A licensing agreement is an agreement wherein the licensor gives something of value to the licensee in exchange for certain performance and payments. Usually what is transferred from one party to the other is some form of industrial or commercial expertise, such as:
- A patent covering a product or process
- The right to the use of a trademark or brand name
- Manufacturing know-how on products or processes (that is not the subject of a patent)
- Technical advice and assistance including (occasionally) the supply of components, materials, etc. which may be required in the manufacturing process
- Marketing advice and assistance
Payment for the expertise involved can take any or a combination of the following forms:
- An initial payment, payable as soon as the licensing agreement is signed, either for know-how or for the initial transfer of machinery, components or designs
- An annual minimum payment
- An annual percentage fee based either on sales or on profits
- A mutual exchange of knowledge and/or patents, i.e. cross-licensing
Advantages of licensing
There are numerous advantages in entering into a licensing agreement with a foreign national:
- Licensing requires very little capital outlay (making it an accessible channel even to small companies) and it should provide a high rate of return on the capital invested
- It provides access to markets which might otherwise be closed because of high rates of duty, import quotas or other restrictions, or because of excessive transportation costs
- Should the licensing arrangement prove to be a failure, it will not result in heavy financial losses
- The exporter does not face the risk of having assets nationalised or expropriated
- The exporter gains access to the licensee’s local marketing and distribution organisations, and existing clientele, thus avoiding many of the problems associated with setting up a wholly- owned manufacturing subsidiary
- Many governments favour licensing over direct foreign investment because licensing brings technology into the country without the disadvantages associated with direct investment
- Because of the limited capital requirements, licensing enables new products to be sold worldwide before competition develops
Disadvantages of licensing
Licensing, however, does have some disadvantages:
- During the period that the licensing agreement is in force, the firm may transfer sufficient expertise to the licensee to enable the latter to set himself up as a competitor, not only in the original market but perhaps also in neighbouring markets or even in the domestic market
- Licensing provides limited returns on the investment of managerial and engineering time – royalties and fees normally constitute less than seven per cent of turnover
- Governments can impose restrictions either on the remittance of royalties or on the supply of components
- It is often difficult to control the quality of the product which, in most cases, is sold under the licensor’s brand name
- Although the contract should specify the responsibilities of each party, misunderstandings and conflicts can arise during the implementation stage. Areas of conflict might include; the marketing efforts of the licensee, the interpretation of exclusivity and the extent of the licensee’s territorial coverage
Managing licensing operations
The selection of the licensee is a vitally important step and a number of candidates should be identified and evaluated before making a final choice. Many companies – to their detriment – have chosen licensees by responding to an initiative from a foreign producer without considering alternatives. The licensing agreement must be carefully drafted in order to protect the interests of both parties. It should include clauses relating to the duration of the agreement, territorial coverage, the royalty rate, protection of trade secrets, minimum performance, and quality control.
The licensor should endeavour to maintain some control over the licensing operation by supplying some of the key components rather than exposing know-how entirely. Alternatively, provision can be made in the agreement for converting the operation into a joint venture on expiry of the agreement, avoiding the possibility of the licensee becoming a competitor. The firm should encourage effective licensee performance by assessing the ability of the licensee to solve production and marketing problems and by maintaining a flow of up-to- date technological know-how, thus ensuring that the licensee will continue to perceive value in the arrangement. Exporters must have both a policy and a plan for licensing, and must have an executive responsible for the implementation of both.
Franchising is a form of licensing whereby the franchiser provides a standard package of components or ingredients together with management and marketing expertise, and the franchisee provides capital, market knowledge, and personal involvement.
Franchising works well for products that are not subject to patents. Pepsi-Cola, for example, relies heavily on franchising. The franchise holders own the bottling plants, employ local staff and control their own advertising and sales promotion. Pepsi-Cola sells the concentrate to the bottlers and provides promotional and managerial support. Franchising holds the same advantages as licensing and creates the opportunity for revenue to be earned from a product that cannot be patented. A franchiser also enjoys a greater degree of control over the operation because they supply the ingredients or components.