In manufacturing, you are aligned; in distribution, you are not.

A critical metric for alignment with the company is absorptive capacity. Absorptive capacity is the ability to bring in and adapt the technology and turn it into something useful or marketable. With respect to more immature technologies, absorptive capacity requires an ability to do R&D—or at least to manage it.

Immature technologies are of interest because the best deals for SMEs are found with them. The reason is larger firms usually do not invest heavily in immature technologies unless it is through buying stock in, or collaborating with, an SME. (The second-best technologies are those with markets too small to interest a large firm. An SME may be happy with a new product that generates $1, $5, or $10 million in sales per year. Large firms are most likely seeking technologies that can generate revenues of $20 million and up.)

The House of Quality is a Quality Function Deployment tool for linking customer wishes with the capabilities and products of firms. In our adaptation, it becomes a tool for evaluating the technologies to acquire in light of customer needs and the capabilities and resources of a firm. Figure 3.9 presents this House of Quality.

Planning Forward

Negotiating to Acquire Technologies

Acquiring a technology is a market transaction. In this respect, it is not different than buying a pair of shoes or a house. Technically, what is being sold is not the physical object but all or some of the rights to control the physical object. The legal transaction defines the rights (to do research with, make, use or sell or both), geographic territory (countries), field of use (markets), and exclusivity being transferred in exchange for money and other terms and conditions addressing warrantees, guarantees, liabilities, default, payment mechanisms, auditing rights, conduct and oversight of IP enforcement, and so on.

As in any market transactions, the seller (licensee) tries to sell high, and the buyer (licensor) tries to buy low. Negotiations involve convergence on a fair price.

During the convergence process, the buyer examines the IP and either makes or is given the first offer. The other party decides the price is fair or makes a counteroffer. The offering price is seldom accepted. One reason is the capitalist dynamic of buy low and sell high. Another reason is any transaction carries the risk that what you buy may not be what you expected. The anticipated patent may not issue because it infringes a previously unpublished patent issued on an application filed earlier but not published during the SME’s due diligence.

When negotiating, consider all terms as part of the price. You can accept them and bear the costs of accepting them or reject them and thus expect a different price. For example, if you accept a limitation on liability, you always have the option to buy an insurance policy to protect yourself against the potential liability (e.g., the house burning down, the shoes being stolen, the IP being infringed). But the cost of that policy should impact the price paid.

That said, unlike banks that insure against bad loans, SMEs cannot expect to insure against failure to make money off the technology. It is critical that the rights being granted in the agreement allow the SME to exploit market opportunities while blocking competitors from competing against them with the same technology. As the caption to Figure 3.10 highlights, when practicing open innovation, SMEs should be seeking a monopoly position for their products.

There are a number of perspectives on how you can and cannot set a fair price. There is more consensus on what you should not do. As a buyer of technology, you should not consider a price based on what it cost to develop the technology to its current state. What was invested to develop it is irrelevant. Besides, many institutions will give you a number based on what was spent and forget to tell you which government agencies, foundations, and others may have subsidized the R&D to date. Indeed, with the overhead included on grants or sponsored research, the institution may have no net investment. But more important than any of this is why you are negotiating. You are interested in this technology because you want to make money. So the first consideration is how much money can you make and what will it cost you to make it.

You can make money in two ways. A new technology can cut your costs. Usually this is the criterion for process (production) technologies. The other way you make money is you get new or better products and services and sell those, hopefully making more profit than you did selling what you had in the past (see Figure 3.11).

On the other side of the income statement are expenses, and on the balance sheet, we have liabilities. These are associated with what the technology will require to bring it to market, given its current level of maturity. Figure 3.12 presents an overview of some of the things that are needed to bring a technology to market. Among the activities are completing applied R&D (Research in Figure 3.12), obtaining any additional funding needed (Financing), designing the product or service (Design), implementing the design through engineering development and documentation (Impl and Eng), testing and evaluating (Test Mgt or Management), setting up manufacturing and controls (Manufacturing Management or Mgt and Controls or Ctrl), obtaining equipment and other processes such as quality assurance (Processes or Prc and Equipment or Equip), arranging for and conducting logistics and disposition of waste or recycling (Logistics or Log and Disposal or Disp), conducting distribution and customer service plus sales (Distribution or Dist and Service or Srvc), and of course, managing the whole process (Management, as shown in the following figure).

The mainstream view of what you should pay for a technology (or more accurately, certain rights to it) is that the price should be no more than to its contribution to the profit you can make. Otherwise you would lose money by acquiring it. Suppose the total profit from a product or service is $X. Suppose the product is a cell phone. We can go further and say the screen contributes around 10 percent of the profit, the keyboard another 10 percent, the central processing unit (CPU) is maybe 20 percent, the battery 10 percent, the memory 5 percent, the antenna 5 percent, the case 1 percent, the size factor 20 percent, and the apps the rest.

The percentages you use are never “correct”; they are your best guesses. Each person views the contribution to value or profit contribution of the various components differently. When we say this technology contributes Y% to the value or profit of the final product or service, what we are more accurately saying is this: In our market’s population, there is a statistical tendency to view the contribution to value as Y%. In another population or at another time, that tendency might be different. (See Figure 3.9, which illustrates that the value of less weight shifts depending on the use of a computer.)

We use a different approach. What you are really buying is, of course, an intangible asset. Assets are supposed to be things you use to make money. At first glance, it seems the ceiling price (i.e., the most you should pay) should be set by how much you can make off the technology, which is equal to the technology’s contribution to value or profit. But there is always a make or buy decision in product development. An SME with good absorptive capacity might do internal development of new technology with its own staff. It might also be able to buy other technology from another vendor. So what the technology is actually worth to the SME is the difference in the profit from adopting this technology versus the next best approach. (The next best approach may be zero, in which case the contribution to value method is used.)

We measure this difference by subtracting the net present value (NPV) to the company of acquiring or internally developing the second-best technology from the NPV of this technology. One part of that is the different revenues and expenses of the two technologies. The other part is time to market. This difference we call the “Present Value of the Growth Opportunity.” That is what the SME is really paying for.

Figure 3.13 illustrates this concept. At the time of negotiations, the SME is formally or informally calculating the benefit of doing the deal. As the figure highlights, that benefit is either from anticipated greater NPV or it is from getting out to market (to revenues) quicker. In Figure 3.12 it is both.

Ultimately, all that counts is what someone will pay and someone will accept. Prior to a deal, all value is speculative. It is fixed by the deal itself.

What is going on is called, in game theory, a “P-Beauty Contest” (where P-Beauty means Probability of Beauty). In a P-Beauty Contest, the judges are voting on who or what is the most beautiful. It can be a person or a “fair price.” However, unlike a traditional beauty contest, in a P-Beauty Contest, the judges are not voting on who or what they see as most beautiful. They are voting on who or what they think everyone else will find the most beautiful. Hence the name, as the P stands for probability. The judges are voting on the probability that all the other judges will agree this specific entrant is more beautiful than the others (see http://en.wikipedia.org/wiki/Keynesian_beauty_contest).

P-Beauty Contests are usually played over several rounds in which aggregated data depicting how everyone voted is disclosed. Over time, there is a convergence on one entrant. Interesting, when the same game is played several times, the convergence takes place quicker as people jump steps to arrive at the convergence point.

Note that repeat players in P-Beauty Contests start out with an advantage over novices if there is a statistical tendency for the games to converge in similar ways. Where that is the case, it makes sense for novices to study what has happened in similar contests in the past.

In the context of IP markets, where IP is like a commodity, the participants in a deal can look at comparable deals to see where others have converged. These prices provide a starting point for guessing what will be seen as fair in this deal. What makes other transactions comparable is that they involve similar technologies, with similar maturity and IP protection, being acquired for use in the same markets or applications. Usually it is hard to find enough comparables to use valid descriptive statistical methods, so the parties improvise by looking at ranges for all technology being acquired to use in that market or analogous technologies going into the same market.

They can also look and see what have been commonly agreed-upon terms. As we noted earlier, the way terms are defined affects the price. For example, an exclusive licensee usually has the obligation to monitor for infringement in a license. In general, the party that can best avoid or mitigate risk should be responsible for doing just that: avoiding or mitigating risk. So the licensee, who is actually making products and providing services, should bear the burden of product liability. To bear the burden means you indemnify the licensor against being sued for product liability and bear the responsibility (and the associated costs) of preventing harm due to products or services dependent upon the technology. This allocation of responsibilities and burdens makes sense because if the most qualified party handles each risk, the likelihood of the drive to market bogging down is reduced.

There is a significant transaction cost when doing a deal, so you want to keep negotiations short and on track. The idea is to use methods that encourage rapid convergence on a price. We recommend offering prices somewhere in the interquartile range as a starting point for negotiations. Unfortunately, we seldom have enough data even for that. Our fallback is to use expert panels. We survey people who have done deals in the space we are interested in. We ask them what they see as fair for a “sanitized” nonproprietary description of the technology. After listening to them, we take our best guess.

We know that a variety of other factors will affect price. In IP transactions, price has two components: fees and royalty rates. Fees are fixed payments. Royalties are paid on sales.

Typically, licensees want an up-front fee. This serves two functions. For sellers, it makes them comfortable that you actually will try to commercialize the technology. Second, it provides cash to offset out-of-pocket expenses like patenting expenses. Patenting expenses here include patent attorney fees and filing and maintenance fees. Third, if the know-how or trade secret is being transferred, and that is not considered in the royalty rate, it is paid up-front.

Unless the deal is a one-time payment, expect running royalties. These are calculated in three ways: net sales (sales − discounts + returns); gross profits (net sales − cost of goods sold); or fixed price (x dollars or x percent of price on each unit sold). If the reader has studied economics or business, he or she will recognize these should all equal the same amount—all other things being equal. But then, all other things seldom are equal and you want the one that will likely cost you the least, given how you plan to make money off the technology. Net sales is generally good for products and services that are not bulk commodities. Fixed price is generally good for bulk commodities. Gross profit is generally good for process technologies.

An NPV analysis could look at various ways of structuring a deal that all have the same NPV but different timing and amounts for fees and royalties. For example, the running royalty rate would be higher if up-front fees are lower. From the perspective of the SME, running royalties are where you want to pay for the technology, because you only pay them when you are making money. The licensor wants them up-front to lower the risk. One compromise is to move some up-front fees into milestone payments. For example, if product development and regulatory approval are completed in two years (or whatever time the parties think is reasonable), a fee of X is owed. However, if they are not, a fee of X + Y is owed every year until they are completed. Caution: It only makes sense to accept terms like this one if you are confident you can do what you have said you can do.

Universities, research hospitals, nonprofit and government labs, and so on will expect to recapture patenting expenses as a minimum up-front fee for an exclusive agreement. That is pretty much the norm globally. The theory behind it is the buyer is the exclusive beneficiary of the patent protection and so the buyer should pay. The counter argument is the licensor is receiving payments. That means the licensor is a beneficiary too. So at a minimum, the patenting fees should be split in accordance with some fair and reasonable principle. For example, if the payments (up-front fees and royalties) due to the licensor for its contribution to the value or profit of the product are equal to X, then the licensor should at least cover that percentage of the patenting expenses.

As noted earlier, running royalty rates are based on comparables. The best place to find them is in government databases, such as the U.S. and Canadian security and exchange commissions. In their corporate filings, companies are required to report seminal events. Often, obtaining a license is a seminal event, so the deals are reported. Sometimes the data on financial terms are redacted, or redacted for some period of years. As noted, expert panels are also a good way to come up with a “comparables” benchmark.

However the “industry average fair market value” royalty rate is determined, once you have it, it still needs to be adjusted for specifics of the technology and IP rights that are being sold here. A variety of actors come into play here. You can model them by building a simple royalty rate calculator on a spreadsheet (see Figure 3.14).

In Figure 3.14, the factors are the ones that often are raised in royalty rate negotiations. The factors in the table are illustrative, not exhaustive. The rate is the adjustment from the industry average royalty rate for this kind of technology. It moves the royalty rate up and down. The weight can be used if some factors are much more important for the fields of use (markets) that will be granted in the license.

When we negotiate, we make a royalty rate calculator and do at least two runs. The first one is what we think is a fair price. Hopefully that is at or below what our customer is willing to pay. The second one is the initial offer or counteroffer. It is, when we represented the buyer, lower. With each factor, we include a few sentences explaining why the rate adjustment has been pegged where it is. Our experience is that the other parties respond by explaining where they disagree and why. This kind of dialogue makes negotiations smoother and quicker as you can agree their position is reasonable or point to data and logic that explains why you think they are misunderstanding the impact of the factor. In other words, we are continuing to use the model of a P-Beauty Contest and arguing over where the market would see a fair price.

Negotiations usually involve other factors that are not part of the general fair market value P-Beauty Contest. These factors are specific to the parties negotiating. With universities and equivalent research institutions, perhaps the most important one is mission. The TTO negotiators are usually juggling a balanced scorecard of several success metrics. Meeting the mission of stimulating the economy and helping SMEs may be more important than making money. If that is the case, the licensor is likely to be less aggressive on price than a corporate lab whose balanced scorecard places a lot more emphasis on making money.

There is an old adage, “First walk in the other person’s shoes.” Here that means if you can understand what constitutes success for the other party, you usually know pretty quickly if you can structure a win-win scenario. If you can, you share it and negotiate in good faith. If not, walk away and do not waste your time negotiating.

Obtaining “Free” Money

To spin up (i.e., mature into a product or service) a technology takes money. The best kind of money for that is other peoples’ money. The best other peoples’ money comes from government agencies and foundations, as it is usually “free money.”

Free money is not really free. You have to write proposals, submit reports, and you may be audited to make sure you did the work you proposed. It is called “free” money because there is no equity cost. At worst, you get to lay part of your R&D costs off on the government (most likely), a foundation, or another company (least likely). At the very best, you get your R&D paid for and make a profit on it. It is a straight funding (the award) for services provided (the R&D proposed) transaction. Even better, in the United States and many other countries, the SME usually is able to retain all commercial rights in the R&D results and any data collected or created.

Free money provides revenues, goodwill, and new IP. Payments under grants and contracts are revenue. As noted earlier, the fact that you can list yourself as an award winner in a competitive program means your firm must have some technical capabilities as well as enough marketing skills to write a successful proposal. Knowledge and insights gained during the R&D, which can be exploited for commercial purposes, are trade secrets. There may also be copyrights and patents. These look good on your books.

As Professor Ron Adner of Dartmouth College’s Tuck School of Business points out in his seminal book The Wide Lens: What Successful Innovators See That Others Miss, for an innovation to make it to market, there must be wins, or at least no negative impact, for all the stakeholders in the relevant “innovation ecosystem.” In Figure 3.15 are some typical stakeholders in an innovation ecosystem. Companies in the supply chain servicing the ultimate customers (end users) are obvious, as are regulators and funding agencies. Often overlooked are opinion leaders (experts, trade publications and other traditional and social media gurus, key people in advocacy groups, etc.), industry and professional association and society officers and committee chairs or members, and key people in relevant nongovernmental organizations (e.g., the World Bank, the World Health Organization, etc.).

As you develop your R&D proposal concept for maturing the technology, you should float the concept with stakeholders to improve your chances of winning. A stakeholder table, like the one in Figure 3.15, can be made using a word processing or spreadsheet program. It allows you to quantitatively rank the support you likely will receive on a scale of more or less. The best way to determine what kind of support you will have is to call people in each stakeholder group. If the proposal concept is not receiving good support, it is better to change it before you start formally writing it.

When calling people, I use a method called “fishing.” I float a general concept with the first caller. He or she bounces off of it and suggests changes. I modify my concept and float the new one with the next person. (In effect, I am using the concept as bait for the discussion. If I do not give something concrete for people to bounce off of, there often is an awkwardness as they are not clear about what I am doing and thus how to respond.) I find after about three to five calls, I start seeing convergence, meaning no one has anything new to offer. At that point, I move on to the next stakeholder group.

Methodologically, what I am doing is a takeoff on a Delphi Panel. In the Delphi method, a panel of experts receives a set of questions and sends answers to a facilitator. The facilitator summarizes them anonymously and sends them back out, together with the reasons for each answer. The experts read the response and are encouraged to revise their earlier answers in light of the replies of other panelists. Over time, there is usually a convergence. Alternatively, at some point, the facilitator cuts it off and develops what he or she feels is an acceptable set of answers. In effect, the Delphi method combines a P-Beauty Contest approach with expert interviews.

If time is limited, there are three critical stakeholders to consult: program managers at the funding agency, commercialization partners (licenses, strategic alliance partners, etc.), and the ultimate end users (the customers).

Ideally, you want to float your R&D proposal concept with the funding agencies to make sure there is interest. In the United States, it is possible to talk to program managers before a solicitation opens, not after. If they like your concept, program officers may even ask for a white paper or draft solicitation topic language. Once the solicitation is issued, no contact is permitted except through the designated contract officer in order to avoid even the appearance of impropriety.

Be aware that whatever you discuss or propose is not likely to show up verbatim in the solicitation or request for proposals. Many years ago, I was working with a small business. They had an idea for a better air circulation model relevant for weather prediction. I found the relevant program manager and the conversation went so well, he asked for a few paragraphs on their approach draft solicitation language. This was provided. A month later, when the request for proposals issued, the researcher at the small firm called me to complain his topic was not there. I got the solicitation, found the topic, and pointed it out to him. He said, “That’s not my language.” I responded, “Of course not. He is not going to break confidentiality and put your approach out for everyone to read. What he has done is put out a call for better air circulation models.” My client wrote a proposal and won.

The views and needs of licensees and other commercialization partners (which we shall call targets) and end users can be addressed through concurrent engineering. In concurrent engineering, the end users and commercialization partners are invited to engage in discussions about new products or services from the beginning of R&D focused toward product development, rather than later in the process after the product definition is locked in. Also included are internal or contractor representatives for manufacturing, marketing and sales, and postsale customer support and maintenance. As Figure 3.16 from Wikipedia (http://en.wikipedia.org/wiki/Concurrent_engineering) highlights, concurrent engineering is a cyclical iterative process rather than a linear sequential one.

For SMEs, I recommend planning for at least two rounds (see Figure 3.17). These rounds are best conducted with everyone in one room, but web conferencing also is viable. The first round takes place early in open innovation, shortly after the acquisition of a new technology. This round focuses on getting formal advice from key people who will be involved in the downstream commercialization either as targets in the supply chain to the ultimate customers and from those customers (the end users) themselves. The goal here is to generate enough support that you can follow up afterward with the outside participants and garner letters of support for your proposal. Even better is to garner in-kind or cash match for the government or foundation money you are seeking. Among relevant in-kind support is the supply of free materials and components from targets who want to be your future vendors and commitments to participate in alpha or beta testing by customers. For potential licensees or other downstream targets, advice on transitioning into production and provision of independent test and evaluation is desirable. A match is a good sign that this technology will head to market if the funding agency puts money into the R&D. The best support is, of course, cash. It is fine if the cash is for an option to acquire all or some of the rights in the technology as it emerges from the government- or foundation-funded work.

The second round takes place near the end of product engineering as you prepare to transition to production engineering and production. This is the last time it is feasible to work design modifications without significant costs. The goal here is to line up and close deals—either sales or licenses.

Of course, a critical aspect of pulling off concurrent engineering is finding the right partners. Figure 3.18 highlights what to look for in commercialization partners. The ideal partners have strong market presence and sales capability but are weaker in technology development and, if you want to produce goods as well, in manufacturing.

Planning for Transitioning

Transitioning involves moving a technology out of R&D and into production. Transitioning is a process of risk reduction and roadblock removal. First, you map out a plan for reaching the market, and then you identify all the potential risks and obstacles and remove them.

The way to think about transitioning is to map out your current technology readiness level (TRL) and then determine what needs to be done in what order to reach the highest TRL (typically 9). Because TRLs were originally developed by U.S. government mission agencies, they need to be adapted a bit for commercial technology. Figure 3.19, from the U.S. space agency NASA, provides a hardware-based example. NASA’s approach is described at www.nasa.gov/topics/aeronautics/features/trl_demystified.html

The University of Southern California’s Marshall School of Business provides a set of TRLs for a variety of different technological areas at www.usc.edu/org/techalliance/pdf/CTC_TRI_Definitions-2007.pdf. You can also find discussions of TRLs for most categories of technology via web searching. A discussion on how to build your own TRL calculator is at www.dtic.mil/ndia/2003systems/nolte2.pdf

Moving from one TRL to the next is a process of risk reduction. Risk has two components in transitioning. The first is delay. This slows down the time to market, thereby reducing the present value of the growth opportunity that open innovation is supposed to provide. The other is cost. Due to poor planning or unforeseen events, the transition costs more than anticipated, thereby reducing the NPV of the acquired technology. These two components are depicted in Figure 3.20. The more the potential for additional cost or delay is controlled, the lower the risk.

Building a tool like the one presented in Figure 3.21 helps focus on what risks exist and how you plan to mitigate them. Figure 3.21 is an example of a Foresight Science & Technology Transitioning Plan. It is based on extending the U.S. Defense Science Board’s Willoughby Templates for transitioning from R&D to production. This example focused on transitioning a quadcopter hardware or software system for wildland fire fighting to the market. The outcome of this process is to highlight areas to emphasize in R&D proposals or in internally funded work when spinning up a technology.

A resource for developing risk reduction plans is the University of Maryland at College Park’s Best Manufacturing Practices Center (www.bmpcoe.org/). The Center has a tool called TRIMS, the “Technical Risk Identification and Mitigation System,” which can be used to build risk reduction models. TRIMS was used to help develop the model behind Figure 3.19. Supporting TRIMS is the Center’s extensive database of risk mitigation reports and know-how. Unfortunately, TRIMS is only available to U.S. companies or “by any person or organization in support of the U.S. government, Department of Defense, or U.S. Industrial or Academic interests.” TRIMS is part of a software and electronic data suite of tools called the Program Managers Workstation (PMWS).

Another factor to recognize is that TRIMS and PMWS only address the transition from R&D to production, so Foresight Science & Technology had to add all the risk reduction tasking associated with entering the market and building market share. A set of useful resources for learning about product development is published by the Product Development and Management Association. See www.pdma.org/p/cm/ld/fid=109

Planning for Exit

Exit is where you make money. Usually exit occurs in one of two ways:

1. 1. You sell or license the technology.
2. 2. You sell products or services based on it or incorporating it.

Doing deals is complicated and my advice is to hire a consultant to help you if you have never done a deal before. To ensure alignment of interests, consultants should have only a small up-front fee and a significant commission on success. The up-front fee is usually required to show you are serious about doing a deal. If the SME has nothing committed, there is nothing to prevent the SME from walking away from a good deal. In general, it is a wise policy to define the minimally acceptable deal up-front when you hire a consultant to help with deal-making. That keeps everyone from wasting each other’s time.

The basic process for deal-making is the same for any approach. You find targets, you pitch them, listen to their responses, and, after figuring out what you want, you try to respond in ways that lead to negotiations (see Figure 3.22).

Once the door opens for negotiations, there usually is a period of tire kicking as they make sure the technology performs as described. Once that is completed, if the target is still interested, financial terms are negotiated. If it seems like a deal is feasible, other terms are negotiated. As indicated earlier in this chapter, all terms have financial consequences and impacts, so the payments and their timing may shift somewhat as the negotiations proceed.

My recommendation for figuring out what you want in financial and other terms is to use a variant of the decision calculus described by the famous American Benjamin Franklin in his autobiography. On a spreadsheet or piece of paper, make three columns with the following headings: Must Haves, No Ways, and Nice to Haves. The must haves and the no ways provide the basis for your term sheet. As in our earlier discussion, the term sheet has to allow for convergence. As the seller, you want to sell high. Nonetheless, it is important to submit something in the “fair and reasonable” range. An outlandish offer will be rejected and cut off the possibility of negotiations.

The negotiation process is one of seeking your must haves and avoiding no ways. You use your nice to haves as trading chips. You trade them away to avoid no ways or obtain must haves. When you have the must haves and do not have any no ways, sign.

The good news is, if you have done concurrent engineering, you likely have already identified your licensee or lead customer and built relationships with the customer. That ongoing relationship should have created trust. Trust allows approaching negotiations from the perspective that you are both on the same team, trying to get this deal past whoever must sign off for both parties.

When negotiating, remember what Ben Franklin said in the Poor Richard’s Almanack: “Pride is as loud a beggar as need and a good deal more saucy.” In our context, what that means is the parties to a deal always have three choices—do it, wait or stall or both, or walk away. Your job is to understand what they need to sign a deal and to help them either get it or find a way to do the deal without it. That means you cannot take a no as no unless the other party says, “Go away and do not darken my door again.” No is simply an opening for a conversation. You want to come away from this conversation understanding the following:

• • Do you correctly understand why the technology is attractive?
• • What is the decision process and who else is involved in what roles or functions?
• • How long does the decision process take?
• • What criteria will be important and why?
• • What information will they want?
• • What kind of deals have they signed in the past and what do they prefer?
• • Who is (are) the decision maker(s)?
• • What other insights do they have that can make the negotiations smoother and quicker?

Usually the problems go back to something Franklin’s Poor Richard also said: “It is hard for an empty bag to stand upright.” What that means is everyone has to make money and be better off after the deal than before. Otherwise, why do it?

When deals make good business sense, they are self-enforcing. Good business sense results when there are three things:

1. 1. Net positive cash flow for all parties
2. 2. A fair allocation of cash flow (the revenues from sales or gross profit to each party are proportional to value contributed)
3. 3. Both carrots and sticks for both parties in the clauses of the agreement

Net positive cash flow has to take into account that cash today is worth more than cash tomorrow due to discounting. Therefore, the total anticipated revenues to the seller should lower where there are one-time up-front cash payments than where running royalties are used. That is because of the risk that the downstream payments may never materialize.

Because deals involve managing risk, another principle is that the more risk a party bears, the more upside cash flow potential it deserves. The objective in negotiations is to allocate risk to the party able to control it or bear it. Finally, if the seller is deferring revenue, milestone payments and penalties for missing milestones are used to make the deal “fair” for the seller.

Closing Thoughts

Using technology transfer as an SME, the open innovation method can be summarized using three quotes:

• • “Nothing happens without a sale,” David Speser, chairman, Foresight Science & Technology Inc. (and my father).

The whole reason for engaging in this process is to sell things profitably. So at each step, ask yourself, “Is doing this making it easier or harder to sell something profitably?” If the answer is harder, do not do it. This principle applies to discrete tasks in open innovation and to engaging in technology transfer in the first place. Technology transfer involves a lot of work. It has real and significant transactions costs.

• • “If opportunity doesn’t knock, build a door,” Milton Berle, vaudeville comedian.

Finding technologies, spinning them up, and flipping them is at the heart of open innovation. In technology transfer, the technologies come from research institutions and they are sold directly to the end users or flipped to companies in a supply chain selling to those end users. Technology transfer is still a relatively young field. It did not exist until after World War II. So the pathways for doing it are still evolving and being worked out. Complicating things is the fact that there is competition for whatever good an SME hopes to introduce to the market or license at the end of its open innovation process. The owners of competing technology would prefer that the SME not succeed. It is up to the SME to make it happen despite their objections and hindrance. To do that, the SME has to build a door into a relevant supply chain, just as it has to build a door into the institutions with the technology. If it wants a subsidy for spinning up the technology, it also has to build a door to the funding agencies. Building doors involves market research. But more importantly, it involves picking up the phone and talking to people or going to visit them. It is people who shake hands and sign contracts and licenses. If you do not get to know them, it is hard to get a deal.

• • “A well-defined imagination is the source of great deeds,” Chinese fortune cookie.

I have presented an approach for doing technology transfer. While the tasks that need to be accomplished can be relatively well defined, the order in which they are done and the ones that are necessary are not set in stone. Flexibility is important.