Strategic Perspectives for International Licensing Managers
16
Strategic Perspectives for International Licensing Managers:
The Complementary Roles of Licensing, Investment and Trade in Global Operations
Les Nouvelles, Journal of the Licensing Executives Society
June 1999
pp. 41-50
By
Dr. Farok J. Contractor
Professor of International Business
Rutgers University
Strategic Perspectives for International Licensing Managers
International licensing managers play a key role in the operations of their companies, in one of the fastest-growing profit segments of their firms. Yet many are unfamiliar with the overall importance and strategic role of licensing in the global operations of their companies. This article provides a “big picture” look at international licensing of US firms, and its place in the country’s balance of payments.
TWO BROAD STRATEGY ROLES
There are two broad strategic perspectives on international licensing[1]. The first looks upon licensing as a foreign market entry alternatives to direct exports or foreign direct investment[2]. That is to say, a customer abroad can receive a so-called American product either by (1) direct import, or (2) by the American company’s affiliate producing in that nation, or (3) by a licensee of the American firm producing and distributing to customers in that nation. For the US economy as a whole, how do licensing revenues compare with exports, or with the sales of US multinational firm foreign affiliates? In the 1986-1996 decade, the “Royalties and License Fees” category of the balance of payments grew at a very high compounded growth rate of 12.6 percent annually[3]. This far exceeded the growth rates for US foreign direct investment or exports which averaged in the 8 percent range, or the average growth of the US economy which was at or below 4 percent for the decade.
The second strategic perspective is different, and regards licensing not as a market expansion alternative, but as an auxiliary channel for income extraction, tax minimization and intellectual property right affirmation. It is not a marketing, but a finance, tax accounting and bottom-line emphasis. How does licensing reduce foreign tax liability?
How do licensing cash flows compare with the profit margins on direct exports, or with the earnings of foreign affiliates? This article will provide some estimates for the US economy as a whole.
Both perspectives are typically found in global operations. The first tends to predominate in small and medium-sized companies which are in their early international expansion. The second perspective often dominates in larger, globally-sophisticated multinational firms, the bulk of whose operations is “intrafirm” – that is to say between affiliates located in various countries.
MOST INTERNATIONAL LICENSING IS INTRAFIRM
This article will present figures on the heavy role of intrafirm royalties and fees in total remittances received by US licensors, as well as paid by US licensees to entities abroad. It will explore the reasons. However, what is seldom recognized is that exports and trade are also heavily intrafirm. And foreign direct investment is, by definition, internal. In fact, the majority of international business, be it licensing, trade or direct investment, is conducted between a firm and its own foreign affiliates! It would be useful for licensing executives to place their roles into this overall strategy perspective. Accordingly, this article presents some figures on exports and imports, and gives an overview of the scope of US-based multinational companies both within the USA and internationally.
Table 1
Licensing In U.S. Balance of Payments
Payments for Royalties and License Fees, and
Technical Services ( $ Billions)
EXPORTS
/ 794.6 / 848.8 / 931.3GOODS
/ 575.9 / 612.1 / 678.1SERVICES / 218.7 / 237.8 / 253.2
· Royalties and License Fees
/ 27.4 / 29.9 / 30.3From Affiliated Parties / 21.7 / 23.8 / 23.4
U.S. Parents as Licensors / 20.2 / 21.9 / 22.0
Foreign Co. U.S. Affiliates as Licensors / 1.5 / 1.8 / 1.4
From Unaffiliated Parties / 5.7 / 6.2 / 6.9
Industrial Processes, Patents and intangible property / 3.6 / 4.0 / 4.5
Other incl. Copyrights, Trademarks, Broadcast Rights / 2.1 / 2.2 / 2.4
· Other Private Services
/ 66.7 / 73.6 / 82.7Receipts from Affiliated Foreign Parties
/ 20.3 / 22.8 / 25.4U.S. Parents’ Receipts
/ 12.8 / 13.8 / 15.0Foreign Co. U.S. Affiliates’ Receipts
/ 7.5 / 9.0 / 10.5Receipts from Unaffiliated Foreign Parties
/ 46.6 / 50.8 / 57.2Of which, Technical & Professional Services
/ 17.8 / 19.2 / 22.1IMPORTS
/ 896.4 / 959.9 / 1045.1GOODS
/ 749.4 / 803.2 / 877.1SERVICES / 147.0 / 156.6 / 167.9
· Royalties and License Fees
/ 6.5 / 7.3 / 7.5Paid to Affiliated Parties / 5.1 / 5.3 / 5.9
U.S. Parents as Licensees / 0.5 / 0.6 / 0.7
Foreign Co. U.S. Affiliates as Licensees / 4.7 / 4.7 / 5.2
Paid to Unaffiliated Parties / 1.4 / 2.0 / 1.6
Industrial Processes, Patents and intangible property / 1.0 / 1.1 / 1.2
Other incl. Copyrights, Trademarks, Broadcast Rights / 0.4 / 0.9 / 0.4
· Other Private Services
/ 39.3 / 42.8 / 47.5Payments to Affiliated Foreign Parties
/ 13.6 / 16.0 / 17.6U.S. Parents’ Payments
/ 6.8 / 7.5 / 8.6Foreign Co. U.S. Affiliates’ Receipts
/ 6.8 / 8.5 / 9.0Payments to Unaffiliated Foreign Parties
/ 25.7 / 26.7 / 29.9Of which, Technical & Professional Services
/ 4.7 / 5.3 / 6.5Sources:
1. Bureau of Economic Analysis (1998) U.S. International Transactions in Private Services, Washington, D.C.: U.S. Department of Commerce.
2. Bach, C.L (1997) “U.S. International transactions, First Quarter 1997,” Survey of Current Business, July, pp. 56 – 99.
3. Survey of Current Business, May 1998, Tables pp. D-51 to D-56 .
LICENSING IN THE BALANCE OF PAYMENTS
The exports and imports of the United States amounted roughly to a trillion dollars each in 1998[4]. (However because of lags in data collection and reporting -- especially for foreign direct investment or multinational company statistics – most of the comparisons in this article will relate to the mid-1990s).
Licensing type payments are now grouped under “Services” as shown in Table 1. “Royalties and License Fees” received by US licensors from foreign licensees are shown under EXPORTS and amounted to $ 30.3 Billion in 1997. By comparison, payments to foreign licensors by US licensees are only a quarter as large, and are shown as $ 7.5. Billion, under IMPORTS. This works out to a four to one advantage for the US, and may be cited as one indicator of the relative dominance of the US in technology vis-à-vis the rest of the world.
“Royalties and License fees” paid by US licensees to foreign licensors, shown in Table 1 under IMPORTS, are mainly those paid by affiliates of foreign companies in the US to their own parent companies abroad ($5.2 Billion out of $ 7.5 Billion in 1997). A later section of this paper will treat the issue of intrafirm payments.
How Important Is Licensing?
How does the Royalties and License Fees figure of $ 30.3 in 1997 compare with other exports, for instance, the export of $ 678.1 Billion of Goods from the US? The latter would appear to dwarf the licensing figures, but this is a false comparison. The $ 678.1 Billion is a sales or gross revenue figure, whereas royalties and fees are akin to profit on the sales effected by a foreign licensee. Two earlier surveys on international licensing done by the author indicate an average royalty in the range of four to five percent for international agreements[5]. If therefore we were to divide the $30.3 number by (0.045) we would get
30.3/0.045 = $ 673.3 Billion,
as an estimate of the sales made by foreign licensees under agreement with US licensors.
And voila, this 673.3 estimate is rather close to the export sales figure of $ 678.1 for US goods exports. Seen in this light, the foreign sales induced by American foreign licensing would appear to be roughly equivalent in magnitude to the direct export of goods from the USA. From the perspective of a foreign customer who either purchases US export goods directly or “US technology derived” goods made by a local licensee, the magnitudes appear to be roughly equal[6].
A superficial reading of the Balance of Payments therefore grossly under-estimates the relative importance of licensing.
Under-estimated Figures for Licensing
The $ 30.3 Billion figure for licensing receipts in Table 1 is, moreover, considerably under-reported, for two reasons. There is another whole category called “Other Private Services” which also includes payments for technical and professional services. See Table 2. These are intended to be for one-time payments for services rendered, where by comparison, the “Royalties and License Fees” categories is intended for longer term agreements and the transfer of rights. Licensing executives know that agreements are typically a bundle of rights and services. The two classifications may overlap, especially for technology or intellectual property transferred under a one-time or lump-sum payment. Companies may not always make such distinctions when reporting the figures to the Department of Commerce[7].
Table 2
What Does the Category of “Other Private Services” Include?
Technical, Professional and Business Services, such as / Estimated Percentage of “Other Private Services”a· Research, Development and Testing / 1.5 %
· Training / 0.8 %
· Engineering/Construction/Architectural Services / 7.6 %
· Information Services / 3.2 %
· Legal Services / 3.8 %
· Management Consulting / 2.9 %
· Accounting / 0.5 %
ALL of Above as Percent of Total “Other Private Services” / 20.3 %
a. Note: The above estimates are based on the year 1996 in Table 1 of Bureau of Economic Analysis (1998) U.S. International Transactions in Private Services, Washington, D.C.: U.S. Department of Commerce. The figures are only estimates because a breakdown of individual types of services is only available in the “unaffiliated” category.
Table 2 shows various sub-categories under Technical, Business and Professional Services where an overlap can occur with the “Royalties and License Fees” category. As much as 20.3 percent of the “Other Private Services” category, or $ 16.5 Billion (20 percent of 82.7) was received in 1997 by US companies for services that could also be covered under licensing.
A second reason for under-reporting occurs in the Royalties and License Fees received from unaffiliated parties (i.e. a licensee in which the licensor has no equity shareholding)[8]. The US Department of Commerce sends its Form BE-93 to only around 1275 firms, and requires companies to report only if the total unaffiliated receipts exceed $ 500,000 in the fiscal year[9]. This has the effect of excluding a possibly large number of (a) smaller licensors whose foreign licensing receipts fall below $ 500,000 and (b) large licensors unaware of the reporting requirement[10].
Licensing Substitutes for and Complements Exports
Three overall conclusions emerge from the Balance of Payments figures shown in Table 1. There is a substantial transfer of American corporate knowledge, for which significant, and rapidly-growing payments are received under both the “Royalties and License Fees” and “Other private Services” categories. The raw figures mask the fact that production abroad, generated from this knowledge transfer, rivals or exceeds the direct export of goods from the US. But licensing is not a pure substitute for trade (as we will see later in the section on intrafirm business). All we can say is that licensing is both a substitute for exports, as well as a complement to trade and investment.
So far we have compared licensing and trade statistics. Let us now turn to the most important mode of international business, namely foreign direct investment (FDI).
FOREIGN DIRECT INVESTMENT
The foreign sales of American company affiliates outside the US (at $ 2140 Billion in 1995) are more than twice the value of US Exports of goods and services. An average foreign customer is therefore more than twice as likely to purchase a so-called American item from a US firm operating within the customer’s country, compared to purchasing an imported American item. (For the planet as a whole a historical threshold was crossed in the mid 1990s—sales by the foreign affiliates of all multinational companies put together now exceed the total value of world trade).
Licensing is an indispensable complement to foreign direct investment (FDI), and to some extent substitutes for it[11].
Table 3
Synopsis of U.S.-Based Multinational Corporations (1995)
No. of Parent Companies in the U.S. 2,658 companies
(tracked by the US Commerce Dept.):
Their Foreign Sales: $ 2140 Billion
Their Sales in the U.S. : $ 4237 Billion
Their Combined Worldwide Sales: $ 6377 Billion
No. of Their Foreign Affiliates: 21,300 firms
- Majority Owned (MOFA) 18,713
Fully-Owned 17,000
Majority Owned 1,713
- 50/50 & Minority 2,587
49% - 50% Ownership 1,175
Less than 49% Owned 1,412
Definitions: Multinational Corporation (MNC): A firm that has at least one foreign affiliate.
Affiliate (foreign): A corporation in another nation, 10 percent or more of whose shares are held by a MNC.
MOFA: Majority owned foreign affiliate (> 50% shares)