Study Notes on Licensing and Franchising

Chapter 15: Licensing, Franchising, and Other Contractual Strategies

Overview of Licensing and Franchising

  • Types of Interfirm Collaborations
    • Number of Partners:
    • 2 partners
    • More than 2 partners
    • Equity:
    • None
    • Some
  • Informal Cooperation:
    • No binding agreement
  • Contractual Agreement:
  • Joint Venture
  • Consortia
  • Equity Participation
    • Minority
    • Foreign Direct Investment (FDI)

Key Elements of Contractual Entry Strategies

  • Contractual entry strategies in international business:
    • Cross-border exchanges governed by explicit contracts.
  • Intellectual Property (IP):
    • Ideas or works created by firms or individuals (e.g., patents, trademarks, copyrights).
    • Knowledge-based assets like industrial designs, trade secrets, inventions, works of art, and literature.

Two Types of Contractual Relationships

  1. Licensing:
    • Arrangement where the owner of intellectual property grants another firm the right to use that property for a specified time in exchange for royalties or compensation.
  2. Franchising:
    • Arrangement which allows another to use an entire business system in exchange for fees or other compensation.
    • Royalty:
      • Periodic fee paid to a licensor for temporary use of IP, often based on a percentage of gross sales from the licensed asset.

Examples of Contractual Relationships

  • Bristol-Myers Squibb & IMCOR Pharmaceutical Co.:
    • Cross-licensing agreement for ultrasound medications.
  • Sanrio (Japanese company):
    • Licensed "Hello Kitty" to multiple manufacturers across various sectors (cosmetics, food, toys, etc.).
  • 7-Eleven:
    • Operates 26,000 stores in 18 countries; several thousand operate under licensing or franchising agreements in Canada, Mexico, and the U.S.

Unique Aspects of Contractual Relationships

  • Governed by contracts that provide moderate control over foreign partners.
    • Control: Ability to influence decisions, operations, and strategic resources.
  • Involves exchanges of intangibles (intellectual property) and services (technical assistance, know-how).
  • Can be pursued alongside other strategies (FDI, exporting).
  • Offers dynamic flexibility for market entry, often transitioning to another strategy (like FDI) over time.
  • Helps mitigate foreign enterprise perceptions, allowing better local integration.
  • Offers stable foreign earnings, being less susceptible to volatility compared to FDI.

Intellectual Properties

  • Patent:
    • Right to prevent others from using an invention for a fixed period, granted for new processes or improvements.
  • Trademark:
    • Distinctive design/symbol identifying a product/service (e.g., Nike's swoosh).
  • Copyright:
    • Protects original works (art, literature, music), with protection duration typically covering author's life plus 50 years.
    • Varies by country, necessitating investigation of local laws before publishing works abroad.

Licensing

  • Licensing Agreement:
    • Specifies the relationship between licensor and licensee.
    • Examples of Licensing:
    • Intel licenses new manufacturing processes to a German firm.
    • Warner licenses images from Harry Potter to global companies.
    • Disney licenses cartoon characters to Asian clothing manufacturers.
  • Typical Deal Structure:
    • Licensee pays fixed upfront and ongoing royalty (typically 2-5% of gross sales).
    • Fixed amount covers initial transfer costs (training, engineering, adaptation).
    • Copyrights and trademarks have lower transfer costs.

Licensing as a Foreign Market Entry Strategy

  • International Licensing is Common:
    • Example: Planters and Sunkist sold in Britain and Japan via licensing.
    • Coca-Cola licenses Evian distribution in the U.S.
    • 50% of major multinational food companies are involved in international product licensing.

Trademark Licensing

  • Grants permission to use proprietary names/characters/logos for a set period for royalties.
    • Generating significant revenue with minimal effort (e.g., U.S. trademark-licensing over $100 billion annually).
  • Examples:
    • Coca Cola, Harley-Davidson, Disney, etc.

Copyright Licensing

  • Enables reproduction and distribution with a protective term typically extending 50 years post-creator's life.
    • Many countries provide minimal copyright protection, requiring attention to local laws.

Know-How Licensing

  • Contract:
    • Focal firm shares technological/management knowledge.
    • Licensor makes patents, trade secrets, or know-how available to a licensee for a royalty.
  • Royalty Types:
    • Lump sum, running royalty, or a combination based on output from the know-how.

Main Advantages and Disadvantages of Licensing

Advantages for Licensor
  • Low investment, involvement, and effort post-establishment.
  • Cost-effective initial market entry strategy.
Disadvantages for Licensor
  • Performance reliant on the foreign licensee.
  • Limited control over assets abroad.
  • Risk of creating future competitors.

Franchising

  • Typical Arrangement:
    • Business format franchising transfers total business methods (production, marketing, training, branding).
    • Requires unique products and high standardization.
  • Master Franchiser:
    • Independent company managing an entire franchising network (e.g., McDonald's in Japan).
  • Types of Franchising:
    • Manufacturer-retailer systems (e.g., car dealerships)
    • Manufacturer-wholesaler systems (e.g., soft drink companies)
    • Service-firm retailer systems (e.g., fast-food outlets)

Advantages and Disadvantages of Franchising

Advantages for Franchiser
  • Low investment and quick international expansion.
  • Minimal effort post-establishment and leverage of local knowledge.
Disadvantages for Franchiser
  • Difficulty in controlling franchisee operations.
  • Limited control over assets abroad.
  • Risk of creating future competitors.

Other Contractual Modes of Entry

  • Turnkey Contracting:
    • Firm manages all aspects of a project abroad, then hands it over post-training local personnel.
    • Common in construction/engineering.
  • Management Contract:
    • Contractor provides managerial know-how to operate facilities in exchange for compensation.
  • International Leasing:
    • Regarding the rental of machinery/equipment abroad (e.g., airlines leasing aircraft).

Example: Delhi Metro Turnkey Project

  • $2.3 billion project to build roads/tunnels in Delhi, commissioned by Delhi Metro.
  • Involves a consortium including local firms and Skanska.

Potential Challenges of Contractual Modes

  • Licensing and franchising are complex, necessitating skillful research and planning.
    • Must research host country's laws on IP rights, royalties, and partner contracts.
  • Key challenges include:
    • Establishing contract law precedence.
    • Deciding on exclusive vs. nonexclusive arrangements.
    • Geographic scope considerations for partners.

Infringement of Intellectual Property

  • Unauthorized use/duplication of protected products/services.
    • Prevalent in emerging markets, affecting brand perception and quality.
  • Counterfeit goods drastically undermine competitiveness:
    • Over $1 trillion (approx. 5% of U.S. GDP) in value.
    • Affects various sectors (clothing, accessories, pharmaceuticals, etc.).

Safeguarding Intellectual Property

  • Weak IP laws in many areas.
  • Key International Treaties:
    • Paris Convention for Protection of IP
    • Berne Convention for Protection of Literary and Artistic Works
    • Rome Convention for Protection of Performers and Broadcasting Organizations
  • WTO's Agreement on Trade Related Aspects of IP Rights (TRIPS).

Foreign Direct Investment (FDI) and Collaborative Ventures

  • Definition:
    • Establishing a physical presence abroad through acquisition of productive assets.
  • International Collaborative Venture:
    • Cross-border alliance pooling resources and sharing risks.
  • Joint Venture (JV):
    • Form of collaboration where firms create a jointly-owned enterprise.

Motives for Foreign Direct Investment (FDI)

Market-Seeking Motives
  1. Access New Markets:
    • Firms pursue growth in large markets.
    • Example: Boeing, Coca-Cola, IBM, McDonald's.
  2. Follow Key Customers:
    • Companies preempt rival servicing of major clients.
  3. Compete with Key Rivals:
    • MNEs confront competitors geographically to weaken their defenses.
Resource or Asset-Seeking Motives
  1. Access to Raw Materials:
    • Necessary in extractive or agricultural industries.
  2. Acquire Knowledge/Assets:
    • Collaborating with local firms for established market presence (e.g., Whirlpool & Philips).
  3. Obtain Technological/Managerial Know-how:
    • Presence in key industrial clusters promotes capabilities.
Efficiency-Seeking Motives
  1. Cost Reduction:
    • Seek low-cost labor/materials in production (e.g., India, China).
  2. Customer Proximity:
    • Production near key markets (e.g., Zara & H&M).
  3. Government Incentives:
    • Avail tax concessions/subsidies to invest locally.
  4. Avoid Trade Barriers:
    • Securing advantages from local integration (e.g., Japanese automakers).

Advantages of FDI

  • Economies of Scale:
    • Fixed costs decrease as production volume increases.
  • Managerial Resource Efficiency:
    • Consistent firm size across international operations.
  • Specialization of Labor:
    • Effective division of labor increases productivity.
  • Financial Economies:
    • Large firms access capital more affordably.

Selection of FDI Location

Leading Destinations
  • Advanced Economies:
    • Popular for attractive markets (e.g., North America, Japan).
  • Emerging Markets:
    • Increasingly preferred for low-cost manufacturing (e.g., China).
Nature of FDI
  • Most complex, high-risk approach, involving tangible production facilities across borders.
  • Firms target markets with comparative advantages, encountering unique social/cultural challenges.

Types of FDI

1. Greenfield Investment vs. Mergers and Acquisitions
  • Greenfield Investment:
    • Establish new facilities from the ground up.
  • Merger:
    • Two firms join to create a new entity.
  • Acquisition:
    • Purchase existing operational entities.
2. Nature of Ownership
  • Equity Participation:
    • Acquiring partial ownership in existing firms.
  • Wholly Owned Direct Investment:
    • Full ownership of foreign assets.
  • Equity Joint Venture:
    • New entity created through joint assets from multiple firms.
3. Level of Integration
  • Vertical Integration:
    • Ownership across multiple stages of production (e.g., Toyota).
  • Horizontal Integration:
    • Ownership over a single production stage.

International Collaborative Ventures

  • Definition:
    • Partnerships involving equity and non-equity projects.
    • Aims to reduce international business risks and expenses.
  • Types of Joint Ventures:
1. Equity Vs. Project-Based
  • Equity Joint Ventures:
    • Formed when no partner has all necessary assets.
  • Project-Based Collaborative Ventures:
    • Limited scope, no new entity created; typically focused on technology development.
2. Other Types
  • Consortium:
    • Non-equity multi-partner project (e.g., aircraft manufacturing).
  • Cross-Licensing Agreement:
    • Access technology on preferential terms between partners.
3. Success Factors
  • Importance of resolving cultural differences, common goals, planning, safeguarding competencies, and adapting strategies.