United States: Trade Secret Cost Management

Last Updated: January 28 2019
Article by Seyfarth Shaw LLP

As a special feature of our blog—guest postings by experts, clients, and other professionals—please enjoy this blog entry from Donal O'Connell, Managing Director of Chawton Innovation Services Ltd.

Cost Management

Cost management is the process of planning and controlling the budget of a business, a function, or a project. Cost management is a form of management accounting that allows a business, a corporate function, or a project to predict impending expenditures to help reduce the chance of going over budget.

Cost management arrangements range from the very simple (e.g. a small project within a corporate department or function) to the highly complex (e.g. a portfolio of international projects owned by a large MNE), but the principle is always that of ensuring that costs are controlled and exceeded by the value of benefits delivered.

In today's competitive environment, more and more companies view all of their spend (direct and indirect) as an investment. They make smart investment decisions based on strategic vision and the internal capabilities of the organization to deliver value from that investment.

Intellectual Property Cost Management

The importance of cost management by in-house intellectual property management is something every IP manager is familiar with.

IP can be expensive, and therefore, costs must be weighed carefully and managed well. Cost management will involve the planning, coordination, control, and reporting of all cost related aspects of an organization's IP activities.

IP cost management is the process of identifying all costs associated with the investment, making informed choices about the options that will deliver the best value for money, and managing those costs throughout the life of the IP assets of the organization.

Decisions about cost must be based on an understanding of the whole supply chain involved in IP—namely IP creation, IP portfolio management, IP enforcement, IP exploitation, and IP risk management.

The associated IP costs must also be weighed against the immense value that IP can generate for business.

Simply put, IP cost management is an essential part of effective and efficient overall IP management.

Not Limited to Patents and Trademarks

The importance of IP cost management, however, is not limited to just patents and trademarks but applies to all of the IP assets within the organization, including unregistered forms of IP such as trade secrets.

Given the growing importance of trade secrets for a variety of reasons, trade secret cost management has, as a result, also risen in importance.

Please understand that unlike patents, there is no regulated registration process for trade secrets. Instead, the onus is on the organization in possession of the secret to take the necessary precautions to maintain it as such. Although there are no official registration fees associated with trade secrets, there are costs involved.

The organization must weigh up the competitive significance of its trade secrets against the cost of protecting them.

The organization must also appreciate that trade secret asset management is an ongoing, proactive process. It is not a one-off event, so trade secret-related costs will be spread out over time.

Trade Secret Cost Management

Perhaps the most obvious means to manage trade secret-related costs is allocating a sensible budget, having good people to ensure that the budget is well prepared, monitoring actual costs versus planned costs, and taking appropriate actions when needed.

An insufficient budget will inevitably result in corners being cut, and the result of this may well mean that the end product is less than satisfactory. On the other hand, too big a budget may lend itself to the outcome that you are less than wise in your spending or do not take cost management seriously.

Using a good fit-for-purpose trade secret cost tracking and reporting tool is also critical to good cost management.

However, let's delve deeper into trade secret cost management.

Defining Trade Secret Cost "Buckets"

Good trade secret cost management starts with being able to separate trade secret-related costs into "buckets." Some IP managers lump all trade secret-related costs into one cost bucket. However, by breaking out costs into separate categories, the IP manager builds up a more accurate picture.

I suggest that there should, at a minimum, be the following trade secret cost buckets defined and taken into use:

  • The costs associated with the creation of the trade secret
  • The costs associated with administrative protection mechanisms
  • The costs associated with legal protection mechanisms
  • The costs associated with technical protection mechanisms
  • The costs associated with the sharing of any trade secrets of the organization with others (such as key suppliers, customers, and collaboration partners)
  • The costs associated with any trade secret disputes

I would also suggest that there are different cost buckets defined for those trade secrets legally owned by the organization versus those trade secrets legally owned by others but entrusted to the organization.

Depending on the maturity and sophistication of the organization with respect to trade secret asset management, there may indeed be other trade secret cost buckets worth considering.

  • The costs associated with regular trade secret audit exercises. In a paper published in 2017, David Cohen defined five categories of goals for trade secret audits. They are: (1) developing a basic awareness of what trade secrets exist within the company and ascertaining all associated metadata about those secrets; (2) review and/or development of agreements appropriate for the company in light of its trade secrets; (3) an assessment of how a company's current, former, and potential employees interact with those trade secrets and the relevant policies that govern those interactions; (4) developing technical tools and processes to maximize trade secret asset protection and policy compliance; and (5) devising a monetization strategy that leverages safeguarded trade secrets in way that bring additional, concrete value to the company. Each goal identified builds on the previous one, and a trade secret audit can have some or all of them as a goal. Regardless of the goal, these are costs associated with conducting a trade secret audit exercises.
  • The costs associated with any formal trade secret valuation work conducted. The rationale for conducting such a trade secret valuation may vary—for management information purposes, for strategic planning, for value reporting, for accounting purposes, for liquidation reasons, for supporting a legal transaction, for licensing, for litigation support, for dispute resolution, for taxation planning and compliance, for fundraising purposes, etc. Regardless of the rationale, there are costs associated with conducting a professional trade secret valuation exercise.
  • The costs associated with taking out trade secret insurance. One leading IP insurance provider's trade secret insurance product currently exists in the form of three separate policies that can be bundled together depending on a client's needs, namely—trade secret enforcement, trade secret defense, and unauthorized disclosure. The three policies each touch on the unique risks associated with trade secrets. Trade secret enforcement allows a company to go after entities that misappropriate their trade secrets, while trade secret defense works in reverse if and when a company is accused of trade secret theft. Finally unauthorized disclosure is insurance against the leaking of trade secrets by rogue employees or others, such as suppliers or vendors with access to such trade secrets.
  • The costs associated with taking a trade secret asset management system or tool into use. If the organization only has a handful of trade secrets, then they probably do not need to consider taking a trade secret asset management system into use. However, if the number of trade secrets in a company is more than a handful, if they are sharing their trade secrets with others, if other entities are entrusting their trade secrets to the company, if the company has staff turnover issues, if the company has any direct or indirect links with entities in the U.S. (given the growing issue with trade secret litigation there), if the company has trade secrets located across diverse EU member states (given the EU Directive on Trade Secrets being enacted in June 2018), if the company is doing any business in China (updated Anti Unfair Competition Law as of 1 Jan 2018, plus some initiatives to enhance it even further), or if the company is conducting any IP due diligence exercises due to some corporate event (M&A, JV, Investment Round, etc.), then the organization should have some trade secret asset management system in use. There will be costs associated with any such system.

The Steps Involved in Trade Secret Cost Management

Produce an Initial Estimate

Compile a realistic estimate. Ensure that it covers all of the trade secret portfolio and all trade secret asset management-related activities and that it contains sufficient contingency.

Achieve a Baseline Budget

Get the estimate signed off formally by senior management, and then ensure that the actual funds get released and allocated to whoever is responsible for trade secret asset management within the organization.

Establish a Monthly or Quarterly Budget

Depending on the size and complexity of the organization and the pace of the business, establish a monthly or quarterly budget. Determine what should be the expected monthly or quarterly running costs.

 Establish Some Trade Secret Cost Controls

Set up some clear trade secret cost controls and sign-off responsibilities for the different types of expenditure. Consider who will be approving and signing off such items. It is important to note that many trade secret cost items will not fall under the responsibility of the Legal or IP function within the organization but instead belong to HR, IT, Quality, Sourcing & Procurement, Facilities, etc.

Track Actual Trade Secret Costs

Check the actual amount of money accounted to this trade secret asset management activity each month or each quarter. Compare and contrast it against the approved budget.

Calculate Some Trade Secret Cost-Related KPIs or Metrics

Calculate and update some trade secret cost-related KPIs or metrics at the end of each reporting period, and include such cost-related KPIs or metrics into IP reports and IP steering committee presentations.

Adjust the Forecasts

Adjust the trade secret cost forecasts on a monthly or quarterly basis to cater for any significant changes that have taken place. Changes could stem from the actual costs being lower or higher than forecast or estimates being lower or higher than forecast.

Communicate, Communicate, Communicate

Create transparency to senior management around the costs associated with the trade secret portfolio of the organization and the management of such assets by including some cost data into the IP reports and IP steering committee presentations. If for some reason the trade secret costs are way off track, then it should be treated as an urgent issue which must be analyzed and resolved.

The Value of Possessing Good Quality Trade Secret Cost Data

Why bother?

Firstly, good quality trade secret cost information allows the IP manager to visualize the costs and identify opportunities to cut unneeded or unnecessary costs.

Secondly, good quality historical trade secret cost data supports the IP budgeting process when trying to estimate future costs as past financial data can help to inform assumptions about the future.

Thirdly, good quality trade secret cost data may become important when involved in trade secret misappropriation court cases. I know of a few trade secret litigation lawyers in the U.S. starting to delve into the trade secret cost information of the opposing party, particularly those lawyers representing the defendants. After all, it may be challenging for the plaintiff to argue that their trade secret is extremely valuable and yet that trade secret has no associated cost data.

Fourthly, having such cost information may prove of great value for the damages part of any trade secret misappropriation court case.

Given the growing interest by the tax authorities in the intangible assets of organizations, including their trade secrets, such cost details may also be of value from an accountancy and tax perspective, especially in areas like intergroup licensing and transfer pricing.

Last but not least, (and as discussed above) having good trade secret cost information greatly assists the in-house IP manager when communicating about trade secret asset management to the IP Steering Committee and/or the C Suite Executives in the organization.

"I have no idea" is not a great answer for an IP manager to give when asked by the IP Steering Committee or the C-Suite Executives how much money the organization is spending on its trade secrets and the management of such assets.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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