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LICENSING
patents, inventions, formulas, processes, designs, patterns; copyrights, literary, musical, or artistic compositions; trademarks, trade names, brand names; franchises, licenses, contracts; and
methods, programs, procedures, systems, etc.
Usually, the licensor is obliged to furnish technical information and assistance and the licensee to exploit the rights effectively and to pay compensation to the licensor.
Economic Motives
Frequently, a new product or process may affect only part of a firm’s total output and only for a limited period of time. The sales volume may not be large enough to warrant the establishment of overseas manufacturing and sales facilities. Furthermore, during the period of acquiring operations there is a risk that competitors will develop improvements that negate the firm’s advantages. As discussed earlier, a firm that is already operating abroad may be able to produce and sell at a lower cost and with less start-up time. Risk of operating facilities and holding inventories is reduced for the licensor. The licensee may find that the cost of the arrangement is less than if the development were accomplished internally. For industries in which technological changes are frequent and affect many different products, such as chemicals and electrical goods, firms in various countries often exchange technology rather than compete with each other on every product in every market, an arrangement known as cross-licensing.
Cross-licensing may violate antitrust regulations if it results in the restriction of entry into a market by one of the parties. The regulations in this respect are extremely complex, and good legal assistance is necessary for any type of agreement. Another cross-licensing problem is that some of the parties may produce more innovations than others. American Home Products participated in pharmaceutical arrangements with several foreign drug makers that later terminated the arrangements because American Home produced few important drugs on its own.7
Even without a cross-licensing arrangement, a licensor may learn from the licensee. For example, Black & Decker’s Heli-Coil, a fastener technology, was licensed abroad, and information on the foreign applications and testing were valuable for marketing Heli-Coil in the United States.8
A second economic motive concerns the resources a firm has at its disposal, a particular consideration for small firms. But large firms may also be constrained. Chrysler, for example, has insufficient resources to establish its own facilities everywhere that overseas production is necessary for Jeep sales. For some of the largest markets, such as India and Australia, Chrysler has subsidiaries. For some smaller markets, such as Sri Lanka and Pakistan, licensing arrangements are used.
Strategic Motives
Large diversified firms are constantly reevaluating and altering their product ijnes to put their efforts where their major strengths best complement their assessment of high-profit businesses. This may leave them with products or
technologies that they themselves do not wish to exploit but which may be profitably transferred to other firms. Because it does not fit into GE’s major lines of business, the company has marketed to other firms its development of a microorganism that destroys spilled oil by digesting it.9 Or firms may license trademarks. Neither Chrysler nor Coca-Cola wish to be in the clothing business, but Murjani Merchandising has licensed the Jeep and Coca-Cola logos, which are valuable in selling a variety of merchandise.10 However, the limited time frame for a licensing arrangement may allow licensor firms to move to a different operating form if the particular technology or trademark use is later deemed to be of strategic importance.11
Political and Legal Motives
Aside from licensing because of restrictions on trade or foreign ownership, licensing may also be a means of protecting an asset. This may come about for two reasons. First, many countries provide very little de facto protection for a foreign property right such as a trademark, patent, or copyright unless authorities are prodded consistently. To prevent the so-called pirating of these proprietary assets, companies sometimes have made licensing agreements with local firms, which then monitor to ensure that no one else uses the asset locally. Second, some countries provide protection only if the internationally registered asset is exploited locally within a specified period of time. If a firm does not use the registration within the country during the specified period, then whoever does so first will have the right to it. Mexico is one such country: In Mexico City, Gucci, Chemise La Coste, and Cartier shops unrelated to the European houses are in close proximity. The Cartier shop copies a Cartier watch dial, bracelet, presentation box, and storefront to the smallest detail, but it puts cheap movements and poor-quality gold filling in the watches. This has hurt Cartier’s reputation among unsuspecting buyers, who then refuse to buy in the authentic stores in New York and Paris. Had Cartier licensed the use of its name in Mexico early on, it might have preempted the nonas-sociated use of the name there. Instead, the real Cartier has opened a shop close to the bogus one in an attempt to educate and steer clients to its legitimate products.12
A firm that doesn’t license may find that another firm can exclude its market entry at a later date or can compete in certain areas of the world through exploitation of the asset, such as in the situations described in Mexico. Western Electric has a liberal licensing policy in order to avoid patent litigation.
Problems and Provisions
Hardly any aspect of international business has been as controversial in recent years as licensing. Given the fact that virtually all royalties are paid to organizations in industrial countries, it is perhaps inevitable that groups within
LDCs have criticized the amounts and methods of payment. Since MNEs view their technologies and trademarks as integral parts of their asset bases, it is perhaps just as inevitable that they are skeptical about transferring their use to other organizations. The following discussion highlights the major concerns of licensors, licensees, and host governments that might be incorporated into a formal agreement.
Control and Competition By transferring rights to another firm the owner undoubtedly loses some control over the asset. There are a host of potential problems with the lack of control that should be settled in the original licensing agreement. Provisions should be made for the termination of the agreement if the parties do not adhere to the directives. The agreement should specify the methods of testing of quality, the obligations of each party concerning expenditures on sales development, and the geographic limitations on the use of the asset. Without these provisions the license may be inadequately worked, the two parties may find themselves in competition with each other, or a poor-quality product in one country may jeopardize product image and sales elsewhere. A good example of the dangers of lack of specification is the case of Oleg Cassini, Inc., which sued the U.S. subsidiary (Jovan) of the Beecham Group from the United Kingdom. Cassini had licensed Jovan to promote and extend sales throughout the world of various Cassini fragrances, cosmetics, and beauty aids. Then Jovan introduced Diane Von Furstenberg products instead and denied Cassini the right to license the Cassini name to other firms. The case was settled when Jovan agreed to market the Cassini products; however, their sales of the products through discount stores won Cassini an award in a later suit because of image injury.13
Some firms have well-known trademarked names that they license abroad for the production of some products that they have never produced nor have had expertise with themselves. The Pierre Cardin label, for example, is used by over 800 licensees in 93 countries to produce hundreds of different products, from clothing to sheets and from clocks to deodorants. Monitoring and maintaining control of so much diversity is very difficult. Two U.S. firms, Saks Fifth Avenue and Eagle Shirtmakers, dropped arrangements with Pierre Cardin-labeled products because the lack of policing for quality on some licensees’ products adversely affected the image of others.14
Depending on the nature of the asset, either the licensor or the licensee stands the risk of developing a future competitor after the agreement expires. If a brand or trademark is involved, the licensee may develop consumer preferences and have to turn the market over to the licensor. If know-how or patents are involved, the licensee may be able to exploit the assets long after the agreement is terminated. Even before an agreement is terminated, the two parties may come into competition with each other because one has made improvements on the licensed technology that make the original patents obsolete. Therefore, it has become common for firms to make provisions in the original contract for the possible use and sharing of superseding technology built on knowledge from the original transfer.
Secrecy The value of many technologies would diminish if they were widely known or understood. Provisions that a licensee will not divulge this information historically have been included in agreements. Some licensors have, in addition, held onto the ownership and production of specific components so that licensees will not have the full knowledge or capability to produce an exact copy of the product.
Secrecy arises as a problem for negotiating agreements to transfer process technology. Many times a firm has developed techniques that it has not yet used commercially but that it wishes to sell. A buyer is reluctant to “buy a pig in a poke,” but a licensor who shows the potential licensee the process risks having the process used without payment. It has become common to set up preagreements in order to protect all parties.
An area of growing controversy is the degree of secrecy in the financial terms of licensing agreements. Within some countries, for example, governmental agencies now must approve royalty contracts once the contracts have been negotiated by the parties involved. Sometimes these authorities consult with their counterparts in other countries regarding similar agreements in order to improve their negotiations with MNEs. Many MNEs object to this procedure because they believe that contract terms are proprietary information of competitive importance and that market conditions usually dictate the need for very different terms in different countries.
Stage of Technology Development Technology may be old or new, obsolete or still in use at home, when transferred to a foreign firm.15 For example, Crown, Cork, and Seal held on to its three-piece can manufacturing technology until it developed two-piece technology, whereupon the older technology was licensed to LDCs. United Technology transferred the same elevator technology it had been using in the United States to the People’s Republic of China. Many other companies transfer technology at an early or even a developmental stage so that products are introduced almost simultaneously in different markets. On the one hand, new technology may be worth more to a licensee because it may have a longer life of use. On the other hand, newer technology, particularly in the development phase, may be worth less because of its more uncertain value in the market.
Figure 15.1
Determinants ot Compensation in International Technology Licensing
The upper left-hand box shows factors in the agreement that can affect the value of technology to the licensee. The upper right-hand box shows factors external to negotiations that can affect pricing. The bottom portion shows a bargaining range based on estimates by the licensor and licensee. Source: Kang Rae Cho, “Issues of Compensation in International Technology Licensing,” Management International Review, Vol. 28, No. 2,1988, p. 76.
Payment There is a wide variation in the amount and type of payment under licensing arrangements, and each contract tends to be negotiated very much on its own merits. Figure 15.1 illustrates the major factors determining the amount of payment. The upper left-hand box, agreement-specific factors, illustrates negotiated clauses that may affect the value to the licensee. For example, the value will be greater if potential sales are high, such as with exclusive worldwide rights for a long period of time before the asset becomes obsolete. The upper right-hand box, environmental-specific factors, lists other conditions that may affect the value. For example, the amount the licensee might pay could be low if its government sets upper payment limits or if other firms are vying to sell similar technology. Since neither the licensor nor the licensee can be sure of the price the other is willing to accept, the bottom of Fig. 15.1 illustrates the bargaining range based on their expectations.
Many LDC governments set price controls on what licensees pay or insist on prohibitions of restrictions.16 One of the thorny issues on sales restrictions as seen by LDCs is that licensees are usually prevented by contract from exporting; thus small-scale production may cause high full costs to the consumers. MNEs have countered that extending sales territories would necessitate high royalties because MNEs could not sell exclusive rights to parties in other countries. They also have argued that the development of process technologies for small-scale production would often be too costly but is done when economically feasible.
Taxes may be assessed differently depending on the methods of arranging payments under the agreement, for example as income or as a capital gain. If the taxes on capital gains are different from those on income, the after-tax receipts will be different. Payment schedules also may be deferred in order to defer the payment of taxes. Fees to be paid for the use of an asset may be made in a lump sum, on a percentage of sales value, on a specific rate applied to usage, or on some combination of these methods.
It is common to negotiate a “front-end” payment to cover the cost of transfer and to follow this with another set of fees based on actual or projected usage. The reason for this is the realization that few technologies may be moved abroad simply by transferring publications and reports. The negotiation process is itself expensive and must be followed by engineering, consultation, and adaptation. The early stages of production usually are characterized by low quality and low productivity.17 The substantial costs in the transfer process increasingly are charged to the licensee so that the licensor is motivated to assure a smooth adaptation.
Sales to Controlled Entities Many licenses are given to companies con-nected in ownership with the licensor. A license may be needed to transfer
technology abroad because operations in a foreign country, even if 100 per-
cent owned by the parent, usually are separate firms from a legal standpoint, When there is a present or potent’ul shared ownership, a separate licensing
arrangement also may be a means of compensating for contributions beyond the mere investment in capital and managerial resources.
The price at which MNEs sell to foreign operations they control is very controversial. Since much of what is transferred among controlled entities of a multinational company is unique to that company, it is highly difficult to estimate what the competitive price would be if the company were selling the same thing to a noncontrolled entity. Yet by altering the price of product, components, patents, and so on, MNEs effectively may transfer more of their profits from one country to another. Critics in donor countries have contended that too little is charged, and thus profits are transferred to low-tax countries. LDCs with low tax rates have contended the opposite, arguing that MNEs have artificially minimized their profits in LDCs in order either to move funds to countries with a stronger currency or to gain certain host-governmental concessions.18 Obviously, MNEs cannot be shifting profits simultaneously to both the home and the host country; nevertheless, the criticisms have made it more difficult for MNEs to establish licensing contracts with their controlled affiliates. Tax authorities in home countries ask for pricing justifications. Governmental authorities in LDCs are increasingly approving transfers on a case-by-case basis.
Positioning the Licensing Unit19
Where the responsibility for licensing is handled typically in organizations depends on the motives for licensing. When licensing is an integral part of a company’s growth and diversification objectives, a separate licensing department is likely to be in charge of buying and selling. In multidivisional firms there may be more than one of these departments. When the strategy is primarily the safeguarding of existing activities, licensing is apt to be a part of the legal or patents department. When a company combines the above two objectives, it tends to attach licensing to the R&D department.