Cost based IP valuation is one of the easiest method from implementation point of view as the data needed for doing the valuation are easily available. In our earlier post we have discussed how we do Income based IP Valuation. In cost based IP valuation the value of the IP is equal to the cost one needs to incur to develop the IP. The cost has two parts namely direct cost and indirect cost.
Now let’s see how we can calculate few of the above costs
Cost of people fully involved in IP development = (salary of the employees + overhead cost per employee) x number of employees involved in IP development
Cost of dedicated tools = Tools license cost x license months used to develop the IP + cost of team required to install and maintain those tools
Cost of shared infrastructure = Cost of tools or infrastructure x duration of the tools needed for IP development
Once the total cost of the IP development is calculated that needs to be multiplied by opportunity cost due to delayed and denied market entry for the IP. The effect of delayed market entry can be calculated as a ratio between market share achievable today to the market share achievable once the IP has been developed in-house. Denied market entry will come from the probability of coming a new standard or new technology which will make the IP redundant
The valuation method is quite useful at the early stage of technology development when other methods are not useful due to lack of data on market potential of the technology, average license price customers would like to pay etc.
Also the method is suitable for valuing IP used for internal consumption as also in that situation the other methods (like income based valuation/ option based valuation) is not applicable
Another key methods used by companies is relief from royalty method. In the relief from royalty method the firms try to estimate the amount which they need to pay to the market if he does not hold the IP. The amount payable in the market can be in the form of license fee as well as royalty.
The value of the IP = discounted present value of the forecasted license fee and royalty fee to be paid
License fee to be paid = license fee for each component of the IP x number of such components to be licensed
Royalty fee to be paid = royalty rate x sales volume in a particular year
For example let us assume that the firm has to pay an amount of ‘x’ as license fee today to acquire license right of an IP. It will take 2 years to make the product and launch the product in the market using the IP. The product has lifetime of 3 years and the expected sales volume are V1, V2, V3. The royalty rate is ‘y’ per product and needs to be paid at the end of the year. The opportunity cost of capital is ‘r’
Then using the relief for royalty method the IP value will be equal to
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