What is Licensing? And Licensing Advantages and Disadvantage in International Markets.
Licensing is one of the way for firm to establish local production in foreign markets without capital investment. It differs from contract manufacturing in that it is usually for a longer term and involves much greater responsibilities for the national party. A licensing agreement is an arrangement wherein the licensor gives some thing of value to the licensee in exchange for certain performance and payment from the licensee. The licensor (the international company) may give the licensee (the national firm) one or more of the following things:
- Patent rights,
- Trademark rights,
- Copyrights, or
- Know-how on products or processes.
Any of these can be given for use in a particular foreign market, or the licensee may have rights in several countries or on a whole continent. In return for the use of the know-how or rights received, the licensee usually promises:
- To produce the products covered by the rights,
- To market these products in an assigned territory, and
- To pay the licensor some amount related to the sales volume of such products.
The licensee assumes a much greater role than the contract manufacturer, taking over marketing in addition to production and is thus the complete foreign-market presence of the international firm for the products covered. Several features of licensing are attractive.
First, it requires no capital and need not deter even small companies. Second, it is often the quickest and easiest way to enter a foreign market. Even the firm that has capital may face a slow process establishing local production and distribution. Third, the firm immediately gains local knowledge.
A fourth advantage is that many governments favor licensing over direct investment because licensing brings technology into the country with fewer strings and costs attached.
Thus, licensing may gain government approval more quickly than direct investment. And from the licensor’s viewpoint, there is no investment to be expropriated. Finally, the general advantages of foreign production also apply to licensing savings in tariff and transport costs, local production where national suppliers are favored, and so on.
The disadvantages of licensing are less numerous, but they may carry greater weight. The chief fear about licensing is that the licensor may establish its own competitor. During the five or ten years of the licensing agreement, the licensor may transfer enough expertise that the licensee can go it alone, and thus the licensor may lose that market, and perhaps neighboring markets, to the former licensee.
This is less likely where strong brands or trademarks are involved.
Another reason for hesitancy about licensing is the limited returns it provides. Although no capital outlay is necessary , the royalties and fees from licensing are not cost free to the licensor, which must invest management and engineering time.
A direct investment approach to the foreign market requires greater effort and resources, but it may yield much greater profits. Licensing returns are limited primarily to a percentage of licensee sales, commonly 3 to 5 percent. Indeed, less developed countries are trying to reduce even further the royalties and fees paid to licensors. In one Korean case, the licensor and licensee agreed on a 5 per cent royalty, but a government ministry adjusted it to 3.2 per cent.
Yet another possible drawback is the problem of controlling the licensee. Although the contract should spell out the responsibilities of each party, misunderstanding and conflicts can arise in its implementation.
Frequent areas of conflict are quality control, the marketing effort of the licensee, and interpretation of the exclusiveness and extent of territorial coverage. These problems arise partly because an agreement that met both parties interests at the time of signing can became unsuitable to one or both as conditions change.