Chapter 5
Problem 5: IP Valuation, Risk and the Negotiation Process
1. Contair is considering competing offers for its VRS
voice recognition software from two companies—GNN, Inc., the world's largest
automobile manufacturer, and Assist, Inc., a start-up company created to
exploit new technologies that can help disabled persons to drive. GNN,
which demands an exclusive, worldwide license, has offered a running royalty
of 5% on net sales of the VRS option on each vehicle so equipped. Assist
also prefers an exclusive license and has offered a 25% interest in Assist
as a lump sum, up front royalty, which you have rejected. In the alternative,
Assist has proposed that Contair and Assist form a joint venture, each contributing
its intellectual property to the venture and sharing any profits equally.
The table below illustrates a hypothetical comparative analysis of
the GNN and Assist offers based upon the following strategic information
you were able to obtain for the negotiation:
The U.S. auto market is about 15 million new vehicles per year; the foreign
(non-U.S.) market is another 20 million. GNN's market share in the U.S.
is 33%; in the foreign market it is 40%.
GNN estimates the initial cost of designing and manufacturing the VRS
option package at approximately $3,500 per car, and the initial retail
price as $5,000. Thus, 5% royalties proposed by GNN would net Contair
$250 for every car sold with VRS installed.
The Assist proposals present special problems. Although its IPO
was a great success and it has considerable capital, Assist is not an
automobile manufacturer, so the Contair/Assist joint venture would need
to sell VRS to the major automobile manufacturers, each of whom would
rather develop its own competing product.
Table of Projected Income, Expenses, and Profit
|
Factor
|
Assist Joint Venture
|
GNN Exclusive License
|
Proposed compensation |
50% equity, no established market value |
5% on net sales of VRS |
| Profit on worldwide sales |
Using GNN's sales figures and assuming 1% market penetration, $195
million in gross profit (assuming same gross margin as GNN's) |
$32.5 million in royalties |
| Costs |
Short-term costs to Joint Venture of R&D, product development,
marketing, regulatory approval, and capital equipment:
$55 million per year
|
$1 million per year |
| Initial annual profit |
$70 million (50% of JV) |
>
$31.5 million |
To better assess each offer, you commissioned the following
risk analysis from an outside consultant:
Table of Risk Factors and Adjustments
|
Factor
|
Assist Joint Venture
|
GNN Exclusive License
|
| Total estimated profits, next 10 years |
$7 billion |
$1 billion |
U.S. patent issues |
85% |
85% |
| Risk-adjusted value |
$5.95 billion |
$850 million |
| Technology is commercialized at affordable retail cost |
60% |
85% |
| Risk-adjusted value |
$3.57 billion |
$722 million |
| U.S. Dept. of Transportation regulatory approval |
50% |
50% |
| Risk-adjusted value |
$1.78 billion |
$361 million |
| Public acceptance |
50% |
65% |
| Risk-adjusted value |
$890 million |
$235 million |
| Public preference |
65% |
85% |
| Risk-adjusted value |
$578 million |
$199 million |
In addition to the above risk factors, how might the following
developments affect royalty projections?
* Any deal will require a significant contribution of time and effort
from Kuruma, the inventor.
* The joint venture will require financial, managerial, and marketing
support from Contair estimated at $50 million per year, in addition to
the $55 million of expenses estimated above. Furthermore, Contair
would have to contribute one of its best high-level executives to become
the joint venture's CEO.
* You have heard a rumor that the U.S. Defense Department would
like VRS for military use and is considering a compulsory license of VRS
to one or more major defense contractors, one of whom is GNN.
* Contair's CEO wants GNN to pay an additional royalty on the increase
in GNN's overall market share attributable to VRS. Could such a
royalty be fairly determined?
2. If the Defense Department were to take VRS via eminent domain (See
Hughes v. United States), which of the offers, if any, would constitute
the best evidence in court of a "reasonable royalty"?
3. GNN has tendered the following royalty language in its proposed
exclusive license:
Net Sales as used herein means GNN's billings for products produced less
the sum of credits on return goods, sales, use and excise taxes, outbound
transportation prepaid or allowed, and packing charges included in the
amounts received. Products shall be considered "sold" when billed
out or invoiced.
* * *
Royalties shall be payable to Contair for every VRS product sold by GNN
as follows:
(a) 5% of the net sales of each unit;
(b) One-fourth of the royalty received by GNN for every sub-license
to other manufacturers;
(c) For derivative works of VRS prepared by GNN on new VRS-related
products, the parties shall negotiate in good faith a royalty amount
that fairly compensates Contair for its development costs and the future
income potential of the Products.
(d) For each VRS product sold other than for use in land vehicles,
1.5% of net sales.
Based on all the information available, should Contair accept GNN's latest
offer? What changes and/or additions should Contair make in
any counterproposal it makes in an attempt to get a better deal? Isn't
it true that "but for" the VRS software, GNN has no voice-controlled vehicle
to bring to market at all? What does that tell you about the
economic value of VRS?
Draft Contair's counter-proposal to GNN taking into consideration legal,
business and economic justifications that Contair's president could advance
in negotiations to justify the counterproposal. Assume that you have
a market study that predicts GNN will increase its U.S. market share by
15% and its share of the foreign market by 10% as a result of having VRS-equipped
vehicles.
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