Alan Letton, PhD, Innovative Technology Management LLC
As a physical scientist, I see the world in terms of the “forces” that govern it. Put water into a sub-zero environment and the temperature difference is the force that drives the water to freeze. Similarly, if you are in a car at the top of a hill, gravity is the force that causes you to roll forward. So, I started asking myself (as a nerd in the investment community) what is the equivalent force in investment? How do these natural laws apply? Do market thermodynamics exist? Well here is the answer.
For convenience, let’s look at the economy, patent production and financial investment as falling into three big buckets: Engineering & Manufacturing, IT and Financial Technology (computer stuff . . .) and Biotech/Pharma. As in the sciences, at equilibrium (optimization) the thermodynamic forces must be neutralized. A car doesn’t move if there isn’t a force compelling it to do so. Water will not change temperature if a thermal difference doesn’t exist. So, what does this all mean for investment?
As part of balancing our investments, we can check to see if there is a thermodynamic drive that suggests our investment will grow; that market opportunities exist for the products or technologies we are investing in. For example, it wouldn’t make sense for anyone to invest in another portable music device like an iPod. Sure, hundreds of new designs can be created with new features but the market place thermodynamics would resist the growth of this new technology. As a matter of fact, market forces, the demand that pulls the product into the marketplace and builds growth, are probably going to yield a rapid decline in the product’s life and therefore a loss in revenue.
To avoid this scenario, we can look at the market’s grown and performance by the three segments and see if they match patent production, followed by a look at venture investment in the same three areas. We believe university patent production is a good representation of development’s leading edge. If we look at patents generated in the three key areas by universities in 2016, they line up as follows.
Engineering & Manufacturing – 50%
IT & Financial Technology – 6%
BioTech & Pharma – 44%
This is only a slight change from 2002’s distribution, although there is a 192% increase in the number of patents from universities in these categories over the same period.
Unfortunately, the revenue data collected by sectors as defined by the federal government do not line up with the categories associated with patent issuance. But there are trends that we can address to support our Market Thermodynamics. The financial sector was the largest contributor to our economy when looking at corporate profits. Given the small percentage of patents produced it is reasonable to assume that there is plenty of room for significant growth in the financial technology space (including Artificial Intelligence) given the market’s continued growth and performance1. If you aggregate the engineering and manufacturing related sectors, it accounts for one of the two largest areas of corporate performance in the country. However, venture and early investment dollars do not align with these trends.
If one looks at the current summaries of venture capital investment by industry segment2, there is a disproportionate investment in Healthcare, Internet, Telecommunications, Software, etc. relative to investments in consumer products, chemical technologies, manufacturing, etc. This simple analysis (I know my economist friends are going to scream at me . . .) shows the limited investment in the physical sciences -engineering, manufacturing, materials technology, etc. This coupled with the corporate performance in the engineering and manufacturing related sectors suggests there is a significant opportunity to realize good gains if IP is evaluated with market and risk mitigation as part of its consideration. Organizations such as Allied Signal, Sealy, which I have a personal experience with, in addition to many other Fortune 1000 companies, manage to thrive when bringing physical science technologies to the marketplace. Watch for our white paper on “Tools for Actively Managing Investment Risk”.
References
- https://www.statista.com/statistics/222122/us-corporate-profits-by-industry/
- https://www.statista.com/statistics/277506/venture-caputal-investment-in-the-united-states-by-sector/
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