Strategic Perspectives for International Licensing Managers

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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 SocietyJune 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 countrys balance of payments.

TWO BROAD STRATEGY ROLES

There are two broad strategic perspectives on international licensing. The first looks upon licensing as a foreign market entry alternatives to direct exports or foreign direct investment. That is to say, a customer abroad can receive a so-called American product either by (1) direct import, or (2) by the American companys 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. 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 PaymentsPayments for Royalties and License Fees, and Technical Services ( $ Billions)

1995

1996

1997

EXPORTS

794.6

848.8

931.3

GOODS

575.9

612.1

678.1

SERVICES

218.7

237.8

253.2

Royalties and License Fees

27.4

29.9

30.3

From 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

82.7

Receipts from Affiliated Foreign Parties

20.3

22.8

25.4

U.S. Parents Receipts

12.8

13.8

15.0

Foreign Co. U.S. Affiliates Receipts

7.5

9.0

10.5

Receipts from Unaffiliated Foreign Parties

46.6

50.8

57.2

Of which, Technical & Professional Services

17.8

19.2

22.1

IMPORTS

896.4

959.9

1045.1

GOODS

749.4

803.2

877.1

SERVICES

147.0

156.6

167.9

Royalties and License Fees

6.5

7.3

7.5

Paid 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

47.5

Payments to Affiliated Foreign Parties

13.6

16.0

17.6

U.S. Parents Payments

6.8

7.5

8.6

Foreign Co. U.S. Affiliates Receipts

6.8

8.5

9.0

Payments to Unaffiliated Foreign Parties

25.7

26.7

29.9

Of which, Technical & Professional Services

4.7

5.3

6.5

Sources:

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. (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--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. 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.

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.

Table 2

What Does the Category of Other Private Services Include?

Technical, Professional and Business Services, such as

Estimated Percentage of Other Private Servicesa

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). 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. 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.

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 customers country, compared to purchasing an imported American item. (For the planet as a whole a historical threshold was crossed in the mid 1990ssales 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.

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)

Sources: U.S. Department of Commerce (BEA) U.S.Direct Investment Abroad: Operations of U.S. Parent Companies and their Foreign Affiliates (Washington, D.C.: U.S. Government Printing Office, 1997) and various issues of Survey of Current Business.

Detailed statistics for foreign direct investment (FDI) are obtainable only from the quinquennial Benchmark Surveys of the US Commerce Department. The latest available information relates to the year 1995. The survey tracked 2,658 US-based multinational companies (i.e. those with at least 10 percent controlling equity interest in a foreign affiliate). The survey captures almost all US FDI. These 2,658 US-based multinationals

INSERT FIGURE 1 HERE

Because of formatting reasons Figure 1 is not in this computer file, but in a separate WORD file markedLES Paper Figure 1

(Attached)

had worldwide sales totaling $ 6377 Billion in 1995. Of this two-thirds, or $ 4237 Billion, was in the US itself. The Gross Product of U.S. Parents (in the U.S. alone) amounts to 26% of the GDP of all private U.S. businesses. Sales by foreign affiliates in their respective nations totaled $ 2140 Billion. This was 2.7 times total US exports. (See Table 1). Clearly, as a means of reaching foreign customers, American companies rely far more on FDI than on exports or licensing, and play a key role in the local economies. Appendix Table A gives a breakdown of sales by foreign region.

Table 3 also shows that 88 percent of foreign affiliates are majority-owned, and 80 percent are fully-owned. Licensing in such affiliates has a key, but subordinate strategy role, detailed later in this article. The negotiation and determination of royalty rates and license fees may not occur on arms-length basis, but other internal strategic considerations also come into play.

THE INTERTWINED NATURE OF INTERNATIONAL LICENSING, FDI AND TRADE

Multinational firms not only invest abroad, but they are also account for the bulk of licensing, exports and imports of major economies such as the US. In many cases, an equity stake in a foreign affiliate is accompanied by a license agreement between parent and affiliate, as well as trade between the two entities. Direct investment, licensing and trade are no longer foreign market entry alternatives, but serve as combined strategies.

In Figure 1, which covers US-based multinational firms, the large circle represents the border of the US with the rest of the world. US-based multinationals made sales within the borders of the US of $4237 Billion in 1995. However of this, $ 445 Billion was exported and $ 205 Billion of this was exported to the companies own foreign affiliates. US-based multinational company foreign affiliates recorded sales of $ 2140 Billion in 1995; but of this at least $ 168 Billion was imported back to the US, $ 139 Billion by the foreign affiliates own US parents.

But this is only for US-based multinational firms. In addition, foreign multinationals in the US also import and export, and much of this is between the US affiliates and their own foreign parents. This is not shown in Figure 1, but in Table 4.

Table 4 summarizes the dominant role of multinational companies (be they American or foreign) in the trade of the United States. (A similar situation prevails in many advanced countries). As much as 77 percent of US exports of goods and services, and 71 percent of US imports, are accounted for by multinational firms. An even more salient fact is that 38 percent of all US exports, and 48 percent of all US imports are intrafirm. In such cases one does not know whether exports led to subsequent foreign direct investment (FDI) or whether FDI, by its very nature, depends on continued inputs and outputs from other parts of the global firm. Clearly, much of trade is not a substitute for investment (in the sense of a customer receiving imported finished good in lieu of local production). Rather, much of trade is complementary to FDI. We can say much the same for licensing.

Intrafirm Licensing

Table 1 earlier provided a breakdown of Royalties and License Fees received from

Table 4

The Role of Multinational Corporations (MNCs) In U.S. Trade in Goods and Services

Exports of Goods and Services

Type of Exporter

($ Billions 1995)

Portion Exported to Affiliated Parties

From U.S.-based MNCs to All Foreigners

445

205

By Foreign Firms in the U.S. to All Foreigners

170

92

By Domestic U.S. firms to all Foreigners

179

n/a

TOTAL EXPORTS

794

297

Hence Share of Multinational Corporations (MNCs) In U.S.Exports

U.S.-Based MNCs

56%

Foreign MNCs In the U.S.

21%

Share of All MNCs in U.S. Exports

77%

Intrafirm Exports as % of Total U.S. Exports

By U.S.-Based MNCs

26 %

By Foreign MNCs In the U.S.

12%

Total Intrafirm Exports as % of U.S. Total Exports

38%

Imports of Goods and Services

Type of Importer

($ Billions 1995)

Portion Imported from Affiliated Parties

By U.S.-based MNCs from All Foreigners

320

168

By Foreign Firms in the U.S. from All Foreigners

317

257

By Domestic U.S. firms from all Foreigners

259

N/a

TOTAL IMPORTS

896

425

Hence Share of Multinational Corporations (MNCs) In U.S.Imports

U.S.-Based MNCs

36%

Foreign MNCs In the U.S.

35%

Share of All MNCs in U.S. Imports

71%

Intrafirm Imports as % of Total U.S. Imports

By U.S.-Based MNCs

19%

By Foreign MNCs In the U.S.

29%

Total Intrafirm Imports as % of U.S. Total Imports

48%

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.

Intrafirm: Transactions such as trade or licensing between the multinational firm and its own affiliates.

Sources:

1. Economics and Statistics Administration (1997) U.S. Direct Investment Abroad: Operations of U.S. Parent Companies and their Foreign Affiliates, 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.

affiliated and unaffiliated parties. The former dominate. To summarize the intrafirm nature of international licensing Table 5 gives the percentages of total licensing receipts and payments that are not arms-length. These generally range upwards from 75 percent.

Table 5

The Role of Multinational Firms In U.S. Licensing Receipts and Payments

Intrafirm Licensing Payments as a Percentage of Total Licensing Payments

1995

1996

1997

U.S.-based Licensorsa Royalties and Fees Received from Affiliated Foreign Parties Abroad

79%

80%

77%

U.S.-based Licenseesb Royalties and Fees Paid to Affiliated Foreign Parties Abroad

78%

73%

79%

Sources: Computed from Table 1.

Notes: a. Licensors include US multinational firms and foreign companies in the US

b. Licensees include US multinational firms and foreign companies in the US

What can explain the dominance of intrafirm licensing? For that matter, why do intrafirm licensing payments occur at all? After all, a parent controls its foreign subsidiary, and cash flows between them can simply be ordered by declaring higher or lower dividends or arranging intra-corporate loans. Why charge additional fees and royalties within the corporate family?

Table 6

Why Make Your Own Foreign Affiliate A Licensee ?

STRATEGIC CONCEPT

EXPLANATION

Tax Advantages

Deductibility of payments by licensee/affiliate

Possibly lower tax also to licensor/parent

Affirming Ownership of Intellectual Property

Establishes legal ownership of IP in foreign nation

Valuation of Intangible Assets

Forces company to formally value its intangible assets especially crucial in a future sale of a foreign affiliate

Cross-licensing

Imperative when exchanged knowledge or territories are of unequal value

Relations with Allies and Joint Venture Partners

Formalizes ownership of IP with alliance partners

Negotiate an auxiliary income stream from a joint venture affiliate (especially useful in 50/50 and minority JVs)

Cash Flow Assurance

A lumpsum is an immediate and certain return

Royalties, if indexed to sales, are generally earned even if affiliates profits are zero

In a JV affiliate profits are shared, but the parent/licensor may get all the royalties

Licensing lowers risk/volatility

Royalties linked to sales are inherently less volatile over the business cycle compared to more volatile affiliate profits

Lowers political and convertibility risk in affiliate nation

Why Make Your Own Foreign Affiliate A Licensee ?

There are at least a dozen reasons in Table 6 describing why it makes eminent sense for a parent firm to sign a licensing agreement with its foreign affiliates. A transfer of knowledge from parent to foreign affiliate is inevitable to the latters success in the foreign market. But there are compelling reasons to formalize this knowledge transfer.

In virtually every nation royalty payments made by licensees, even to their own foreign parents, may be treated as an expense item provided the royalties are reasonable. In addition, the licensor/parent may receive tax advantages in their home country, for example in cases where licensing receipts are treated as an amortization of certain R&D outlays. Tax reduction is a powerful motivator for licensing agreements between affiliated parties. Furthermore, good intellectual property (IP) management requires legally establishing the companys rights in the foreign nation by both registration, use, and a formal agreement with the user even though the user is ones own affiliate. Companies frequently cross-license with affiliates. The financial values of the bundles of IP, unregistered intangible assets and territories exchanged are typically unequal. This often requires formal valuation procedures and cross-agreements. Formalizing legal ownership and putting a value on IP and knowledge transfers is an even more crucial activity where joint venture and alliance partners are involved. International joint ventures may have a half life of only five years or so on average. Upon termination of an alliance relationship, claims and counter claims as to the ownership of intangible assets could be avoided or mitigated if a formal license agreement exists between the JV/alliance firm (as licensee) and one of its parents (as licensor).

Some joint venture negotiations neglect an obvious, but sometimes forgotten, fact. Whereas the profit stream is shared by the equity joint venture partners, the parent firm which is the licensor to the venture earns all the royalties and license fees. In general, even with a fully-owned subsidiary, a license agreement has the virtue of creating an auxiliary income stream -- a cash flow channel to extract returns from a foreign operation, in addition to normal dividends.

This returns us to the initial question: Why have licensing returns when a dividend repatriation provision already exists to extract earnings from a controlled affiliate? From a financial perspective there are fundamental differences between a dividend or return on equity, and licensing-type cash flows. These differences exist in terms of (a) timing (b) degree of volatility and (c) uncertainty. Dividends are uncertain -- in the sense that they depend on the business cycle, good performance of the company, concurrence of joint venture partners (if any), and on government permission in the event of currency controls in emerging markets. On the other hand, lumpsum payments are immediate and relatively certain. Royalties are typically indexed to sales. This means that they do not depend on volatile earnings (on which dividends are computed) but are much more stable over the business cycle. (It is axiomatically true that Sales are much more stable than Profits). In the extreme, even if profits disappear, sales and royalties in most firms will be only somewhat shy of normal levels. Finally, to the extent that some emerging countries exhibit political risk or impose capital controls, licensing-type payments, being considered under the purview of an international agreement, may be somewhat safer compared with ordinary earnings and returns on foreign equity.

THE BOTTOM-LINE COMPARISON

How do (i) licensing, (ii) exports and (iii) foreign direct investment (FDI) compare as to their bottom line impact on company profits? True, they are often intertwined strategies where the three are not so much foreign market entry options, but rather are viewed as alternative channels for cash flows from foreign operations. It would be of interest to see what impact the three have on net cash flows.

Table 7 shows some estimates. While the US Commerce Department does report the earnings of US-based multinationals foreign affiliates, net profit levels on licensing and exports are unknown, and have to be estimated. It should be emphasized that these are somewhat tenuous estimates, and would vary depending on the assumptions. Hence these are clearly stated (in the ensuing discussion, in Table 7, and in related endnotes to this article) so that the reader can make alternative assumptions to his or her satisfaction.

Table 7

Impact of Licensing, Exports and Foreign Direct Investment on US Firm Profits

Cash Flow Type (1995)

Source

Bottom Line Contribution (1995)

Foreign Royalties and License Fees Received by US Licensors

Balance of Payments Statistics; Table 1 and earlier discussion in this article.

$ 24.7 to $ 36.7 Billiona

Exports (excluding Royalties and License Fees)b

- do -

$ 38.36 to $ 76.7 Billionc

Earnings (net) on FDId

Survey of Current Business, July 1997

Total $ 87.0 Billion

Distributed 33.0 Billion

Reinvested 54.0 Billion

Notes: a. At 90 percent of gross figures of $ 27.4 40.74 Billion.. See Table 1 and earlier discussion. See also Reference No. 21 at the end of this article for further details.

b. Exports of Goods and Services minus Licensing Returns = 794.6 27.4 = 767.2 Billion. See Table 1.

c. 767.2 multiplied by either 0.05 or 0.10.

d. Before withholding taxes and not including interest

The Earnings on FDI figures from the US Department of Commerce are fairly reliable. $ 87 Billion was reported. This amounts to 4.1 percent of the $ 2140 Billion in Sales of Foreign Affiliates (see Figure 1). $ 33 Billion in earnings were distributed and $ 54 Billion reinvested. To estimate the bottom line contribution of US Exports, we need to multiply the gross Exports figure of 767.2 Billion (see Table 1 and Note b in Table 7) by some profit margin assumption. If we assume 5 percent, the bottom line impact would be $ 38.36 Billion; if 10 percent it would be $76.7 Billion. (There is no better information on the profitability of US exports). For licensing receipts, 90 percent of the gross figures (in Table 1) were assumed to be the bottom line impact. An earlier study by the author -- perhaps the only one that measured compensation as well as costs in a sample of 102 international technology licensing agreements -- reported that direct costs, associated with earning international license revenues, amounted to less than 10 percent of licensing receipts in US licensor companies. Accordingly, multiplying the gross figures by 0.9 gives a reasonable estimate for the bottom line impact of international licensing.

How do the three compare. Clearly, FDI plays the leading role, followed by exporting, and then licensing. However, licensing revenues for US licensors have been growing at upwards of 12 percent annually, compared with an 8 percent or below growth for trade and investment. (A similar comparison made by the author 5 years ago for 1990 figures showed licensing as only a very distant third. In Table 7 above, for 1995, the upper end of the licensing range is just shy of the lower end of the range for exports).

SUMMARY AND CONCLUSIONS

This article is intended to acquaint licensing managers with the rapidly-growing role that international licensing plays in the US economy and balance of payments. Comparative statistics were presented for licensing, exports and foreign direct investment (FDI) of the US. At the same time conclusions were drawn from the analysis as to the strategy and profit role that licensing plays in companies in general, and multinational firms in particular.

The article also presented data on the relative importance of licensing, foreign direct investment and trade as modes of international business, both in terms of sales and in terms of likely bottom line profit impact.

International licensing may be viewed from two strategic perspectives. In the first, as a foreign market entry strategy, licensing substitutes for exports or foreign direct investment as a means of reaching foreign customers. In the second perspective licensing, while playing crucial roles, is nevertheless complementary to foreign direct investment. In fact, for globally-sophisticated companies, all three modes, licensing, trade and investment co-exist and are intertwined and simultaneous strategies. That is to say, foreign affiliates are often simultaneously the recipients of equity investment, as well as licensees or licensors, and trading partners with their own parents and sister firms. The article outlined the extent to which crucial cross-border flows of goods, services, proprietary corporate knowledge (and their accompanying royalties and fees) are heavily intrafirm. The bulk of worldwide licensing, and the majority of world trade occur between companies that have some equity stake in each other.

International licensing plays crucial roles in being a legal means for reducing tax liability, in affirming ownership of intellectual property, in the proper valuation of intangible assets, in structuring relations with joint venture partners and allies, and in reducing the volatility and risk associated with repatriated earnings from foreign operations.

These larger perspectives are important to the practice of licensing executives, and in presenting the strategy role of international licensing to the top management of companies.

REFERENCES

See F.J.Contractor, Licensing in International Strategy: A Guide for Planning and Negotiation (Westport, CT and London: Quorum Books, 1985).

Foreign Direct Investment (FDI) is generally defined as a company having 10 percent or higher controlling equity interest in a foreign firm. This excludes portfolio or passive investment which is not of interest here.

This growth rate is for the receipts of Royalties and License Fees category (under US Exports see Table1) which increased from $ 8.11 Billion in 1986 to $ 29.9 Billion in 1996. The Other Private Services category showed an almost equally high compounded growth rate of 11.1 percent over the same period. (Sources: U.S. Department of Commerce).

The figures in Table 1 are compiled from various issues of a US Commerce department monthly publication, Survey of Current Business, and draws particularly on Bureau of Economic Analysis (1998) U.S. International Transactions in Private Services (Washington, D.C.: U.S. Department of Commerce), and Bach, C.L (1997) U.S. International transactions, First Quarter 1997, Survey of Current Business, July, pp. 56 99.

See F.J.Contractor, International Technology Licensing: Compensation, Costs and Negotiation (Lexington, MA: Lexington Books, 1981) and Licensing in International Strategy: A Guide for Planning and Negotiation (Westport, CT and London: Quorum Books, 1985).

The phrase appear to is used since the story is actually more complicated because of intrafirm licensing payments. This will be treated in a later section.

In fact, it is likely some firms report services, even under formal, long-term license agreements, into the Other Private Services category. But the incidence of this overlap is unknown.

The unaffiliated definition also includes cases where the licensor has less than a 10 percent equity share in the licensee firm. However such cases are very rare in international licensing.

See U.S. International Transactions in Private Services (Washington, D.C.: U.S. Department of Commerce) page 64.

The US Commerce Department however asserts that its methods capture 95 percent of the reportable figures.

The extent of the complement versus the extent of the substitution will be examined later under the section on intrafirm business.

Complete detailed results of the 1995 estimates were not released until Spring 1998.

The survey includes firms if at least one of their foreign affiliates has assets or sales exceeding $ 3 million. This has the result of excluding from the statistical universe several hundred smaller US parent firms and possibly a few thousand of their foreign affiliates. In addition, an unknown number of US parent firms intentionally or inadvertently fail to file reports with the Commerce Department. However, the US Department of Commerce asserts (with some justification) that the 2,658 firms in the survey represent over 95 percent of the universe of American FDI by value. There is therefore somewhat of a large company bias in the statistics.

US company Majority Owned Foreign Affiliates (MOFAs) alone account for 12 % of Irelands GDP, 9 % of Canadas, 8 % of Singapores and 6 % of the UKs. Figures for 50/50 and minority affiliates are not available, but they would obviously add to the numbers.

For a detailed discussion see F.J.Contractor, "Foreign Market Entry Strategies" in International Encyclopedia of Business Management (London: Routledge, 1998).

The Benchmark survey only covers exports back to the US by majority affiliates ($ 168 Billion). Similar exports by 50/50 and minority affiliates would increase this figure, but it is unknown.

Presumably at a favorable rate. There is an enormous volume of international intra-corporate loans.

Reasonable in effect amounts to what is acceptable to both the firms and the tax authority. This article does not intend to discuss the large literature on this subject exemplified by W.M.Lee, Determining Reasonable Royalty, Les Nouvelles: Journal of the Licensing Executives Society, September 1992; Matsunaga, Y., Determining Reasonable Royalty Rates, Les Nouvelles: Journal of the Licensing Executives Society, December 1983; Evans, L., Pricing the Technology, in Technology Licensing 1988 (New York: Practising Law Institute, 1988); Contractor, F., International Technology Licensing: Compensation, Costs and Negotiations (Lexington, MA: Lexington Books, 1981); Chrocziel, P., Overview of Licensing Negotiation, Les Nouvelles: Journal of the Licensing Executives Society, June 1995, pp. 59 66; Anson, W., US Intangibles Taxation: Big Value, Big Headache, Managing Intellectual Property, Sept. 1993, pp. 14 18; Gravelle, J., and Taylor, J., Tax Neutrality and the Tax Treatment of Purchased Intangibles, National Tax Journal, March 1992, pp. 77 88; Parnes, A., United States Tax Considerations In Organizing a Foreign Joint Venture, Journal of Corporate Taxation, Spring 1993, pp. 3 43; Reilly, R., Economic Evaluation Techniques, Les Nouvelles: Journal of the Licensing Executives Society, June 1995, pp. 53 58 and Fuller, J., The Treatment of Intangible Property Rights In International Tax Planning, Taxes, December 1992, pp. 982 - 997.

A surprising number of joint venture companies are formed with no formal agreement between the principals, especially in foreign cultures like Japan where there is presumed to be an aversion to legal specificity. Building trust is deemed more important and insistence by one party that there be an agreement, is said to be an obstacle to the formation of the alliance in the first place. What may be more important to JV success and longevity however, is the willingness of the principals to be flexible in later years, and amend their relationship, even if a formal agreement exists. See F.J.Contractor and P. Lorange, Cooperative Strategies In International Business (Lexington, MA: Lexington Books, 1988).

Actually they are a slight underestimate because banks are excluded from much of the Benchmark Surveys. The figures are only for non-bank firms.

Table 1 showed 1995 Royalties and License Fees earned by US-based licensors to be $ 27.4 Billion. Moreover, Table 2 showed that up to 20 percent of the Other Private Services category additionally could be construed to be licensing-type returns. This yields a range of $ 27.4 Billion (conservative) to $ 40.74 Billion (optimistic) for licensing returns earned from foreign licensees.

F.J.Contractor, International Technology Licensing: Compensation, Costs and Negotiation (Lexington, MA: Lexington Books, 1981)

But these direct costs, such as maintaining a licensing department and negotiating and monitoring agreements, do not include R&D outlays. If so, is 90 percent of gross licensing revenue a pure profit contribution, or merely amortization of past R&D outlays? This is an unanswerable, almost philosophical, question.

See Reference No. 3 above.

"A Note On The Complementary Roles of Foreign Equity Investment, Trading And Licensing in the Strategies of U.S.-Based Multinational Firms" by F.J. Contractor in Multinational Enterprises And The Global Economy, Lee E. Preston (ed.), (College Park, MD: CIBER, Maryland, 1995).

APPENDIX

This Appendix treats two subjects, (1) the geographical distribution of US-based multinational company activities worldwide, and (2) an overview of the activities and scope of foreign companies in the US.

Geographical Distribution of US Multinational Company Activity

Two-thirds of the sales of such corporations occur in the US itself, as seen in Appendix Table A. Of the rest, the single most important region for American company affiliates is Europe, although the single most important nations are Japan and Canada.. Latin America and the Caribbean continue to register more sales than Asia (outside of Japan)

Appendix Table A

Distribution of U.S.-Based Multinational Corporation (MNC) Activity

Sales Recorded In Nation/Region by the Foreign Affiliates of US Parents1

Percentage of Worldwide Sales (Average)

In the U.S. Itself (By the Parent Companies)

66 %

Abroad, By Affiliates In

34 %

Europe

19 %

Canada

3 %

Latin America & W.Hemisphere

4 %

Japan

4 %

Australia

1 %

Other Asia

3 %

Other

1 %

TOTALS

100 %

34 %

1 Note: This includes exports from that nation

Sources: Economics and Statistics Administration (1997) U.S. Direct Investment Abroad: Operations of U.S. Parent Companies and their Foreign Affiliates, Washington D.C.: U.S. Department of Commerce.

Activities and Scope of Foreign Companies in the US.

Direct investment by foreign firms in the US has grown rapidly in the past decade. In 1995, the combined sales of 21,300 American company affiliates abroad was $ 2140 Billion which was spread over many regions and countries shown above in Appendix Table A. In contrast, 12,497 foreign companies in the US alone registered sales of $ 1562 Billion. Please see Appendix Table B.

Foreign companies play a significant role in US trade, accounting for $ 170 Billion in US exports and $ 317 Billion in US imports. This is a large trade imbalance for this group of firms. US-based multinationals also contribute to a net trade deficit (See Table 4) but it is, percentage-wise, much smaller. The remitted profits of foreign firms in the US, at $ 20 Billion, amount to 1.3 percent of sales. The equivalent ratio for US-based multinational is similar, namely 1.5 percent. Foreign firms in the US play a much smaller role in cross-border licensing flows than do US-based multinationals, with a negative technology balance unlike their American counterparts. (See also Table 1).

Appendix Table B

Synopsis of Foreign Multinational Corporations in the U.S. (1995)

No. of Foreign Companies in the U.S.: 12,497

Their Combined Sales In the U.S.: $ 1562 Billion (Goods $ 1257; Services $ 305)

Exportsa from the U.S. (Goods and Services )

($ Billions)

To Foreign Parent Group

73

To Other Foreign Affiliate Companies

19

To Unaffiliated Parties Abroad

78

Total Exports By Foreign Firms In the U.S.

170

Importsa into the U.S. (Goods and Services )

($ Billions)

From Foreign Parent Group

242

From Other Foreign Affiliate Companies

15

From Unaffiliated Parties Abroad

60

Total Imports By Foreign Firms In the U.S.

=SUM(ABOVE) 317

Dividends or Remitted Profits: $ 20 Billion

Royalties and License Fees Received into the U.S. from Abroad: $ 1.5 Billion

Royalties and License Fees Paid To Foreigners outside U.S.: $ 4.7 Billion

a Note: Extrapolated estimatesSources

_____ (1997) Survey of Current Business, October 1997, pages 75 118.

Economics and Statistics Administration (1997) Foreign direct Investment In the United States: Operations of Foreign Companies, Washington D.C.: U.S. Department of Commerce.

Bach, C.L (1997) U.S. International transactions, First Quarter 1997, Survey of Current Business, July.