The cost method is one of the commonly used methods for IP valuation. This approach estimates the value of an IP asset by determining the costs incurred in developing it to its current status. This approach assumes that the value of the IP is equal to the sum of the costs invested in its creation to date.
To apply the cost method in the biotechnology and pharmaceutical sectors, innovation professionals typically consider the direct and indirect costs associated with IP development. Direct costs include expenses related to research and development activities such as laboratory supplies, equipment, personnel salaries, clinical trials, and IP and regulatory filings. Indirect costs include overhead expenses, administrative costs and other expenses incurred to support the development process.
By carefully documenting and tracking these costs throughout the development stages of the IP, innovation professionals can establish a comprehensive record of the financial investment made in the IP asset. This information forms the basis for the cost method valuation.
However, it is important to note that the cost method alone may have limitations when valuing IP in the biotechnology and pharmaceutical sectors. It does not directly consider the potential market demand, future cash flows or the commercial potential of the IP asset. Therefore, it may not capture the full value of the IP, especially in cases where the costs incurred do not align with the future earning potential of the technology.
That said, the cost method can be appropriate under certain circumstances, particularly when evaluating IP assets at later stages of development or when assessing the value of tangible assets associated with the IP. Valuable insights can be gained via the cost method, under certain circumstances, such as:
Early-stage IP – In the initial stages of a biotechnology project, where substantial investments have been made in research, development and initial testing, the cost method can be useful. It helps capture the resources and expenses incurred to date, providing a baseline for assessing the IP’s value. This approach acknowledges the time, effort and financial commitments required to reach the current stage of development.
Tangible assets – It is particularly relevant when valuing IP assets that involve tangible components, such as laboratory equipment, manufacturing facilities or proprietary technologies. By considering the replacement or reproduction costs of these assets, the cost method can help determine their value within the broader IP valuation framework.
Internal decision-making – The cost method is valuable for internal decision-making purposes, such as budgeting, resource allocation and project prioritization. It allows biotechnology companies to assess the financial implications of their investments in research and development and make informed choices about resource allocation based on the costs incurred.
In the field of biotechnology, it is important to recognize that spending money on research and development does not automatically guarantee the creation of valuable products. Even if a firm has made investments in research and development, the development of useful products may not have been fully realized, resulting in sunk costs. For instance, in the pharmaceutical industry, products that fail in clinical development have a minimal value despite the significant resources invested in advancing new chemical entities into clinical trials.
When using the cost method in IP valuation, it assumes that the development process has been effectively managed and efficient. To illustrate this, consider a scenario where three competing firms have developed a novel drug delivery technology and associated manufacturing processes for specialized dose forms. Each firm has spent varying amounts: USD 10 million, USD 40 million and USD 60 million, respectively. The value of the technology to a potential acquirer using the cost method can vary widely within this range. However, it is reasonable to consider a value towards the lower end of the range as a reflection of efficient development.
The cost method may be more applicable in cases where there is an outright acquisition of all rights to a compound asset or technology. However, when seeking a geographically restricted exclusive license or dealing with non-exclusive rights, it can be challenging to apportion costs effectively between different territories, leading to complexities in valuation. In negotiation practice, the cost method may sometimes serve as a psychological floor on the price, particularly when divesting all rights to a technology or product.
In general, it is more helpful to focus on the benefits that access to the technology can provide to the acquirer rather than solely considering the costs incurred by the developer. The income approach allows for the evaluation of these factors and provides a more comprehensive perspective in IP valuation.
The cost method should not be the sole method employed for IP valuation in the biotechnology sector. Given the high attrition rates and uncertainties associated with biotechnology projects, additional approaches, such as the market approach, income approach and real options method, should be considered to provide a more comprehensive and accurate assessment of IP value. The cost method can be used in conjunction with these methods to provide a holistic view of the IP’s worth, considering factors beyond the costs incurred, such as market potential, competitive landscape and technological advancements.