What’s it: Licensing is an arrangement whereby a licensor grants another party (the licensee) the right to use its intellectual property rights for a specified period. In return, the licensor receives royalties from the licensee. The agreement can be exclusive or non-exclusive.
Intellectual property rights may include patents, trademarks, copyrights, manufacturing processes, and trade secrets. The arrangements allow the licensee to use, make, or sell the original copies. The licensee may use patented technology or apply a brand name or trademark owned by the licensor.
Licensing has pros and cons. It becomes a way to monetize intellectual property at no additional cost. But, it is vulnerable to theft of its intellectual property when the contract expires.
Why is licensing important?
Two reasons explain why licensing is important. First, it becomes a way to grow revenue. Companies extend their intellectual property to be used by other parties to make money. If the licensee is successful, so will the licensor because they will receive more royalties.
Licensing does not involve additional costs in operation. Companies do not need to spend on market research, production, and marketing. Everything is done by the licensee.
Second, licensing is a safe way to enter international markets. This practice is common in international business.
Licensing is a strategy to enter foreign markets. Unlike other strategies, such as export or direct investment, licensing is relatively easy. In addition, it is also important to avoid restrictive trade and investment practices such as import tariffs or foreign capital investment controls.
Example of international licensing
You may find many examples around you. And below, I list examples of international licensing.
The following are examples of the top 10 global licensors:
- Disney Consumer Products
- PVH Corp
- Iconix Brand Group
- Sanrio, Inc.
- Warner Bros
- Major League Baseball and Nickelodeon
- Collegiate Licensing Company
Three differences between licensing and franchising
Licensing might be considered conventional in business. A more advanced cooperative arrangement is franchising. The two differ in several ways.
First, licensing applies to registered trademarks. Meanwhile, the franchise agreement relates to all brands and business operations.
Second, cooperation under licensing is more limited. The arrangement is more straightforward, i.e., the licensor allows the licensee to use his intellectual property. The relationship between the two was only around that.
In contrast, the relationship between the franchisor and the franchisor is more complex because it involves more control and interdependence.
Franchisors don’t just license intellectual property rights. However, they provide ongoing support to franchisees and enable business model duplication. In addition, the arrangement also involves the transfer of business knowledge or procedures to operate the business.
Three, the difference between licensing and franchising is the duration of the partnership. Licensing cooperation can be valid between 16-20 years. Meanwhile, franchises are of shorter periods, usually around five years, and can be extended for up to 11 years.
Licensing advantages and disadvantages
Licensing is a cheap strategy to exploit a company’s competence and intellectual property. Thus, they can make money without incurring additional costs for market research, operating the business, supporting partner operations, or marketing products.
However, licensing also carries some risks. Licensees can become potential competitors if they enter international markets by exporting products to markets where the licensor operates.
Licensing offers several advantages. First, it allows companies to make more money. Companies can optimize the economic benefits of the intellectual property they own.
Second, the company need not be directly involved in the licensee’s business operations. Thus, it is lighter than a franchise or direct investment arrangement because they do not need to be involved in operations and commercialization.
For example, under franchising, the company provides support to the franchisee. The goal is to ensure franchisees operate the business according to their standards.
Other advantages of licensing are:
Less substantial risks. Licensing minimizes risks due to restrictions on trade or foreign investment in partner countries. The risks involved are less significant than with other foreign market entry strategies such as joint ventures or direct investment.
Speed. Licensing is a good strategy because it offers speed and convenience when a company enters a foreign market. For example, they don’t need to research foreign markets when exporting. Or, they have to build production facilities as in greenfield direct investment.
Low investment. Licensors do not need large-scale investments to monetize their innovations and intellectual property. They only license it to those who can exploit it and keep the intellectual property rights to them.
No extra cost. The company earns revenue without additional costs. They don’t have to spend money to produce, promote or sell the product.
Specialization. The company focuses on the current target market because it has better competence and market knowledge. Instead, to maximize growth and revenue overseas, they leverage the expertise and competence of licensees to make money.
Licensees understand their market better than licensors. Thus, they are more likely to be successful because they are familiar with local needs and customers.
Cannibalizing the market is a risk for the licensor. For example, the licensee is a manufacturer. Once the domestic market has matured, growth opportunities are low. The manufacturer might expand their market by exporting the product. If they target the market in which the licensor operates – as it is not stipulated in the license agreement-they end up being direct competitors.
Licensing also has several other drawbacks. First, the licensor can potentially lose money due to intellectual property theft. The licensee may copy and use the license rights commercially after the agreement expires.
Second, the licensee damages the image. They may not have a winning strategy. Thus, they cannot maximize the license by commercializing it effectively. Their bad strategy or unethical business practices are not only their business success. However, it also has the potential to damage the licensor’s reputation.
Third, arrangements can be ended at anytime as they are less permanent. Unlike direct investment, licensing arrangements can end when the licensee leaves, for example, due to business failure or switching to another business.
Fourth, the license does not generate material direct money. Licensees need time to commercialize a product successfully, especially if they are a new company.
If royalties are based on a percentage of profits or sales, the money won’t flow to the licensor immediately. If it fails to compete, the licensee cannot generate any sales.
Fifth, royalties or license fees are subject to import duties. So, the money received decreases when the government increases the duty.