Mercer Capital's Financial Reporting Blog

Economics of Elon Musk’s Patent Altruism

Elon Musk just opened Tesla Motors’ patents to the public in “the spirit of the open source movement” (and maybe as a subtle dig at its namesake’s biggest rival, Thomas Edison). Mr. Musk is a cofounder of Zip2 and PayPal; founder, CEO, and chief designer of SpaceX; cofounder, CEO, and product architect of Tesla Motors; and Chairman of SolarCity. He has bet, with the help of his companies’ innovations, that solar power will provide a plurality of our energy in less than 20 years and that humanity will step foot on Mars in 10 to 12 years. He often makes some iteration of the following self-deprecating joke:

“Did you hear the one about the guy who made a small fortune in the space industry? He started with a large one.”

With the various successes of Tesla Motors, SpaceX, and SolarCity in the last year, the market seems to think otherwise. In an ostensibly altruistic act, Mr. Musk stated last week that “Tesla will not initiate patent lawsuits against anyone who, in good faith, wants to use our technology.” So, what are these patents that Tesla Motor’s cofounder is seemingly giving away actually worth?

Most important to a patent’s value is its ability to enhance cash flows by either direct monetization (royalties) or higher margins from lower competition. Conceptually, it’s best to use some combination of the following approaches:

  • Cost approach: how much it would cost to recreate the patent;
  • Market approach: the price at which market participants would agree to transact the patent; and,
  • Income approach: future cash flows (likely amounts and associated variability) attributable to the patent.

Further, the ability of a patent to enhance cash flows is inextricably linked to the enforceability of the exclusive right to a product or process that it provides. If a court will not uphold the patent, then it is worthless as it provides no revenue or competitive advantage. Mr. Musk has been a skeptic of patents for years. In regard to lack of SpaceX patents on their spacecraft and rockets, he stated in a TED interview over a year ago, “Since our biggest competition is national governments, the enforceability of patents is questionable.”

He wrote in his recent press release, “a patent really just meant that you bought a lottery ticket to a lawsuit, I avoided them whenever possible.” Mr. Musk went on to say:

“At Tesla, however, we felt compelled to create patents out of concern that the big car companies would copy our technology and then use their massive manufacturing, sales and marketing power to overwhelm Tesla. We couldn’t have been more wrong. The unfortunate reality is the opposite: electric car programs (or programs for any vehicle that doesn’t burn hydrocarbons) at the major manufacturers are small to non-existent, constituting an average of far less than 1% of their total vehicle sales.”

If no one’s using the technology, and there are no royalties, are the patents worthless? Has Mr. Musk found himself with the only fax machine on the planet? While a great invention, the value of faxing was only partly in the plastic box—most of the technology’s value can be attributed to a robust and near-ubiquitous network of machines that made wide-scale document transmission feasible.

An electric car, without a cost-effective nationwide network of charging infrastructure, is likely a novelty without much use outside of short, daily commutes. By giving away these patents, Mr. Musk probably hopes to create a system of sufficient size to overcome the cost of his nationwide recharging stations—not just the cost of building the stations, but waiting times or just the psychological signal that buying and waiting for electric vehicles to charge is acceptable behavior. We have actually seen similar moves with emerging technologies before: Bessemer steel mills and General Motors’ catalytic converters are just two examples.

During a conference call on his recent decision, he stated, “You want to be innovating so fast that you invalidate your prior patents, in terms of what really matters. It’s the velocity of innovation that matters.” Elon Musk is likely investing in future demand for his next generation of patents. Ultimately, one has to assume that Mr. Musk is trying to drum up demand for his wares: Tesla’s third generation Model X, batteries from its new factory, or solar power built and financed by SolarCity. Perhaps shrewdly, he appears to have concluded that the cash flows he is giving up today in the form of foregone royalties or potentially lower margins will be more than made up by future cash flows from a more vibrant solar power-based transportation network.

Mercer Capital regularly values patents and other intangible assets in the context of financial reporting and tax-related engagements. Please contact us to discuss your valuation issues in confidence.

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Mercer Capital monitors the latest financial reporting news relevant to CFOs and financial managers. The Financial Reporting Blog is updated weekly. Follow us on Twitter at @MercerFairValue.