Software economics+ssitc13 tutorial

Software Economics:
How Do the Results of Intellectual Efforts
Enter the Global Market Place
SSTiC 2013, Tarragona, 22-26 July 2013.
Gio Wiederhold
Stanford University, Stanford CA
http://infolab.stanford.edu/people/gio.html
1/18/2014

SSTiC 2013
CS207 fall2013
SSTiC 2009

1

Syllabus, part 1
22 July 2013 , 13:00-15:00

1.
2.
3.
4.
5.
6.
7.
8.
9.

Background & Definitions
Why should software be valued?
Principles of valuation. Cost versus value.
Market value of software companies.
Intellectual capital and intellectual property (IP).
Methods based on comparisons.
Methods based on assessing life of software
Sales expectations and discounting.
Putting it all together in a simple business model.
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2

Syllabus, part 2
22 July 2013 , 19:00-21:00

1.
2.
3.
4.
5.
6.
7.
8.

Alternate business models.
Service models
Open source software
Freemium
Allocation among IP contributions
Estimating development efforts
The role of patents, copyrights, and trade secrets.
Advertising.

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3

Syllabus, part 3
25 July 2013 , 13:00-15:00

1.
2.
3.
4.
5.
6.

Licensing and Royalties
Separation of IP rights from the property itself.
Outsourcing and offshoring development. IP flow.
Effects of using taxhavens to house IP rights.
Changing taxation.
Summary

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4

Flow of
innovation
Research
&
Inno vation

Tool
building

Consumer
Product
building &
marketing

General
Technology

Push

Information
Technology

Pull

Business
needs
Government
responsibilities

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1

2

Background

Two aspects to Software Economics
1.Minimizing the cost of building effective SW
Much literature exists, taught as part of SW engineering

Factors
1. Well educated scientists  you
2. Good languages  expressive and constraining
3. Good methods  Waterfall, Spiral, Rapid prototyping,
Scrum, Extreme programming, Agile processes.

And when the work is done

2.Predicting & maximizing the benefits of the SW
the topic of this course
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Current State
1. Software producers traditionally care about
Cost of writing software
Time to complete products
Capabilities

2. When the value is a concern
Business people
Economists
Lawyers
Promoters
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life

inconsistent
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What is
the problem?
Say you create some great software and then ship it on a
CD to a company that sells software.
• Let’s assume they get the exclusive right to the SW.
1.
2.
3.

4.

•

What should the selling company pay you?
The cost of the CD and mailing it? about €10.-?
The amount it cost you to write the SW:
5 months at €10,000/month = €50,000.- ?
Half of their sales that year (~ 50% is their cost of selling) :
50% of 10,000 copies at €49.99 = €250,000.- ?
50% of their €2M lifetime sales = €1,000,000.- ?

How does what you get affect your obligations?
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Why is value a
Concern
• Making decisions about creative tradeoffs
Elegance versus functionality
Rapid generation versus maintainability
Careful specification versus flexibility

• Dealing with customers
Dijkstra model: for self-satisfaction
Engineering model: formal process driven
Startup model: see if it sticks to the wall

• Gain respect: know what you are doing
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Computer Science
vs. other professions
• Architects of buildings
Know if they are designing public housing or a castle
That helps specify the type of furnishing and fixtures: zinc / nickel

• Car Designers

Produce

~1M/year

or

~1K/year

Know if they are designing a people’s car or a Siddeley
That helps specify the level of sound insulation and parts’ life time

• Software scientists and engineers
Don’t consider if the software will be widely used,
Bugs, when encountered by many customers, are costly
May spend much time refining software that will be used rarely
Not taught, no textbook
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Value depends on use
When the value is a concern
Business people
 Income from sales or businesses improvements
 Price or license determination

Economists
 Effects on national productivity
To an economist, reality is a special case, and usually the least interesting [Kenneth Arrow]

Lawyers
 Settlement of disputes and infringements

Promoters
 Motivating investments
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Where is the scientist ?
11

What’s left to
value?
• Common software that is sold or licensed
• Software that enables Internet Services
• Software that is written inside companies to
improve their business
• Software purchased from vendors by
companies to improve their business
• Software purchased from vendors by
government to improve its operations
 Military, Social Security, IRS, Healthcare, . . .
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Economic
Loop

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Accounting
simplified
Sales = units sold x unit price

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Operating
Research

COGS

Gross
Admin.overhead

Distributor
markup

Production cost

SW company revenue

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Net
Capi Earnings
tal Tax
cost -es Profit
14

Assets

MNC

Plant

Factories in the US
and Malaysia

Property

Land in
Malaysia. Unsold
inventory

Equipment Manufacturing
tools & Office
equipment

$

Liabilities

40M

30M

100M

subtotal

tangible assets

220M

Goodwill

Left from the
$300M initial
acquisitions
after write offs

total
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book assets

Mortgages

Factories and land
in the US & offshore

35M

Rents on
leases due

US land, offices all
over the world

15M

Retirement, health
care & employment
contracts

Debts and
interest due

Loans for
acquisitions & to
start subsdidiaries

Reserve for
taxes due

Accumulated each
quarter before paid

50M

Bank, notes,
receivables due

Mainly from
acquisitions

$

Obligations to
employees

Cash &
equivalent

Capitaliz’d
R&D

MNC

subtotal

90M

Shareholders’
equity
140M
450M

=
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total

tangible liabilities
$100M in excess
tangible assets plus
$230M in
intangibles.
book liabilities

11M

50M
9M
120M

330M
450M
15

Income example

model |

high tech

actual

ForestLabs:

MNC

Distributor
markup

Production
cost

after

Business
overhead

after

Research
after

SG&A

R&D

$$

$56/unit

74%

250M

$45/unit

59%

164M

$40/unit

53%

Earnings 154M

Capital
cost after

CoGS

100%

44%

Net income

$76/unit

67%

Operating income

130%

284M

Gross income

140%

76%

after

$99/unit

100%

Corporate revenue

525M
375M

Sales revenue = units sold x unit price
after

gadgets ForestLabs
MNC pharma

Taxes

41%

$35/unit

47%

Profit 100M $33/unit
44%
27%

Value
Profit margins are the excess left after
CoGS
[Cost of Goods Sold]
and business costs
(SG&A, capital cost, tax) are deducted

Cost +
 If goods are sold based on their creation cost, there is no accounting
for the value added due to their uniqueness.
 If anyone can compete profit margins will be modest.

• Uniqueness has value because it raises profit margins
• Uniqueness in software (etc.) is not a tangible
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Quick definitions:
Intangibles
In a business there are 3 parts that have value
(Contribute to potential income)
1. Tangible goods: buildings, computers, working capital
2. The know-how of management & employees
3. Intellectual property: Software, designs, methods,
trademarks, etc.
• 2. + 3. make up the Intangible Capital of a company.

• Software is an intangible good
If it is owned then it is Intangible Property
or Intellectual Property
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similar – distinction is metric

18

Intangibles
• Product of knowledge
Cost of original >> cost of copies
1.
2.
3.
4.
5.
6.

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by

Books
authors
Software
programmers
Inventions
engineers
Trademarks
advertisers
Knowhow
managers
Customer loyalty
 Interacts with long-term quality
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Ownership
Claimed via
3. Patents
2. Copyright
1. Trade secret

More on those issues in Part 2

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Intellectual
Capital

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• Corrective maintenance

ongoing
IP sources

 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
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Minor features thatSSTiC 2013 be charged for
cannot

22

• Technical alternatives

Approaches
to assess IP
€

1. Income Prediction
Based on expected sales, life, lag

2. R&D roll-over

∫

×1.?

Based on life and effectiveness of R&D

• 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
royalties gathered, costs/earnings (price/earnings needs market cap)
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•

Fraction of
intangibles
Principle
The sum of all future income
discounted to today (NPV)
Implicitly estimated by shareholders through the market cap

•

Example: Market Cap value of a company (SAP, 2005)
 Largely intangible – like many modern enterprises
1. Market cap = share price × no. of shares
2. Bookvalue = sum of all tangible assets

€31.5B 100%
€ 6.3B
20%

Equipment, buildings, cash

€25.2B

3. Intangible value per stock market

80%

Intangible/tangible = 4 x .b

 How much of it is software at SAP ?
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Market cap :
only a hint

Issues
•
Stockholders don’t know what is really going on




•

Wisdom of the crowd ?
Are fed limited information
Indirect indicators are delayed: sales by principals

Market cap is unreliable due to high variability



•

Market bubbles mislead . . . . . Facebook lemmings
Option values are hard to judge . startups 30% of stock

In a multi-product company


Allocate income to each product line

Over time, many factors should even out
Never ignore the market capitalization if available
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To hide a bubble
Adjust market cap
of some company

$M

Reduced Market Cap
Deal with the argument:
“Market cap is due to bubble !”

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Expense Rollover
A valuation based on cost
1.
2.
3.
4.
5.

Collect the expenses ei over the total lag period p
Adjust the expenses by a discount rate d, ai= (1+d)p-i
For year i = 1 → p estimate the R&D retained ri =1- 1/p
Aggregate retained to the end date, R = Σ ri x ei x ai
From experience, publications obtain an expected expense
to income margin m; m can range from 1 to 20 ...
6. Expected value of IP V = m x R
m≈2 in the first model we used
But the estimation of m is verrrrrrrrrrry iffy
Technological advances are rarely stable
But used for a) advertising -- much untrustworthy data
b) stable maintenance component only
c) venture capitalist’s result assessments
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• Sum of future income
Sales = price x copy count
Maintenance fees if service subscription

• Minus sum of future costs
Cost of goods sold
Cost of marketing
Cost of doing business
Cost of maintenance

• Discounted to today
To account for value of money and risk
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Independent of cost

Basis for Software
value as of today

28

A better, direct
approach
• Value the software specifically by expected
income over its lifetime
• But software is not stable over time: Slithery
 Getting long-term income requires maintenance
 Maintenance enables long-term income

• Much more so than other intangibles
Books, music,

• Similar to brand intangibles
Costumer loyalty, trademarks
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Software is
slithery !
Continuously updated
1. Corrective maintenance
bugfixing reduces for good SW

2. Adaptive maintenance

Life time
100%

80%
60%

externally mandated

3. Perfective maintenance
satisfy customers' growing
expectations
[IEEE definitions]
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40%
20%

Ratios differ in various settings
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30

years
13

12
11
10
9

100%
90

8

80

7

70

6

60

5

50
40

4
3

30
20
10

2
1

Lifetime maintenance cost
depreciation / year = 1 / lifetime

Maintenance
is beneficial

0

PCs
Typical Life
3years
Maintenance 2%/year
Maintenance cost 6%
Depreciation 33/y. linear
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cars

software

intangibles

5 years
12 years
18 years
5%/year
15%/year
13.75%/year
21%
80%
most over asset life
20%/ y. linear 8%/y. linear 12% geometric
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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 Federal 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
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Makes looking into the future less risky
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Current value
Prior investment has created what you have now
“a bunch of software”

 That’s what’s to be valued
 Based on reasonable expectations
• future maintenance will be needed to earn income
• future maintenance represents future investments
More “software code”
 not promises of new innovations ← new IP

Later we look at other valuation/business models
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Technical
Parameters needed
IP is to be valued as of some specific date
1. Life of the IP in the product from that time on

design,
code,
....

The interval from completion until little of the original stuff is left

2. Diminution of the IP over the Life
A bit like a depreciation schedule, but based on content replacement,
until little IP is left. 10% is a reasonable limit.

3. Lag period*, interval from transfer to start of IP diminution
•

also called “Gestation Period

Effective Lag = the average time before an investment earns revenue

4. Relative allocation, if there are multiple contributors to income.
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Crucial assumption
for a quantitative valuation

• IP content is proportional to SW size
 Not the value, that depends on the income
=======================================

 Pro: Programmers’ efforts create code
 An efficient organization will spend money wisely

 Counter: not all code contributes equally
 early code defines the product, is most valuable
 new versions are purchased because of new features

• Arguments balance out
 it is the best metric we can obtain
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Maintenance
→ SW Growth

Rules: Sn+1 = 2 to 1.5 × Sn per year [HennesseyP:90]

Vn+1 ≤ 1.30% × Vn [Bernstein:03]
Vn+1 = Vn + V1 [Roux:97] ([BeladyL72], [Tamai:92,02] [Blum:98] indications)
Deletion of prior code = 5% per year [W:04]

at 1.5 year / version

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•
•

Linear growth has been observed, is reasonable
Software cannot grow exponentially
Because
1.

Cost of maintaining software grows exponentially with size


2.
3.

The number of interactions among code segments grow faster [Brooks:95]

Can't afford to hire staff at exponential *2
Cannot have large fraction of changes in a version


4.
5.

no Moore's
Law

And get it to be reliable

Cannot impose version changes on users < 1 / year
Deleting code is risky and of little benefit


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except in game / embedded code
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37

Price
remember IP = f(income)

•

But --- Price stays ≈ fixed over time
like hardware Moore's Law
Because
1.
2.
3.
4.

•

Customers expect to pay same for same functionality
Keep new competitors out
Enterprise contracts are set at 15% of base price
Shrink-wrapped versions can be skipped

Effect

The income per unit of code reduces by 1 /
size →

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Growth
diminishes IP
For constant unit price


at 1.5 year / version

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Total income
Total income = price × volume (year of life)
• Hence must estimate volume, lifetime
Best predictors are Previous comparables
 Erlang curve fitting (m=6 to 20, 12 is typical)

and apply common sense limit = Penetration
 estimate total possible sales F × #customers
 above F= 50% monopolistic aberration
P
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Lag measures
Prior effort
“Gestation period”

E

Staff Growth: Linear
Effort total = ½ E x T
A simple metric: lag vs completion=
Centroid of prior expenditure
here @ 33% (without discounting)

100
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87.5

75.0

62.5

Overall
@0.33→

50.0
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37.5

25.0

12.5
T left

0.0
41

Timing of expense
and income
Manufacturing &
distribution delay

←→

Costs →

Release to Production

development lag
Centroid of total
development cost ..

Distribution
to Sales

←─→

Centroid of
revenue

Testing
~60%→

←

Research,
Design, Implementation

Sales lag .
−−−−−−−−−−−−−

→

Development done → ←→ marketing lag
Marketing
← Costs

Centroid of presales marketing costs
part of investment: IGE
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Sales

Revenues →

capitalization of cost
allowed under GAAP

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time →

Post-sales marketing,
part of sales cost: CoGS
42

Lag differs less than
development period
Testing

R&I

done
done

start

Testing
R&I
done

start

Testing
Effective lag =
Development period × Centroid fraction
start
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R&I
done
done
43

Sales models
1. Normal curve: simple, no defined start point
2. Erlang: realistic, more complex
both have same parameters: mean and variance

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Sales curves
%

Depreciation
Normal
Erlang or Weibull

100
90
80
70

Vn

60

Vn+1

Vn+2

50
40
30
20
10
0
0
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1

2

3
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4

5

years 
46

Erlang sales
curves
m=mean/variance
18,000

^ 50,000 w hen
| Erlang m ~ infinite

16,000
Erlang m = 6

14,000

For 50 000 units over 9 years

12,000

Flash-in-the pan

10,000
8,000

One-time promotion

6,000
4,000

Long-lived single product

Erlang m = 12

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15

14

13

12

11

10

8

7

6

5

4

3

2

1

0

0

9

|
| end of time horizon
| 9 years
|

2,000

47

Ongoing
Version
Sales sales
Predicted product sales for 5 versions, stable rate of product
3 year inter-version interval, first-to-last product 12 years, life ~15 years
Product Line sales

1.00
0.90
0.80

sales

0.70
0.60

Replacement
Product

0.50
0.40
0.30
0.20
0.10

approximation

0

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

years
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Fraction of
income for SW
Income in a software company is used for
• Cost of capital
Dividends and interest

typical
≈ 5%

• Routine operations -- not requiring IP
Distribution, administration, management ≈ 45%

• IP Generating Expenses (IGE)
 Research and development, i.e., SW
 Advertising and marketing

≈ 25%
≈ 25%

 Joint distributor & creator
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These numbers areSSTiC 2013
available in annual reports or 10Ks
49

Recall:
Discounting to NPV
Standard business procedure
• Net present Value (NPV) of
getting funds 1 year later = F×(1 – discount %)
Standard values are available for many businesses
based on risk (β) of business, typical 15%
Discounting strongly reduces effect of the far future
NPV of €1.- in 9 years at 15% is €0.28
Also means that bad long-term assumptions have less effect
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Example

Software product
 Sells for €500/copy
 Market size 200 000
 Market penetration 25%
 Expected sales 50 000 units
 Expected income €500 x 50 000 = €25M
What is the result?
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Combining it all
factor
Version

today

y1

1.0

y2
2.0

y3

y4

3.0

y5
4.0

unit price

€500

500

500

Rel.size

1.00

1.67

2.33

3.00

3.67

New grth

0.00

0.67

1.33

2.00

replaced

0.00

0.05

0.08

old left

1.00

0.95

Fraction

100%

57%

500

500

y6

y7

5.0

500

y8

y9

6.0

7.0

500

500

500

500

4.33

5.00

5.67

6.33

7.00

2.67

3.33

4.00

4.67

5.33

6.00

0.12

0.15

0.18

0.22

0.25

0.28

0.32

0.92

0.88

0.85

0.82

0.78

0.75

0.72

0.68

39%

29%

23%

19%

16%

13%

11%

10%

Annual €K

0

1911

7569

11306

11395

8644

2646

1370

1241

503

Rev, €K

0

956

3785

5652

5698

4322

2646

1370

621

252

SW IP 25%

0

239

946

1413

1424

1081

661

343

155

63

Due old

0

136

371

416

320

204

104

45

18

6

Disct 15%

1.00

Contribute

0

Total
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0.87
118

0.76
281

0.66

0.57

274

189

0.50
101

0.43
45

0.38
17

0.33
6

0.28
2

1 032 ≈ € 1 million
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Software product

Result of
Example

 Expected sales 50 000 units
 Expected income €500 x 50 000 = €25M
Earnings (Profit before taxes) is just € 1M
after your salary etc ...
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Combining it all
and adjusted for endof-life
factor
Version

today

y1

1.0

y2
2.0

y3

y4

3.0

4.0

unit price

500

500

1.00

1.67

2.33

3.00

3.67

New grth

0.00

0.67

1.33

2.00

replaced

0.00

0.05

0.08

old left

1.00

0.95

Fraction

Income

€500

Rel.size

I
P

y5

100%

57%

500

500

y6

y7

5.0

500

y8

y9

6.0

7.0+

500

500

500

500

4.33

5.00

5.67

6.33

7.00

2.67

3.33

4.00

4.67

5.33

6.00

0.12

0.15

0.18

0.22

0.25

0.28

0.32

0.92

0.88

0.85

0.82

0.78

0.75

0.72

0.68

39%

28%

22%

17%

14%

11%

9%

8%

Units sold

0

1911

7569

11306

11395

8644

2646

1370

1241

596

Rev, €K

0

956

3785

5652

5698

4322

2646

1370

620

299

SW IP 25%

0

239

946

1413

1424

1081

661

343

155

75

Due old

0

136

371

416

320

204

104

45

18

6

Disct 15%

1.00

Contribute

0

Total SW

990

1/18/2014

0.87
118

0.76
276

≈ € 1 million

0.66

0.57

263

178

0.50
94

0.43
40

0.38

0.33

15

6

0.28, 0.25
2

out of €14 771 discounted sales
SSTiC 2013

54

Example
revisited
Software product

7 versions

 Expected sales 50 000
50 785 V1-V7
 Expected income €25M
 Discounted gross income €14.7M
 Available for SW maintenance €3.7M
Ok but see when it is needed
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Result of
Example
• Selling 50 000 SW units at €500 ≈ € 1M
not € 25M
Once its in a spreadsheet, the effect of the
many assumptions made can be checked.
When assumptions later prove unwarranted
then management can make corrections.
To be wise, don't spend more than ≈ €500 000
to develop the software product.
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Total income vs
technical cost

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57

Net income,
after sales cost
End of profit
on sales

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End of profit
on all income

58

Life of
Software
We learned now why software has a finite life
Although SW can be indefinitely maintained
Eventually the maintenance costs exceed income
• A very well-selling product can have a long life
1. Unique
2. High quality
3. Well maintained

Conflict?

• An easy to maintain product can have a long life
1. Well designed
2. Insulated from change by established standards
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Dealing with
Income Factors
1. Business overhead takes 50% of net revenue
 An average, when sales are low, fraction is higher
 Be lean, especially when sales fall
 Focus on on-line sales

2. Marketing uses 25% of net revenue
 Assess customer base, but don’t skimp here

3. Available for maintenance is still 25% of net
 Enough once sales become substantial
 Requires initially additional capital
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Transients due
to versions
Customer behavior w.r.t. new versions, superimposed on basic sales curve
2-year version life
Vn+1

Vn+2

Overall steady state sales

New version
release

New version
announced

Q4
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Q1

Q2

Q3

Q4

Q1

Q2

Q3

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New version
announced

Q4

Q1 Q2

Q3

Q4

Q1
61

Ongoing
development
New considerations
1. Have staff already
a. Early versions rapid growth, but observe ~20% limit
b. Later, best grow slower

2. Can overlap version development
a.
b.
c.
d.

Don’t let valuable staff be idle
Missing features should already be understood
Rapid analysis of problems to allow next version fixes
Any research should be done before major staff effort

3. Adequate testing to keep reputation

more next session
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Marketing
• Business model must allocate spending optimally
 Technology, as needed, long life and lag

&

 Marketing, necessary, less lag, slower growth
 Life of advertising 50% of technology, mix product & brand
in your
brain
forever

• Interdependence





viral

Consistent
SW value
Relevant
Linked by a common name and label
Honest name for file software misled: FLASH for flexible, but it wasn’t fast

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Let’s ignore the
intangibles, we
cannot measure
them reliably.
Book
value

Intangibles

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End of Part 1
References at
ilab.stanford.edu/VIC

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65

Syllabus, part 2
July 22, 19:00
1.
2.
3.
4.
5.
6.
7.
8.

Service-based models
Open source software
Freemium
Allocation among IP contributions
Estimating development efforts
The role of patents, copyrights, and trade secrets.
Advertising

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Summary of part 1
Valuation is important for business decisions.
Always based on expected future income: uncertain
Using multiple methods reduces uncertainty:
1. Fundamental: Income prediction (sales – costs)
based on SW growth, maintenance, IP diminution

2.
3.
4.
5.

Market estimates
Wisdom of the crowd
Leverage of R&D: investment expectation
Comparison with parameters of similar businesses
Comparison with other corporate investments

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Multiple method
results compared

Interquartile
mean

Average

error
MC-VM

Inc-VM

IIP-VM

CUT-VM

CP-VM

PS-M

RO-VM

ATA

Guidance
obtained earlier

Income determines value
Income is due to sales
• We applied an overall Erlang sales curve

 new versions keep market going but customers do
not replace earlier versions

• The assumption are sufficiently simple that
alternatives can be intelligently discussed
1.
2.
3.
4.
5.
6.

1/18/2014

keep development costs low
design so that SW maintenance is low
charge a higher price
minimize sales cost, without reducing market size
broaden the market
or →
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69

Example
revisited
Software product

7 versions

 Expected sales 50 000
50 785 V1-V7
 Expected income €25M
 Discounted gross income €14.7M
 Available for SW maintenance €3.7M
Ok but see when it is needed
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Business models
0. New versions do not replace earlier versions
Alternative business models
1. New versions encourage replacement
2. Provide related services
3. Charge for maintenance
Lower initial cost, slower income stream

4. Make product Open source to broaden market
Charge only for services

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Alternate
business model
Consider maintenance and its income
"Service model"
More assumptions – now include cost @50% of value
1. Original cost €500 000 (used to estimate 2.)
a.
b.
c.

Maintenance cost 15%/year of aggregate original cost
Maintenance fee 15%/year of original price, 1 year delay.
85% annual retention of customers.

2. Maintenance Lag = Δ (t cost , t income) = 1 year
3. Stop maintenance when cost > income
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Additional Effect
of service model
factor

today

Version

1.0

Org.cost €K

y1

y2

500

Maint.cost

y3

2.0

y4

3.0

y5
4.0

y6

y7

5.0

y8
6.0

y9
7.0

Assume designed for maintenance

0

75

99

114

75

86

99

114

131

SW@Cust.

0

812

4475

9456

Maint.Fees

0

0

122

671

1419

2060

2060

2400

2437

2277

Total income

0

956

3906

6324

7116

6382

5045

3806

2897

2380

Contribute @25

0

239

977

1581

1779

1569

1261

952

724

570

Unspent SW

-75

153

877

1467

1648

1445

1088

752

495

306

Unspent Disc.

-75

133

663

965

942

718

470

162

87

40

Spending

86

4 348 ≈ € 4.3 million

Total

131
151

151
174

174
200

200
230

230

Σ1523

13735 15997 16243 15176 13520 11744

>> sales only

but €1 523M for maintenance

Cost of maintenance = 1523/(500+1523) = 75% of total
typical
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Service model
factors
• Same proportion was used for SW contribution: 25%
 Maintenance income has lower sales cost, perhaps more should
be made available for software improvements

• Discount total only after maintenance cost
 Income comes at time of spending

• Maintenance fees still generate substantial income
 Organize business sector to collect those in out years
 Use excess SW income for replacement or new products

• Continue longer, but stop in time!
 When maintenance costs more than income

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More years of
service model ?
factor
Version
Curr.cost €K
Maint.cost

Cont.

y10

7.0

y11
8.0

y12

y13

9.0

y14
10.0

y15

y17

11.0

y17
12.0

y18
13.0

1530
229

264

303

349

401

461

530

610

702

Spending

264

303

349

401

461

530

610

702

540

SW@Cust.€M

11.7

10.1

8.6

7.3

6.2

5.3

4.5

3.8

3.2

1.9

Maint.Fees

2038

1761

1511

1289

1098

933

794

674

573

487

Total income

2280

1855

1543

1300

1101

934

794

674

573

487

Contribute @25

570

464

386

325

275

234

198

169

143

122

306

160

40

-76

-186

-297

-411

-533

-397

-145

Unspent Total 2015

1551

1194

898

639

404

184

-27

32.6

221

Unspent Disc.

133

663

965

942

718

470

162

87

40

Unspent SW

Total SW

-75

4 158 Less, out year losses because €5 687M spent on maintenance
Good time to quit

1/18/2014

540

But still have income to v12
SSTiC 2013

Quit: reduce expense &
income 1/3 each75
year

All Graphs

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76

Open Source
software?

Should software should be a free good?

Implicit in that view is that government, universities, and foundations should
pay for software development, rather than the users.

1. Programmers are creative artists, creating beauty
and benefits for all of Mankind !
vs.

2.Software is an industry.
SW revenue is $121B per year in the U.S. alone, well over 1% of the US GDP.
Non-software companies spend yet more for business-specific software.
Over 4.8 million people are employed in IT, earning nearly $333B annually.

• It is unlikely that universal free software is an achievable and
even a desirable goal.
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Open Source
Practice
• Appropriately, open source initiatives actually
focus on software that deserves wide public
use and should be freely available to students
and innovators, as editors, compilers, and
operating systems.
• Much open source software is incorporated
into Commercial software, that is not made
freely available,
 even if it should be made available.
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78

Sue us if
you can !

Open Source SW,
from a 10-K report

• Certain of our software (as well as that of our customers) may be [is]
derived from “open source” software that is generally made available to the
public by its authors and/or other third parties.
• Such open source software is often made available to us under licenses,
such as the GNU General Public License (GPL), which impose certain
obligations on us in the event we were to [for] distribute[ing] derivative
works of the open source software.
• These obligations may require us to make source code for the derivative
works available to the public, or license such derivative works under a
particular type of license, rather than the forms of licenses [it] customarily
used to protect our intellectual property.
• In the event [If] the copyright holder[s] of any open source software were to
successfully establish[their rights] in court that we had not complied with the
terms of a license for a particular work, we could be [must] required to
release the source code of that[our] work to the public and/or stop
distribution of that work.
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Freemium

Software is free
1. Charge for fancy version
2. Charge for upgrades (maintenance)
3. Charge for multi-user version
4. Charge for Internet sharing

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80

Planning:
Consistency in plans
When comparing business alternatives
• Give each choice the same chance
1. Temporal consistency
 Computing versus communication
 Local versus Cloud in 2012


Skate to where the puck is going [Gretsky]

2. Discount rate
3. Resource prices
 Green alternatives
 Benefits may depend on future price of oil –

1/18/2014

if you assume future price = 3 x now, why not invest in oil
instead
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81

Example
Enterprise SW versus cloud
[Benioff:2009]

• SIEBEL enterprise sales force management $
1.
2.
3.
4.
5.


Price $1,500 per seat, at 200 users
$54,000 for support (18%) /year, x 5
$1,200,000 consulting for installation
$100,000 admin.personnel/year, x 6
$ 30,000 training / year, x 6
6 years’ usage
Total

Note that the customer’s total is

1/18/2014

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>>

= 300,000
= 270,000
=1,200,000
= 600,000
= 180,000
= 2,550,000

than the price

82

Software
users & IP
Companies that
1. develop & sell software
•

→

*

Basis of IP: income from sales

2. purchase & license software for internal use
•

Do not generate IP with software

3. develop software internally for their own use
•

Basis of IP: relative SW expense × all income

4. combinations
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83

Review:
Intangibles
• Software is an intangible good
If it is owned it is considered Intangible Property
In a business there are 3 parts that have value.
(Contributes to potential income)

1. Tangible goods: buildings, computers, money
2. The know-how of management & employees
3. Intellectual property: Software, patents,

etc.
2. + 3. make up the Intellectual Capital of a
company.
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IP Protection
Intellectual Capital
all intangibles that contribute to non-routine returns
People: “Operational capital”
hard to protect
encourage loyalty
stock options
Intellectual Property
Should be protected against misappropriation
a) Patents
tranches
b) Copyright
c) Trade Secret
All can be
 Sold
gone to someone else

 Licensed

1/18/2014

• if you cannot use them profitably
specified rights to the IP box are rented
• Sales of a product in Europe, Japan
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85

Overview IP
protection
1. Patents

Federal Law
 Use only if the invention is visible in the product
 Or use to hinder others …. “blocking patents”

2. Copyright

Federal Law

 Protects source code and chip masks
 Not the underlying ideas

3. Trade Secret

State law

 If it can be kept secret, best choice
 Must be defended: NDAs, action when violated
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1. Patents
1. Device patents
• Good for visible ideas

[DiggL:12] C.Digg and S.Lohr: The patent used as a Sword; NYT,
7 Oct.2012, http:// www.nytimes.com/2012/10/08/technology/
patent-wars-among-tech-giants-can-stifle-competition.html

• Headlights built into fender
(Pierce Arrow ~1918)

2. Materials patents

Does the law support inventors or investors; NYT, 10
Oct.2012, http:// www.nytimes.com/roomfordebate/
2012/10/10/does-the-law-support-inventors-or-investors.html

Analyzable stuff
 Glue, drugs,

3. Business patents

Garret A. FitzGerald: Can Intellectual Property Save Drug
Development?; Science, 26 Oct.2012, Vol.338, 26 Oct. 2012
http://www.sciencemag.org/content/338/6106/483.full

 hard to assure that they represent new findings
 Amazon (1999, 2006↑US , 2011↓Europe): One-click ordering
 Grand Fishery of Great Britain (1720): ocean fishing ─ rejected
 Wireless Electronic Mail (NTP versus RIM [Blackberry], Nokia, suing Palm)
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Limits to patents
• Genes
 Recent ruling overturns patentability

• Stemcell : EU Court of Justice, said the use of human embryos ‘for
therapeutic or diagnostic purposes which are applied to the human embryo and
are useful to it is patentable. But their use for purposes of scientific research is
not patentable.’





case: http://curia.europa.eu/jurisp/cgi-bin/form.pl?lang=en&typeord=ALLTYP&numaff=&ddatefs=12&mdatefs=10
&ydatefs=2011&ddatefe=19&mdatefe=10&ydatefe=2011&nomusuel=&domaine=&mots=&resmax=100&Submit=Rec
hercher
pro: http://www.nationalrighttolifenews.org/news/2011/10/stem-cell-patent-ruling-is-a-triumph-of-ethics-overcommercial-expedience-and-will-open-fruitful-new-areas-of-research/
con: http://www.sciencebusiness.net/news/75509/European-Court-of-Justice-rules-against-embryonic-stem-cellpatents

case was Re: Greenpeace versus Oliver Brüstle, Director of the Institute of Reconstructive
Neurobiology at Bonn University, whose research in turning embryonic stem cells into neural cells for
treating Parkinson’s disease.

• Business Methods
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Patent troll
instance?
Sharing Sound, which holds an actual, government-approved patent.
Improbably issued in 2001, Sharing Sound’s absurdly broad patent covers “distribution of musical
products by a web site vendor over the internet.”
Actually: specifically includes the generation of a user-specific key that is inserted into the music file at the
time of purchase and used in conjunction with keys on the user’s computer to verify authorization.
The inventor was Bernhard Fritsch, whose short-lived MCY.com music service launched in early 1999 does
appear to have been the first to employ this type of system. Sold the patent to Sharing Sound,

Instead of creating a product or service with the patent, Sharing Sound lied in wait and finally in
May 2010 filed patent infringement lawsuits in the U.S. District Court for the Eastern District of
Texas against Apple, Sony, Microsoft, Rhapsody, Brilliant Digital Entertainment (BDE) and Napster,
and separately also sued Amazon, Netflix, Barnes and Noble, Wal-Mart, and GameStop. The
patent (here is a good summary of it) essentially describes how these companies sell music
online. Other than BDE, all of the companies have reportedly settled, the latest being Apple and
Rhapsody. But online selling of digital goods was well underway before the Patent Office issued
the Sharing Sound patent.
The terms of the settlements remain private, Sharing Sound no doubt kept its monetary demand

below the defendants’ anticipated cost of litigation.
[Glenn Lammi: The Legal Pulse; Washington Legal Foundation, 2010 & comments]
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Patent
bundles
• Many – 100’s – patents are needed for many modern products.
• Negotiating with all the patent owners is much work and leads to costly
total royalties ► 20% of cost of GSM phone
• Alternative – standard-specific patent organization ► UMTS for 3G
1.
2.
3.

Bundles all patents needed for a standard, SEP patents
Collects a global royalty from all manufacturers
Reimburses all patent owners – keeps say 6%
Historical model: U.S. aircraft industry at the start of WW II
without a patent pool no manufacturer could build good planes

• Bundles also used to negotiate among companies
• Still threatened by patent trolls
East Texas district court
 Costs for a legal defense are huge, often companies just give up
○ Devise a work-around

 Pay-up for a license .
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2. Copyright
Differs by country, although ongoing harmonization
even when laws are the same, expectations differ

Often changed, last major US changes 1978, 1990
• grants very long period: 120 years or
70 years after the death of the author
was 28 years in the U.S. but renewable another
67 years

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Copyright
• To defend your work you must show the violation
 Substantial code must match precisely
 Automatically derived code is protected as well
 Binary versions are protected, even if they differ
 Changes of variable names don’t invalidate copyright
 Damage awards depend on loss sustained

• Recoding the embodied concepts is not protected
 Feasible for well defined tasks
 Worked for IBM PC BIOS  (COMPAC, now HP)

 Difficult for large, diverse code
 Fujitsu IBM case for OS370 (base OS 360 was not protected)
o Used a clean room, but did not succeed, had take a license out.
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Trade secret
• Origin in Roman law: Actio servi corrupti
 Bribery, kidnap of servants/slaves to divulge secrets
 Guilds in the middle ages protected their secrets
o watchmaking, black-cloth dying,

• Also applies to marketing schemes
• Supported by Agreements

+for company / + $ for employee?

 Non-disclosure agreements
 Employees, Consultants, Contractors, Customers, Tax officials

 Invention assignment agreements to cover
 Invent for hire, invent using resources, invent independently

 No-compete agreements

(limits differ by state: CA↓ MA↑)
 Even covering one’s own inventions, but not routine knowledge
 Are limited in time (3 months to 3 years), but deceit is a violation

• Must be defended when a violation is known
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Trade Secret
federal
There is at least one type of trade secret that is
recognized by US federal law:
• Exclusive access for 4 or 12 years to
•

Small molecules ● biological material

the `sponsor’ of IP material collected for





Clinical trial data
Software to design drugs
Drug-making processes
Software to control drug-making processes

Even though the information must be made available
to the FDA for drug approval.
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Trade secret
and SW

• Reverse engineering of public SW is legitimate!
 Unless copyright is violated – masks, code
 Threats in the fine print that is ignored by most

• Getting a patent invalidates the trade secret
 Patents invite trolls

• Determining loss of trade secret is hard
 Code and Documents in hand of thief
 Often voluminous
 Having labeled documentation helps greatly
 `company confidential’
 Tracking of documents and document copying
 Meetings in room without personal, but corporate recording

• Prosecution is hard
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Protecting
trade secrets
Covers majority of IP value in modern companies
• Period of usefulness is limited in practice
 . . . but adequate given its simplicity versus
patent, copyright

• Reasonable practice is important
• Do not hire employees based on loyalty vs. smarts
Pay for loyalty commitments as well as for smarts
Employee should receive a comparable benefit for
signing a restrictive covenant.
 New hires should arrange a parachute (payment for
not divulging secrets) at hiring
don’t wait for the termination.
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Employee
motivation
Convey benefits of keeping secrets to your staff
and contractors
Contracts should not infringe employee mobility / betterment

Doctrine of `inevitable disclosure’
even without a non-compete contract

State laws differ:
California supports mobility, leakage; Midwest less so

• Dishonesty or aggressiveness on either side
makes a difference in court. Use facts.
•

•
•

Legalistic NDA forms make enforcement awkward
Brief summary and discussion with signer should be routine
Exceptions should be possible: student intern vis-à-vis professor
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Allocation
• When there are multiple products
• When there are other contributors to income
 Substantial hardware
 Financial consultants in financial firms
 Experts in call centers
 Brand name
Not all of the income can be allocated to the software

• Pareto Optimum
 Assume the company invests its income optimally

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Pareto Optimality
(not Pareto Efficiency : 80/20 rule)

The point were any change lowers the total benefit/cost
• Spending more on software will have less
than spending on other stuff
 People
 Hardware
1870 startup: Rome Railway Co.
 Advertising

benefit

 For large 10 IT companies the average value allocated
to their brand name is 22% (BW survey).

Conclusion:
• If a company is managed optimally, we can allocate IP contribution by
multi-year spending patterns

Σi costi ,

1.

simple total

2.

Exponential diminishing

1/18/2014

for i = n .. 0

Σi 80%i x costi ,
SSTiC 2013

for i = n .. 0, 20% annual loss
99

Review Allocation
When is allocation needed?
1.

Technology, Pharmaceutical company:


2.

income due to R&D versus advertising

Financial Company:


income due to software versus investment experts

3. Internal ▬ product mix
Expenses for a. products
b. tangibles
c. personnel needed to realize income from the products
d. marketing, advertising

For a Pareto-optimality allocation of income we use cost.
 But recall: Do NOT use cost as a surrogate for value, value of
intangibles come from derived income.
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100

Timing of expense
and income
Manufacturing &
distribution delay

Costs →

Release to Production

development lag
Centroid of total
development cost ..

Distribution
to Sales

←─→

Centroid of
revenue

Testing
~60%→

←

Research,
Design, Implementation

Sales lag .
−−−−−−−−−−−−−

→

Development done → ←→ marketing lag
Marketing
← Costs

Centroid of presales marketing costs
part of investment: IGE
1/18/2014

Sales

Revenues →

←→

SSTiC 2013

time →

Post-sales marketing,
part of sales cost: CoGS
101

Development done → β ← General
availability

Sales

Costs →

↔

development lag

←→

includes testing

Centroid of revenue

&Test

ing

Revenues →

SW Lags

←−−−−−−−→
sales lag .

← Costs

Research,
Implementation

1/18/2014

↔

Centroid
marketing lag
of pre-sales
marketing Marketing
costs
SSTiC 2013

time →

102

Lag delays benefits
of R&D investments
Estimate
effective lag .
growth limit

Effort →

~37% →

growth limit

start
1/18/2014

@27.4%

Research
75%

Gestation period →

→

~14% →

Testing

Development
35%→

50%
SSTiC 2013

25%

done
103

Start-up
development
A startup is unlikely to ramp up linearly
Use exponentional growth, exp 0.025
Assume
1. 12.5% research
Given that idea is clear, only towards for implementation
2. 25.0% testing
Minimal and risky
3. 67.5% left for implementation
• Overlap research and implementation until testing starts
• Overlap implemtation and testing until RPS
Results
Overall centroid
@0.27 before RPS -- later
Research from 1.00 to 0.33,
centroid @ 0.65 before RPS
Implementation from 0.67 to 0.00, centroid @ 0.29 before RPS
Testing from 0.17 to 0.00, centroid @ 0.08 before
Hiring rate at RPS 21%, at the limit for effectiveness
Ignore different
1/18/2014

SSTiC 2013

staff salaries

104

Graph of start-up
development

100%
80%

Res., Imp, &
Implementation starts when Test @0.27 →
67% time remains →

60%
40%
20%

21% effort
growth

Testing starts when

25%
Testing

Research ends when
12.5% Research

62.5%
Implementation

@0.65→

@0.29→

0
start
1/18/2014

0.75

0.50
SSTiC 2013

0.25

done
105

Development in mature
company with
12.5% research and
25% testing effort,
62.5% implementation

38% effort growth
at start

Relative Effort →

100%

Res., Imp, &
5% company staff growth
Test @0.42 →
Testing starts when
←−−− 40% time remains
Research ends when
T
← 65% time remains
←Implementation starts when
85% time remains

Available
resources

75%
50%

R

I

25%

@0.46→
@0.85→

0

1.00

0.75

0.50

0.25

done

Values based on finite integration, exp= 0.05
1/18/2014

SSTiC 2013

106

2nd version
technical lag

Relative Effort

→

100%

Staff becomes available when prior version enter testing

25% Testing
for version n

75%

All 100%

Starts at .057

0.57→

50%

Research for
version n
release

25%

0.19→

Implementation
for version n
release
Research &
Implementation

←0.76

done
0.25
1.00
0.50
0.75
←−−−−−−−−−−− Version n development interval −−−−−−−−−−−−−→

1.50

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1.25

SSTiC 2013

107

Mature ongoing
technical lag

Effort →

Staff becomes available when prior version enter testing

75%

Overall
@ 0.63 →

Research &
Implementation for
version n release

50%

25% Integration
and Testing
@0.21
.
→

@0.77 →

Testing n-1

25%

1.50

1.25
0.25
done
1.00
0.50
0.75
←−−−−−−−−−−− Version n development interval −−−−−−−−−−−−−→

1/18/2014

SSTiC 2013

108

2nd Version
substantial
testing

Effort →

100%

56%

43% Testing
during version n
All@0.61→
interval
T@0.33→

75%

50%
R&I @1.00 →
25%

1.50
1/18/2014

1.25

Release
version n
SSTiC 2013

0.75

0.50

0.25

done
109

Version development,
mature growth, much testing
100%

Effort →

Overall
@0.77→
Testing at 35% effort
75%
during version n
Research & Implementation
interval
effort towards version n
@0.33→
release
50%
@1.00→

25%

1.50
1/18/2014

1.25

Release
version n
SSTiC 2013

0.75

0.50

0.25

done
110

2nd Version
substantial
testing

Effort →

100%

56%

43% Testing
during version n
All@0.61→
interval
T@0.33→

75%

50%
R&I @1.00 →
25%

1.50

Release
1.25 version n-1

0.75

0.50

0.25

done

Staff becomes available when prior version enters testing
1/18/2014

SSTiC 2013

111

Growth and
Perception
E-commerce [this slide based on a 2001 CS99/73N class exercise]
• Gartner: 2000 prediction for 2004: 7.3 T$
• Revision:2001 prediction for 2004: 5.9 T$ drastic loss?
50 companies, each after
20% of the market

Extrapolated
growth
DisapCombipointment
natorial
growth

Examples
Artificial Intelligence
Databases
Neural networks
E-commerce

Perceived
growth

Perception level

Failures

Perceived initial growth

Invisible growth
0

1

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2

3

4

5

6

7

8

SSTiC 2013

9

10

11

12

13

14

15 ...
112

Advertising
1. Audience

3. Logo & name

Focused
 Salesforce
In front of competitors
annual sale meetings 3x
1. Fake demonstrators in SF.
2. Give coffee, mugs, rides,
literature to attendees in NY
3. Hire all taxis in Nice, give
free rides to site in Cannes.

Vs. Superbowl?
• Much buzz
• Huge audience
• Your audience?
1/18/2014

Essential for branding
Metaphor

4. Timing
Have Product ready
• Few bugs

Negative?

• Clear operation
• Useful

2. Address
a. Buyers in corporations
b. Users and employees

c. Both

Understand motivations for change
SSTiC 2013

113

Trends
1998 : 1999

• Users of the Internet 40%  52% of U.S. population
• Growth of Net Sites (now 2.2M public sites with 288M pages)
• Expected growth in E-commerce by Internet users [BW, 6
Sep.1999]

books
music & video
Toys
travel
tickets
Overall

1999

7.2%  16.0%
6.3%  16.4% Centroid, in 1999
3.1%  10.3% ~1% of total market
2.6%  4.0%
1.4%  4.2%
8.0%  33.0% = $9.5Billion

%








1998



segment

90
80
70
60
50
40
30
20
10

E-penetration
Toys

0
98 99 00 01 02 03 04
0.3 1 3 9 27 81 **

Year / % 

An unsustainable trend cannot be sustained [Herbert Stein, Council Econ. Adv, 1974]

 new services
1/18/2014

SSTiC 2013

115

Why me
US Treasury concern:
• Much software is being exported as part of
offshoring (offshore outsourcing)
• It is typically property – i.e., protected
• If it is not valued correctly – i.e., too low
1.
2.
3.
4.

Loss of income to the creators
in the USA
And loss of taxes
to the US treasury
Excessive profits
kept external to the USA
Increased motivation for external investment

• Book: How Multinationals avoid Taxes
 Chapters available for review
1/18/2014

SSTiC 2013

116

Ancestor in 1758 to sell clocks
to the King of Spain
Preparation & correspondence
over a year
Travel 49 days travel
Wait for appointment.
Sale arrangement 1 week
Travel back with gold pieces

1/18/2014

Rapid Change
in business,enabled by
1. The Internet
2.Containerized
shipping
Today 255 years later
Gain interest 15 minutes
Sale arrangement 1 minute
Delivery of goods 3 days
Cost of shipping iPad $1.from China to Europe/US
Delivery of funds 1 minute

SSTiC 2013

117

Syllabus, part 3
25 July 2013 , 13:00-15:00

1.
2.
3.
4.
5.
6.

Licensing
Separation of IP rights from the property itself.
Outsourcing and offshoring development. IP flow.
Effects of using taxhavens to house IP rights.
Changing taxation.
Summary

1/18/2014

SSTiC 2013

118

Multi Version product
effort and lag
Effort total = 8.6 x original effort
Test ratio: 37%
Overall
@0.42→
Testing
@0.38→
100

87.5

Releases:
1/18/2014

75.0

62.5

50.0

37.5

25.0

initial

ver.2

ver.3

ver.4

ver.5

SSTiC 2013

12.5

→
0.0

ver.6 latest

119

First to market
advantage
v1(O)

s(O)

Effort total = 8.6 units

Overall
@0.42→

Original Multi Version efforts and
lag

→
start Re-creation

Original product creation time

Competition (drawn to scale)
Growth Rate 20%/year average
Effort total = 5.4 units
Competition/ Original multi version source
Effort ratio R/O = 0.63
Time ratio (t(R)-s(R)/t(O)-s(O)) = 0.41
Effective Lag ratio = 0.23

Overall
@0.33→

100 75.0
t(O)=s(R)

50.0

25.0

0.0
t(R)

But at that point the original is 3.5 versions ahead of the competition!
1/18/2014

SSTiC 2013

120

Sharing IP
2 situations
1. No product yet
2. Already have a product,
Selling to an independent exploiter
But want more growth
Sharing with a participant

Inventor
Developer,
Manufacturer,
Marketeer,
Seller

Inventor,
Developer,
Manufacturer,

Marketeer,
Seller

Selling IP +
Bundling & valuing the box
1. Piece by piece
or
2. Tranche of the company – say, all sales in Europe
3. Can include available knowhow (+) for maintenance

$

1. Package the box
 Create a subcorporation to hold the rights to the IP+
2. Sell the subcorporation to European sales co.: SE
1. Receive a single payment matching the value


Requires a well-off buyer

2. Receive payments over time of equivalent NPV
3. Make a royalty (fraction of SE’s sales) arrangement
1.
2.
3.
1/18/2014

€

SE

A fraction of sales at SE commensurate with the amount of IP
A period that is sufficiently long to recover the IPs NPvalue
A premium to compensate the seller for the risk of SE defaulting
SSTiC 2013

122

Setting
License fees
Say you want to delegate sales in Europe to some company
EUsales that can do it easier over there
• How do you set the fees or royalties?
1.

You have computed a value of your SW of $1M



But without discounting, it is actually $1.6M = Σ(due old, slide 5)
You will also maintain the SW 1.36M = Σ(maintenance cost, slide 12)

The total due is $3M
2. You expect the European sales will be 40% of total, 20 000


•

The reason for not discounting is that funds arrive at the same times.

To earn the same you should charge 1./2.= $150/unit



1/18/2014

It does not matter how EUsales sells it and what it charges
Complexities are required language, interface improvements

SSTiC 2013

123

Setting
License fees
Say US company want to delegate sales in Europe to a local
company EUsales that can do it easier over there
• How do you set the fees or royalties?
You have computed a value of your SW of €1M

1.




But without discounting, it is actually €1.6M = Σ(due old, slide 5)
You will also maintain the SW 1.36M = Σ(maintenance cost, slide 12)

The total due is €3M
2. You expect the European sales will be 40% of total, 20 000


•

The reason for not discounting is that funds arrive at the same times.

To earn the same you should charge 1./2.= €150/unit


1/18/2014

It does not matter how EUsales sells it and what it charges
Complexities are required language, interface improvements
SSTiC 2013

124

Example of Free
• Adobe produced software to generate and read
markup text (pdf) for sale to companies.
 minor business for internal publishing

• Arrangement with the IRS that if Adobe would
separate the reader and provide for free, it
would publish tax forms using pdf
 huge business – now everyone needed a reader and
companies bought pdf generators to publish in pdf

• When patents ran out, others companies made
pdf generators available
 Adobe still provides many pdf related services
1/18/2014

SSTiC 2013

125

Cloud delivery
by salesforce.com
• Benioff Saleforce.com new entry:
 $150.-month & user only -- monthly billing
 Make interface look like Amazon – no training needed
 Low risk for individual adopters
 Still a high risk for a changeover in large businesses, where
changes are controlled by a risk-adverse IT manager or CIO.

 Start focusing on small businesses
 Hard to reach a broad market with little cash
 Must make a lot of noise

 Later sales force had to change its initial model
 Deal with large companies
 Deal with the Dot-com bust, when many companies failed

 Business must remain flexible
1/18/2014

SSTiC 2013

126

Rights are flexible
price

REco

rents
USco

owner

Covert Property to
cash minus rents

tenant

New owner

These rights can then be moved off-shore.
Income from these rights can avoid taxes.
Even easier to do with intellectual property
And invisible – not on corporate books
1/18/2014

SSTiC 2013

127

Internal sale
Tangible example
1. A US company, USco needs cash. It owns a splendid HQ building
2. USco may sell its HQ building to a real-estate enterprise REco
with a provision that the REco will lease the building back to USco.
3. If USco has received a fair value for the building, USco's total tangibles
remain unchanged until it spends the money it received
 REco may offer an attractive lease because of tax advantages.
4. Actually, REco can be set up by USco and controlled by USco,
which also remains its only tenant.
5. Nobody moves and few employees will notice a change.
o
o
o

There is a new brass plaque on the building
A sign `REco' on the door to the rooms housing the folk who maintain the HQ.
The public consolidated annual report of USco only lists the name and location
of the controlled subcorporation REco; the assets of both are combined.

6. Since the lease receipts at REco and payments by USco are similar,
the more complex financial flow is invisible.
1/18/2014

SSTiC 2013

128

buy

rents

USco

USco

Owner

RE
co

Needs cash

New owner

Tenant

MyREco

rents

USco

Owner
1/18/2014

USco

Converts to
partial tenancy

Formal tenant
SSTiC 2013

Formal owner
129

Internal sale
for intangibles
Procedure functionally identical to tangible example, but
• Even less visible


•
•

IP is a much larger fraction of corporate value than HQ
The consumers of the IP are the sales organizations


•

IP transactions are harder to value than buildings

Not the tenants

Typically involves three or more entities
1.

Parent company, creator, or sponsor


2.

Creates and maintains the IP

IP holding company, often in a tax haven


3.

Buys IP initially and pays for its maintenance. Licenses its use.

IP consumer: selling company


4.

1/18/2014

Buys license to use the IP in products it sells, pays royalty to IP holder
Off shore IP generators  more to come

SSTiC 2013

130

Offshoring
Task transfer to Enterprises in Foreign countries
Two aspects:
1. Work migration: jobs are moved to
lower-cost countries
2. Support software etc. is moved to enable
similar productivity in those countries

Income is generated by people and
(intellectual) capital
1/18/2014

SSTiC 2013

131

Types of
Foreign Entities

• Independent Foreign Contractors
 IFC may serve multiple customers
Share trade secrets with competitors

IFC

 Owners need contracts to protect the IP
Hard to monitor and enforce

• Owned, Controlled Foreign Corporations
 CFC provides much more control over IP
 Ownership often in third-party countries
Avoids taxation of sales to other countries
1/18/2014

SSTiC 2013

CFC
132

Hypothesis
• Offshoring of jobs is effective because of concurrent
Intellectual Property (IP) transfer
• Much of that IP is corporate property

• Transfer of corporate IP & IP rights is poorly
understood
 IP as property is not well defined, hard to measure
 There are many components to IP, coming from
 Open source, R&D, marketing, reputation as
 Patents, copyright, trade secret (covered by NDAs)

• Even if hard to value, IP & IP rights is a significant export
1/18/2014

SSTiC 2013

133

Knowledge
is the Link
To be effective a worker has to know what has to be done
•

That knowledge consists of
 The technology


• call center employees
• engineers

technicians
● managers
●

Documentation, prior versions, quality control

 The business methods



•

How technology in the product is marketed
The flow from buyers to improved products and methods

Companies distinguish themselves by proprietary IP
1.

Patents, sometimes Copyrights

2.

Confidential Documents

3.

Knowledge within its people - protected by NDAs

1/18/2014

SSTiC 2013

Trade
secrets
134

Transfers of rights
tangible ≈ intangible

Creator

Rights to tangible

Owner

$ Price

Creator

Rights to intangible
$ IP value ??

Lease
€ rents

Use

Use Rights

Owner

€ fees

Use

But setting the right value is harder, and easily misused
1/18/2014

SSTiC 2013

135

IP flow in the
Hard-& Soft-ware industry
Design &
validation
in US

Development, testing
in the US
and at CFCs

manufacturing,
distribution

Product Sales within
the US

CD creation
Internet

Product Sales
external to the US

Income is taxable
1/18/2014

Technical IP
Investment

Part of income is due to
US contribution & taxable
SSTiC 2013

136

Flow of IP in the
financial industry
say: INYB investment bank

INYB
system
experts
in the US
INYB finance
experts
within the US

Design &
feedback

Technical IP
Investment by INB

Operations of
INYB

Finance experts
at INYB site

within the US externat to the US

external to the US

Operations
of INYB

Service Sales
within the US
All US Income is taxable
1/18/2014

Programming
and testing

Financial IP
Investment by INB

Service Sales .
external to the US

Income due to
technical US
contribution is taxable
SSTiC 2013

137

MNC

EMEA
distributor
and adapter

*

*¤
Taxable income

*

LSA
distributor

Manufacturing

*
¤

Booking of sales

Income from sales

PFE
distributor

*

Taxhavens
Places where
1. Taxes are low
2. Financial and IP supervision is minimal
3. Reporting requirements are minimal

• Three cooperating types are needed

Dutch sandwich

1. Primary tax havens (about a dozen countries)




Small populations,
Can live largely of license fees
Cayman Islands,pop.50K, 90K companies @ 3000/year

2. Semi-taxhavens (more, but diverse)



Large populations, need jobs
Enact, often temporary, tax benefits for foreign work
3. Conduit taxhavens (few, small, financially active countries)
 trusted, separate taxhaven activities by ringfencing
 can shuffle funds invisible among locations
1/18/2014

SSTiC 2013

139

IPrights

CAAS

MNC
US

¤

*
*

MNC LSA

¤
MNC
EMEA

*

MNC PFE

¤CONCH
MNC MY
MNC JB

Manufacturing

*
¤

Booking of sales
Income from sales
to taxhaven

map from CIA Factbook

Flow
Semi-taxhaven

Malaysia, India

MNC

Conduit

California

Holland

Need 3 types of
taxhaven entities

Primary

IP

Palm Island
1/18/2014

SSTiC 2013

141

Structure
MNC
California

Parent:

I
P

MNC

Malaysia,India +Holland +Palm Island

SemiCFCs:
MNC
JB

CFH:

Primary

CONCH

MNC
MY

Advisor:

ATA

CFI:
$
CAAS
$ €£¥
1/18/2014

Conduit 2013
SSTiC

142

Forest Labs flow
[from Business Week 14 May 2010]

0. Initial transaction:
0. Initial transaction
IP rights transfer
IP rights transfer
to Bermuda
to Bermuda

Cost $5
$64

IP rights

FFBV
FLI ($17+0.11 Irish tax)

Forest
Labs.Research,
St. Louis, MO FLR

$99

6

FRX

$76
$5

$7

a

FLH b
$2.38 US taxes for public use

7

$50 available for new investment?

[Design Hermann Zschiegner]

1/18/2014

SSTiC 2013

143

With Taxhavens:
Three-party flow
Parent corporation

Offshore
job sites

Salaries
Initial
purchase

$
$$

License
fees

$

Sub corporation
“CFH”

Integration

Highvalue
Products

IP documentation

purchased the
rights to IPb
1/18/2014

SSTiC 2013

144

Capital and IP
creates more IP and Income
Capital and IP
in CFH

Capital & IP
at source

Income

Income
1/18/2014

SSTiC 2013

145

Example
Apple paid less than 2% corporation tax on its profits outside
the US, its filing with US regulators has shown.
The company paid $713m in the year to 29 September on foreign pre-tax profits of $36.8bn, 1.9%.
It is the latest company to be identified as paying low rates of overseas tax, following Starbucks,
Facebook and Google in recent weeks.
It has not been suggested that any of their tax avoidance schemes are illegal.
All of the companies pay considerable amounts of other taxes in the UK, such as National
Insurance, and raise large sums of VAT.
Apple's figures for foreign tax appear on page 61 of its form 10-K filing with the US Securities and
Exchange Commission (SEC), used to summarize the performance of public companies.
It had paid a rate of 2.5% the previous year.
Apple channels much of its business in Europe through a subsidiary in the Republic of Ireland,
which has lower corporation tax than Britain.
But even Ireland charges 12.5%, compared with Britain's 24%.
Many multinational companies manage to pay substantially below the official corporation tax rates
by using tax havens such as Caribbean islands. http://www.bbc.co.uk/news/business-20197710

1/18/2014

SSTiC 2013

146

Capital flow with
a taxhaven

Controlled Foreign
Holding Company
Source
IP Creator

I PIP

CFH

IP license

Buy-in
Tax havens:

Income

CFC
IP consumer
Income

Capital and IP

Vanuatu
Cayman islands
Barbados

Capital

Royalties

Capital

US
taxes

Fees

Foreign
taxes

Tangibles are harder to move than IP
1/18/2014

SSTiC 2013

147

Job Flow @
different levels
of personnel
$

IP

Parent ------------------------ CFC
Is knowledge transmitted from the top or
acquired from experience at the bottom?
1/18/2014

SSTiC 2013

148

Longer term
effect
• Repatriation of €->$ from the CFH to the US is taxed.
• Current workers are paid by the CFH.
US and offshore employees are unaware of the source of their
paycheck

 The CFH acquires an increasing fraction of the IP
 The CFH is paid an increasing fraction of the income
 The CFH in time can becomes richer than the company.

• It is more efficient for the company to invest in low-tax
countries and create jobs there.
 Job losses in the U.S. increase

• Eventually the CFH can buy the parent company.
 Control by stockholders is gone as well
1/18/2014

SSTiC 2013

149

Effects over time

1/18/2014

SSTiC 2013

150

Flows are messy
MNC
S
Sales

Delaware

Typical FCM
One-time
Buy-in

IP

6-year rights
royalty tranche

FCM-I
International Ltd
Isle of Man

Owns
US
Revenue
~40%

Fabless Chip
Manufacturer

FCM-D
Design & development

Costshare
payments

IP:
designs
IP use licensing

U>S.

documents,
knowhow

profit

MNC
A
SG&
A
U.S.
offshore

FCM-H
BV
Netherlands

FCM-I
Ireland

Offshore
Revenue

Chip and board manufacture
offshore

~60%

FCM Products
1/18/2014

SSTiC 2013
OEM fabricators, US and offshore

151

Not all taxhavens
are offshore: Delaware

Formal
HQ of HQ of
Coca-Cola, Ford, General Motors,
Google, Hewlett Packard, Intel, Kentucky
Fried Chicken, Texas Instruments and
200,000 more corporations

owner:
Corporation Trust,
a subsidiary of
Wolters-Kluwer, a
Dutch publishing house.
1/18/2014

SSTiC 2013

[Shaxton:11]

152

Future:
Outsourcing and IP export
Need Increased understanding and accounting for IP exports
in the past handled by customs officials imposing `toll charges’

(making them visible)

To rationalize political concern by populists & traditional conservatives
versus strong lobbyists pressures and globalists

Correct pricing, licensing and its taxation of IP exports
• will increase corporate profits in the U.S.
• reduce cash in offshore accounts, more for U.S. investment
• provide taxes that could be used to compensate
• for R&D support provided by the government
• for educational costs
• for unfunded retirement benefits of workers whose IP was outsourced
• Is unlikely to stop offshoring substantially

• Amounts would be large in a number of cases

• But ….
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153

Doonesbury 1/2

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154

Doonsbury 2/2

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155

Corporate income
$B
1500
1400
1300
1200

W

US total worldwide
corporate earnings
$1,550B /year

US corporate earnings
sources → destinations

$620B
D
available for
corporate
dividends
&

(less during 2008-2009)

investment
in the U.S.

1100
1000

1,250B from
domestic sources
W-F

900
800
700
500
400

300
200
100

US tax paid on US
Corporate earnings
$335B

U US-sourced
earnings moved
abroad = $300B

600

US corporate
tax revenue
$340B

available in
taxhavens
for corporate
investment
SSTiC 2013

200
100
0
(100)

$690B

Earnings on $1,800B
income from foreign
sources = $400B

400
300

R

T

F

1/18/2014

$B

(200
)
(300)

156

Who pays taxes
Government
Employees

Businesses
Misc.:
Customs
Fees

1/18/2014

dividends

Shareholders

In dependent
SEP workers
Double ?
taxation
SSTiC 2013

157

Proposal: Eliminate
corporate taxation and
full income taxation

No corporate taxation and
no reductions on dividend and capital
gains taxes
• Removing a component of US tax revenues is worrisome
• But now no `double taxation’ Corporate + Shareholders
 Revenues from corporate taxation are decreasing,
 Its contribution to the US economy in 1994 was already less than 2.5%
of GDP.
 The 2008 recession lowers the amount of corporate income tax colected

A linear extrapolation of the trend in corporate tax rates
makes the revenues from corporations zero by 2050!
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158

Trend

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159

Economic
Models
[Orrell: Economyths+]

• Used to predict effect of policies and tax changes





use assumptions  based on: counterexamples
Equilibrium  ignores dynamics and lag: housing
Normal distribution  based on additive model
many effects are multiplicative: power-law
Symmetric distribution  value S-curve not centered:
downside risk hurts more than upside gain
Rational behavior  perfect foresight: shopping

• Governments get poor advice

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160

Estimate
Taxed item

Action

Change

Abolish

($143.3B)

Corporate income tax (CIT)
for C-corporations -- not Scorps. LLCs

Dividends to individuals

Motivation and result
75
%

$30.4B
Tax as
income

Capital gains by
individuals
Effect of taxation of
greater dividend
Corpayouts
porate
Direct effect of investment

$69.0B

$9.6B
$20.4B

Treat all sources of individual
income identically
Tax on compensation of shareholders for their increased
taxes.
Purchases (based on DoD
spending)

Research credit , similar corporate No $ change. No
tax, no tax credit
tax deductions (loopholes),
corporate AMT
Indirect effect of increased
No effect of
investment and repatriation of
“Laffer curve”
offshore holdings
1/18/2014

Cannot be administered fairly

SSTiC 2013

If incentives are still desired, they
must be replaced by explicit
grants
No trustworthy data

(7.2%) of business161
tax

Why now
Worrying about economics is a sign of a maturing field
Phases:
1. Get new stuff to work
2. Getting adequate performance
3. Get it to be sufficiently reliable to be useful
4. Get it into routine production
5. Increase capacity
6. Make it safe

7. Make it affordable
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162

Problems
•

There is a lack of trustworthy data

1. $ 209M

spent

[US commerce department, 2003]

+

4 663

jobs lost [U.S. labor dept, 1Q04]

2.
+

$2 400M
50 000

•

Attitudes are inconsistent

income [Business week, in 2003]
jobs gained [Indian NAS&S Cos, Fy04/4]

Greenspan 1: IP rights have assumed increasing importance [27Feb03]
Greenspan 2: Our economy is best served by full and vigorous engagement in the

global economy – when defending reducing protection

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[11Mar03]

163

Related Intellectual
capital issues
Not all intellectual capital is owned, property, IP
1. Education: Services that transmit valuable,
but non-proprietary knowledge to others.
 If receiver pays, certainly can take it anywhere
 If the state pays, can it / should it be reimbursed? Now not.

2. Publication: IP placed into the public domain is no longer IP
 Who benefits?

 The reader gets knowledge / The writer gets fame
 Society becomes more egalitarian, effective

• These 2 aspects can easily confuse IP discussions

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164



Symmetry 

Exports and Transfers go both ways
• There is innovation everywhere
• If the U.S. imports IP, the receiver should pay
 Basic and fundamental research in the U.S. is declining
 Growth was motivated by WW II experience [Vannevar Bush]
 Many countries now fund fundamental research

 The ratio of applied to basic research is increasing
 Industrial research is mainly applied
 Technological research is rarely basic

 Development requires more resources

B

F

A

D

 Industrial and management infrastructure
Good in the U.S
 Demonstration and Beta sites - early adopters
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165

Discussion
• Many parameters used
to estimate IP
 Uncertainty !
 But better than not
knowing what’s going
on.

• Many choices now
a. Technical options
b. Business options
Interact with each other.
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166

The end!
Question?

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167

Numbers
2009

T B M K
$ .
14, 259, 800, 000, 000
US GDP
.
.
14, 014, 800, 000, 000
US GNP
.
.
2, 524, 000, 000, 000
US tax revenues
.
21, 584, 866, 000, 000
US business revenue
US business net income 1, 614, 866, 573, 000
894, 900, 000, 000
US business taxable.
204, 996, 000, 000
US tax on business .
143, 000, 000, 000
US tax on C-corporations
US tax paid by multinationals
75, 182, 000, 000
Home mortgage interest
5, 400, 000, 000
Research credit
.
123, 570, 203, 000
Dividends @15% .
231, 547, 946, 000
net Capital gains
.
1/18/2014

SSTiC 2013

%

#M

5.8

75%

1.7

18.1% 25.4
9.6% 20.3
168

$1 Billion
100
million

Stanford x 2.5
10
million

1
million

$100,000

Your
Life

one $100 bill

1/18/2014

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169

US government
2.5 in 2.9T out
In 2008

1/18/2014

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170

References
Gio W.: Valuing Intellectual Capital, Multinationals and Taxhavens; series Management for
Professionals, Springer Verlag, New York , to appear March 2013.

Gio W.: "Follow the Intellectual Property: How do Companies pay Programmers when they
move the related IP rights to Offshore Taxhavens?"; Communications of the ACM
(CACM), Vol.54 No.1, January 2011, pp.66-74.
Gio Wiederhold, Amar Gupta, and Erich Neuhold: "Offshoring and Transfer of Intellectual
Property"; Information Resources Management Journal (IRMJ) Vol.23 No.1, JanuaryMarch 2010, pp.74-93.
Gio Wiederhold, Shirley Tessler, Amar Gupta, and David Branson Smith: "The Valuation of
Technology-Based Intellectual Property in Offshoring Decisions"; The Communications
of the Association for Information Systems, Vol.24 No.31, Jan 2009.
Gio Wiederhold: "Determining Software Investment Lag"; Journal of Universal Computer
Science (JUCS), Springer Verlag, Vol.14 issue 22, 2008, ISSN 0948-695x;
Wiederhold, Gio: "What is Your Software Worth?"; Communications of the ACM, Vol.49 No.9,
Sept.2006, pp.65-75.
Gloria T. Lau, Kincho H. Law, and Gio Wiederhold: " Analyzing Government Regulations
Using Structural and Domain Information"; IEEE Computer, Vol.38 No.12, Dec. 2005,
pages 70-76.
1/18/2014

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171

Topics see
http://infolab.stanford.edu/pub/gio/cs207/
For a motivation see Jeff Hawkins: What I wish I’d learned

in college

<A

HREF=“http://ecorner.stanford.edu/authorMaterialInfo.html?mid=2289”>
Slides from all lectures:
Why should software be valued? Open source software, theory and reality. Scope.
http://infolab.stanford.edu/pub/gio/cs207/CS207-1.pdf; last year.... cs207/CS207-1-2011.pdf

>*

Intellectual capital and property (IP). Principles of valuation.

Cost versus value. Market value of software companies. Sales expectations and discounting,.
Life and lag of software innovation
The role of patents, copyrights, and trade secrets. Managing IP.
http://infolab.stanford.edu/pub/gio/cs207/CS207-6.pdf, last year.... cs207/CS207-6-2011.pdf
Off shoring (Prof. Amar Gupta) from 2009
http://infolab.stanford.edu/pub/gio/2009/Stanford-Nov09.pdf>
Licensing. Separation of use rights from the property itself. Offshoring alternatives. Risks.
Effects of using taxhavens to house IP.
Acquisitions and growth, Summary .
1/18/2014

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172

Management for Professionals

Gio Wiederhold

Valuing
Intellectual
Capital
Multinationals and Taxhavens

1: MNC

created, sold rights to
42% of the initial IP.
Controls all actions.

Initial IP $
buy-in for
purchas 5
years
e

$
Salaries
for R&D
costs

4: Sub corporation
CONCH
purchased the
rights
to hold and license
the IP to others.

Consolidated enterprise

3.1:
MNC JB 3.2:
3.3.
License MNC MY
and exploit the
...&
IP
2.1:
Integration MNC
EMEA
IP
documents .

Distribution
2.3:
2.2:
MNC
LSA

routine

PFE

$M
200
180

MNC

Bu
y-in

MNC U.S.

160
140
2nd
roun
d

120
100

80

Profit

60

0
1st
roun
d

@AJC

A

tax
rate

40

←───→ Acquisitions paid mainly by MNC ←Acquisitions
paid by CONCH
←CONCH established

20
0

Before buy-

After buy-in, actual MNC in U.S

%
100
90

MNC U.S. earnings
share AJCA–motivated

80
70

60

Sales in
U.S.

acquisitions

initial
acquisitions

50

US earnings
held at
CONCH

40
30
20

unadjusted cost-sharing payment

Foreign

sales

10
0

Before Buy-in

CONCH earnings share
Acquisitions
paid
mainly by
MNC

Acquisitions
paid by
CONCH

After Buy-in and cost-sharing

$M

MNC U.S. only
220
Bu
y-in

200
180

MNC

160
140

120
100

US Profit

80

1st
roun
d

2nd
roun
d

@5.25
%

60

AJCA
tax
rate

40

←───→ Acquisitions paid mainly by MNC ←Acquisitions
paid by CONCH

20
0

Before buy-

After buy-in and acquisitions, US earnings

$M

MNC’s consolidated corporate value

8,000

private

public

6,000

4,000

2,000

0
MNC has an offshore holding company: CONCH

time

MC-VM: Valuing MNC on the basis of its share
values
Valu
e
$M
3,000

Events

Valuation
point

Stock options granted:
dilute share value
increase stability, IP

2,000

Incom
e
$M/y
1,000

500

net income
acquisitions
organic

Acquisitions made:
paid with shares & cash
add IP and income
Setting up CONCH:
minor cost
IP and income shared
tax avoidance ensues

0

0
history

future

$M

Prepackaged Software SIC 7372 / NAICS 51121

1,600,000
1,400,000
1,200,000
1,000,000

$
10.-

800,000

8.-

600,000

6.-

400,000

4.-

200,000

2.-

0

0

1999
2005

2000

2001

2002

2003

2004

Inc-VM: Valuing MNC on the basis of its operating
income
Value,
Income
$M
3,000

Valuation
point

2,000

Incom
e
$M/y
1000

1,000

500

0

0
history

future

OngoIng

Maniac
1000

Maniac Maniac
2000 3000
.

MNC

Inputs

Maniac

%
of total
Maniac
IP

I n t e l le c t u a l

Maniac
4000

Distribution to Sales

Maniac
5000
.
.

Maniac
6000

Maniac
7000

Time

Crop
14.44 y 14,5
13.84 y 13,10

Becomes Figure Ch5.4

OngoIng

%

Maniac

of
total
Mania
c
IP

1000

lag
Lc

Maniac
2000


Mania
c
3000

Maniac
4000

Maniac
5000

Maniac
6K

Software contribution
Maniac s

for sale

Software embedded in Hardware

Crop

Inputs

hardware component


Time

Maniac
7000

Software versions embedded in Maniac s

%
of
to- Versio
tal
n
SW
1.0
size

0

1

Version
2.0

2

3

4

Versio
n
3.0

5

6

Version 4.0

Version
5.0

.

7

8

9

Ver
sio
n
6.0

10

11

12

13

Version
7.0

15

14

Time

over a long time
7.96 y 8,0
To be cropped. Scale based on 100% = 3”

9.45 y

9,5

16

17

Valuation point

%
of
total
size

expected Maniac release
date . actual Maniac
release date
VerVersion
Version
Version
Version sion
4.0
8.0
7.0
Maniac software
5.0
6.0
Versio
Estimate Estimate Estimate Estimate Estimate Estimate
n
4.0
6.0
5.0
7.0
8.0
9.0
Version
3.0
1.0 Version
2.0

histor
y
Maniac s built

0

5

future

10

future

Maniac s

To be cropped. Scale based on 100% = 3”


15

Maniac
Mania
c1000

Maniac
2000

Mania
c
3000

lag
periods

Maniac
4000

OngoIng

Maniac
5000

Man
-iac
6K


Maniac
7000

Inputs

Mobile
specifi
c input

%
of
total
ManiMobile
IP

M-Mob
m1

M-Mob

M-Mob
m3

M-Mob
m4

m2

ManiMobile
Time

M-Mob
m5

IIP-VM: Effect of discounting
Income
$M/y

M
M 7K
6K

Valuation
point

800

M
5K
M
4K

600
M
2K

400

M
3K

M
1K

200

0
history

future

M
8K?

without AJCA acquisitions

laglag

cut-off
IP life

future

Earnings
Assets

Price
Earnings

for M8

Operating income
Product revenue
Gross income
CoGS + SG&A

Market cap - Debt
Total net assets

Operating income
CoGS + SG&A
Operating income
Maintenance R&D + CoGS + SG&A

Operating income
0.85 R&D + CoGS + SG&A

Common Margins

Earnings due to IP
q

p

$

E
m=E/C
available

Delay

Non-roputine earnings
derived from sales →

Cost of IP generation

1500

(ignored)

1000

→

Total discounted
earnings after R&D

500
IGE Costs

C
relevant R&D

0
-13

-5

-12

-4

-11

-3

-10

-2

-9
-9

-1

-8

0

-7

-6

-5

-4

-3

R&D capitalization permitted by GAAP

-2

-1

0

time →

Options

Decision Point

Income
from selling
ManiMobiles

Acquistion date

Manufacturing &
distribution delay

←Costs

Development lag

Sales lag

Research, Develop ,

MobIP

~60%
→

Test

0

1

Alternative 2:

2

3

4
time →

abandon mobile idea

no further cost, no further income
←Costs

$

Income →

Alternative 1:
build ManiMobile

MobIP

5

3000

4000

5000

6000

7000

8000

9000

300%

400%

500%

600%

700%

800%

900% 1000% 1100%

100% 75.0% 60.0% 50.0% 42.9%
11

40

47

13

17

57

104

117

67

10K

11K

37.5% 33.3% 30.0% 27.3%
(83)

184 212

100% 60.8% 40.6% 24.6% 17.2% 10.0%

42

42

42

42

226

267

309

351

7.6%

4.9%

3.2%

2.1%

Source ?

% of GDP
@35.4
%

rates
Federal/central
+
average of
states

@30%

2004
@38.3
%

@39%

@35.1%

[OECD:06]
@40.9
%

Canada

France

United Kingdom Germany

Italy

@39.6
%

Japan

Income
$M/y

Planning-point

800
Maniac
5000???
Maniac
4000??

600

Maniac
3000?
Maniac
2000

400
Maniac
1000
released

200

0
history

future

[Folbre:11]

Center for Budget and Policy Priorities

Relative growth metrics
$1,640B

US GDP (base)

$149,000M

$14,500B
$14,700
B

all scaled by GDP growth
to show relative growth rate
values are actuals

$15,000B

$88,000M

offshor
e
holding
s x 10
$1,000,000

63
K
4,300
K
$368
B
$188B

3K
270
K

$103B
$10,572

$229
B

World income by multinationals

RoW
earnings

US earnings

IRS share

Taxhaven share
16%

84%

Federal Corporate income Tax / Corporate after-tax Profit

From Felix Salmon via [Cowan:11

Inventor,
Inventor
Developer,
Manufacturer,
Marketeer,
Seller

Developer,

Manufacturer,
Marketeer,

Seller
Conventional Royalty split. Platform split.
CROP

Repatriation of
rights to intellectual
capital

IP .
.rights

reduced .

.

linked

Non-routine
Earnings
ongoing

future earnings

Repatriation
of financial
capital
Home Country

Retained
Financial
Capital
Taxhavens

Foreign
Countries

Federal Corporate income Tax / Corporate Earnings

extrapolation of trend

2020

2030

2040

2050

0.05
0.00

Felix Salmon of the St.Louis Federal Reserve Bank
and [Drum:11]

2050?

Statutory US Corporate Tax Rate Compared to OECD Averages,
1981 to 2012T

Federal & States
35%

(279.0)

(301.2)

(4.3%)
(27.2%
Relative US population growth (8.0%,
)
scaled )

adapted from [Sullivan:11L]

(279.0)

(301.2)

(4.3%)
(27.2%
)

Relative US population growth (8.0%,
scaled )

adapted from [Sullivan:11L]

Staff Growth: Linear, Total effort = ½ E x T

Effort
E

Centroid of prior expenditure Lc
here @ 33% of T
(without discounting)

Product
ready for
manufacturing,
distribution,
and sale

Gestation period T

100

87.5

75.0

62.5

50.0

37.5

25.0

%T Time left

12.5

0.0

Comparable A
2300 Comparable B

Original set of
16 comparable
transactions

1380
INTER-QUARTILE RANGE

STATISTICAL MEAN = 1000
INTER-QUARTILE MEAN = 925
=

Inter-quartile 330
range per
IRS formula =
1450 to 325

2200
2100
2000
1900
1800
1700
1600
1500
1400
1300
1200
1100
1000
900
800
700
600
500
400
300
200
100
0

High, not typical
Comparable C

Comparable D
Comparable E
Comparable F
Comparable G
Comparable H

Trusted set of
9 comparable
transactions
Still
high
1230

Comparable I
Comparable J
Comparable K

760

Still low
Comparable L
Comparable M
Comparable N Low
Comparable O
Comparable P

Inter-quartile
range per
IRS formula =
1305 to 685

2300
2200
2100
2000
1900
1800
1700
1600
1500
1400
1300
1200
1100
1000
900
800
700
600
500
400
300
200
100
0

Comparable A
Comparable B

Comparable C

Comparable D
Comparable E
Comparable F
Comparable G
Comparable H

Comparable I
Comparable J
Comparable K
Comparable L
Comparable M
Comparable N
Comparable O
Comparable P

<Moved to Appendix F>

Givens

Results

CONCH income
Diminished CONCH
Income

Income valuation methodI
Income diminished by IP diminution

Incomes

and discounted to annual NPV
$ 250M

$
200M

$
First
full
year

$ 150M
$ adjustments
fraction

$ 100M
$

End of life

$ 50M
$
$ 0M
Relative years

Software economics+ssitc13 tutorial

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