Licensing is a contractual arrangement whereby the firm, the licensor, offers proprietary assets to a foreign company, the licensee, in exchange for royalty fees. Let’s say you are unable to export to an overseas market due to complex rules and regulations or because the transportation cost is prohibitive. That’s where licensing works. You license a foreign company to manufacture your product and sell it in that market in return for a royalty payment.
Here’s one real-life example. Many years ago when I worked at a small specialty chemical cleaning company, we produced a crystal chandelier cleaner in a 14-ounce aerosol can and a 32-ounce plastic spray bottle. Our customer in Sweden purchased both products, and we loaded as many as we could into a 20-foot container to keep the transportation cost at a flat rate. Our customer figured the more he imported, the lower his per unit price (that is correct thinking, by the way).
After a couple of years of importing this way, he learned that the product was 90 percent water with a secret formula making up the rest. Lo and behold he discovered he was spending thousands of dollars a year to import water. It was at that point he asked us to license the product to manufacture in Sweden, and we did. We shipped 55-gallon drums of concentrate, provided instructions on how to make the product--he also had to sign a confidentiality agreement--and then our customer made batches at his end.
His profit improved dramatically because he could exercise more control of production, quality, and price. We, in turn, had less work at our end and more money in our pockets as a result of the arrangement, which included a nice fat profit margin on the drum concentrate, along with a royalty payment with each order.
Some licensed royalties are dutiable, so be sure to inquire with your international attorney and your transportation company well advance of signing any contract.
Licensing can also be for use of a trade name, for the distribution of imported products and for a service. 7-Eleven is considered a leader in licensing in the convenience store industry and signed its first United States area licensing agreement in 1968.
You can also license the technology for a fee. This can be effective when the technology is complex or unique and the risk is high to enter a foreign market on your own.
Benefits to Licensing
As outlined above, licensing can prove to be very lucrative if put into place correctly. Licensing is generally viewed as a supplement to exporting or manufacturing rather than the only means of entry into foreign markets.
Here are six benefits to licensing:
- Not too demanding on the company’s resources (good vehicle when capital is scarce).
- Requires a low-commitment to international expansion.
- Access markets that are closed to imports.
- Avoid taxes that might otherwise be levied on a product if exported.
- Governments in the foreign market might prefer licensing arrangements for local companies.
- Protect intellectual property against cancellation or nonuse.
A Word of Caution
The licensee may not be fully committed to the licensor’s product or technology. Lack of enthusiasm can definitely impact the success of a product in a foreign market, so beware if you spot weak or no sales growth! Further, don’t nurture a future competitor. It would be easy for a company to run with your product or service idea. Make sure you work with an international attorney to protect your assets and intellectual property well in advance of sealing any deal.
Licensing may not be the most profitable way to enter a foreign market, but it does offer less risk than a direct investment, which can be time-consuming and costly.