It’s not easy being lean: acquiring patent attorney businesses and capital management

Hello!  I thought I’d take a look at how margins influence decision making for the listed patent attorney firms.

One of the things that you will notice that listed patent attorney firms are concerned with is their margin, which roughly is yet another word for profitability.  In essence, it is a measure for how many dollars you spend to make a dollar of profit.  A margin of 33% means you spend $2 to make about $3 in revenue and therefore $1 in profit.  At the moment, the listed patent attorney firms (IPH and QANTM IP)  make about a 30% margin although IPH has often been higher.

A margin of 20% means for the same $2 you make $2.50 in revenue and only 50c profit.

So if you improve your margin from 20% to 33% you can double your profit.  A margin of 50% (which was the figure bandied around for some of IPH’s operations) would mean that you make $2 in profit for every $2 you spend.

Why is this important?  Well first, if you follow my posts you know how hard it is for mature patent attorney firms to acquire large game-changing clients particularly in a flat market.  It is much easier to increase your profit by cutting costs – for example, by introducing a streamlined software system that can handle docketing, word processing and accounts, thus reducing a lot of the red tape and double handling that afflicts patent attorney firms when managing their case load.  The end game in making things more efficient in this way is to reduce the unit cost for each unit of revenue, thus increasing profitability.  Because patent attorney firm costs are mainly related to employees and rent, this means you need less employees (and less office space) per unit of revenue.  This is often called capital management.

Why increase profit?  Well, it’s what the market expects of course.  And it provides a buffer if, say, you lose a client or your rent goes up – low margin businesses are very fragile.  But there’s another reason: if you can make your systems and processes efficient enough (and transferable enough) then it means you can justify paying more for a particular acquisition if you can see that you will be able to increase their profitability by applying your systems and processes to the business of that acquisition.

The recent acquisition of Cotters Patent and Trade Mark Attorneys by QANTM IP might serve as an example.  Using the rule of thumb from my previous post which related profitability to price, I calculated that Cotters generated around $600,000 profit per year.  But what if that was at a 20% margin and, by using the back office systems of QANTM IP, Cotters could increase their margin to 33%?  Then that firm is worth $1.2 million a year in profit or a value of $12 million to QANTM IP.  (Never bad to buy something at half price!  Except, of course, yoghurt).

The acquisition of AJ Park by IPH may represent the consequence of such a difference in systems and processes as applied to margins.  Rumor has it that IPH outbid QANTM IP on the basis that IPH thought they could increase the margins of AJ Park’s business significantly, thus justifying a higher price in their hands.

So, what does this mean?  Well, I have commented before on QANTM IP’s hire of a CEO who is looking to transition the company (by which is meant moving them to a more efficient IT platform).  It doesn’t sound that exciting.  But if it means that QANTM IP is better positioned to acquire more patent attorney businesses going forward, then the strategy starts to make a lot more sense.

Toodaloo!

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