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Licensing Agreement: Definition, Example, Pros and Cons

Licensing Agreement - Definition, Example, Pros and Cons

Licensing agreements are extremely common in the international transfer of technology and their number is growing more and more.

The factors that underlie the dynamically developing process of increasing international licensing exchange are mainly related to the increasing licensing of research results conducted in universities; the boom of small high-tech enterprises, which suffer from a lack of resources to penetrate international markets by other means; increasing the value of innovation and shortening the life cycle of products, which requires rapid, vigorous action, especially in international markets; striving to avoid duplication of research and development costs through licensing or mutual exchange of licenses; the emergence of sectors such as biotechnology, pharmaceuticals, electronics and others in which licensing is considered a vital necessity.

Overseas licensing

In short, overseas licensing is becoming an important tool today to help companies defend their technological advantage internationally and compete successfully in a complex and rapidly changing international business environment.

Licensing agreements are formed for the joint solution of technological, production, and sales tasks with significant derivative results.

As an agreed type of inter-company cooperation, licensing can be considered both as a stand-alone operation and as a component accompanying exports and overseas production.

In practice, licensing agreements are a way to produce and sell abroad, avoiding significant investments for own production and absorption on the foreign market.

Licensing differs from export and production contract

Licensing differs from the export and production contract mainly in that it involves the licensee in a much wider area of ​​responsibilities and activities – the right to use a certain scientific and technical result in the long run, taking over the overall marketing of products with the assistance and on the recommendations of the licensor, achieving efficient distribution, etc.

The counterparty, the licensor, collects a steady income for its technical knowledge without making a continuous commercial or production effort. Although he receives only a part of the realized profit, it is not uncommon for this part to be greater than the income of any other method of conquering the market.

However, not many companies rely solely on licensing agreements to ensure their presence in international markets. For large export-oriented companies, license revenues rarely exceed one to two percent of total sales.

However, it can be said that once a company has the experience and knowledge gained through the use of some form of international technology transfer, it gains the necessary self-confidence and is ready to embark on other more sophisticated approaches to overseas expansion.

This is in full unison with the idea that each company must be flexible according to the circumstances and that the different methods are above all complementary, rather than competitive.

The licensor gains access to the relevant market

The licensor has access to the relevant market without the need to overcome customs and other administrative import difficulties, ie. at minimal risk, and the licensee does not have to start from scratch, as he immediately acquires a well-known prestigious product, technological, and production experience.

In this sense, licensing is considered the most efficient and reliable way to quickly and relatively smoothly enter and develop the foreign market. It is a method of penetrating abroad, practically without investing capital in a given foreign market.

Only insignificant and, in some cases, no capital, transport, or other costs are required. This can be extremely attractive for smaller technology companies entering the international market for the first time.

As a rule, it is the licensee who should make the necessary investment for the production and trade of the goods in question within its powers.

With its help, the licensing company secures access to and contacts with the reality of the foreign market.

Not unimportant is the fact that many governments favor licensing production mainly because of its importance for local employment and the long-term benefits of technology transfer and the management contribution it makes to the host country without the foreign company intervening in the market.

As a result, it is often easier to obtain approval for licensing than for direct investment. The licensor has no reason to fear expropriation or nationalization, as well as other unfavorable political risks and dangers inherent in countries with an unstable political situation.

On the other hand, a foreign licensing company can hardly be criticized for acting only as an exploiter who benefits from more favorable production conditions in developing countries, such as lower wages.

On the contrary, where the licensee is from a developed country and the recipient is from a less developed country, the type of operation in question also carries an obvious risk of a ‘boomerang effect’ due to differences in wage levels, other things being equal, the newly produced product to be more competitive.

To avoid this, many leading licensors include in the contract a kind of buy-back clause, which provides for the repurchase of certain parts produced by the licensee, which are subsequently combined with those produced by the licensor in his own country to production costs are reduced. But this can only be the second stage of a strategy that is initially offensive.

Analyzing the circumstances and motives that lead companies to grant licenses, different authors come to opposite conclusions. Some argue that “in general, the main motive for licensing follows short-term and medium-term revenue generation as opposed to long-term market development goals.”

Others argue solidly to prove that licensing is much more than a short-term tactic to achieve certain immediate revenues, and should be seen as a long-term relationship, a viable strategic alternative to other basic forms of development in international markets in the world of international and economic constraints.

The license agreement is of relatively long duration

As the license agreement has a relatively long duration (5-10 years), it is clear that this is a form of permanent and stable accommodation in a particular foreign market.

Licensing almost always entails a long-term expansion of merchandise exports and imports – the use of the license requires additional equipment, new parts, components, units, often requires the supply of specific raw materials, and often companies provide licenses abroad and to secure for a long period cheap by-products or semi-finished products from the licensee’s enterprises and thus to ensure their future competitiveness.

In this context is the opportunity for the licensor to establish control and have a lasting impact on the business operations of its counterparty, especially when the latter pays the license fee by assigning shares and between the two companies are established not only commercial but also technological connections based on specialization and industrial cooperation.

Overseas expansion

From the point of view of overseas expansion, licensing is also important as a valuable backup strategy. In case of interruption of an export channel due to political or economic turmoil in the country, the company may formally withdraw from this market, but maintain its presence through licensing.

The disadvantages and risks for the licensee are not many, but they can be very serious:

Regardless of the precisely prepared initial license agreement, difficulties and misunderstandings can always arise in the transfer of complex, often advanced technology from one company to another and from one culture to another;

Loss of personal physical contact with technology and the market;

Obtaining a lower license fee due to the limited profitability of the licensed production and/or due to concealment of the proceeds from the licensee;

Opportunity for the licensee to further develop the technology and product and make them more competitive, and when the contract expires, the licensor may find that he has indirectly created a strong future competitor who has used the acquired skills and experience to build a competitive organization;

In case of subsequent export of the licensed product, there is a danger of creating parallel competition on third markets;

In case of low quality of the produced and sold licensed production, the business authority of the licensor may be damaged.

Good knowledge of these difficulties and risks in the practical application of the license agreement and the preliminary preparation for their successful overcoming would minimize the possible negative results.

In modern conditions, the system of foreign licensing can be considered either as a stand-alone effective alternative to other more expensive and risky forms of access to foreign markets or as their accompanying supplement.

In any case, licensing is a means of penetrating and developing international markets, which should not be used arbitrarily and lightly.

The reason for this is the complex problems arising from the divergent interests of the participating countries, the heavy technical, financial, and management framework, the various legal regulations, and state requirements.

At this stage, it is difficult to give an unambiguous answer to the question of whether licensing as a means of penetrating highly closed and restricted markets is an appropriate form of achieving relatively short-term goals or vice versa – it is better to apply as a long-term strategy. sustainable market development.

In practice, it can be used for both – it all depends on the size of the company, the nature of the sector, and the technology and environmental conditions.

Regardless of the motive for foreign licensing, however, the defining main requirement inevitably comes down to the need for a pre-prepared and carefully planned staging, clear and understandable for all those involved in the forthcoming foreign trade operation.

Types of licensing

Depending on the object of licensing agreement we distinguish:

Patent licenses – license agreements protected by exclusive rights documents.

Non-patent licenses – licenses for objects that are not protected by a patent (know-how).

Combined licenses – up for a site protected by exclusive rights documents and know-how franchise agreement. Reference: “Complete revocation of rights: complete refusal of direct state intervention”, https://www.kosovatimes.net/revocation-of-rights-refusal-state-intervention/

Licenses according to the granted rights

Depending on the scope of the granted rights:

Non-exclusive licenses are also called simple licenses. In these cases, the Licensor reserves the right to assign licenses to other persons, as well as to use the licensed site itself. This type of license agreement is another example of the peculiarity of the objects of intellectual property, expressed in the possibility of multiple realizations of the price of the intellectual product by granting several licenses.

Exclusive licenses – the right to use the site is acquired only by the exclusive licensee. The licensor loses the right to use the site itself, as well as to grant licenses for this site to other persons for a certain territory.

Full licenses – the licensor grants the licensee the right to use the site in all possible ways. He loses rights to the licensed object for the term of the license agreement. It is also called an exclusive license for all territories. The difference between the sale of the patent and the assignment of a full license is that after the expiration of the contract the licensor restores the exclusive right over the object.

Restriction in the contract of use

Depending on whether there is a restriction in the contract for the use of the object of intellectual property: limited licenses, unlimited licenses. A full license is inherently an unlimited license. Other types of licenses for which there is no single classification feature are:

Sublicenses – these are granted by the licensee to an exclusive or full license to third parties. The only condition for granting sublicenses is that there is no clause in the initial licensing agreement that explicitly prohibits this. The recipient of an exclusive or full license may not sublicense more rights than he has received.

Cross licenses (counter licenses) – the licensee provides to the licensor as a form of license payment. remuneration.

The compulsory license – granted by a competent state body under an administrative act. This is a restriction on the rights of the patent owner to prevent the abuse of the patent monopoly. Any interested person may request to be granted a compulsory license in his favor if the following conditions or at least one of them is met:

The patent-protected invention has not been used for 3 years from the date of grant of the patent or 4 years from the date of filing of the application, taking into account the period which expires later;

The invention has not been used sufficiently to meet the needs of the national market within the above time limits.

The invention is of public interest.

Declared national state of emergency – a compulsory license is granted for a period of duration of the state of emergency.

If the patent owner of the basic patent refuses to grant a license on fair terms to the owner of the dependent patent.
The only condition for an interested person to obtain a compulsory license in his favor is that he has not already become a violator of foreign rights.

License by right

A license by right (license standby status) is in the signing of a declaration by the patent owner, in which he expresses his readiness to assign the right to use the protected object to any interested person under the conditions of a non-exclusive license and for a fee.

The license form remains the only possible form of economic realization, which:

  • The industrial development of the site implies significant investments, which the manufacturer does not have.
  • When the invention is a by-product of a research process in the company and its implementation is not appropriate.
  • The advantages of the license form are expressed in the following areas:
  • The license can be granted at all stages of the life cycle of the invention.
  • No additional capital investments are needed, as well as time for the industrial development of the site.
  • It is not related to possible production failures and difficulties in the realization of the production.
  • It allows for multiple realizations of the economic potential of the invention by granting several licenses.

The economic justification for purchasing licenses

Advantages for the buyer:

Buys a finished product with proven parameters, ie. the risk of unsuccessful research results is eliminated.

It saves time by proceeding directly to the industrial operation and implementation of the site.

Funds are saved, which are significantly higher when conducting their research.
The following factors must be taken into account when choosing whether to purchase a license or conduct your research.

The costs for the purchase and use of the site and the costs for producing own research.

The estimated annual profit when purchasing licenses and when implementing a site in the number of own research needs.

The time required to purchase a license and the time required to conduct one’s research.

The term of validity of the license agreement and the term for moral obsolescence of the site.
When buying and selling licenses, a study is made for the selection of a counterparty in the license exchange. This study is twofold: a study on the licensee and the licensor.

License price

The pricing of intangible objects is characterized by some features.

In licensing transactions, we do not have the expropriation of property. The patent owner may continue to use the invention himself, although he has been assigned the right to use others. faces.

Intangible objects always have a unique character, ie. the cost of creating them is also unique. They cannot be averaged in public.

The price of one intellectual product can be realized many times over by granting several licenses.

Although the intangible object is the same, each license for it may have a different price.

In practice, there are 2 known methods for determining license prices.

1. Over-profit quota method.
2. Licensing method

The over-profit quota method includes two stages:

Determining the magnitude of the expected effect (the amount of excess profit).

The distribution of this effect between the seller and the buyer.

The magnitude of the effect is determined by taking into account the main directions for obtaining economic benefits.

Reduction of production costs per unit.

Increasing the volume of production.

Higher production prices as a result of higher quality.

Extraction of additional profit as a result of the application of the principle of premium pricing.

A combination of the above.

License profit

This part of the effect that remains for the licensee is called the license profit, and the percentage of the effect that the licensor will receive as a reward is called the license price. Determining the amount of the price is done following the following factors.

The type of license granted – the following data are derived from practice: for a full license, the price varies between 40-50% of the effect (over profit), for an exclusive license the price is 30 – 40% of the effect and for a non-exclusive – 20-30%.

Existence and degree of stability of patent protection – in the case of patent-protected objects the price is higher.

Degree of industrial development of the site – industrially developed sites that have proven their parameters in real use are preferred.

Opportunities for production and trade cooperation between the two parties to the contract.

Nature and manner of conducting the negotiations. Reference: “Negotiation strategies in a multicultural business environment”, https://www.nebraskasocialstudies.org/negotiation-strategies-in-a-multicultural-business-environment/

Licensing method

In the method of license deductions, the amount of the percentage deductions from the volume of the licensed production, established in practice, is taken as a starting point in the pricing.

The price thus determined (for both methods) is not the actual price of the license. They call it the estimated price. Specifically, the amount of remuneration that the licensor will receive depends on many factors, the main one being the method of payment of the price.

Production contract

This is a contract of our manufacturers with those from abroad for the production of a product. For the foreign company, this contract has the following risks: limited control over the production process and loss of potential profits from production. On the other hand, it gives the company a chance to start a partnership or buy (buy-out) the local producer.

Jointly owned enterprise

This is a form of creating a company related to a foreign investor, to develop a local business in which the partners will share ownership and control. The company can buy shares from the local company or both parties can create a new business unit – Joint Venture (J.V.). Reference “What are leasing and a joint venture?”, https://www.dobrojutro.net/what-are-leasing-and-a-joint-venture/

A new unit may be needed for economic or political reasons. The company may not have enough financial, physical, or managerial resources to start a business on its own. The contracts for the presentation of licenses with their full or partial payment with manufactured products: provide for a clear division of the markets, as the goal of the partner company is to gain appropriate access to the markets of the foreign partner. The foreign company may retain the exclusive right to sell in some of its pre-conquered markets. Reference: “Management contract and complete withdrawal of rights”, https://www.kievpress.info/management-contract-and-complete-withdrawal-of-rights/

The co-production agreement

The co-production and specialization agreement provides, as a rule, for the strict division of markets on the same principles as for licensing agreements.

The subcontractor reserves the right to supply a certain quantity of manufactured products for the domestic market. In most cases, the international partner reserves exclusive rights to its trademark in all markets.

In creating the joint venture the partners agree on the division of the markets. An exemplary classification of marketing positions in all forms and types J .V. may include strict market sharing, flexible marketing agreements, assistance with marketing organization.

From what has been said so far, we can give the following definition:

“A joint venture is a newly formed organizational unit separate from but owned by at least two independent undertakings.

From the perspective of the foreign investment host country, the joint venture is : (1) foreign enterprises and at least one local enterprise participate in the joint venture, (2) only foreign enterprises of the same nationality participate as partners in the joint venture, and (3) only foreign enterprises participate in the joint venture. , at least one of which has a national affiliation different from that of the others “(Marangozov, 2005: forthcoming).

Consortium

Consortia are often confused with joint ventures. “The main difference is that compared to joint ventures there is no capital participation. A consortium is a type of contractual joint venture that is established for the duration of a project.

Many companies establish a relationship to share the costs and risks of one (large) project ”(Bell, 1996: 12). A typical example of a consortium is the construction of the Channel Tunnel.

International mergers

Mergers are the complete unification of two (or more) organizations into a single organization (Borys & Jemison, 1989: 235). Unlike strategic alliances, the companies involved in a merger lose legal independence as a new legal and economic unit is created (Tsarev, 1995: 16).

On the other hand, “unlike a merger, a joint venture [a capital strategic union] involves the pooling of a subset of the resources of two (or more) companies to achieve a goal under the combined management of two (or more) founding companies”. “(McConnell & Nantell, 1985: 520).

Complete and partial international takeovers

An international takeover is the purchase of the trade name and assets of one company (the acquiree) from another company (the acquirer) whose registered office is outside the country where the acquired company was established.

The acquired company is subject to managerial, economic and legal control by the acquiring company “(Newburry & Zeira, 1997: 89). Unlike strategic alliances, the acquired company loses economic independence and the right to make autonomous decisions” (Hoffmann & Schaper-Rinkel, 2001). : 132).

Partial takeovers are a hybrid option between the two alternatives – full takeover and joint venture. Partial takeovers are takeovers (by only one company or by several companies) of part of the capital of a company previously established in the host market.

Thus, partial acquisitions combine some of the characteristics of both total acquisitions and joint ventures as a capital strategic alliance. On the one hand, like total acquisitions, they involve the acquisition of capital by an existing firm; on the other hand, like joint ventures, they involve the sharing of control of the foreign unit with other partners “(Lopez Duarte & Garcia Canal, 2002: 305).

Fully owned foreign subsidiaries

A wholly-owned foreign subsidiary is a subsidiary established from the outset by a firm, the latter of which is the only firm that can influence the decisions of the former (Bell, 1996: 136).

On the other hand, as can be seen from the simultaneous analysis of alternative institutional forms of organization and implementation of international transactions with increasing degree of internalization of transactions in companies engaged in foreign business activities, bisector-based alternative forms correspond to increasing degrees of control over foreign operations, invested resources for servicing foreign markets and risk in the foreign operating environment.