Licensing and Franchising Notes

Licensing and Franchising - Part 3: GMOs & Entry Modes

Learning Outcomes

• Present licensing and franchising as contractual entry strategies.
• Understand licensing as an entry strategy.
• Describe the advantages and disadvantages of licensing.
• Understand franchising as an entry strategy.
• Explain the advantages and disadvantages of franchising.

Concepts and Examples

Contractual Entry Strategies

• Cross-border exchanges where the relationship between the focal firm and its foreign partner is governed by an explicit contract.

Intellectual Property

• Ideas or works created by firms or individuals, including patents, trademarks, and copyrights.
• Knowledge-based assets such as industrial designs, trade secrets, inventions, works of art, literature, and other “creations of the mind”.

Contractual Relationships

• Licensing: An arrangement where the owner of intellectual property grants another firm the right to use that property for a specified period in exchange for royalties or other compensation.
• Franchising: An arrangement where a firm allows another the right to use an entire business system in exchange for fees, royalties, or other compensation.
• Royalty: A fee paid periodically to compensate a licensor for the temporary use of its intellectual property, often based on a percentage of gross sales generated from the use of the licensed asset.

Examples of Contractual Relationships

• Sanrio licensing "Hello Kitty" to manufacturers of cosmetics, food, toys, clothing, etc.
• CBS licensing deal with PPTV in China for streaming rights.
• Pfizer (US) and Novartis (Switzerland) licensing pharmaceutical inventions to each other.
• 7-Eleven operating stores via franchising agreements in Canada, Mexico, Asia, and Europe.

Advantages of Contractual Relationships

• Provides a moderate level of control over the foreign partner.
  • Control reflects the ability of the firm to influence the decisions, operations, and strategic resources of a foreign venture.
• Generates consistent earnings from foreign operations compared with FDI.
  • Less susceptible to volatility and risk.
• Provides dynamic, flexible choice for initial entry in foreign markets.
  • Firms may switch to another entry strategy, such as FDI, as conditions evolve.
• Can reduce perceptions of the firm as a foreign enterprise.
  • Facilitates blending into the local market.

Licensing

• A licensing agreement specifies the relationship between the licensor (owner of intellectual property) and the licensee (the user).
  • Example: Intel licensing a new process for manufacturing computer chips to a firm in Germany.
  • Example: Warner licenses images from the Harry Potter books and movies to companies worldwide.
  • Example: Disney licenses the right to use its cartoon characters in producing shirts and hats to clothing manufacturers in Asia.
• Licensee pays the licensor a fixed amount upfront and an ongoing royalty (usually 2-5%) on gross sales generated from using the licensed asset.
  • The fixed amount covers the licensor’s initial costs of transferring the licensed asset to the licensee, including training, engineering, or adaptation.
  • Certain types of licensable assets, such as copyrights and trademarks, have much lower transfer costs.

Licensing as a Foreign Market Entry Strategy

• Licensor provides:
  • Intellectual property (patent, trademark, design, copyright, or know-how)
  • Supporting products (parts, components, raw materials, etc.)
• Licensee compensates the licensor through:
  • Lump-sum payment
  • Down-payment plus royalty
  • Products
  • Know-how
  • Cross-licensing

International Licensing

• Coca-Cola has a licensing agreement to distribute Evian bottled water in the U.S. on behalf of Danone.
• Budweiser is brewed in Japan by Kirin under license from Anheiser Busch.
• A review of 120 of the largest multinational food companies revealed that at least half are involved in some form of international product licensing.

Types of Licensing

• Trademark Licensing
  • Involves a firm granting another firm permission to use its proprietary names, characters, or logos for a specified period in exchange for a royalty.
  • Trademarks appear on clothing, food, toys, home furnishings, etc. Examples: Coca Cola, Harley-Davidson, Disney.
  • U.S. firms derive trademark-licensing revenues exceeding $100$ billion annually.
• Copyright Licensing
  • A copyright gives the owner the exclusive right to reproduce art, music, literature, software, etc., as well as prepare derivative works, distribute copies, or perform or display the work publicly.
  • The term of protection varies by country, but the creator’s life plus 50 years is typical.
  • Many countries offer little or no copyright protection.
• Know-How Licensing
  • Involves a contract in which the focal firm provides technological or management knowledge about how to design, manufacture, or deliver a product or a service.
  • The licensor makes its patents, trade secrets, or other explicit know-how available to a licensee in exchange for a royalty.
  • The royalty may be a lump sum, a “running royalty” based on the volume of products produced from the know-how, or a combination of both.

Leading Licensors by Licensing Revenues

Advantages of Licensing (for Licensor)

• Low investment
• Low involvement
• Low effort, once established
• Low-cost initial entry strategy

Disadvantages of Licensing (for Licensor)

• Performance depends on the foreign licensee
• Licensor has limited control over its asset(s) abroad
• Runs the risk of creating a future competitor

Franchising

• Most typical arrangement is business format franchising, in which franchisor transfers to the franchisee a total business method, including production and marketing methods, sales systems, procedures, training, and the use of its name.
• More comprehensive and longer-term than licensing.
• Master Franchiser: An independent company authorized to establish, develop, and manage the entire franchising network in its market (e.g., McDonald's in Japan).

Franchising as an Entry Strategy

• Franchisor provides:
  • Trademark-protected business concept; plus
  • Everything needed for its implementation (patents, know-how, training, services, products)
• Franchisee compensates the franchisor through:
  • Lump-sum payment
  • Down-payment plus royalty
  • Other mark-ups and contributions (e.g., finance charges, sale of related products)

Examples of Leading International Franchises

Advantages of Franchising (for Franchiser)

• Low investment
• Can internationalize quickly to many markets
• Low effort, once established
• Can leverage franchisees’ local knowledge

Disadvantages of Franchising (for Franchiser)

• Maintaining control over franchisees may be difficult
• Franchiser has limited control over its assets abroad
• Risks creating a future competitor

Franchising in Emerging Markets

• China and India are promising markets for fast-food franchising (e.g., KFC and Pizza Hut in China).
• Most residents of developing economies and emerging markets lack sufficient income to patronize restaurants.
• Most do not live in the major urbanized areas where international franchisors are concentrated.
• Laws in such countries vary and often evolve quickly.
• Food and eating habits are rooted in national culture.
• Successful franchisors carefully study economic, demographic, legal, and cultural dimensions before targeting foreign countries with franchises.

Example: Yum! Brands

• Yum! Brands, based in Kentucky, USA, owns and operates restaurant chains, including KFC, Pizza Hut, and Taco Bell.
• Yum! operates about $50,000$ fast food outlets worldwide, most as franchises.
• In 2015, about one-half of Yum!’s revenues came from China.
• In 2016, Yum! spun off the China division to create Yum China, the country’s largest restaurant company.
• In China, Pizza Hut is the largest casual dining restaurant chain and KFC is the largest fast-food chain.

Management of Licensing and Franchising

• Licensing and franchising are complex undertakings, requiring skillful research, planning, and execution.
• The firm must research in advance the host country's laws on intellectual property rights, repatriation of royalties, and contracting with local partners.
• Key challenges include:
  • Establishing whose national law takes precedence for the contract
  • Deciding whether to grant an exclusive or nonexclusive arrangement
  • Determining the geographic scope of territory to be granted to the foreign partner

Readings

• Cavusgil, S.T., Knight, G., Riesenberger, J.R. International Business: Strategy, Management and New Realities. Pearson (chapter 15)