Architecting a Valuation System for R&D Investments by Mitzi Ann M. Mori B.S. Computer Science and Engineering, California State University, Long Beach, 1988 Jacqueline Y. Tyson M.S. Electrical Engineering, Penn State University, 1993 B.S. Electrical Engineering, North Carolina A&T State University, 1990 SUBMITTED TO THE SYSTEM DESIGN AND MANAGEMENT PROGRAM IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF SCIENCE IN ENGINEERING AND MANAGEMENT AT THE MASSACHUSETTS INSTITUTE OF TECHNOLOGY FEBRUARY 2002 2001 Mitzi Ann M. Mod and Jacqueline Y. Tyson. All rights reserved. The authors hereby grant to MIT permission to reproduce and to distribute publicly, paper and electronic copies of this thesis document in whole or in part. Signature of Author 2 MitziAnnM.Mon System Design and Management Program Signature of Author Jacc elined. Tyson System Design and Management Program Certified by Janice A. Klein Thesis Supervisor Senior Lecturer, School Of Management Certified by James M. Utterback Thesis Supervisor David J. McGrath jr. Professor of M/nagement and Innovation, School Of Management Corporate Sponsor Tom A. Kavassalis Manager of Strategy & Planning, XIG, Xerox Corporation Accepted by GM LFIV Ko Steven D. Eppinger Co-Director, LFM/SDM or of Management Sience and Engineering Systems Accepted by TNSTITUTE MASSACHUSES OTECHNOLOGY OF - JUL 1 8 20O2 LIBRARIES C Co-Director, LFMISDM Professor of Aeronautics & Astronautics and Engineering System ----Intentionally Left Blank---- 2 Architecting a Valuation System for R&D Investments by Mitzi Ann M. Mori Jacqueline Y. Tyson Submitted to the System Design and Management Program in Partial Fulfillment of the Requirements for the Degree of Master of Science in Engineering and Management at the Massachusetts Institute of Technology, January 2002 Abstract In an era of intense competition and limited resources, companies continually make critical investment decisions with the expectation these decisions will pay off sometime in the future. One investment area in most companies involves technology. So, given current budget constraints and limited human resources, what technologies should be invested in? The VERDI framework has the potential to provide a standard process to assess early-stage technologies. Value does not always equate to monetary worth. The meaning of value changes just as a technology transforms and progresses through its maturity cycle. Companies need to recognize that they attain more than just a monetary return on technology investments. This thesis provides the background information on the composition of a firm; an explanation of the technology maturity cycle; foundations in technology strategy; explanation of commonly practiced methods for valuing technology and the basis for understanding the importance of intangible assets and their role in valuing early-stage technology. The thesis consists of six sections, Section 1, introduction to the problem and composition of the firm; Section 2, a literature overview, containing the bulk of the background material; Section 3, the valuation methods that have been practiced or are in practice at Xerox, including introduction to resource-based view; Section 4, the VERDI framework, explanation of the adaptation of RBV to the framework; Section 5, the proposed application of the framework at Xerox, VERDIX, including details on committee make up, infrastructure, and a detailed example; and Section 6, the summary, including next steps and further research. 3 ----Intentionally Left Blank---- 4 Acknowledgements We would like to thank our thesis advisors, Janice Klein and James M. Utterback for their guidance, helpful comments, and supportive attitude during the thesis process. Our gratitude is extended to our corporate advisor, Tom Kavassalis whose knowledge, experience and insights were invaluable to us during the writing of this thesis. A special thank you to the SDM staff, our SDM colleagues, and our company, Xerox Corporation, especially our respective local management for supporting us throughout the two-year program. In addition, we extend heartfelt thanks to our families and friends for their undying support, encouragement, understanding and patience. Mitzi Ann and Jacqueline There are some very extraordinary people I would like to express my gratitude toward who encouraged and supported me throughout the SDM experience. The first is my husband and friend, Craig Goldenson, who has been a source of continuous support and positive energy these past two years; my parents, Mitsuru and Carol Ann Mori, for their unending encouragement and for providing a strong foundation on which I have been able to build upon to better myself; Mike G. Salfity, my mentor and friend, who believed in my abilities and encouraged me to apply for the SDM program. And to my thesis partner Jacqueline, to whom I am indebted to, for her dedication, team spirit and hard work during these past two semesters as we have worked and at times struggled on thesis, but I am most grateful for her enduring friendship and sense of humor. Mitzi Ann I would like to thank my parents, Colleen and James Tyson, who have always encouraged me in all of my endeavors. I appreciate your love and support. Thank you, Joel A. Kubby, for being interested in my continued development and encouraging me to apply to the SDM program. And to Mitzi Ann, my thesis partner, for her commitment, thoughtful insights, and tireless efforts during the summer and fall sessions on our thesis. I am grateful for your friendship. "Trust in the LORD with all thine heart; and lean not unto thine own understanding. In all thy ways acknowledge him, and he shall direct thy paths" (Proverbs 3:5-6 KJV). Thank you God for directing my path. Jacqueline 5 ----Intentionally Left Blank---- 6 Table of Contents A b strac t ...................................................................................................................... 3 Acknowledgem ents ............................................................................................... 5 Table of Contents................................................................................................... 7 L ist of F ig u re s ........................................................................................................... 11 L ist 13 ............................................................................................................ Section 1: Introduction........................................................................................... 15 Ov e rv ie w ............................................................................................................... 15 Com pany Overview ...................................................................................... 18 Com pany Values, M ission and Vision Statements........................................ 18 Thesis Outline ................................................................................................... 20 Section 2: Literature Overview ............................................................................. 23 The Charter of .......................................................................................... Marketing and Finance in Support of R&D..................................................... 23 24 The Im portance of Valuing Early Stage R&D Technology ................................ 27 Technology Maturity Cycle ........................................................................... 27 Technology Strategy .................................................................................... 28 Dom inant Designs......................................................................................... 30 Technology S-Curves.................................................................................... 31 Technological Discontinuities....................................................................... 32 R&D Project Portfolio ......................................................................................... 34 Patent Portfolio ................................................................................................. 36 Current Methods Used in Valuation .................................................................. 39 Return on Investm ents.......................................................................................40 Net Present ue ........................................................................................ 40 Internal Rate of Return.................................................................................. 41 Expected Com m ercial Value......................................................................... 42 Options / Real i 44 n .................................................................................. Sum m ary........................................................................................................ Intangibles ....................................................................................................... W hat is an Intangible Asset?....................................... 7 . ... ... .. ... ... .. ... ... .. ... ... .. . . 46 49 49 Im portance of Intangible Assets..................................................................... 50 Types of Intangibles......................................................................................... 52 Intellectual Capital......................................................................................... 52 Hum an Capital ............................................................................................. 54 Structural Capital........................................................................................... 55 Value Extraction................................................................................................ 55 W ays of Valuing Technology ........................................................................... 59 Maxim izing Value from Patent Portfolio ....................................................... 59 Recognizing a Radical Innovation................................................................ 62 Sum m ary...................................................................................................... 64 C on c lu s io n ............................................................................................................ Section 3: The Xerox R&T Valuation Process..................................................... 66 69 O rganizational Structure .................................................................................. 69 Process Context ............................................................................................... 70 Valuation Process.............................................................................................. 71 Resource-Based View ....................................................................................... 75 Foundation of the VERDI Framework.............................................................. 76 Section 4: VERDI Fram ework ............................................................................. 77 The Filtering Process....................................................................................... 79 VERDI Methodology ......................................................................................... 81 Governance ...................................................................................................... 82 Required Inform ation ......................................................................................... 85 Adaptation of the RBV Method for Technology Assessment ............................ 87 Definitions ...................................................................................................... 87 Technology Stage............................................................................................. 90 Technology Assessm ent................................................................................... 91 Section 5: Proposal for VERDIX............................................................................ 95 O ve rv ie w ............................................................................................................... 95 Xerox's Values ............................................................................................. 95 Xerox's Vision and Mission Statements ....................................................... 96 Mem bership...................................................................................................... 97 Accountability ................................................................................................... 99 8 M e e tin g s ............................................................................................................. 1 0 1 Supporting IT Infrastructure ................................................................................ 103 Valuation Process ............................................................................................... 106 S c o rin g ............................................................................................................... 1 09 Assessment Questionnaire ................................................................................. 110 In im ita b ility ...................................................................................................... 1 1 0 D u ra b ility ......................................................................................................... 1 14 A p p ro p ria b ility ................................................................................................. 1 15 E xte n s ib ility ..................................................................................................... 1 16 Competitiveness .............................................................................................. 116 Market Attractiveness ...................................................................................... 118 Assessment Outcome ......................................................................................... 120 Illustration using tone r/man ufactu ring process A ................................................ 121 In im ita b ility ...................................................................................................... 1 2 1 D u ra b ility ......................................................................................................... 12 5 A p p ro p ria b ility ................................................................................................. 12 6 E xte n s ib ility ..................................................................................................... 12 6 Competitiveness .............................................................................................. 127 Market Attractiveness ...................................................................................... 129 Recommendations .......................................................................................... 131 Section 6: Summary ............................................................................................... 137 F utu re W o rk ........................................................................................................ 14 0 B ib liog ra p h y ........................................................................................................... 14 1 R e fe re n c e s ......................................................................................................... 14 3 ----Intentionally Left Blank---- 10 List of Figures Figure 1: Generic Company Structure.................................................................. 18 Figure 2: Marketing Support................................................................................ 25 Figure 3: Elements of a successful strategy ......................................................... 29 Figure 4: Technology "S-Curve"........................................................................... 32 Figure 5: Popularity of Project Selection & Portfolio Methods .............................. 35 Figure 6: Value Hierarchy.................................................................................... 36 Figure 7: Corporate Value Model ......................................................................... 39 Figure 8: Determining the Expected Commercial Value....................................... 42 Figure 9: Solution Methods and Option Calculators ............................................ 45 Figure 10: Financial methods comparison............................................................ 47 Figure 11: Relationship of Intangibles .................................................................. 51 Figure 12: Intellectual Capital of the Firm............................................................ 53 Figure 13: Human Capital and Intellectual Assets............................................... 54 Figure 14: ICM Preferences by Company Type .................................................. 56 Figure 15: Sources of Valuation and Conversion Mechanisms............................ 56 Figure 16: A Model of an IC Company ................................................................ 58 Figure 17: Corporate Decision Model for Investing in Intellectual Property.......... 60 Figure 18: 2x2 Patent Map.................................................................................. 60 Figure 19: Patent Funnel Map............................................................................. 61 Figure 20: Patent Value Model............................................................................. 62 Figure 21: A Radical Innovation Hub.................................................................. 63 Figure 22: Xerox Corporation - Organizational Structure ..................................... 69 Figure 23: R&T spending distribution .................................................................. 71 Figure 24: Portfolio Balance ............................................................................... 73 Figure 25: Example of a bubble chart................................................................... 74 Figure 26: Embryonic to Growth inside R&D Lab................................................. 77 Figure 27: Filtering of an Idea ............................................................................. 79 Figure 28: VERDI Methodology........................................................................... 81 Figure 29: Example of Committee ....................................................................... 83 Figure 30: Resource Assessment ........................................................................ 94 11 Figure 31: Example of the VERDIX committee membership.................................97 Figure 32: askOnce T M Interface ............................................................................. 104 Figure 33: S um m ary M atrix .................................................................................... 120 Figure 34: Toner/manufacturing process A Summary Matrix.................................131 Figure 35: Inimitability Assessment ........................................................................ 133 Figure 36: Competitiveness Assessment ............................................................... 133 Figure 37: Market Attractiveness Assessment ....................................................... 134 Figure 38: VERDIX Assessment ............................................................................ 134 Figure 39: Example outcomes................................................................................135 12 List of Tables Table 1: Characteristics of R&D as a function of technological maturity .............. 27 Table 2: Significant Characteristics of the phases of innovation .......................... 30 Table 3: Value Hierarchy Levels .......................................................................... 37 Table 4: Knowledge Workers, 1900-1999 ........................................................... 50 Table 5: Types of Knowledge ............................................................................. 53 Table 6: Management for Value Extraction ......................................................... 55 Table 7: Technology Proposal................................................................................107 13 ----Intentionally Left Blank---- 14 Section 1: Introduction Overview From the time we are children we are taught the importance of saving for the future. Many of us have vivid memories from the day we opened our first interest bearing savings account and were awarded the responsibility for its maintenance. We remember the excitement of watching it grow over the years, and at that time we may not have fully appreciated the idea of compounding interest, but we understood money put into savings today grew into future earnings tomorrow. Not much has changed since then; today investments are made in the hopes of attaining greater value in the future. Often, as illustrated in the previous example, returns on investments are valued or measured in terms of the money earned or gained. However, other forms of value exist for investments, for instance donating one's time to a volunteer project, where the reward is not necessarily monetary, but instead is the sense of accomplishment or providing service. The art world holds many examples where both non-monetary and monetary value is received. For instance, the painter takes a blank canvas and applies paint to create a scene or a portrait, producing a completed painting, which can be sold at an art gallery. To the patron who buys the painting they purchase it for the "emotional value", for the love of the painting, and though they may understand that in the future the painting may be worth more (may appreciate in value), it is not the driver behind making the purchase. In this instance the art is valued both in terms of non-monetary and monetary terms. In one specific area, marble sculpting, the artist views the raw material both as what it is and as a potential for "what it could be". To many of us, we would just see a slab of marble, but for the artist they can see its future, they see the possibility of what they could create from it. In many instances this scenario parallels early-stage technologies. In this instance, the company would be the 15 artist, and the early-stage technology, the slab of marble. Like the artist, the company has the required skills and tools to develop the early-stage technology into its final form. Sculpting is similar to technology in that the final form is not fully presented at the onset of the process, it is slowly revealed over time as the sculpture evolves from its rough shape to a more refined and completed figure. Technology like art is transformed over time. In for-profit companies, investments and their returns are measured in monetary terms, including R&D investments. Because monetary returns are important the value of R&D investments are primarily based on financial models. R&D investments usually consist of projects in various stages of progress. Some of these projects are actually technologies, which are under development. Like a project, a technology develops and matures over time. During this maturity process more information and data is available, reducing the uncertainty surrounding it. As more information is known, this progression permits for more accurate predictions to be made for its application and potential market appreciation, which allows for the use of financial methods in establishing its value. Much research has been conducted in the area of valuing technology during this latter stage of maturity and after its commercial application. Technology matures and the valuation process associated with each of the maturity levels is different. This is a key correlation many firms consider, but do not adequately account for. The time span between when an investment in a technology is made, to when a monetary return may be realized is not a standard fixed amount of time. Like the technologies themselves, the time frame will vary from one to another, and the rate in which they pass through each maturity stage will differ as well. Sufficient consideration of the dynamic nature of this process is needed in order for the firm to be able to create a process to value the technology in each of its stages. 16 Our interest is in valuing technology before it's been commercialized, and even before it has reached a mature state. Because technology changes over time, in the early stages very little is known about it, including its possible applications, which means there is a lot of uncertainty surrounding it. Since little information is known, the use of financial methods alone is inadequate to assess the value of early stage technology. The thesis explores work performed in the area of R&D valuation and examines the effect of technology maturity on these methods. It examines how value changes as the technology changes over time. The thesis is meant to offer engineers, scientists and managers who are interested in valuing R&D activities in the early-stages with an understanding and a framework to assist them. Enough background has been supplied making this work comprehendible for managers without a technical background. Additionally, this is suitable material for an entry-level engineer or scientist with no exposure to common business practices. To provide some general information, we start with the overview of a firm. 17 Company Overview In setting the background for the research work conducted in this area, it is first important to provide a brief overview of company structure, its vision, mission and strategies. Figure 1 illustrates a company structure that is functionally organized. At the top of the company is the corporate office; at the next level are the major business units (BU) and other business groups that provide support. Corporate R&D Marketing Sls Finan ce Manufacturing BU 1 ..-. BU n Figure 1: Generic Company Structure Company Values, Mission and Vision Statements The values of a firm are the beliefs held collectively by the employees who make up the company. The vision and mission statements are based on the values of the company. The purpose of the vision statement is to establish an understanding of the future of the company, the "where" and "what" the company wants to be in the future. The intent of the mission statement is to explain at a high level, what steps are necessary for the company to achieve its vision. The mission statement defines what the company will do, and allows for each organization within the company to create their own mission statement to aid the firm in achieving its vision. The strategies of the company are put into place to support the mission statement of the company. The business strategy is broadly stated allowing the individual organizations that make up the firm to create the specific strategies to support their mission statement and help achieve the corporate vision. 18 The technology strategy complements the business strategy and provides direction to the technical communities within R&D. The patent and project portfolio strategies and their management are part of the technology strategy. The technology strategy helps each group in the R&D organization to align their objectives to the organization's mission to aid the company in meeting its mission, and ultimately to achieve its vision. 19 Thesis Outline Section 2, contains the literature overview that covers important areas needed to provide the background information on understanding the valuation practices currently used. It provides an understanding of the charter of R&D, technology maturity, marketing and finance. Financial models are introduced, briefly described, and their advantages and disadvantages listed. This section introduces intangible assets and their importance in the valuation process. Lastly it concludes with our findings that a new framework needs to be established to value early stage technology. Section 3 details the methods and practices used at Xerox Corporation. This section includes current practices as well as methods that have been tried in the past. It provides an explanation of the current practices, why they are used and the deficiencies of each. Introduces the resource-based view perspective (RBV) and proposes how this method will be used in the new framework created to assess early-stage technology. Section 4 provides the new framework, VERDI (Valuing Early-stage R&D Investments). Details how RBV was adapted to assess early-stage technologies. The framework is defined in its entirety, including the infrastructure required, the committee and the governing regulations. This section ties together the concepts introduced in Section 2. Section 5 is an example application of the VERDI framework, a proposal for use at Xerox Corporation. It details the extent of how the framework needs to be customized for a company, like Xerox, to adopt and use it. The customized framework, VERDIX (\aluing Early-stage R&D Investments at Xerox) is presented in detail. Included is the composition of the committee, the process by which they will conduct themselves and the assessment criteria used. The section concludes with scoring the assessment and making recommendations. While a proposal for application of the framework is outlined, it has not been tested on valuing early-stage technology. 20 Section 6 is the summary that recaps the intent of the thesis. It includes what specific application the authors would have liked to perform, and the next steps that should be taken to prove the framework can assess early-stage technologies. Also it provides a suggestion for further research that could perform a side-by-side comparison of the various assessment techniques discussed in the thesis. 21 ----Intentionally Left Blank---- 22 Section 2: Literature Overview The Charter of R&D The introduction briefly outlined the structure of a corporation, its foundation, vision, mission, and strategies. For the purpose of this work, it is necessary to elaborate on how the corporate strategy impacts the charter of the R&D organization, which is to identify and develop technologies to support current and future products, and/or create the potential for external opportunities. The R&D organization defines the technology strategy ensuring proper alignment to the overall business strategy. Contained within the technology strategy are the IP (intellectual property, i.e., patents, trademarks, etc.) and R&D project portfolio strategies. So, the project and patent portfolios are governed by the overall technology strategy. All strategic decisions are made in the hopes of improving the future of the company, but the decisions involving R&D "are difficult because they are usually - made in the face of many uncertainties . The time between the decision point and the point at which the cash register starts ringing is typically long and filled with unknowns; . The R&D process is inherently uncertain (without uncertainty there would be no R&D); no one knows whether and when R&D will succeed, nor the level of that success; . The markets to be served are most uncertain at the time R&D projects are commissioned; and Successful R&D often takes a company into unfamiliar areas requiring partnerships, alliances or acquisitions, and new ways of doing business." (Matheson, 1998, p.8) Keep in mind the R&D organization does not work in a vacuum. To be effective it requires information and input from corporate, marketing and finance. 23 Corporate establishes direction; marketing provides information on customer needs, market trends, competition, and etc.; and finance, provides the tools which underpin the assessment within both the R&D project and patent portfolio processes. More specifically, the portfolio decision-making processes synthesize this information to enable the company to strive toward its overall mission. Marketing and Finance in Support of R&D One primary support function in the company is the marketing group. Their job is to identify and understand customer needs and to provide this information to the company, enabling it to profitably produce products and services to meet these needs, to retain current customers, in addition to attracting new customers. (Ariely, 2000; Kotler, 1999, p.3) In order to identify and understand these needs, the marketing group must obtain information on the customers. The marketing group amasses a large amount of data to help them understand customers' wants and needs. There are three main types of data collection, internal, intelligence, and market research data. Internal data comes from within the company; data is usually housed in the internal databases maintained by the various organizations of the company. Intelligence data contains publicly available information on competition and market trends, the process of collecting and analyzing this data is marketing intelligence. Finally, market research is a formalized study to gather specific data for a certain market situation. (Kotler, 1999, p.100-101) Since the market place is dynamic, this data collection is an on-going activity. Marketing can be defined as "the process by which decisions are made in a totally interrelated changing business environment on all the activities that facilitate exchange in order that the targeted group of customers is satisfied and the defined objectives accomplished." (Hisrich, 2000, p.3) The relationship of marketing to other groups in the company is best illustrated in the Figure 2. 24 R&D Purchasing Manufacturing Finance Managment ManamentMarketing Accounting Figure 2: Marketing Support Source: (Kotler, p.65) Another support function in the company is the finance group. "Finance is the application of a number of financial and economic principles to maximize the wealth or overall value of a business" (Gropelli and Nikbakht, 2000, p. 3). Their job is to manage the cash within the company as well as track its assets. The finance group supports the business operations and yearly budgeting activities of each organization. This allows each organization to understand its current level of spending at anytime during the year. In addition, they look for opportunities to increase capital and for the best opportunity to invest capital to increase value. So, how is value assessed? The word valuation traditionally means the monetary worth of an item a company has rights to or owns. Financial (economic) methods are a means of quantifying this monetary value. This includes the valuation of physical assets as part of the annual reporting process, and the use of Generally Accepted Accounting Principles (GAAP) to ensure uniform reporting. We have shared how the organization must interact to achieve its desired objective, but it is just one part of a bigger picture. More importantly, intellectual capital (i.e. human capital, intellectual assets) is the foundation of an organization's ability to capitalize on the knowledge needed to create value for the firm. Not enough emphasis is placed on the importance of these intangible 25 assets. Our work will address how intangible assets factor into valuing early stage R&D investments. We begin by addressing why it is so important to value early stage R&D investments. 26 The Importance of Valuing Early Stage R&D Technology In order to understand the importance of valuing early stage R&D technology, it is essential to understand that technology changes with time. We start by defining the technology maturity cycle. Technology Maturity Cycle In order to discuss the technology maturity cycle, a definition of technology is needed. Roussel, et al "view technology as the application of scientific and engineering knowledge to achieve a practical result" (Roussel, et al, 1991, p. 13). The phrase, "achieving a practical result" implies technology moves through a cycle (process), and ultimately it approaches a limit at some point in time. Table 1: Characteristics of R&D as a function of technological maturity Adapted from Source: (Roussel, 1984, p. 30), Research Management - Table 1 represents characteristics of R&D as a function of technology maturity. For our purposes, we define the technology maturity cycle using three stages (1) embryonic, (2) growth, and (3) mature. In the embryonic stage, the attributes of the idea/technology are documented and studied to determine its viability before further development can occur. If it passes the first phase, it enters the growth stage. In this phase, further studies are conducted to prove the technology is reliably repeatable and all its characteristics fully studied and understood. Having passed the second phase, it enters the mature stage, where it is tested to determine where it will be most useful. Upon successful completion 27 of the third phase, the technology is mature enough to leave the confines of R&D and enter the product development organization'. Progressing technology through these three stages is the primary output of an R&D organization. The ability to successfully compete requires innovations be incorporated into new products/services produced by the business units (BU's) of the firm for delivery to the marketplace. Technology maturity is an element of something much broader, innovation. Innovation is described as "a connected process in which many and sufficient creative acts, from research through service, couple together in an integrated way for a common goal" (Morton, 1971, p. 3). Implied in this process is timeliness. If a product fails to reach the market in the predicted time or is pre-empted by competition, the expected growth may not be sufficient to warrant the investment. While the company expects its innovations will be included in new products/services, the reality is some are not. Regardless of inclusion, the innovation process has positive results in organizational learning and may provide other benefits such as patents or the potential for licensing. So, how is this value (benefit) determined? Technology Strategy Investing in early stage R&D has the potential to create significant long-term value for the company. If successful commercialization takes place within the "right" market window, the firm has the potential to reap the benefits (early profits) of being the first-mover. "In some industries, a first mover may be in a position to enjoy temporarily high profits from its position. It may be able to contract with buyers at high prices during early scarcity of a new item, for example, or sell to buyers who value the new technology very highly." (Porter, 1985, p. 188) 1 In this definition, the R&D organization matures the technology to a point where it can be developed into a product. The development (commercialization) usually occurs in a business unit, and not in the research organization. 28 Given monetary gains are essential for companies to survive, a strategy which enables them to achieve this objective is needed. So, what are the elements of an effective strategy? "Effective strategies rest on three foundations: 1) value I----------------- I I ,What technologies I 'Ho should we invest | in? II I ------------ ' - - creation, 2) organizational capability, and 3) competitive understanding" as shown in Figure 3 (Henderson, 2001, Lecture 1). Mark s v will we deliveri |val ue across the Ival ie chain? ation '-- T ---------- Organizational Competitive Understanding Capability ------------ I- iwshall we pture the 'va lue we create? IHc :How shall we ,support innovation |ca 'across the firm? I I----- I I. -- -- -- -- ---- -- Figure 3: Elements of a successful strategy Adapted from Source: (Henderson, 2001, Lecture 1) Value creation requires a decision on what technologies the company should invest in. This decision can be tied to managing the innovation process within the company and begins with an assessment of the technology (dominant designs, S-curve, etc.), and the nature of the market (Moore and Christensen) (Lim, 2001). The tools are used to 1) assess where the technology is with respect to the competition, and 2) investment in incremental technology alone will not maintain a company's competitive edge. 29 Dominant Designs In Utterback's work, he defines three phases fluid, transitional, and specific of industrial innovation (Utterback, 1996, p. 92). Table 2 provides significant characteristics in the three phases of industrial innovation. Innovation Sources of innovation Products Production Processes R&D Equipment Plant Fluid hase Frequent major product changes Transitional phase Major process changes required by rising demand Industry pioneers; product users Diverse designs, often customized Manufacturers; users Flexible and inefficient, major changes easily accommodated Focus unspecified because of high degree of technical uncertainty General-purpose, requiring skilled labor At least one product design, stable enough to have significant production volume Becoming more rigid, with changes occurring in major steps Focus on specific product features once dominant design emerges Some sub-processes automated, creating islands of automation Small-scale, located near user of source of General-purpose with specialized sections Low Few, but growing in numbers with widely fluctuating market shares Functional product performance Informal and entrepreneurial To imitators, and patent challenges; to successful product breakthroughs Moderate Many, but declining in numbers after emergence of dominant design Product variation, fitness for use Through project and task groups To more efficient and higherquality producers Specific phase Incremental for product and with cumulative improvements in productivity and quality Often suppliers Mostly undifferentiated, standard products Efficient, capital intensive, and rigid; cost of change high Focus on incremental product technologies; emphasis on process technology Special-purpose, mostly automatic, with labor focused on tending and monitoring equipment Large-scale, highly specific to particular products innovation Cost of process change Competitors Basis of competition Organizational control Vulnerabilities of industry leaders High Few, classic oligopoly with stable market shares Price Structure, rules, and goals To technological innovations that present superior product substitutes Table 2: Significant Characteristics of the phases of innovation Source: (Utterback, 1996 p. 94-95) Taking a closer look at R&D, the following characteristics exist: " "Fluid - focus unspecified because of high degree of uncertainty * Transitional - focus on specific product features once dominant design emerges * Specific - focus on incremental product technologies; emphasis on process technology" (Utterback, 1996, p. 94-95) Successful integration of early stage technology can provide the impetus for a dominant design. "A dominant design in a product class is, by definition, the one 30 that wins the allegiance of the marketplace, the one that competitors and innovators must adhere to if they hope to command significant market following. The dominant design usually takes the form of a new product (or set of features) synthesized from individual technological innovations introduced independently in product variants" (Utterback, 1996, p. 24). Typically, before a dominant design many competitors are in the market space. However, once a dominant design emerges, a number of competitors exit the market. This can amount to significant market advantage to those firms still remaining. So, the dominant design perspective is helpful in assessing the technology, and in comparing where the technology is compared to incremental and non-incremental technology. Also, it gives a visual representation as to which phase in the industrial innovation process the company resides. Technology S-Curves Another mechanism to assess the stages of technology is the technology Scurve. Foster's S-Curve is a mechanism that can be used to determine the technological position of a firm relative to its position in the industry. While knowing the exact position is difficult, one can use this to help forecast where the firm should be to remain a player. As such, we recommend the S-curve be used as more of a descriptive tool than a prescriptive tool (Henderson and Lim). It is also useful to get a handle on when the firm is approaching the natural/physical limit of a technology (See Figure 4), because as the technology reaches its physical/natural limit, more effort ("money") is required to make incremental improvements. In simple terms, there is a significant cost to making these improvements, resulting in smaller gains. 31 Natural Limit Performance Metric 2 1 Figure 4: Technology "S-Curve" Adapted from Source: (Henderson, 2001, Lecture 2) Managing the transition between S-curves is a critical strategic task: sticking with an old S-curve can be disastrous (Henderson, 2001, Lecture 3). Technological Discontinuities "The Innovator's Dilemma" by Clay Christensen asserts that customers don't understand discontinuities. A discontinuity is a breakthrough innovation that advances by a large margin the technological performance of an industry (Christensen, 1997). Often, in its earliest embodiment, the performance is below that of the sustaining technology as shown by the second S-curve in Figure 4. "Value is created when new technology is matched to customer need. But customer needs change: as the technology evolves existing customers develop new needs, and in addition the technology may appeal to new kinds of customers, with new kinds of needs" (Henderson, 2001, Lecture 3). This perspective can help a firm understand its technology position as it relates to others in the industry. Christensen sites a number of examples (i.e. disk drive) of how companies in certain industries could not make the leap from incremental to discontinuous technological advances. Incremental advances do not enable the company to benefit from discontinuous technological advances (Christensen, 32 1997). This is further evidence for the importance in knowing how to value early stage R&D. We have stated a company cannot maintain its competitive advantage by solely making incremental improvements to current technology. These incremental improvements often don't provide the highest margins on the investment and consequently, the company must invest in new technology in the hopes of creating long-term value. Therefore, it is imperative to know how to value early stage technology (potential disruptive technology) as a means to capitalize on these investments. 33 R&D Project Portfolio The R&D project portfolio is a collection of on-going projects in various stages of technology development and having varying levels of risk. The R&D projects are managed in a portfolio to maintain a certain risk balance. The portfolio is dynamic. As projects progress through the development cycle, decisions need to be made to determine which projects will remain in the portfolio, which will be abandoned and if applicable which will be added. (Balachandra, 1989, p.19) It should be noted that these projects, though listed, as independent entities in the portfolio are usually dependent. For example, three of the projects may be required to integrate at their point of maturity to form a subsystem that will be used in a product. The following chart indicates methods used for selection of projects and for managing the portfolio process. R. G. Cooper et al cooperatively with the Industrial Research Institute (IRI) published results from an "R&D portfolio management best practices study: method used & performance results achieved" (Cooper et al, 1998). One conclusion from this benchmarking study follows. "Economic models are the most popular project selection tools (Figure 5). They are familiar to managers, and they are accepted for other types of investment analysis in the business - for example, for capital expenditure decisions. But they do have limitations. The toughest project selection decisions lay in the first few gates of the process when relatively little is known about the project. And it is here that traditional economic approaches suffer the most, because they require considerable financial data that are quite inaccurate" (Cooper et al, 1998). 34 77.5 77.3 Financial Method 1 78.0 72.5 Business Strategy 1 42.1 40.6 Bubble Diagram Scoring Model 137.9 23.1 Checklists 36.1 Others 0 Reads: . 77.3% of businesses use a Financial method for project selection & portfolio management. 77.5% of the top performers use this method. 40 20 60 80 Percent of Business Using (%) Figure 5: Popularity of Project Selection & Portfolio Methods Source: (Cooper et al, 1998) 35 100 Patent Portfolio Companies want to obtain the maximum benefit from their patents. The most obvious use is to incorporate the patents into successful opportunities. A framework that many companies are trying to successfully incorporate into their overall strategy is the idea of extracting the maximum value from their patent portfolios for monetary returns. This is not a new idea, but has become increasingly more strategic in nature given the rewards that certain companies have had in aggressively using their IP portfolios. A primary example is IBM, who currently receives $1.5 billion in revenue annually from licensing of its intellectual property. (Davis & Harrison, 2001, p.2) A study conducted on how various companies' extracted value from their IP portfolio yielded the Value Hierarchy. It's a pyramid that has five levels, and each level represents what the company expects to receive in terms of value from its IP portfolio. It is important to understand, that the levels build upon one another. (Davis & Harrison, 2001, p.12) Figure 6 shows the Value Hierarchy and Table 3 provides a description of each level in the pyramid and the best practices to achieving each level. Visionary Integrated Profit Center Cost Center Defensive Figure 6: Value Hierarchy Source: (Davis & Harrison, 2001, p.12) 36 Level Level 1 Level 2 Name Defensive Cost Center Key Objectives Generate a significant number of patents for their IP portfolio Ensure that their core * business is adequately protected Initiate basic processes to * facilitate patent generation and maintenance * Initiate basic processes for enforcing patents * Ensure that their technical people have freedom to innovate & Reduce costs associated with their IP portfolio(s) Refine and focus the IP that * is allowed into their portfolios * 1. 2. 3. 4. 5. 1. 2. 3. 4. 5. Level 3 Profit Center o 0 Level 4 Integrated 0 * " Level 5 Visionary 0 * * Extract value directly from their IP as quickly and inexpensively as possible Focus on non-core, nonstrategic IP that has tactical (as opposed to strategic) value 1. 2. Extracting strategic value from their IP Integrating IP awareness and operations throughout all functions of the company Becoming more sophisticated and innovative in managing and extracting value from the firm's IP 1. Staking a claim on the future Encouraging disruptive technologies Embedding intellectual assets and IA management into the company culture 3. 4. 5. 2. 3. 4. 5. 1. 2. __ Best Practices Take stock of what you own. Obtain intellectual property while ensuring design freedom. Maintain your patents (don't let the good ones lapse). Respect the IP rights of others. Be willing to enforce, or don't bother to patent at all. Relate patent portfolio to business use. Establish an IP committee with cross-functional members. Establish a process and criteria for screening patents. Set detailed guidelines for patent filing and renewal. Regularly and systematically review the portfolio to prune patents not worth maintaining. Obtain management buy-in. Start a proactive licensing organization. Consider IP donations and royalty audits. Organize to extract value. Develop advanced screening criteria. Align IP strategy with corporate strategy. Manage IP and intellectual assets across multiple functions. Conduct competitive assessment. Codify IP knowledge and share it with all business units. Focus on strategic value extraction. Patent strategically - Identify and exploit trends in one's own industry to create new rules of the game. Institute a performance measurement and reporting system. Table 3: Value Hierarchy Levels Source: (Davis & Harrison, 2001) 37 The Value Hierarchy is a tool that "allows companies to understand where they are in their awareness of IP as a business asset, and to create a way for them to articulate where they want to be, and then identify the best practices to allow them to get there." (Davis & Harrison, 2001, p. 11) It's also important to understand not all companies need to strive to be at level 5, and that many companies are actually engaging in activities from several different levels. (Davis & Harrison, p.14) 38 Current Methods Used in Valuation Let's look at value using the Corporate Value Model in Figure 7. "Corporate value is derived from four elements: its operations or business units, its financial structure (assets and liabilities), its management, and its opportunities. Value of Corporation Operating Businesses Management Financial Structure Other Opportunities R&D Cash Other Figure 7: Corporate Value Model Source: (Boer, 1999, p. 17) The independence of a company's operations from its financial structure is now widely accepted in the science of valuation. The most common valuation approaches determine the value of the operating businesses based on their earnings or cash flow, subtract the liabilities, and add back the value of any nonoperating assets" (Boer, 1999, p. 17). These do not account for the future value a company can receive based on investments made at a particular point in time. For example, an R&D investment has the potential to create value in the future. So, how can we measure the value (return) of this type of investment? 39 Return on Investments Investments are made on the premise the outcome will be of greater value than the initial amount invested. A common method to value an investment is to calculate the return on investment (ROI). This calculation can be performed before, during or after the investment has been made. The base formula is earnings divided by the investment. If the calculation is attempted before the outcome of the investment is known, than the earnings become a discounted cash flow. Net present value and internal rate of return are two of the most common methods. Alternatively, other methods exist to forecast the potential monetary returns on an investment. Two methods in use today are expected commercial value and options (real options). Though other methods exist, we provide a short description of NPV (Net Present Value), IRR (Internal Rate of Return), ECV (Expected Commercial Value) and Options. Following the description is a comparison among these methods. Net Present Value "The net present value (NPV) is defined as the present value (PV) of a project's future cash flow minus the initial investment (1) in the project" (Gropelli and Nikbakht, 2000, p. 151). NPV = PV - I If the project has a negative NPV, the cost of the project is more than what it will be worth, so the decision would be not to invest. However, the investment is recommended for projects with an NPV greater than or in some cases equal to zero. 40 Internal Rate of Return "The internal rate of return (IRR) is a measure of the rate of profitability, and the discount rate that makes the NPV equal to zero" (Gropelli and Nikbakht, 2000, p. 159). In other words, "it provides a percentage figure that indicates the relative yield on different uses of capital" (Riggs, 1982, p. 119). IRR = (FV/PV)l/" - 1 FV = future value PV = present value N = number of investments One major weakness of these methods is using a current snap shot in time. Both methods produce a result that is the discount cash flow value of "today", and do not account for "tomorrow" or anytime out in the future. In reality, the farther out the more difficult it is to estimate. Another shortcoming is using a constant discount rate over the project duration, this leads to inaccuracies because in reality the discount rate fluctuates just as inflation and interest rates do. Finally, neither of these takes into consideration the technology or market success factors. Technology success and a certain level of market success are implied to create the future cash flow earnings. ECV and Options take into account time and the success factors (technology and market). These are an improvement over simple NPV and IRR since uncertainty in both technology and market success can be refined as more information is attained. 41 Expected Commercial Value "The ECV method seeks to determine the value or commercial worth of projects (see Figure 8) and is one of the more well-thought financial models" (Cooper et al, 1998). "It uses decision-tree analysis, breaking the project into decision stages - for example, Development and Commercialization". The benefit of decision-tree analysis is it defines the various possibilities with probabilities of each occurring. "This method also approximates real options theory, and thus is appropriate for handling higher risk projects" (Cooper et al, 1998). Commercial Success $ECV Development PCs Technical Success Launch Pts $C Yes No Yes Commercial Failure Technical Failure $ECV = [(NPV * Pcs - C) * Pts - D] $ECV = = $ Pts $PCs= = $D = $C $NPV = Expected commercial value of the project Probability of technical success Probability of commercial success (Given technical success) System development costs remaining in the project Commercialization (launch) costs Net present value of projects future earnings (discounted to today) Figure 8: Determining the Expected Commercial Value Source: (Cooper et al, 1998, p. 165) Unlike NPV, ECV recognizes technology investments are not always one-time investments, but are traditionally made in increments over time. In addition, it takes into account technology and market success factors. However, in order to calculate ECV, the formula requires calculating the expected NPV, and suffers from the same inherent shortcomings. 42 Cooper et al revealed in their best practices survey, "in spite of their theoretical rigor, financial models (NPV and ECV) yield the worst portfolios of projects, not because the models are wrong, but because the input data were so much in error" (Cooper et al, 2001, p. 5). In essence, the outcome is only as good as the assumptions. 43 Options / Real Options One of the most prevalent uses of options is in the stock market. For example, many employees are given stock options as part of their compensation packages. Stock options are presented in a document stating the maximum number of shares that can be purchased, the exercise price and expiration date of the options. These options are call options and allow the employee to purchase stock at the price stated in the document within the specified time. Options are not permanent and need to be exercised before their expiration date because once they expire they are worthless. The idea behind stock options is the opportunity for large gains; it allows the employee to decide when in the future (bounded by the options expiration date) to exercise the options to gain the most value. For a call option, the employee wants to exercise the options when the exercise price is much less than the market share price. "A real option is the extension of options pricing theory for managing real (nonfinancial) assets." (Amram & Kulatilaka, 1999, p. vii) The real options approach is not always needed, and when there are no options present, traditional tools are sufficient. Real options are beneficial when "uncertainty is large enough that it is sensible to wait for more information; value seems to be captured in possibilities for future growth options rather than current cash flow; and there will be project updates and mid-course strategy corrections." (Amram & Kulatilaka, 1999, p.24) "The following inputs are the only information you need to value a real option: . The current value of the underlying asset . The time to the decision date, which is defined by the features of the investment . The investment cost or exercise price . The risk-free rate of interest . The volatility of the underlying asset 2 Non-financial is added for clarity 44 . Cash payouts or non capital returns to holding the underlying asset" (adapted from Amram and Kulatilaka, 1999, p. 37) Figure 9, is a representation of the real options process and solutions methods and option calculators. laI Identify and Define Real Options 1*o Establish the Mathematical Representation Choose Solution Method Dynamic Programming PDE J4 .9 co) 4I Simulations 4' 4, Choose Option Calculator * Analytical Solutions Binomial Model Monte Carlo Method (e.g. Black-Scholes) , Analytical Approximations . Numerical Solutions (e.g. Finite Difference Methods) Figure 9: Solution Methods and Option Calculators Source: (Amram and Kulatilaka, 1999, p. 108) The "real option" approach addresses risk and uncertainty, because levels of uncertainty are dealt with in relation to time. (Amram & Kulatilaka, 1999, p.14) Flexibility exists with this approach in that managers can change their investment decisions when things don't turn out as planned. "Every good manager knows that many decisions are best taken later rather than sooner, thereby allowing us to observe how conditions actually evolve before committing ourselves to capital expenditures" (Verity, 1999, p. 1). 45 Though Merck has been using options thinking since the mid 1990's (Nichols, 1994, p.88-99), the options approach for valuation is not widely used. Pharmaceutical companies invest heavily in R&D, and "options thinking" is a good method to apply over the course of this industries commercialization process. "In the words of the company's CFO Judy Lewent "When you make an initial investment in a research project, you are paying an entry fee for a right...To me all kinds of business decisions are options" (Nichols, 1994, p. 8899). One of the shortcomings of the Real Options approach is the complexity in using it. "Although the option valuation model vastly increases our ability to value financial and non-financial assets, it remains a model. Our experience is that model risk, caused by poor model framework, fails to capture the key drivers of option value and is the largest potential source of an error in the real options approach.. .Framing a model requires trade-offs. Novice users of the real options approach tend to include too many sources of uncertainty in the model framework, increasing the potential for tracking error." (Amram & Kulatilaka, 1999 pp.60-61) Summary Each method discussed above has its benefits and shortcomings. Our major findings in the analysis of current financial methods are as follows: . NPV is more applicable in assessing the expected value of a technology in its mature stage rather than in its earlier stages. . NPV and IRR rely on the prediction of future cash flows. However, no one can predict the future with a high degree of accuracy. Also, these methods don't take into account uncertainty and risk. In most instances, more risky investments equate to higher returns if successful. . The ECV method requires calculating NPV, so the same shortcomings apply. It also relies on predictions of technical and commercial success. 46 . To be effective, real options must account for all possible outcomes. In addition, it relies on assumptions. The outcome is only as good as the assumptions. Method NPV Advantages * Uses Cash flows instead of net earnings " Recognizes time value of money " Straightforward IRR 9 Uses Cash flows instead of net earnings " Recognizes time value of money " Straightforward ECV * Options Decision tree analysis 9 Can use for incremental investments * Considers technical and commercial success factors * Handles staged investments * Not a one time decision Disadvantages e Prediction of future cash flows * Wrong assumption on future cash flow can lead to wrong decision . Discount rate can change from year to year like interest rate * Doesn't take into account risk * No consideration of staged investments . Assumes technical and market success e Gives unrealistic rates of return * Give different rates of return * Doesn't take into account risk * R&D usually has staged investments * Assumes technical and market success * Uses NPV so has its shortcomings * Assumptions on technical and commercial success e Complex * Dependent on correct model/framework * Not easy to use . Assumptions on technical and commercial success Figure 10: Financial methods comparison "Traditional concepts of return on investment (ROI), such as pay-back period, discounted cash flow, net present value and internal rate of return, can be applied with increasing degrees of precision along the new product development sequence. A rough estimate can be made after comparing the proposed opportunity with the selection criteria and assigning priority. A better estimate 47 can be made at the conclusion of the quantitative confirmation research, and a best estimate can be made after the final production model of the product and marketing mix have been designed." (Bacon and Butler, 1998, p. 127) Our conclusion is if used in isolation, these methods are inappropriate to value technology in its earlier stages. 48 Intangibles Intangible assets have been around for a long time. Even before the accounting system was implemented, merchants and traders were reliant on their reputations for the well being of their business. Their reputation influenced their customers in ways such as attracting or dissuading potential business. It's reasonable to argue most people would prefer to do business with a fair and honest merchant rather than one they thought of as dishonest. Though these merchants may not have associated a monetary value to their reputation, they knew it added value to their business. The question is, if intangible assets have been around so long, and we knew they were valuable, why are they so important now? To answer this, we first need to define in more detail intangible assets and then examine the emergence of their importance. What is an Intangible Asset? Simply stated an intangible asset is a "claim to future benefits that does not have a physical or financial (a stock or a bond) embodiment." (Lev, p.5) In the example above, the intangible asset was reputation. Today, we can think of many companies that have strong reputations and brands, for instance Coca Cola or Disney. The terms intangibles, intellectual capital and knowledge assets are often used to refer to intangible assets. Three major linkages of intangibles exist and are characterized by their relation to the generator of the assets: discovery (innovation), organizational practices, and human resources. Product innovations are an example of intangibles generated from discovery and are usually produced from a company's R&D organization. Intangibles created by organizational practices, relate to better, smarter and different ways of doing business. And those produced from human resources are generally created by unique personnel policies. (Lev, pp. 6-7) We define intangible assets as nonphysical sources of value (claims to future benefits) generated by innovation, unique organizational processes or human resources, or a combination of these. They often interact with tangible assets to 49 create corporate value and economic growth. (Lev, p7; Sullivan, p.17; Boulton, p.30) Importance of Intangible Assets So, why are they so important now? As quoted by Alan Greenspan, the U.S. Federal Reserve Chairman, "virtually unimaginable a half-century ago was the extent to which concepts and ideas would substitute for physical resources and human brawn in the production of goods and services." (Boulton, 2000, p xv) Recently in a speech given at the Washington Economic Policy Conference of the National Association for Business Economics, Washington, D.C. on March 27, 2001, Greenspan stated, "over time, and particularly during the last decade or two, an ever-increasing share of GDP has reflected the value of ideas more than material substance or manual labor input". These statements are backed by the increase of knowledge workers in the workforce. As proof of this, Table 4 shows the increase of knowledge workers in the U.S. workforce over the past century. Year 1999 Knowledge Workers (millions) 7.6 Propo rtion of all Emplo yment (%) 5.7 1990 5.6 4.7 1980 3.7 3.8 1970 2.6 3.3 1960 1.6 2.3 1950 1.1 1.9 1900 0.2 0.7 Table 4: Knowledge Workers, 1900-1999 Source: (Lev, 2001, p.15) There are two related economic factors behind this - the first is intense business competition brought on by globalization and the second is information technology. "These two fundamental developments have dramatically changed the structure of corporations and have catapulted intangibles into the role of the 50 major value driver of businesses in developed economies." (Lev, 2001, p.9), see Figure 11. Intensified competition, Induced by globalization, deregulation, technological change Fundamental corporate change, Emphasis on innovation, non-vertical organization, intensive use of information technology Innovation - related intangibles Human Resource intangibles Organizational intangibles Figure 11: Relationship of Intangibles Adapted from Source: (Lev, 2001), Intangibles: Management, Measurement and Reporting 51 Types of Intangibles A number of intangibles have been identified as interacting with one another to create the intellectual capital of a firm. The identification of these capitals has come about by the models developed around intellectual capital. There are two primary areas of focus, "one is to help understand and discuss how an organization might develop intellectual capital; and the other is to understand intellectual capital so value may be extracted and used by the organization." (Stewart, 1998, p.76-77) Teece has also identified value can be captured from knowledge and competence. (Teece, 1998) In valuing R&D investments, our emphasis is in the area of value extraction. The main drivers in extracting value are the three 'capitals' intellectual, human and structural capitals. Intellectual Capital Intellectual capital is essentially the knowledge of the company, both tacit and codified, and "is the sum of everything everybody in a company knows that gives it a competitive edge", (Sullivan, 2000; Stewart, 1999). The knowledge of a company is equated to 'capital' because it "brings to the foreground the brainpower assets of the organization, recognizing them as having a degree of importance comparable to the traditional land, labor, and tangible assets." (Sullivan, 2000, p.4) Codified knowledge is knowledge that has been captured in some form of communication medium, i.e., electronic, documentation, etc. Tacit knowledge resides with an individual and is often a skill, ability or classified as 'know-how'. (Sullivan, 2000) The difference between tacit and codified knowledge is best defined and depicted in Table 5, below. 52 Industrial Knowledge Tacit Definition Knowledge which is difficult to articulate and may be embedded in Codified Knowledge which is written down in some medium ways of doing things Ownership Examples Ownership resides with the holder of the know-how; difficult to copy and/to Technology easier to protect using the mechanism of the law; yet also easier to transfer transfer Blueprints Experience Computer Programs Formulae Documents Lore Group Skills Table 5: Types of Knowledge Source: (Sullivan, 2000, p.228) Included in intellectual capital, are intellectual property and intellectual assets as illustrated in Figure 12. Intellectual assets are the human knowledge that is captured in some form of media, and thus owned by the company. Intellectual property are those intellectual assets that are legally protected. These are the sources of innovation the firm can commercialize to realize profits. The main difference between an intellectual property and an intellectual asset is formal legal protection. Intellectual property takes the form of patents, copyrights, trade secrets, and trademarks. (Sullivan, 2000, p.231) Intellectual Capital Figure 12: Intellectual Capital of the Firm Source: (Sullivan, 2000, p.229) 53 Human Capital Human Capital is really the source of all knowledge in the company. It is not owned by the company, but on loan to the company from the people who possess it. (Mayo, 2001, p.31) Contained in it are the individual and collective capabilities, commitment, personal knowledge and experience, including tacit knowledge, of all persons related to the company whose job is directly related to delivering service or value to the customer, these include employees, contractors, suppliers, etc. "But it is more than individuals alone: It includes the way in which they work together, and the relationships they have both inside and outside the organization" (Mayo, 2001). Human capital is a resource to the company because it can generate value for the company, yet the company could not deliver this value without the employees themselves. (Sullivan, 2000, p.229230) From a value extraction perspective, it is important to understand the difference between human capital and intellectual assets. The company owns its intellectual assets, but does not own the human capital it employs. So it is imperative the company transforms knowledge from its human capital to intellectual assets so it can assert ownership of it. (Sullivan, 2000, p.229) Figure 13 shows the relationship between human capital and intellectual assets. Human Capital Intellectual Assets Knowledge Commercializable Intellectual Assets & _ _ _ _ _ _ _ -_ _ _ Know-How Supporting Intellectual Assets - Administration - Infrastructure Figure 13: Human Capital and Intellectual Assets Source: (Sullivan, 2000, p.158) 54 Structural Capital Structural Capital is the mechanism to support the intellectual capital. It remains in place when the human capital goes home and encompasses direct and nondirect support, as well as physical and non-physical assets. Examples of direct support include physical elements like desks, computers, and telephones, and non-physical items such as information systems, software and work processes. Indirect support includes physical elements such as lights, electricity, and water, and non-physical items such as strategic plans, cost structures and payroll systems. Overall "the structure capital provides the environment that encourages the human capital to create and leverage its knowledge." (Sullivan, 2000, p.232) Value Extraction There are three types of management practices that view intellectual capital as a form of value extraction. They are IAM, (Intellectual Assets Management), IPM (Intellectual Property Management) and ICM (Intellectual Capital Management). Table 6 provides a detail description of each. Management Type IAM (Intellectual Asset Management) IPM (Intellectual Property Management) ICM (Intellectual Capital Management) Characteristics Involved with all activities, decision and work processes, IT infrastructure (i.e., databases) used for commercializing and obtaining additional value from the firm's intellectual assets and innovations. Involved in the same activities as IAM, but concentrates on value from commercializing individual patented technologies or innovations. This is a narrower focus than IAM. Uses the intellectual capital of the company as the foundation to define its vision; achieves benefits by aligning intellectual capital resources with the vision and strategy; advertises externally on the firm's strategic uses of intellectual capital and the how these uses affect the firm's long-term ability to create value for shareholders. Table 6: Management for Value Extraction Source: (Sullivan, 1998, pp. 12-13) There is an important relationship between the nature of the company's business and its need to use one or more of the three management systems. (Sullivan, 1998, p.11) Figure 14 summarizes the findings of this relationship and provides examples. 55 Service Companies Product Companies Process Emphasis Product Emphasis Continuous Service Provided Discrete Services Provided Exam ples Refinery Company Oil & Gas Pipeline Automobile Companies Computer Companies Electric & Gas Utilities Telephone Companies Banks Insurance Companies Law Firms Consulting Firms Intellectual Property Large Amount Large Amount Small Amount very Small Amount Human Capital ICM Focus Management Systems Needed Small Amount of Technical, Large Amount of Managerial Administrative & Intellectual Assets Small Amount of Large Amount Large Amount Technical, Administrative, Technical, Administrative, Technical, Large Amount of Managerial & Managerial Managerial Administrative Yes Yes Yes Yes Tactical & Strategic Tactical & Strategic Strategic Strategic IPM, IAM, ICM IPM, lAM, ICM 1CM 1CM Figure 14:1CM Preferences by Company Type Source: (Sullivan, 1998, p.12) Sources of value extraction include those intellectual assets that can be sold or used to generate money or wealth in the marketplace. Figure 15 depicts an example of how value is extracted. The activities involved in extracting the value concentrate in key areas like managing the innovation process, the generation and maintenance of the intellectual assets of the firm, competitive assessments, enforcing the legal rights of the intellectual property and converting the value into profits. (Sullivan, 2000, p.184) Conversion Mechanism Sources of Value * Innovations * Complementary Business Assets, e.g.: o o o o Purchasing Manufacturing Distribution Sales . . . * * * * Sale Out-license Joint Venture Strategic Alliance Integrate with Current Business Create New Business Donate Figure 15: Sources of Valuation and Conversion Mechanisms Source: (Sullivan, 2000, p.234) 56 In order to extract value from intellectual assets, the activities of the company need to align to the strategic direction of the company. Alignment of the technology to the company's strategies (both business and technology) and its values needs to occur. If the technology does not align, it should be abandoned because development will not help the company achieve its vision. The current intellectual capital (including both assets and properties), the core competencies and capabilities, and the human capital should be taken into consideration when valuing technology. Technology should be viewed in relation to the intellectual and human capital and needs to complement or improve upon them. The core competencies and capabilities of the company are major components of intellectual capital. A core competence is a critical skill/expertise in a particular area. A firm's strengths and weaknesses help to identify capabilities. Assessing human capital allows the firm to strengthen weak areas, and capitalize on its competencies. A companies capabilities and competencies come from its employees (people). The Intellectual Capital Management (ICM) model uses management of intellectual, human and structural capital combined with physical assets to create value for the company. (Sullivan, 1998, pp. 69-70) Figure 16 illustrates how the intangible and physical assets can be used to create value. 57 Intellectual Capital (Unique Assets) Human Capital Value Extraction Intellectual Assets (n A0 Cz Intellectual Property C 0 0 Structural Capital (Generic Assets) Figure 16: A Model of an IC Company Source: (Sullivan, 2000, p.30) 58 U- $ Value Creation Complementary Business Assets (Differentiable Assets) U, Ways of Valuing Technology We highlight two approaches used to aid in the valuation of early technologies. The first way demonstrates this by utilizing IPM and the second is based on radical innovation. Maximizing Value from Patent Portfolio When the strategy for using the patent portfolio is to maximize value extraction, the amount of value an early stage technology has is primarily determined by its potential as a patent. The importance of aligning the company's strategies is demonstrated in the assessments used to value early stage technology. The technology strategy of the company dictates the intellectual property management strategy, which details how the intellectual property portfolio will be used to generate value for the company. The guidelines used for managing the IP portfolio help to establish the criteria for assessing early technology. So in order to maximize the value, "The focus is on maintaining a strong link between patenting activities and the company's business strategies." (Sullivan, 1998, p.149) As an example of how IPM is used we examine Avery-Dennison. It has an aggressive value extraction strategy; they want to maximize the return on their intellectual property. In order to accomplish this, they use the following tools to help them in valuing the discovery of new technologies, including those that are not incremental in nature. They use the Corporate Decision Model, the Patent Map, the Patent Funnel Map and the Patent Value Map. (Avery-Dennison information source, Sullivan, pp. 230-235) The Corporate Decision Model ranks the potential opportunities for each intellectual asset as it compares to the competitions. This helps them identify if and where they will have exclusivity with the introduction of the new technology. 59 a 0 Trade Secrets Trade secrets: very Limited employee exoosure Journal Article (Publication) or German Utility Trade Secrets: Seek licens or Stoo US or Foreign Specific Seek license or Stop NJ as y- C- 0 C E S US + Specific US + Big 2-3 Model Foreign Patents Figure 17: Corporate Decision Model for Investing in Intellectual Property Source: (Sullivan, 1999, p.232) The Patent Map is a 2x2 map, where the technology is mapped against time. Each quadrant is a categorization for the technology and provides direction on what form the intellectual property should take. The mapping occurs by answering two questions, 1) What is the timing? and 2) What is the technology value? Soon 1-3m PROVISIO NAL REGULAR PATENT Used if claims match product or to establish market or techncology leadership position throug h patenting File CIP as needed to capture new technology developments Used if produc-t still being developed Abandon prov isional if market doesn't accept produc E Technology value Low or TBD o -- High or Unknown 4-6 m nths Make business decisior n based on bIity to cam ble product if can claim, makta file patent f n't claim, and can maintain secrecy, keep as trade secret Value to Corporate High Unsure if a claim will cover product Value to Corporate low at this time Develop technology Keep confidential No patent filing DEVELOP TECHNOLOGY or PUBLISH 7-12 months Figure 18: 2x2 Patent Map Source: (Sullivan, 1999, p.233) 60 TRADE SECRET The Patent Funnel Map tracks the development of the firm's intellectual property. It tracks an idea from inception to its outcome and helps to facilitate where in the patent process the idea resides. STAGE 1 Documentation Brainstorm Concept Patent Map STAGE 2 Invention Disclosure STAGE 3 Internal Technical/Business Review STAGE 4 Draft Preparation STAGE 5 Draft Review FILED EA #2 EA# OrhnTest: Trade Secret __EA# Gatea 1:tthere Gate : 2 Is Gat: an invention? TetIRWien Gae 3: GaWite ete 3:roe es:Apod Gate 4: Draft Gate 5: Final draft approval Figure 19: Patent Funnel Map Source: (Sullivan, 1998, p.234) The last model is the Patent Value Model, and this is used to assess the value and control of the firm's patents and other intellectual assets. This model was originally developed for the Neste Corporation, and has been customized to maximize the benefits for the firm in categorizing its patent portfolio. It is used to classify each of the firm's patents by one of five technology values: * Key - grow the company * Base - protect core competencies * Spare - not currently using . Pacing - those needed to merely keep up with competition * Emerging - will move the company ahead of competition - The control of the asset is defined by its sponsorship * Prohibited - not fully owned by the firm 61 . Strategic - is controlled by internal strategic business unit and is currently not commercialized . Commercial - asset is fully owned by the firm and is on sale in at least one market . Potentially strategic - asset is currently supported by corporate R&D . Excess - asset can be licensed, sold or abandoned . Not possible - further development work or competitive analysis must be done to determine if the asset will be of value to the firm. VALUE: How used? SPONSORSHIP Internal/External Control Figure 20: Patent Value Model Source: (Sullivan, 1999, p.235) Recognizing a Radical Innovation The Rensselaer Radical Innovation Research Project defines a radical innovation as one that has "either unprecedented performance features or familiar features that offer potential for significant improvements in performance or cost. In our view, radical innovations create such a dramatic change in products, processes, 62 or services that they transform existing markets or industries, or create new ones." (Leifer et al, 2000, p.5) Recognizing and valuing a non-incremental technology is part of what they call the "fuzzy front end". The reason for this fuzziness is all the uncertainty surrounding it. There is a high degree of technical and market uncertainty. This is further aggravated by trajectory, idea opportunity and recognition, process, and business case, among other things. (Leifer et al, 2000, pp.19-20) To aid in identifying and valuing a radical innovation, they introduce the concept of a "radical innovation hub", pictured in Figure 21 below. Initiate a spin-out. Form a project team to launch an internal venture. Return ideas that aren't "ripe" to the hub, which can serve as a repository. Recommend licensing the technology. Initial Evaluation . . -- Radical Innovation Hub Consults with senior management about using articulation of strategic intent to modulate the level of radical innovative activity. Implements techniques for stimulating idea generation. .Acts as home base for hunters and gathers and as "receiver" for radical innovations. .Helps the champion articulate the opportunity. .Convenes the evaluation panel. Gatherer Hunter Business lUnit A Corporate R&D Business Unit B Figure 21: A Radical Innovation Hub Source: (Leifer et al, 2000, p.51) 63 Once ideas are generated they need to be "delivered" to the proper place for assessment. There are two ways in which these ideas are delivered, first through "hunters", these are people who are actively seeking out ideas with business potential and second via "gatherers", these are people who are alert to and react to promising ideas. (Leifer et al, 2000, p.37) The initial evaluation and assessment cannot be left to gut instincts, but must be based on a system with metrics. They outline "the crucial steps for an initial evaluation of a radical idea: . Build an evaluation team that includes senior business and corporate managers, business development managers, veterans of radical innovation projects, and when appropriate, outside experts. . Focus on the commitment of human and financial resources to take the next step, assuming that evaluators like what they see. In most cases, the next step is to attack the most critical uncertainties, questions, and assumptions uncovered during the initial evaluation. . Develop an evaluation protocol with criteria appropriate for assessing radical innovations. Initial decisions about a growth opportunity should not be based on projections of financial cash flows, market share gains, or the measures typically applied to incremental innovation projects. Rather, the focus should be on the deliverable benefits of the technology - how rich and robust they might be - and on whether the market will be 'big enough' if the benefits envisioned for the new technology are delivered. The initial evaluation process is unlikely to answer any of these questions and will probably generate more questions than it answers. Management will be justifiably uncomfortable, but the process should uncover what is known and some of what is unknown about the radical innovation and the perceived business opportunity." (Leifer et al, 2000, pp.49-50) Summary IPM and radical innovation both establish criteria for valuing early stage technology. Though other methods exist, these demonstrate how specific the criterion needs to be for any particular company. Both methods stress the 64 importance of strategic alignment, and value the technology based on the perceived potential it possesses. The main disadvantage of IPM is that it aids in valuing the technology mainly from a patent potential. While the main disadvantage of the radical innovation, is it concentrates on non-incremental innovations. It is clear the method selected must be able to balance the strategies of the company. 65 Conclusion Companies are continually looking for better ways to manage their R&D investments during the innovation process. It is important for companies to be able to identify those technologies, both incremental and non-incremental that hold potential value as early as possible. Though incremental technologies help to provide value for the company today, it is critical the company be able to identify those new technologies that will help them to either create or to sustain leadership in their industry in the future. In addition to identifying the valuable technologies, companies must effectively manage their limited resources. Some examples of these constraints are, the number of ongoing projects at a given time, and the allocation of resources (people and equipment) and funds. R&D establishes the guidelines for managing the project and patent portfolios to ensure a proper balance exists between technology risk and market success. "Corporations define value according to the standards put in place by the accounting profession. In accounting, value is not "accounted for" until it is realized or a transaction has occurred. Yet we all know that in-process R&D (technology maturity cycle)3 - as well as the entire patent portfolio - has immense value to the firm, even though it does not show up on balance sheets. Our view of the world has been shaped by double entry accounting, which was first created in 1494 by Luca Pacioli, an Italian monk. This is fundamentally the same accounting system that is used by global corporations around the world today to calculate and report revenues, profits, and expenses, and make decisions about resource allocations, risk management, and investment returns. While accounting is very good at recording transactions that have occurred in the past, it is not good at predicting future revenue streams. In addition, accounting only records events and transactions, so financial statements routinely exclude ideas that have not yet manifested themselves in a transaction" (Davis and Harrison, 2001). 3 Words in italics added for clarity (in-process R&D equates to technology maturity cycle) 66 With the emerging importance of intangible assets, it stands to reason financial methods we used in the past should change or new ones be created. As noted earlier, the deficiencies of these financial methods include not reporting the value created by intangibles or their usefulness in helping businesses make the critical decisions needed in this complex business environment (Lev, 2000). Companies today are creating value in new ways with physical and intangible assets that traditional accounting systems cannot measure. (Boulton, 2000, p xvi) It is clear a new framework for valuing R&D investments in the early stages is required, so companies can create the maximum value from its investments. 67 ----Intentionally Left Blank---- 68 Section 3: The Xerox R&T Valuation Process Organizational Structure Xerox Corporation consists of five main areas, the corporate office, business operations (BUs), customer operations, operations support and the innovation group. Figure 22 is a top-level organizational view of Xerox Corporation; note the Xerox Research and Technology group (R&T) is part of the Xerox Innovation Group. .a...... * rhnWlogyERatpsib mghesa Bv Maa.n.s e ra* Offio ProductfSolutions *ALM aTix 'WomrhMoi *LAWt *,b1. IAffai *XKuv * muskuiqrgcsunauIcamu EFhibssfumqi - FX RehU Figure 22: Xerox Corporation - Organizational Structure Source: (http://www.xerox.com) 69 Process Context The corporate office sets the direction and defines the overall strategy for the firm. The business operations, customer operations, operations support groups (i.e., marketing, finance, etc.), and R&T establish their strategies in alignment with the corporate strategy. This ensures supporting strategies put in place align to the overall business strategy and enable the company to meet its objectives. The R&T organization is responsible for the technology strategy of the corporation. One of its primary functions is to discover, grow and mature technologies. The development (commercialization activities) is the primary output of the various business operations groups. A major component in the technology strategy is the technology valuation process, which is critical in identifying the new technologies needed to achieve the company's growth and is used in the yearly planning process. The business operations are the revenue generators of the company and plan their expenses in order to support revenue generation and potential opportunities for future revenue. The R&T budget impacts several areas, the research organization, the business operations, supplies and manufacturing organizations. Though R&T is considered centralized, the supplies and manufacturing organizations conduct limited research internally. The business operations groups are focused on product development and have agreements with centralized R&T for specific research in their market segment to aid in commercialization as well as developing new technologies for future products. As a result, it is essential that coordination between these groups and the research organization exist eliminating duplication of effort. Some of the monies received into R&T are designated to support technology in the near term (current business needs) of the business operations groups, while the balance is used to develop new technologies to expand current business applications or leverage competencies to create new opportunity technologies within the company. 70 This division of resources and organization charters aligns with technology maturity. Early stage technology is analogous to R&T, and mature stage technology is developed into products in the business operations groups. Corporate Funding BU1 BU2 ..- BUn R&T Figure 23: R&T spending distribution Figure 23 depicts how the money is distributed to support the research activities of the firm. The company has standing committees to review strategy as it relates to strategic areas of the business. The members are from various parts of the company, for example research, the business units and corporate strategy. These committees meet as needed and it is their responsibility to approve technology that should be used in these areas. Valuation Process When a technology is in the embryonic stage, in many cases little information is known about its potential uses. However, as the technology matures, information accumulates and potential uses are identified. Therefore, Xerox's valuation process must take into consideration these different stages of technology maturity when valuing investments. Xerox does not manage projects on a project-by-project basis, but manages projects within an R&T portfolio. Xerox has tried different methods in the past to assess R&T investments in their attempt to ensure proper selection of projects enabling the company to meet its business objectives. 71 Traditional methods such as net present value and expected commercial value have been applied to mature projects within the portfolio. The calculation for these methods is not too difficult and is well understood. The decision to proceed with developing a product uses an NPV sensitivity analysis to capture many scenarios as part of the projects preliminary business case. So, organizations are quite familiar with this method of valuation. However, the information required for these methods put any investment in early stage technology at a severe disadvantage. This is mostly due to the uncertainty of technical and market success, and the assumptions around deriving these "success" probabilities. In addition, there is uncertainty related to where and how the technology can be applied. The numerical outcome is typically less desirable (NPV and ECV close to zero or negative in many cases) or if it is a decent value, is not taken as highly credible, due to the assumptions made to attain the value. So the decision at that moment in time, known as a go/no-go decision, may be not to invest, but the question remains "How sound is that decision based on the predictions made?" Therefore, two shortcomings exist: 1) the information used to make these decisions is not well known in the early stages, and 2) these methods provide a one-time decision. A couple of methods have been used for valuing early stage technology. The first two methods are the predominant methods that are used to value early stage technology. Though technical committees consisting of subject matter experts perform the valuation there is an amount of intuitiveness relied upon, rather than precise measurement. The first method uses a couple of indicators to assess the technology. Market attractiveness is the first of these indicators. No precise measurements are taken to determine this; instead the technology is viewed against how well it aligns with the market opportunity. In more specific terms the technology is categorized into a specific market segment, and the particular market segment is examined to determine the size of the market and the outlook of its growth rate. These are used to determine how attractive the market space is for the 72 technology. The second indicator is how well this technology fits into the current R&T project portfolio. The aim of the portfolio is to balance the investments against the opportunities. The market segment that a particular project is targeting usually defines the opportunities that it should capture. The desire is to maintain a proper balance to achieve the desired vision of the company. This means that larger investments are occurring in areas where the opportunities are growing rather than shrinking. Figure 24 shows the types of projects that are contained in the portfolio, and the mix of these projects determines how the balance is maintained. L Defend current market share in a high growth area Seek opportunity to increase market share in a high growth area Defend current market share in a low growth area Seek opportunity to increase market share in a low growth area Defensive Opportunity Figure 24: Portfolio Balance To pictorially show the potential opportunities for the technology, a bubble chart is created. An estimate of the potential market size is plotted against the market growth rate. The size of the bubble indicates the relative size of the investment. This process shows how the project aligns with market opportunities and ensures alignment with the overall strategy. 73 10- -C 0 CD CO 0 2 4 6 8 10 Market Size Figure 25: Example of a bubble chart Adapted from Source: (http://chartworks.com) The second method used is the risk/reward method. This process weighs the technical value against the risk. The outcome is a bubble chart plotting market uncertainty against the technology uncertainty, and an overall probability of success (the size of the bubble is the "hoped for monetary return"). This requires knowledge of the both technology and market success, which again is difficult to ascertain for technology in the early stages. The third method that has been tried is the options approach using the binomial model. Its major shortcoming is the need to develop the entire decision tree in order to make a decision, and the detail needed to assign probabilities for technical and market success. Also, it is not as familiar as traditional methods, which makes it more difficult to use. The valuation team has not been satisfied with any one method and desires a consistent method of valuation for R&T investments. A process, which nurtures competencies that can deliver value, is credible, efficient, and easy to understand and use is needed to achieve this goal. A method that has been used in assessing Xerox's resources to understand where they are today and where they need to be in the future is the Resource- 74 Based View (RBV). Realizing the importance of intangible assets, such as intellectual capacity, especially human capital, requires the use of a method that accounts for them, and assesses them in relation to the value of the technology. The RBV perspective can be adapted to allow for consistent measurements to be made and allows nurturing and growth of critical competencies needed to bring that technology to market. Resource-Based View In the RBV perspective resources of the firm are viewed as they relate to competitive advantage. (Fahy et al, p.126; Peteraf, 1993; Wernerfelt, 1995) The view starts with an assumption that the firm desires sustainable competitive advantage (SCA) and that by achieving this, allows it to earn above-average returns measured in conventional terms such as market share and profitability. (Fahy et al, p.126) "Successful firms possess heterogeneous collections of resources, that these varied collections of resources allow firms to implement different strategies, that different strategies yield different returns, and that successful strategies and their associated return streams are sustainable to the extent that they are prohibitively costly to imitate." (Foss and Robertson 1) The main idea behind the strategies used in the definition of RBV, is they are not only inward looking, but also outward looking taking into account industry analysis and the competitive environment. The strength behind it is resources can be either physical or intangible. This approach has its foundations in economics and explains how the resources of a company drive its performance in a competitive business environment. (Collis and Montgomery, 1995, p.119) - There are five tests in RBV 1. Test of inimitability: Can the resource be copied easily? 2. Test of durability: How long will the resource last? 3. Test of appropriability: Who captures the value created by the value? 4. Test of substitutability: Can a different resource replace it? 5. Test of competitive superiority: Whose resource is really better? (Collis and Montgomery, 1995, pp.120-123) 75 The RBV takes into account both tangible and intangible assets, and these are both needed in establishing criteria to value early stage technologies. It is grounded in economics, which provides rigor to the assessment criteria and at the same time is not dependent on financial methods for valuation. Most importantly, it takes into account the strategies of the company. The RBV provides a foundation on which to establish criteria for valuing early stage technologies. Foundation of the VERDI Framework The foundation for this new framework is rooted in RBV. The methods that were introduced in Section two and that are being used today at Xerox have not taken into account the entire value stream. The RBV method takes into account both tangible and intangible assets; it provides rigor to the assessment criteria and at the same time is not dependent on financial methods for valuation. Most importantly, it takes into account the strategies of the company allowing for alignment and entire value stream. Thus, the RBV method provides a foundation to establish criteria for valuing early stage technologies. 76 Section 4: VERDI Framework The foundation of the VERDI (Valuing Early-stage R&D Investments) framework is based on a resource-based view perspective published by Collis and Montgomery (1995). The framework is applicable for early-stage technology, specifically for technologies just entering or in the growth stage. Both the embryonic and growth stages are considered early-stages, but since there is so little known information about a technology in the embryonic stage, creating standard assessment criteria is very challenging. This paper is not meant to cover the full spectrum of R&D activities, but an example here may clearly illustrate why the VERDI framework is appropriate for early-stage technologies beyond the embryonic stage. Often times in companies that engage heavily in R&D activities, the very first stage of technology maturity, the embryonic stage occurs in the laboratory. Usually a discovery is made or an invention is proposed, and the goal of early stage R&D is to stabilize and ensure the discovery is real or that the invention has the potential to work. The technology is developed to a point to prove stability and repeatability, as well as investigate possible uses. By the time greater investments need to occur, the technology is usually on the cusp of entering, or has just entered the growth stage. Figure 26 illustrates this process schematically. Technology evolves idea IE Embryonic Growth Inside the R&D Laboratory Figure 26: Embryonic to Growth inside R&D Lab It is during the growth stage that the VERDI framework can help to assess the value of the technology. As stated earlier, it is usually premature to use 77 traditional financial methods in the early-stages of technology. However, enough information is available at the growth stage to apply a non-financial assessment to obtain some measure of value. As the technology matures and more information is available on its potential uses and applications, the organization can use VERDI to determine its value in non-financial terms and begin to use some of the traditional financial methods for determining its value in financial terms. 78 The Filtering Process VERDI starts with the established vision, mission and strategies of the firm. These are essential pieces in laying the groundwork for the assessment criteria. Each of these can be thought of as a filter, which will either trap the technology or allow it to pass through to the next criteria level. If a technology successfully makes it through all filters, it becomes a serious candidate for investment. Figure 27 shows a pictorial representation of this filtering. 0> 0 CD 0 0O 0n U) a) U) 0 UI) 5 F 0 S' Ca 06 0Investments U)0 " Idea 0 ' >1 CD, CU Filters Figure 27: Filtering of an Idea As with any filtering process, each filter has a specific level of purification. In Figure 27 above, the filters start at a coarse level and progress to a higher degree of refinement. As the idea progresses into the Technology Strategy filter, it is faced with the two finest levels of filtration, the Intellectual Property (IP) strategy and the R&D project portfolio strategy. The actual level of refinement in these two filters is dependent on the particular firm in which VERDI is being implemented. For some companies, the IP strategy filter may be just as stringent in its filtering properties as the R&D project portfolio 79 strategy. In other firms, the IP strategy may be quite coarse or even non-existent in terms of what it will filter out and allow to pass-through. Recall in Section 2, figure 6, the Value Hierarchy, a pyramid containing five levels of IP values. A company in the first level with a defensive strategy will not have a fine level of filtration; their goal is to build up their patent portfolio as quickly as possible. In this situation for the most part, any idea worth patenting is invested in and added to the portfolio. Conversely, a company in the second level of the pyramid, the Cost Center, will have a finer filtering process. The goal at this level is to patent wisely to save money in terms of maintenance costs in managing the IP portfolio. This means only those technologies that have been assessed and are worth paying the patent filing and maintenance fees are considered. All other ideas that do not at least meet the minimum criteria are discarded. 80 VERDI Methodology idea Technology evolves - IDEA R&D Laboratory Technology Assessment V E R D ,,Interim Opportunity E Decision Information Available N Final Decision Figure 28: VERDI Methodology The process starts with a technology concept (as depicted above, this usually occurs in the R&D laboratory) and ends with a decision. As visually illustrated, the technology evolves from the embryonic to the growth stage before entering into the VERDI process. After the technology has incubated and reached the growth stage, the technology assessment can be performed. Based on the outcome of the assessment, potential technology opportunities are brought forth and as additional information is available, re-assessment should occur. Finally, a decision on which opportunities to invest in is made by the appropriate governance body. We recommend a panel consisting of knowledgeable business and technology managers. 81 Governance Central to the creation and implementation of the process are people with the right kinds of skills and knowledge. As stated earlier in the paper, it is necessary that decisions represent the interests of all stakeholders. Though at some level each employee and stockholder has a vested interest, it is impossible to have everyone participate in the process. The participants in this decision process should represent the various stakeholders and their interests and should include subject matter experts (SMEs) in specific areas and/or competencies of the firm. For the best possible outcome and subsequent actions, the members selected to participate must be senior decision makers that have the authority and resources to act on the decisions that come out of VERDI. In terms of size, the exact number of people selected and the specific areas they represent will vary from one company to the next. A general rule of thumb is that too large a body can be ineffective if fast decisions and continuity of participation is important. An additional requirement for the committee is to have a small number of members who participate in every meeting. This core set of individuals (the nucleus of the committee) will ensure stability and help to maintain consistency in the valuation process. The chair of the committee needs to have a vested interest in the outcome of the VERDI decision-making process that is, to look for and develop the best technology opportunities to secure the future of the firm. In terms of a generic company organization structure the position that best personifies these characteristics is the Chief Technology Officer (CTO). In most instances this individual has the charter to develop and/or pursue those technology opportunities that have the greatest benefit to the company, both in the present and the future. This requires opportunities be examined inside and outside the firm. The committee members should be senior decision makers who have the 82 authority to make the decisions and the power to act on them by using their resources to carry them out. The following figure is an example of the potential make-up of the committee. u MnarBusinstsin e FinanceBusiness p Unit #4 n wl h p e " g n dsMat rnsandurBusiness Gciurin Unit #2 ~ Business Unit #1 of the committee. Each member may have an allegiance to their home organization, but they have the responsibility and the incentive to act in the best interest of the firm. The VERDI committee is a governing body who is responsible for making the best decisions for the company's future technology investments. This will help to cut down or prevent altogether the traditional politics, gaming and personal agendas that can occur. An advocate or sponsor for each technology in the process is desirable. We propose that the technologies under discussion be divided equally (or possibly even randomly) between the members of the assessment committee; this implies 83 that the advocate for a particular technology may not be responsible for a technology that directly impacts her organization. The purpose of the division of responsibility is to foster extended learning and to decrease the likelihood of personal agendas. As stated earlier, each member has taken the responsibility to act in the best interest of the firm, and not just in the best interest for herself or her organization. This means that even if the assigned advocate is not wholly behind a technology he/she is still responsible for taking the appropriate actions based on the consensus of the committee. It is the responsibility of the advocate to track the technology as it moves through its maturity cycle. Again we point out, information surrounding the technology changes throughout this cycle so, the advocate must be in charge of gaining access to and providing the most accurate information to the committee during the technology assessment. The advocacy policy fosters a well-rounded and balanced assessment committee. The committee should meet regularly to provide the assessment of each technology. Meeting frequency should be determined based upon availability of new information on the technology, market and trend data. 84 Required Information Not only are people needed to carry out the process, but also information is necessary for the committee to make the assessments required. The level of information and availability will vary from one technology to the next, but at a minimum the following information is needed: 1. Detailed information on the technology should be made available. It is important to formalize what is known about the technology as soon as possible. An idea becomes an intellectual asset once the information has been codified, until then, the idea does not have a fair chance at assessment. It needs to be in a format that can be shared with others to allow them to appraise its potential value. The most common method to codify information is in a document, either hard copy or electronic format. Given the availability of digital recording, the information could be recorded, as voice, or image and voice as appropriate. No matter what media is selected, the committee needs to have access to the technology in its codified form in order to assess it. 2. Market intelligence needs to be accessible, and will provide information on the firm's competitors, who they are and detailed information on their current and future products as well as provide an understanding of the current and future market place trends. Understanding the firm's core competencies, skills and overall capability is essential in determining how far a technology can be developed internally. Access to the database(s) that contains the intellectual assets including intellectual property, pending patents, and trade secrets is needed. Information pertaining to partnerships, cross licensing and joint ventures may also be required for the assessment. Additional information can also be made available to the committee, but those listed above are the minimum set of data needed to perform the assessment. To 85 help facilitate the assessment, it would be best if a common interface and mechanism to access the data were developed. The most common problem faced by many firms is too much data, with poor or inadequate means of accessing it. 86 Adaptation of the RBV Method for Technology Assessment The original five tests in RBV were (1) Inimitability, (2) Durability, (3) Appropriability, (4) Substitutability, and (5) Competitive Superiority (Collis and Montgomery, 1995). In order to value technology as opposed to resources or competencies, these tests need to be adapted. In examining technology, we found it convenient to combine some of the criteria. For instance, inimitability and substitutability can be examined and determined at the same time. In the exploitation of technology it is important to consider what applications might be pursued, what value chains might be used, what business models may be practiced, and how might the world of competitors respond. Thus, we propose a set of valuation criteria as follows: (1) Inimitability, (2) Extensibility, (3) Durability, (4) Appropriability, (5) Competitiveness, and (6) Market Attractiveness. Definitions We strictly define the following terms to prevent any misinterpretation of their intended meanings. "The application of scientific and engineering knowledge to achieve a practical result" (Roussel, et al, 1991, p. 13). Embryonic stage The attributes of the idea/technology are documented and studied to determine its viability before further development can occur. Growth stage The technology is reliably repeatable and all its characteristics fully studied and understood. Mature stage The technology is tested to determine where it will be most useful. Path dependency The technology depends on knowledge built up from current technologies. Complementary assets Other technology or products needed to get value (complement) out of the technology. Appropriability How the firm receives the value from applying the technology - - - - - - - Technology 87 - The "new"9 criteria are as follows 1. Inimitability - This criterion examines how unique a technology is and how easily it can be substituted. The theory here is that unique technologies that cannot be easily substituted are inherently more valuable. Combining the original RBV test of inimitability and substitutability into one derived this criterion. 2. Extensibility - This new criterion explores in what other industries, applications, etc. this technology may be pertinent. It is believed technologies that have multiple uses and broad applications are of greater value. The ability to identify additional potential opportunities allows the selection committee to better understand the value of the idea. 3. Durability - This criterion examines how long the technology can endure. Durability is not just the life of the idea, i.e., if it becomes a U.S. patent it is protected for 20 years from the date of patenting or those filed prior to June 1995, 20 years or 17 years from date of issuing. It also encompasses the idea of incremental and non-incremental technologies. This test helps the committee understand if the idea presented could be a potential disruption to a current technology. 4. Appropriability - This criterion poses the question of who will receive the benefits of applying the technology. Will value be extracted from the outcome of the applied technology, as well as through the entire value chain? Technologies that cannot be exploited because of a weak or nonexistent value chain are, in general of lower value. This criterion builds some rudimentary understanding of potential business models (e.g. vertically integrated at one extreme and licensing out at another). 5. Competitiveness - This criterion examines the competitiveness of the technology against alternative technologies. The information gathered in this test may also help the committee understand if the current technology in use is hitting its natural limit, and if the new idea presented could be a 88 disruption. Note that the competitiveness criterion is not orthogonal to the previous points i.e. the competitiveness may be tied to criteria 1-4 above. 6. Market Attractiveness - Finally we employ a criterion to identify where and how the technology could be used. The tests in this area could identify what markets it could be useful in, how large these markets are and how successful it could be in these markets. This criteria will help to determine if this is a market the firm should enter - i.e., identifies new market opportunities. This new series of criteria extends the RBV framework for the assessment of growth stage technologies. The explanation of the terminology contained in this process ensures that the VERDI panel speaks a common language. This is critical given panel members come from different functions across multiple organizations. Furthermore, this common language encourages communication in a fair and unbiased manner for selection of technologies that enables the company to sustain its competitive advantage in current and future markets. 89 Technology Stage As indicated earlier, VERDI is applicable to those technologies in the growth stage. To determine if VERDI can be used to assess the technology, it is first necessary to identify the stage of the technology. If either potential applications or markets cannot be identified, the technology is still in its embryonic stage and further development in the laboratory is required. On the other hand, if potential applications and/or markets are known, and though there is a considerable amount of uncertainty, the technology is considered to be in the growth stage. Technologies at this stage can be assessed using our framework. 90 Technology Assessment In order to perform the assessment, a process needs to be established for the committee to follow and practice. The process created will be highly dependent upon the firm and its standard practice of doing business. The questions listed below in each of the six categories are meant to guide the creation of the process. The actual implementation could be a questionnaire, a ballot, a series of open-ended questions for discussion, etc. The firm adopting this framework would best know how to implement it based upon the current work culture and environment. Below is a list of general questions to assist in developing the assessment criteria for the technology in the six areas: 1. Inimitability Unique function " Does it provide a unique function or, does it perform a function in a unique way? * If it's unique is it desirable to patent it or keep it as a trade secret? * Does prior art exist? Are there related patents? * Can the competition develop a work around? * Can an alternate technology be substituted for this one? Path dependency * Does this build on prior technology? * Is its development dependent on the core capabilities/skills of the firm? * Do competitors share a similar knowledge base? * Do we have brand loyalty in providing the solution? Would our customers expect this from us? * Does any competitor have greater brand loyalty associated with the solution? Economic deterrence * How much will it cost to imitate/substitute this technology? Is the magnitude large or small? Does that magnitude identity where potential competitive responses may come from? * Can the marketplace handle additional competitors (cannibalization, increased market share)? 91 * Does the competition have or have access to the physical assets and resources required to replicate the technology? * Does the competition have or have access to technical skills to support development of the technology? 2. Durability " What is the potential life of this idea? Does the technology perform its function significantly better than any competitors? Will it take a long time for competitors to catch up? " Can complementary assets be added to lengthen the duration in which its value will persist? * Do we have the complementary assets needed to lengthen its durability? * Does the competition have complementary assets needed to lengthen durability? * Will a change in market conditions deem this idea obsolete? (e.g. instant film is obsolete in the face of digital photography. 3. Appropriability * * Does a value chain exist to support exploitation of the technology? * Who owns those assets? * Do we have to partner to receive the value from the technology? Does this technology rely on other technologies outside of the industry? 4. Extensibility " Does this technology have additional uses internally? Externally? * Can it be used across the business? * Does it have application outside core industry? Do we have the skills to develop it for outside use? * Does extensibility factor into cost to develop the technology and if so, how? 5. Competitiveness " Is the technology superior? * How does this technology "compete" or "compare" against current technology performing similar functions? Both internal and external to the company. * How does this technology "compete" or "compare" against known future technology? Both internal and external. " How far out is the technology from commercialization? " Does the rating of competitiveness help to identify opportunities for disruption? Or is the technology incremental? 92 6. Market Attractiveness " Can this technology exist in the current market or in an appreciable size market? * Is there potential for huge market growth? * Does a new market have to be created to support the technology? Can we create it? Is it accessible to us? Once the process has been defined, the committee is charged with obtaining the required information to answer the questions related to each technology and establish the frequency of assessment meetings. The assessment should be conducted as a collective and corroborative decision making process in order to achieve consensus. The discussion of each technology provides a way for the committee not only to learn about those technologies being assessed, but also to reach a reasonable and impartial judgment on research investments. Assessing technology requires a mechanism to distinguish between those opportunities having the potential to create substantial value for the firm and those that do not. This also provides a level of confidence that decisions are not made based on politics or someone's gut feeling. Some of the criteria are more important than others; so weighting these criteria is necessary. Again, we do not propose which criteria should be weighted more heavily than another, as this is dependent upon the strategies of the firm implementing it. Many technologies exist at the onset of this process. However, all of them will not progress in a satisfactory manner to the maturity stage. Sufficient resources both monetary and non-monetary do not exist to develop every technology entering this process. It is up to the committee to make sound judgments about early-stage technology investments. Due to the dynamic nature of this process, technologies with a potential to create value for the company should be supported as long as continual progress takes place. As technology progresses through the growth stage, more information is available. The ability to invest now with the option to stop investments later based on refined information is a useful approach coined "the options thinking approach". This approach allows for uncertainty to be refined based on an accumulation of information. 93 In order to fully assess the technology, in addition to the VERDI assessment an account of resources needs to be included as well. A resource assessment will help the firm to understand if the technology can be developed in-house or if they will need to obtain resources from outside the firm, or possibly to partner in order to develop the technology. See Figure 30. 0 U) =3 0 U,) Potential I Investment U) CD ca. (D C: CO 0 0 pr Investment 0 0 0 JF C Figure 30: Resource Assessment VERDI needs to be adapted and personalized to fit the individual needs of the firm in which it is to be applied. In the next section, this broad framework is customized for Xerox. 94 Section 5: Proposal for VERDIX (Valuing Early-stage R&D Investments at Xerox) In this section we elaborate on how the VERDIX process can be implemented. The suggestions here are based on knowledge of the Xerox culture and processes. Our emphasis in this section is to describe the formal processes and infrastructures that could bring about a disciplined and repeatable process that is reasonably lightweight and therefore won't discourage participation. The basis of the valuation methodology is as described in the preceding section. Overview Prior to our discussion on the valuation methodology, it is first important to provide a brief overview of Xerox's organizational structure, its foundation, vision, mission and strategies. This overview provides the proper context for application of VERDIX. Xerox is functionally organized as previously mentioned in figure 22 of Section 3. At the top of the company is the corporate office; at the next level are the major business units (BU) and other business groups that provide support. Xerox's Values These are the beliefs held collectively by the employees and are as - follows "Since our inception, we have operated under the guidance of six core values: . We succeed through satisfied customers. . We value and empower employees. . We deliver quality and excellence in all we do. . We provide superior return to our shareholders. . We use technology to deliver market leadership. 95 . We behave responsibly as a corporate citizen" 4 Xerox's Vision and Mission Statements As acknowledged in Section 1, the vision and mission statements are based on the company's values. The vision establishes an understanding of the company's future and the mission provides a high-level explanation on the steps they will take to pursue it. Xerox's vision statement is simply, "The Document Company",5, it is meant to convey to the world that Xerox wants to be synonymous with the word "document", in every possible way, both current and future. Today documents are both physical and nonphysical. The physical form is a piece or pieces(s) of paper; the nonphysical form is the digital form or file. Today Xerox is producing, supporting and providing services for paper documents, and currently leading the market in digital document services, as well as working on paperless technologies like electronic paper6 . In order to attain its vision, the company needs to create a mission statement. The mission statement details at the highest level the steps the company will take to reach its vision. Xerox's mission states, "Our strategic intent is to help people find better ways to do great work - by constantly leading in document technologies, products and services that improve our customers' work processes and business results."7 This broad mission statement defines what the company as a whole will do, and allows for each organization within the company to create their own mission statement to aid the firm in achieving its vision. 4 Xerox's values are taken from http://www.xerox.com. 5 Xerox's vision is taken from http://www.xerox.com. 6 Xerox spun off Gyricon Media in December 2000, producers of SmartPaperTM, the amazing media that combines the functionality of a LCD screen with the thinness and flexibility of regular paper. Xerox's mission is taken from http://www.xerox.com. 96 Membership The VERDIX committee we propose is ideally made up of members that represent varying interests throughout the company. Each business, operation and support organization may have at least one representative. There should be at minimum three representatives from the Xerox Innovation Group (XIG), with at least one representative from XIG R&T, XIG IP, and XIG strategy. A single delegate from an organization will have complete and total representation for that organization. If an organization has more than one person, than one person must be identified from the contingency that possesses complete and total representation for that organization. The selection of this person is left up to the local organization. Figure 31 shows an example of the VERDIX committee membership. Xerox Innovation R&T Xerox Innovation IP Chief Technology Officer Dcouen\ Systems b rGttor & Xerox Innovation Strategy Corporate Business Strategy m r Xerox Global Services Office Products Office Figure 31: Example of the VERDIX committee membership The composition of the committee is just one aspect of membership. Let's now address the qualifications needed to be a member. Given the charter of the committee, it is necessary for these individuals to be senior members of their respective organizations. In this capacity, they have the broadest understanding of the business, as well as an adequate knowledge of the technologies supporting their specific businesses. 97 Essentially, they wear two "hats"; the first represents the interests of the company and the second the interests of their home organization. The incentives offered to the senior members need to be balanced between both VERDIX as well as their home organization. Each individual must consciously bring impartial input to the assessment process. In their role as advocate, it is their responsibility to ensure all required information for the technology they represent is provided to the committee during assessment. Their responsibility is not to provide a preliminary judgment as to how any technology should be assessed, since this is the outcome of a consensus decision made by the VERDIX committee. 98 Accountability As stated previously, each organization will need representation on the committee. Different cultures and work processes exist across organizations. Therefore, we will require each organization to establish a process for selecting its committee representative(s). Remember, these people represent the interests of the organization, and the main representative needs to maintain the balance between acting in the best interest of the corporation and their home organization. The VERDIX committee has an enormous charge in that it must make critical investment decisions for the future of the company. As such, this membership should be taken very seriously. Not only should the expectations of this position be conveyed across each organization, but also incentives should be structured in a way as to achieve the desired objectives of the position. Serving in this capacity should become part of the individual's yearly objectives. Otherwise, it could potentially become a low priority task for him/her. Each committee member has the following responsibilities: 1) Be prepared for each meeting. 2) Provide input as required. 3) Assume the advocacy role for one or more technologies. 4) Attend regularly scheduled meetings. While this is not an exhaustive list, everyone is expected to perform all of the necessary tasks to be productive members of the committee. An advocate is assigned to each of the potential technologies. To maintain a sense of balance, we propose technologies be handed out round-robin style. The advocate may not be from the same organization as the technology and, at the same time, at a personal level may not wholeheartedly agree on pursuing the technology. The fact is they have the responsibility to act on the actions determined by the committee. 99 Advocacy is an important part of membership, and in order to preserve a level playing field, incentives need to be carefully implemented. The intent of this committee is twofold. First, it will help organizations prioritize how they use existing technology funds. Second, it will assist in decisions concerning what technologies to foster and/or those to exploit. 100 Meetings Due to the amount of innovation that occurs, assessment meetings will occur monthly. The meeting dates will be determined at the beginning of the year, so that the dates are published and communicated to the entire firm. To simplify and standardize the process a standing agenda will be used. The agenda will contain current technologies that are in VERDIX and those that are potentials for entrance into VERDIX. A sample of the agenda is as follows: Old Business Potential Technology 1 Potential Technology 2 Potential Technology n New Business Idea 1 Idea 2 Idea n An agenda will be compiled five business days before the scheduled meeting date. The published agenda will show each item and the time slot for its discussion. The meetings will be conducted using standard Xerox meeting methods. The appointed chair of the VERDIX committee, the Chief Technology Officer, or someone from his office with the proper authorities granted, will lead the meeting, and the roles of facilitator, timekeeper, scribe and scorekeeper will be assigned prior to the start of the meeting. The items under old business are those ideas that made it through the initial assessment, but are being monitored closely to determine whether they will remain in the R&T growth project portfolio, or if they will be abandoned or redirected. These re-enter the assessment process only 101 when a significant8 amount of pertinent information has been made available. If there is not enough new information, or no new information, then these technologies remain in a monitor state. If no new information becomes available within six months, then the committee needs to determine if the technology is still worth monitoring or if it is a candidate for abandonment. 8 Significant - in this instance means information that would change one or more of the established ratings for any of the six characteristics of the framework. 102 Supporting IT Infrastructure As noted in Section 4, a large amount of information needs to be collected, categorized and made available in order for the assessment to be accurate and meaningful. There are several databases that will be used to compile the information needed. Xerox maintains several internal databases in addition to providing access to external ones. Listed below are the databases that are accessed to obtain the information required for - valuation 1) USPTO (United States Patent and Trademark Office) 2) Xerox patent and pending patent 3) Market intelligence 4) Market trends 5) Resources 6) Finance/Spending 7) R&T Project Database 103 Query 1: Does technology z provide a unique function? Response: Ifa match(s) occur the following info is presented: a Patent ID e Patent life e Owner 9 Related patents e Industry e Citations Resources Skills / core competencie Finance -Money -Money - Money allocated for R&T spent year to date remaining sets Avlability of personnel costs Availability of resources rFuture plsns for sdded resources -Skill - Outsourcing Market Intelligence Market Trends*> - Trends in current industry (smong competitors) - Complementary industry trends -Customer trends Info on competitors (firm into) - InTo on competitive products - Info on technologies used by competition - Competition customer info - Action to the query Xerox Patents R&T Projecti Portfolio tech category core technology area frame -time - related technology(s) - money invested to date filed associated products -date - - related techs -licensing; partnership info USPTO* Xerox Patents issued Pending! Old Ideas category date issued; expiration date products related techs licensing; partnership info -tech -all - associated - US patents issued to date -categoies dates of expiration ownership * These represent external databases Figure 32: askOnceTM Interface In order to efficiently access the databases a common interface to access them is required. Within Xerox, we recommend use of the Xerox developed askOnceTM meta-search software. This is a relationship tool that can extract the required data from the provided sources and present it to the user in a meaningful format. The advantage of askOnceTM is it allows for multiple repositories (various databases with different formats and structures) and data-types to be searched with a single query. Figure 32 depicts an example of how the databases are linked, how a query to the linked databases is acted on, and what data is extracted and presented. 104 If askOnceTM is not available for use, alternative methods using the existing infrastructure can be implemented. Many data repositories, internal databases, DocuShareTM sites (web interfaced document repository systems), and file servers reside in Xerox. These can be accessed manually to extract the information necessary for assessment. However, this would be a very time consuming task. 105 Valuation Process Any technology in its growth stage requiring investment by Xerox is presented to the committee in great detail. Any idea that has passed through the embryonic stage gets committed to a form of documentation, known as a proposal. One of the primary reasons for providing the proposal is to establish where the technology is in relation to the maturity cycle. The VERDIX assessment is only to be used for those technologies in the growth stage. The information provided in the proposal helps determine if the technology has entered VERDIX too early or even possibly too late. The proposal contains detailed information on the potential technology as demonstrated in Table 7. 106 Description Information Required Descriptive Title of idea/new technology Description of the problem the idea/new technology addresses. Title, name of the technology Details of the problem, how it was solved in the past (if at all) and how the new technology solves/addresses the problem. Summary of idea/new technology Executive summary Detailed description of idea Full technical description of the idea. Describe how to make and use the idea and its novel embodiments. Cover the process, method, materials with sketches, flow charts, usage etc. What are the advantages of your idea for Xerox? Team Members If applicable, list those individuals who have worked on this or on a similar idea. Related concepts or prior art searches Provide any/all related patents. Information obtained through search of USPTO, internal Xerox database, and current database of pending ideas. Provide detailed information on the development to date Development Information I Prototype Opportunities for use (by Xerox or outside) on the technology, to prove repeatability and stability. If applicable provide prototype, model or experiment data. Provide information if there is a definite plan to use this in a future Xerox product, list product/project names if applicable. If this is applicable for another industry, provide the detail information. Input from the submitter's management. The information provided is the pre-assessment, which is made by the manager. Management input Table 7: Technology Proposal 107 The proposal must be made available to the committee chair one week (or at the latest five business days) prior to the meeting. All required pre-read material is sent out via email and posted electronically five business days before the date of the meeting. The proposal is an electronic data entry process. All required information is entered by the submitter(s) and the sponsoring management's input is an added source of credibility. The information can be entered via a web interface or submitted via an electronic document and the data is captured for use in a database. The deadline to submit a proposal is one week prior to the scheduled meeting date; this allows ample time for the agenda to be established and for all pre-read information to be provided to members so they can be prepared for the meeting. The committee members are expected to have reviewed all proposals and pre-read materials prior to the meeting. The submitter and their immediate management are expected to be oncall to field any questions that the committee may have concerning the proposal. They will receive information on the time slot assigned in which they need to be accessible. Thus, the contact person needs to be available via phone or web meeting during the scheduled time slot. Additional information that must be available for the committee to use is market information (trend data) and technology trends, financial data, resources and skills/core competencies. This data is available in the databases and readily accessed using the askOnceTM interface. 108 Scoring Each committee member will have access to a copy of the document (either hard or electronic) containing a series of questions (as discussed below under the heading "questionnaire") based on our adapted RBV approach for technology valuation. The responses given to this sequence of questions combine to make up the assessment score for each of the six criteria. The questions are answered according to a 9 - point scale (1,3,5,7, and 9), with the 1 representing the lowest (worst) value and 9 representing the maximum (best) value. Since no individual balloting takes place, the committee must reach a consensus, from an adequate discussion of the technology, on each question before assigning its score. The scorekeeper enters the score assigned to each of the six categories and compiles them in an electronic document (Excel spreadsheet). The macros provided in the spreadsheet manipulate the data and the value for each criterion is assigned. Graphical views of the assessment are generated for ease of viewing. Lastly, based on the combination of the individual category scores a determination to invest, partner, or abandon the technology can be obtained. To better understand the assessment and scoring procedures, a demonstration is provided after the introduction of the assessment questionnaire. Based on the assessment outcome (scoring), potential recommendations are presented to complete the valuation process. 109 Assessment Questionnaire The potential technology is assessed using the guidelines in the questionnaire below. Each question is to be answered and scored by the group rather than individually and should be discussed before a rating has been determined. The length/amount of discussion does not have to be long, but needs to be thorough to ensure that the best rating was achieved. Inimitability There are three factors, labeled a, b, and c, comprising the inimitability criteria. a. 1. Uniqueness Does it provide a unique function? a. No b. Yes Assessment 1 9 Additional Considerations Score Has a full new/novel test been I conducted? If the answer to Q1 is "Yes", skip to Q2, if "No" then proceed to Q1a. la. Does it provide a function in a unique way? a. No b. Yes Assessment 1 9 Additional Considerations Score Has a full new/novel test been conducted? If the answer to Q1 a is No, then this idea is not likely to generate high value as an intellectual property, but may have an application in a product. It should be abandoned only from the IP perspective. 2. Do we want to patent this technology? a. No b. Assessment Additional Considerations 1 Why not? Provide reasons for it remaining a trade secret rather than an IP. 9 Yes 110 Score Additional Considerations Is there significant prior art that would challenge this invention? a. Yes * 3. b. Does this mean that it is an incremental technology? Who owns the related patents? How strong is their position? Will Company X benefit from patenting this? Does this indicate first mover advantage? Does this indicate that it is too costly? Will the market accept it? No _1 *This question should be thought about when scoring uniqueness. It is not part of the numerical scoring, because a technology should not be penalized if significant prior art exists. On the other hand, if prior art doesn't exist, Company X can potentially achieve the benefits of the first mover advantage, by getting this technology commercialized before any competitor. 4. Can the competition* develop a work around? (Degree of difficulty to develop work around) a. Low degree of difficulty Assessment Additional Considerations 1 Provide time line. Faster than Company X? Lower in cost? Provide time line. Faster than Company X? Lower in cost? Provide time line. Faster than Company X? Lower in cost? b. Medium degree of difficulty 5 c. High degree of difficulty 9 Score *Competition - could be deemed to be those firms that have products/similar technologies competing in the same market segment as Company X. Competition could also be any firm that has the capabilities to develop the same technology, for instance a company that has like resources including skills and money to invest in development. 5. Is there a substitute for this technology? a. Yes b. Assessment 1 9 No 111 Additional Considerations Is the substitute more costly than this new technology? Is the substitute better than this technology? Who owns the substitute? If Company X owns it, are we willing to cannibalize? Score b. 1. Path dependency Additional Considerations Is this technology (or application of it) built on or dependent upon current technologies in use, i.e. incremental? a. Yes b. Score Need to assess where on the technology curve the related technologies reside. Is this an area that Company X wants/needs to expand in? Does the benefit far out way the cost? Is this a sign of disruption? Is this discontinuous? Is it the natural progression? Is the market ready to accept it? Is the switching cost high? Are complementaries in place? No Discussion about Q1 is required. However, this question does not become part of the final path dependency score. 2. 3. Is this technology (or application of it) within core competencies/skill sets? (Degree low-med-high) a. Low Assessment Additional Considerations 1 b. Medium 5 c. High 9 Can it be outsourced? Is it affordable to outsource? Can the balance be outsourced? Is it affordable? Are the resources available (free to work on this)? When will the resources be free to work on this? Will they be free in time? If not, can we afford to outsource? Assessment Additional Considerations 9 Would it be financially feasible for them to outsource this? Would it be financially feasible for them to outsource this? What advantage do they have? Could they beat us to commercialization? Could they do it cheaper? Do our competitors share a similar knowledge base? (Degree lowmed-high) a. Low b. Medium 5 c. High 1 112 Score Score 4. Is this technology (or application of it) synonymous with our brand? (Degree low-med-high) a. Low b. c. 5. Additional Considerations 1 Is this a risk to our reputation? Is this a candidate for licensing? For partnering? For spin-off? c. Economic Deterrence 1. How much will it cost the competition to implement this technology? a. < 1x Assessment 1 5 9 2. 1 If the cost is low, what makes this advantageous to pursue? Is it tactical? Is it strategic? Is this enough of a significant amount of difference? 3 5 7 9 < 20x < 100x Assessment 9 5 1 113 Score Is it therefore advantageous for Company X to lead the market with it? Offer it as a license? Partner? Spin off? Abandon? Additional Considerations < 5x Does the competitor have or have access to technical skills to support development of the technology? If not can they acquire them? a. Very unlikely b. Likely c. Highly likely Additional Considerations Assessment c. < lox d. e. Score 5 9 Medium High Is this technology (or application of it) synonymous with our competitor's brand? (Degree lowmed-high) a. Low b. Medium c. High b. Assessment Score Would competition be willing to follow us? Is the market ready to accept this? Does our trend data agree with this? Additional Considerations Can they acquire these assets or use of these assets at low or high cost? If at low cost, what threat does this pose? Score 3. 4. Does the competitor have the physical assets or resources? If not can they acquire them easily? a. Very unlikely b. Likely c. Highly likely Assessment Does the competitor have or have access to technical skills to support development of the technology? If not can they acquire them? a. Very unlikely b. Likely c. Highly likely Assessment 9 5 1 9 5 1 Additional Considerations Score Can they acquire these assets or use of these assets at low or high cost? If at low cost, what threat does this pose? Additional Considerations Score Can they acquire these assets or use of these assets at low or high cost? If at low cost, what threat does this pose? Durability 1. What is the estimated life of the technology against current technology? a. < Amount* b. Assessment Additional Considerations 1 Is this tactical? Even if short lived, is it cheaper than current technology? If it is strategic, will it be cost effective during its life versus current technology? 9 > Amount Score *Amount - is determined by the committee. 2. What is the life estimate given current market condition? a. < Amount b. > Amount Assessment 1 9 *Amount - is determined by the committee. 114 Additional Considerations Is it high because of firstmover advantage? Will our processes be able to meet the market demands of lower cost in the timeframe it will demand it? Score 3. Who controls the complementary assets? a. Competition b. 4. 1 9 Company X Is a change in market conditions likely to deem the technology obsolete? a. Low b. Medium c. High Additional Considerations Assessment Can we gain control? How much will it cost us to gain more? Can we maintain control? How much can we afford to lose? Additional Considerations Assessment 9 5 1 Score Score What is the time frame? Will we be able to benefit from first mover advantage? L Appropriability 1. Does Company X own the value chain? a. Yes b. No Additional Considerations Assessment 9 1 Score Can we create one quickly? Cheaply? If the answer to Q1 is "Yes", Score will be 9, if "No" then proceed to Q2 and use its score. 2. 3. Can a value chain be easily created? a. Very likely b. Likely c. Highly unlikely Assessment Additional Considerations 9 5 1 Can we afford to? Can we afford to? Are there other possibilities to consider? Does this technology rely on other technologies outside of the industry? a. Yes Assessment Additional Considerations 1 Are they proprietary? Can we have access to them? b. No 9 115 _ Score Score Extensibility 1. Does this technology have additional uses internally? a. Very likely b. c. Assessment Additional Considerations 9 Can it be used for another application without adapting it? Slight modification Likely Highly unlikely 5 1 2. Does this technology have Assessment Major overhaul needed Additional Considerations additional uses externally? a. Very likely 9 Can it be used for another b. c. 5 1 application without adapting it? Slight modification Major overhaul needed Likely Highly unlikely *Amount - is determined by the committee. This is dependent on number of businesses in the company. Competitiveness In assessing competitiveness we are trying to determine whether it is superior to any possible alternatives. When comparing the function provided by the technology to its alternatives, appropriate figures of merit (FOM) must be selected. There should be a minimum of two and a maximum of five FOMs identified and used. Development cost is one example of an FOM. For instance, technology "A" costs significantly less (i.e., a factor of 1Ox) to develop than any of its alternatives. Because each technology has its own performance characteristics the committee must determine the appropriate FOMs required for the assessment along with the corresponding industry benchmarks. The FOMs are needed to allow the committee to answer questions one through three. More specifically in each of our comparisons these attributes are utilized. 116 Score Score 1. 2. 3. How does the function of the technology "compare" against the function of alternative technologies? a. Significantly below alternative technology Assessment Additional Considerations 1 Must determine what is meant by significantly below, below, above, and significantly above b. c. Below alternative technology Same 3 5 d. e. Above alternative technology Significantly above alternative technology 7 9 How does this technology "9compare" against current technology in use? a. Significantly below current technology This is on par with current level Assessment Additional Considerations 1 Must determine what is meant by significantly below, below, above, and significantly above b. c. Below current technology Same 3 5 d. e. Above current technology Significantly above current technology 7 9 How does this technology ''compare" against predicted future technology? a. Significantly below future technology Assessment Additional Considerations 1 Must determine what is meant by significantly below, below, above, and significantly above b. c. Below future technology Same 3 5 d. e. Above future technology Significantly above future technology 7 9 Score Score This is on par with current level Score This is on par with current level I 117 4. How far out is the technology from commercialization? a. > 7 years Assessment Additional Considerations 1 Provide a potential timeline for commercialization; maybe this would be fine given we don't have good durability at this time; or complementary assets don't exist b. c. 5 years < x < 7 years 3 years < x < 5 years 3 5 d. e. 1 years < x < 3years < 1 year 7 9 Score All the same comments apply in all these categories Provide a potential timeline for commercialization. Just because this can get out in a year, doesn't mean that the market will be ready for this in a year. For market attractiveness, the committee must understand the size of the current market and any potential growth in that market. Growth can also be gained from the creation of a new market. Market Attractiveness 1. Can this technology live within the existing market (this means a market that Company X is In)? a. Highly unlikely b. c. 2. Additional Considerations 1 No differentiation based on current technology in the market; too much competition exists for this technology to provide value 5 9 Likely Very likely Does a new market have to be created to support this technology a. Very likely b. c. Assessment Technology is best in breed and market data shows there is value in developing this technology Assessment Additional Considerations 1 A new market must be created to support this technology. 5 9 Likely Highly unlikely 118 Score This technology can exist within the current market Score 3. What is the potential market growth for this technology? a. Small b. c. Assessment Additional Considerations 1 Market potential < 10%* growth Market potential is about 10%* Market potential >> 10%* growth 5 9 Medium Large This amount should be determined by the trends related to the particular market. * 119 Score Assessment Outcome After each criterion score has been tabulated, a summary table as shown in Figure 33 is prepared. The summary table allows the committee to easily view the results. Since each business unit produces products for a particular market segment, the importance of one criterion may be different, or seen as more important than another. This should be accounted for in the scoring. Based on the business strategies of the company, a weighting factor for those criteria having more importance should be stipulated by the committee. Taking this into account, each value is calculated by weighting the criterion inimitability, durability, appropriability, extensibility, competitiveness, and market attractiveness by the values of 20%, 12.5%, 12.5%, 5%, 20%, and 30%, respectively. The summary matrix allows for recommendations to be made based on the scores from each criterion. Criterion Criteria Value Inimitability Uniqueness Path Dependency Economic Deterrence Durability Appropriability Extensibility Competitiveness Market Attractiveness Figure 33: Summary Matrix 120 Illustration using toner/manufacturing process A In the assessment process, completing our questionnaire requires thinking about the technology under consideration as compared to other technologies. For the purpose of this illustration, toner/manufacturing process B is used as the alternate technology. Inimitability There are three factors, labeled a, b, and c, comprising the inimitability criteria: uniqueness, path dependence, and economic deterrence. A weighting factor is used for this criterion since uniqueness is more important than path dependency and economic deterrence. Thus, to calculate the score for inimitability requires the committee to use 50%, 25%, and 25% as weighting factors for uniqueness, path dependency and economic deterrence, respectively. a. Uniqueness 1. Does it provide a unique function? a. No b. Yes Assessment 1 9 Additional Considerations Score 1 Has a full new/novel test been conducted? If the answer to Q1 is "Yes", skip to Q2 and use score from Q1, if "No" then proceed to Q1a and use score from Q1a. la. Does it provide a function in a unique way? a. No b. Yes Assessment 1 9 Additional Considerations Score 9 Has a full new/novel test been conducted? If the answer to Q1 a is No, then this idea is not likely to generate high value as an intellectual property, but may have an application in a product. It should be abandoned only from the IP perspective. 2. Do we want to patent this technology? a. No b. Yes Assessment Additional Considerations Score 1 Why not? Provide reasons for remaining as trade secret rather than IP. 9 9 121 3. Additional Considerations Is there significant prior art that would challenge this invention? a. Yes b. Does this mean that it is an incremental technology? Who owns the related patents? How strong is their position? Will Company X benefit from patenting this? Does this indicate first mover advantage? Does this indicate that it is too costly? Will the market accept it? No *This question should be thought about when scoring uniqueness. It is not part of the numerical scoring, because a technology should not be penalized if significant prior art exists. On the other hand, if prior art doesn't exist, Company X can potentially achieve the benefits of the first mover advantage, by getting this technology commercialized before any competitor. 4. Can the competition* develop a work around? (Degree of difficulty to develop work around) a. Low degree of difficulty Assessment Additional Considerations Score 1 Provide time line. Faster than Company X? Lower in cost? Provide time line. Faster than Company X? Lower in cost? Provide time line. Faster than Company X? Lower in cost? 5 b. Medium degree of difficulty 5 c. High degree of difficulty 9 *Competition - could be deemed to be those firms that have products/similar technologies competing in the same market segment as Company X. For example, if the technology being assessed were determined applicable in the office environment, then the main competitors in this arena would be HP, Canon, and Ricoh. Competition could also be any firm that has the capabilities to develop the same technology, for instance a company that has like resources including skills and money to invest in development. 5. Is there a substitute for this technology? a. Yes b. No Assessment 1 Additional Considerations Is the substitute more costly than this new technology? Is the substitute better than this technology? Who owns the substitute? If Company X owns it, are we willing to cannibalize? Score 1 9 (9+9+5+1)/4 6.0 Uniqueness Score 122 b. Path dependency 1. Additional Considerations Does this technology (or application of it) add value something currently providing value for the company, i.e. incremental? a. Yes b. Score Need to assess where on the technology curve the related technologies reside. Is this an area that Company X wants/needs to expand in? Does the benefit far out way the cost? Is this a sign of disruption? Discontinuous? Natural progression? Is the market ready to accept it? Is the switching cost high? Are complementaries in place? No Discussion about Q1 is required. However, this question does not become part of the final path dependency score. 2. 3. Is this technology (or application of it) within core competencies/skill sets? (Degree low-med-high) a. Low Assessment 1 b. Medium 5 c. High 9 Do our competitors share a similar knowledge base? (Degree lowmed-high) a. Low Additional Considerations Can it be outsourced? Is it affordable to outsource? Can the balance be outsourced? Is it affordable? Score 9 Assessment Additional Considerations Score 9 Would it be financially feasible for them to outsource this? Would it be financially feasible for them to outsource this? What advantage do they have? Could they beat us to commercialization? Could they do it cheaper? 1 b. Medium 5 c. High 1 123 4. Is this technology (or application of it) synonymous with our competitor's brand? (Degree lowmed-high) a. Low b. Medium c. High Assessment 1 5 9 Additional Considerations Score 9 Is it therefore advantageous for Company X to lead the market with it? Offer it as a license? Partner? Spin off? Abandon? (9+1+9)/3 6.33 Path Dependency Score c. Economic Deterrence 1. How much will it cost to implement this technology? a. < 1x b. <5x c. <lox d. e. 2. 3. < 20x < 100x Assessment Additional Considerations Score 1 If the cost is low, what makes this advantageous to pursue? Is it tactical? Is it strategic? 5 3 5 7 9 Does the competitor have the physical assets or resources? If not can they acquire them? a. Very unlikely b. Likely c. Highly likely Assessment Does the competitor have the technical skills to support development of the technology? If not can they acquire them? a. Very unlikely b. Likely c. Highly likely Assessment Would competition be willing to follow us? Is the market ready to accept this? Does our trend data agree with this? Additional Considerations 9 5 1 9 5 1 124 Score 1 Additional Considerations Score 1 (5+1+1)/3 Economic Deterrence Score 2.33 (((0.5*6)+6)+((0.25*6.33)+6.33)+ ((0.25*2.33)+2.33)))/3 Inimitability Score 6.61 Durability 1. What is the estimated life of the technology against current technology? a. < Amount* b. > Amount Assessment Additional Considerations Score 1 Is this tactical? Even if short lived, is it cheaper than current technology? Even if longer, will it be cost effective during its life versus current technology? 9 9 *The amount is 7; this is a substitute for toner/manufacturing process B 2. What is the life estimate given current market condition? a. < Amount b. > Amount Assessment 1 9 Additional Considerations Score 9 Is it high because of firstmover advantage? Will our processes be able to meet the market demands of lower cost in the timeframe it will demand it? The amount is 15; this amount is chosen based on trends in the printing industry (the assumption is that the need exists for printing for 15 years) * 3. Who controls the complementary assets? a. Competition b. 4. Company X Is a change in market conditions likely to deem the technology obsolete? a. Low b. Medium c. High Assessment 1 9 Assessment 9 5 1 125 Additional Considerations Can we gain control? How much will it cost us to gain more? Can we maintain control? How much can we afford to lose? Additional Considerations Score 9 Score 5 What is the time frame? Will we be able to benefit from first mover advantage? (9+9+9+5)/4 Durability Score 8 Appropriability 1. Does Company X own the value chain? a. Yes b. No Assessment 9 1 Additional Considerations Score 9 Can we create one quickly? Cheaply? If the answer to Q1 is "Yes", Score will be 9, if "No" then proceed to Q2 and use its score. 2. 3. Can a value chain be easily created? a. Very likely b. Likely c. Highly unlikely Assessment Does this technology rely on other technologies outside of the industry? a. Yes Assessment Additional Considerations Score 1 Are they proprietary? Can we have access to them? 9 b. No 9 5 1 Additional Considerations Score Can we afford to? Can we afford to? Are their other possibilities to consider? 9 (9+9)/2 Appropriability Score 9 Extensibility 1. Does this technology have additional uses internally? a. Yes b. No Assessment Additional Considerations Score 9 Can it be used for another application without adapting it? This could also mean that it is not used in the current industry. 9 1 126 2. Does this technology have applicability externally? a. Very likely b. c. Likely Highly unlikely Assessment Additional Considerations Score 9 Can it be used for another application without adapting it? This could also mean that it is not used in the current industry. 1 5 1 (9+1)/2 Extensibility Score 5 Competitiveness The FOMs identified for toner/manufacturing processes are: 1. Environmental impact (green), 2. Particle size, and 3. Cost These FOMs are needed to allow the committee to answer questions one through three. More specifically in each of our comparisons these attributes are utilized. Many companies in the printing industry use toner/manufacturing process B. Therefore a comparison between the FOMs identified for both toner/manufacturing process B and A is needed to assess competitiveness. For environmental impact, a significant amount of energy is needed to generate small particles from large particles. Typical particle size for toner/manufacturing processes B and A range from 7-9ptm and less than 6pm respectively. Additionally because of the particle size toner/manufacturing process A is more cost effective than B. 127 1. 2. 3. How does the function of the technology "compare" against the function of alternative technologies? a. Significantly below current technology Assessment Additional Considerations Score 1 Must determine what is meant by significantly below, below, above, and significantly above 7 b. c. Below current technology Same 3 5 d. e. Above current technology Significantly above current technology 7 9 How does this technology "compare" against current technology in use? a. Significantly below current technology This is on par with current level Assessment Additional Considerations Score 1 Must determine what is meant by significantly below, below, above, and significantly above 7 b. c. Below current technology Same 3 5 d. e. Above current technology Significantly above current technology 7 9 How does this technology ''compare" against predicted future technology? a. Significantly below current technology Assessment Additional Considerations Score 1 Must determine what is meant by significantly below, below, above, and significantly above 5 b. c. Below current technology Same 3 5 d. e. Above current technology Significantly above current technology 7 9 128 This is on par with current level This is on par with current level 4. How far out is the technology from commercialization? a. > 7 years Assessment Additional Considerations Score 1 Provide a potential timeline for commercialization; maybe this would be fine given we don't have good durability at this time; or complementary assets don't exist 9 b. c. 5 years < x < 7 years 3 years < x < 5 years 3 5 d. e. 1 years < x < 3years < 1 year 7 9 All the same comments apply in all these categories Provide a potential timeline for commercialization. Just because this can get out in a year, doesn't mean that the market will be ready for this in a year. (7+7+5+9)/4 Competitiveness Score 7 For market attractiveness, the committee must understand the size of the current market and any potential growth in that market. Growth can also be gained from the creation of a new market. Market Attractiveness 1. Can this technology live within the existing market (this means a market that Company X is In)? a. Highly unlikely b. c. Likely Very likely Assessment Additional Considerations Score 1 No differentiation based on current technology in the market; too much competition exists for this technology to provide value 9 5 9 129 Technology is best in breed and market data shows there is value in developing this technology 2. Does a new market have to be created to support this technology a. Very likely b. c. 3. Likely Highly unlikely What is the potential market growth for this technology? a. Small b. c. Medium Large Assessment Additional Considerations Score 1 A new market must be created to support this technology; in this case it would be outside of the office market 9 5 9 This technology can exist within current market Assessment Additional Considerations Score 1 Market potential < 10%* growth Market potential is about 10%* Market potential >> 10%* growth 5 5 9 (9+9+5)/3 Market Attractiveness Score 7.67 130 Criteria Criterion Value Inimitability Uniqueness Path Dependency Economic Deterrence Durability 6.61 Criterion Weighted Value 7.93 8 9 Appropriability 9 10.125 Extensibility 5 5.25 Competitiveness 7 8.4 7.67 9.97 Market Attractiveness Figure 34: Toner/manufacturing process A Summary Matrix Interpretation of the values from the summary matrix of Figure 34 is based on the nine-point scale listed: 1 - significantly below 3 - below 5 - on par 7 - above 9 - significantly above Recommendations Upon completion of the technology assessment process, the committee has some additional decisions to make in order to determine the suitable course of action. This section advises the committee on the appropriate next steps to be taken. The recommendations listed are not meant to be an answer key, and should not be used in that manner. Instead, the results are to be used to direct the committee as they determine a course of action. The recommendations asserted here are based on the individual scores achieved by each criterion as well as the combination of key criteria in the process. 131 Multiple combinations of the criterion exist. Therefore, to simplify the final decision, obvious things are stated at the onset. If all of the criteria are assigned a score of one, this technology should not be considered for further investment. On the other end of the spectrum, if all criteria are assigned a value of nine, an obvious decision to invest in this technology is desired. Since, a value of five equates to on par, a very solid decision to invest occurs when all the criteria have a criterion value greater than five. Let's explore the toner/manufacturing process A summary matrix shown in Figure 34. By weighting inimitability, competitiveness and market attractiveness, we in essence give them more importance than other criterion. These factors should be above par when contemplating investing decisions. In this case, all criteria except for extensibility scored above par. So then, what decision should be made? The graph in Figure 35 is used to highlight the values that comprise inimitability. Uniqueness and path dependency scored high in comparison to economic deterrence. Because of its uniqueness, a recommendation for toner/manufacturing process A to be reviewed by the IP group is necessary. This group can determine what appropriate patent(s) can be filed, and what potential licensing opportunities can be explored. In terms of path dependency, Company X possesses the core competencies in this area. 132 Inim itability econonic deterrence path dependency uniqueness 1 0 4 3 2 6 5 7 Assessed Value Figure 35: Inimitability Assessment We stated that competitiveness and market attractiveness are important indicators in this process. Figures 36 and 37 show the corresponding values that make up these criteria. Competitiveness 04 0 Q3 Q2 01 0 2 6 4 Assessed Values Figure 36: Competitiveness Assessment 133 8 10 Market Attractiveness Q3 0 Q2 Q1 10 8 6 4 2 0 Assessed Values Figure 37: Market Attractiveness Assessment From the graph in Figure 38, the committee can visualize how the criteria stack up against each other. VERDIX Assessment (weighted) Market Attractiveness Competiveness Extensibility Appropriability Durability Inimitability 0 2 4 6 8 10 12 Weighted Values Figure 38: VERDIX Assessment However, before making a final decision, a skills assessment should be conducted. From the questions related to path dependency, it was determined Company X has a core competence in this area, but this does not address if 134 resources are available to develop this technology. Toner/manufacturing process A is a definite candidate for investment. When results for each criterion do not rate higher than par, special consideration needs to be taken to ensure that the appropriate follow-up steps are taken. For example, in Figure 39, we show the assessment outcomes for two technologies, Oppi and Opp2, the non-weighted and weighted values are shown. Graphical illustrations similar to those created for the toner example should be created for all example outcomes. Criteria Inimitability Uniqueness Path Dependency Economic Deterrence Durability Appropriability Extensibility Competitiveness Market Attractiveness Opp1 9.94 Opp2 7.78/9.33 5.00/5.62 5.00/5.62 5.00/5.25 4.0/4.8 3.67/4.77 7.00/7.87 3.00= 5.00/5.25 7.5/9.0 7.67/9.97 Figure 39: Example outcomes In Oppl, the value for inimitability is quite large in comparison to the other values attained. In fact all other values are right around the par value of five. By looking at the majority of values, one may jump to the conclusion that this technology should not be considered for investment, but before that assessment is made, the high rating for inimitability needs to be thoroughly considered. The committee is not in a position to determine how this technology should be handled by the IP group, but a recommendation that the IP group examine this technology is an appropriate next step. Looking at Opp2, the criteria with the larger weight values, market attractiveness, competitiveness and inimitability are very high, averaging over nine. In this case 135 we note that appropriability is low in comparison to the other values in the matrix. It is worth investing in if the company will be able to receive the monetary stream from it - and in this case the current information is indicating that Xerox does not have the appropriability for the technology. The appropriate next step in this situation is for the committee to engage the Business Opportunities Group in XIG. They have the charter to create business opportunities with Xerox technology, and their further assessment may reveal potential partnership opportunities for Xerox to pursue with this technology. 136 Section 6: Summary As stated throughout this thesis, value is not solely measured in monetary terms, but because it is commonly associated with financial worth, many methods established for determining value have their foundations in financial models. We have recognized that since technology progresses through a maturity cycle, in its earliest stages, its value cannot be readily determined by using financial methods. The value for early-stage technology is determined by accounting for tangibles and intangibles, and its investment returns are both non-monetary and monetary. Since technology development is dynamic, different methods of valuing technology during its maturity cycle are required, thus in later stages of maturity it is appropriate to use financial tools. We have explicitly accounted for this by designing an adapted resource-based view framework (Collis and Montgomery, 1995), VERDI. We have also suggested an approach for adopting and using this framework in a particular application at Xerox Corporation. We were able to show how the VERDI framework could be adopted and customized to meet the needs of a particular firm, in this case Xerox Corporation. For this thesis, the authors desire was to test this framework by applying it to past technologies, where the outcome is known, but unfortunately did not have the time frame to accomplish this task. By performing this analysis it would have allowed us to see the relevance of valuing the technology early. The VERDI framework was established to provide a standard assessment process for early stage technology investments. The outcome of a standard committee based process may offer consistency in both the assessment and scoring methods. It has the potential to provide rigor to reduce the potential for gaming and personal agendas. While the scoring assessment is one outcome of the committee, the most important consequence is the learning gained from the discussion surrounding key questions within the assessment and scoring each technology. As a result of VERDI, a common understanding and language is established and could be used by the individuals involved in the process. 137 It is possible to not only use the framework as an assessment tool, but a communications tool as well. The standardized process and common terminology developed is not only beneficial for the assessors, but enables the innovators to understand the value of their work and the process by which it is valued. As a defined process, incorporated into a firm's day to day operations, it allows everyone to understand how new technology is valued and the avenues that are pursued to gain the most from investing in it. From an organizational standpoint, VERDI demonstrates proper alignment of values, visions, and missions with corporate and business unit strategies and provides a stable unbiased assessment process. It allows those outside of the R&D group to understand that innovation in its earliest beginnings can be valued. As described in Section 1, many firms are structured with business units and a centralized R&D function. The business units run like independent businesses within the firm. They are responsible for their bottom line and it is important they manage their funds and make wise investments to increase their net profit back to the firm. On the other hand the R&D organization has resources allocated to them at the beginning of the year from corporate or the business units directly and since they are not a profit center, they are not expected to return profits back to the company. Therefore, the central R&D group is often viewed as an overhead expense. The VERDI framework is the vehicle to communicate to others outside the R&D organization the value of their day-to-day operations and the importance of investing in them. In order to successfully implement VERDI, the framework needs to be customized to fit the firm. We were able to propose an application of VERDI that could exist within the context of Xerox Corporation. The customized framework, VERDIX, detailed the specific steps and processes that would be used if the framework were adopted within the company. The explicit terminology and course of actions outlined in Section 5 accounts for the corporate culture of Xerox. We caution that it may not be suitable to simply lift this modification of 138 VERDI and apply it to another firm. Cultures vary from one firm to the next and the team that carries out the task of customizing VERDI needs to consider how change, or new processes are rolled out and adopted in the enterprise. Furthermore, understanding the values, vision and mission in conjunction with the strategies of the company is critical to establishing the assessment subcriteria for the framework. This understanding will aid in setting the working procedures and membership norms by which their assessment committee will operate. The framework involves a committee comprised of highly skilled and experienced individuals who represent the combined interests of the firm and have the authority to act on their decisions. Since the leader of the assessment committee is the chief technology officer, or a similar position, it is imperative that he/she endorses the VERDI framework and adoption. If this cannot be achieved, then the VERDI framework if applied will not be a governing and authoritative power, but will only be able to act as a recommendation panel. As seen through an example, the VERDI framework can be applied to companies who design and manufacture products. It is most applicable to those companies that engage heavily in R&D activities, for instance high-tech companies, manufacturers of durable goods, like the automotive industry and aerospace and defense contracting firms. The VERDI framework could also be tailored for use by venture capitalists that invest in high technology start-ups. It would allow them a method to value and monitor the technology. A subset of VERDI can be used to assess the resource and competency base of the firm, which is where our framework has its roots. 139 Future Work The next step for the VERDI framework is to test it with early-stage technologies under development today. Assessment of the technologies needs to occur and the results cataloged. The technologies could be monitored through maturity, and the results of the assessment could be reviewed to see how useful the VERDI framework was in valuing the technology in its early stages. The authors hope to perform a similar task upon return to Xerox. A number of books in the literature have dealt with the idea of extracting value by including tangible and intangible assets. In addition, some authors provide insight on the methods used for valuing technology in the context of the portfolio of R&D projects. To understand how these methods stack up against each other, a study should be performed to compare the outcomes achieved by using these methods. Using past technologies in this study, one could show which technologies were chosen for investment. Gathering information on past technologies would be much easier and would make a good point of comparison since you would know how these technologies progressed through their maturity cycle. 140 Bibliography 1. Amram, Martha, Nalin Kulatilaka, Real Options: Managing Strategic Investment in an Uncertain World, Boston: Harvard Business School Press, 1999. 2. Ariely, Dan. Lecture 1. Marketing Management. Cambridge, MA. February 7, 2000. 3. Bacon Jr., Frank R., Thomas W. Butler, Jr., Achieving Planned Innovation@: A Proven System for Creating Successful New Products and Services, New York: The Free Press, 1998. 4. Balachandra, R., Early Warning Signals for R&D Projects:How to Pick the Winners and Make Your Investments Pay Off. Lexington: Lexington, 1989. 5. Boer, F. Peter, The Valuation of Technology: Business and Financial Issues in R&D, New York: John Wiley & Sons Inc., 1999 6. Boulton, Richard E.S., Barry D. Libert, Steve M. Samek, Cracking the Value Code: How Successful Businesses are Creating Wealth in the New Economy, New York: Harper-Collins, 2000. 7. Christensen, Clayton, M., The Innovator's Dilemma: When New Technologies Cause Great Firms to Fail, Boston: Harvard Business School Press, 1997. 8. Collis, David J. and Cynthia A. Montgomery. "Competing on Resources: Strategy in the 1990s". Harvard Business Review July/August (1995):118128. 9. Cooper, Robert G., Product Leadership: Creating and Launching Superior New Products, Reading: Perseus Books, 1998. 10. Cooper, Dr. Robert G., Scott J. Edgett, Elko J. Kleinschmidt, Portfolio Management for New Products, Reading: Perseus Books, 1998. 11. Cooper, Dr. Robert G., Dr. Scott J. Edgett, Portfolio Management for New Products: Picking the Winners, working paper #11, Product Development Institute, 2001. 12. Davis, Julie L., Suzanne S. Harrison, Edison in the Boardroom: How Leading Companies Realize Value from Their Intellectual Assets, New York, John Wiley & Sons Inc., 2001. 13. Fahy, John, Francis Farrelly, Pascale Quester. "A Resource-Based Perspective of Sponsorship Management & Interpretation". Marketing and Global Economy Proceedings, Argentina 2000. 14. Foss, Nicolai J. and Paul L. Robertson. "Resources, Technology and Strategy: Explorations in the resource-based perspective", London: Routledge, 2000. 141 15. Greenspan, Alan. "The Challenge of Measuring and Modeling a Dynamic Economy". Washington Economic Policy Conference of the National Association for Business Economics. Washington , D.C. March 27, 2001. 16. Groppelli, A.A., Ehsan Nikbakht, Finance, 4 th Edition, New York: Barron's, 2000. 17. Henderson, Rebecca, Lecture 1. Technology Strategy. Cambridge, MA. March 2001. 18. Henderson, Rebecca, Lecture 2. Technology Strategy. Cambridge, MA. March 2001. 19. Henderson, Rebecca, Lecture 3. Technology Strategy. Cambridge, MA. March 2001. 20. Hisrich, Robert D., Marketing, 2 nd Edition, New York: Barron's, 2000. 21. Kotler, Philip and Gary Armstrong, Principles of Marketing, New Jersey, Prentice Hall, 1999. 8 th Edition, 22. Leifer, Richard, Christopher M. McDermott, Gina Colarelli O'Connor, Lois S. Peters, Mark P. Rice and Robert W. Veryzer. "Radical Innovation: How Mature Companies Can Outsmart Upstarts". Boston: HBS Press, 2000. 23. Lev, Baruch, Intangibles: Management, Measurement, and Reporting, Washington, D.C., Brookings Institute Press, 2001. 24. Lev, Baruch, "New Math for a New Economy". Fast Company. Jan/Feb 2000:pp 214-222. 25. Lim, Kwanghui, Lecture 3. Managing the Innovation Process, Cambridge, MA. September 2001. 26. Matheson, David, Jim Matheson, The Smart Organization: Creating Value Through Strategic R&D, Boston, Harvard Business School Press, 1998. 27. Mayo, Andrew, The Human Value of the Enterprise: Valuing People as Assets - Monitoring, Measuring, Managing, London, Nicholas Brealey Publishing, 2001. 28. Miller, William L., and Langdon Morris, 4 th Generation R&D: Managing Knowledge, Technology, and Innovation, New York, John Wiley & Sons Inc., 1998. 29. Morton, J. A., Organizing for Innovation, McGraw-Hill, Inc., 1971. 30. Nichols, N., Scientific Management at Merck: An Interview with CFO Judy Lewent, Harvard Business Review, January - February 1994, p. 89-99. 31. Peteraf, M.A., "The Cornerstones of Competitive Advantage: A ResourceBased View". Strategic Management Journal. 1993: vol 14, pp. 179-191. 32. Porter, Michael E., Competitive Advantage: Creating and Sustaining Superior Performance, New York, The Free Press, 1985 33. Riggs, James L., Engineering Economics, McGraw-Hill, Inc., 1982. 142 34. Razgaitis, Richard, Early-Stage Technologies: Valuation and Pricing, New York: John Wiley & Sons, 1999. 35. Roussel, Philip A., Technology Maturity Proves a Valid and Important Concept", Research Management, vol. 27, no. 1, January-February 1984. 36. Roussel, Philip A., Kamal N. Saad, Tamara J. Erickson, Third Generation R&D: Managing the Line to Corporate Strategy, Boston, Harvard Business School Press, 1991. 37. Stewart, Thomas A., Intellectual Capital: The New Wealth of Organizations, New York: Doubleday, 1999. 38. Sullivan, Patrick H., Profiting From Intellectual Capital: Extracting Value from Innovation, New York: John Wiley & Sons, 1998. & 39. Sullivan, Patrick H., Value-Driven Intellectual Capital: How to Convert Intangible Corporate Assets Into Market Value, New York: John Wiley Sons, 2000. 40.Teece, David J., Capturing Value from Knowledge Assets: The New Economy, Markets for Know-How, and Intangible Assets, California Management Review, Volume 40, Number 3, Spring 1998. 41. Utterback, James M., Mastering the Dynamics of Innovation, Boston, Harvard Business School Press, 1996. 42. Verity, Dominic, Real Options - An Analytical Approach to Aligning Risk Management and Corporate Strategy, Corporate Finance Review, July 1999. 43. Wernerfelt, B., "The Resource-Based View of the Firm: Ten Years Later". Strategic Management Journal. 1995: vol 16: pp.171-174. References 1. Ackoff, Russell, Redesigning the Future: A Systems Approach to Societal Problems, New York: John Wiley & Sons, 1974. 2. Blanchard, Benjamin S., Wolter J. Fabrycky, Systems Engineering and Analysis, New Jersey, Prentice Hall, 1981. 3. Boisot, Max H., Knowledge Assets: Securing Competitive Advantage in the Information Economy, New York: Oxford University Press, 1998. 4. Branscomb, Lewis M., Philip E. Auerswald, Taking Technical Risks: How Innnovators, Executives, and Investor's Manage High-tech Risks, Cambridge: MIT Press, 2001. 5. Dess, Gregory G., Joseph C. Picken, Beyond Productivity: How Leading Companies Achieve Superior Performance by Leveraging Their Human Capital, New York: Amacom, 1999. 143 6. Eliasson, Gunnar, Firm Objectives, Controls and Organization: The Use of Information and the Transfer of Knowledge within the Firm, Dordecht:Kluwer Academic Publishers. 7. Fahey, Liam, Robert M. Randall, Learning from the Future: Competitive Foresight Scenarios, New York: John Wiley & Sons, 1998. 8. Gubman, Edward L., The Talent Solution: Aligning Strategy and People to Achieve Extraordinary Results, New York, McGraw-Hill, 1998. 9. Lackner, David I., Strategic Technology Investment Decisions in Research and Development, Thesis, MIT, 1999. 10. Morey, Daryl, Mark Maybury, Bhavani Thuraisingham, Knowledge Management: Classic and Contemporary Works, Cambridge: MIT Press, 2000. 11. Riggs, James L., Engineering Economics, Hill Book Company, 1982. 2 nd Edition, New York: McGraw- 12. Utterback, James M., Marc H. Meyer, Peter Tertzakian, Metrics for Managing Research and Development in the Context of the Product Family, Management Science, Vol. 43, No. 1, January 1997. 13. Wesolowski, Piotr J., Technology Strategy: Real Options in Research, Development, and Engineering, Thesis, MIT, 2000. 144