Licensing is a transfer-related market entry strategy. It involves a company (known as the licensor) granting permission to a company in another country to use its intellectual property for a defined time period. The intellectual property can include patented manufacturing processes, trademarked products, copyrights and technical assistance.
In return for this permission, the licensor demands a fee from the company it has granted permission to (the licensee) and periodic royalty payments.
Advantages and disadvantages
Licensing is a very attractive method for entering a target market if a company has valuable intellectual property. It involves minimal initial costs and provides companies with regular income from overseas.
Licensing also has the following advantages:
- It enables a company to enter a market that has restrictions on foreign companies.
- The licensor company benefits from the licensee company’s local market knowledge. The licensor company gains a market stronghold very rapidly.
- The licensor company’s capital is not tied up in foreign operations.
- The licensor company has the option to expand into the market further by investing in the licensee company at a later date.
- The licensor company can move into several markets at one time.
However, as with all forms of market entry, licensing does have some disadvantages:
- Entry into the target market is limited.
- The terms of the license must be monitored over the lifetime of the agreement, and enforcement might become necessary
- The licensee company might use the intellectual property provided to become a competitor company.
- Intensive research and planning is required to identify the best licensee and develop a beneficial licensing agreement.
- Companies that engage in licensing should consider the possibility of extending their market entry by moving into a joint venture with licensee companies.
When is licensing a suitable strategy?
Companies with a strategic goal of increasing market share should consider licensing if they have a proprietary product that can be manufactured easily at a foreign location. Licensing provides an opportunity to rapidly increase the sales volume of a product. However, this increase does not result in large profits because returns are limited to a percentage of each product unit sold.
Companies that wish to expand into one or more markets with minimal risk and commitment will find that licensing could be the best market entry strategy.
The overseas licensee is responsible for all risks and expenses involved with production, distribution and marketing. However, the licensing agreement must be monitored and enforced if necessary and it will not be possible for the company to withdraw from the market rapidly.
Licensing will not be suitable if the company cannot cope with the risk that its intellectual property will be lost or that it might be increasing levels of competition in the future.
Ideal conditions for licensing
What are your company’s goals? The strategic objective is to expand market share. The company must not require large profits from international trade.
What’s the size of your company? Any size of company is suitable.
What resources do you have? The company must be able to devote time and resources to locating licensees, negotiating contracts and monitoring the licensee. It does not want to, or is not able, to devote substantial monetary resources to international trade.
What stage is your product or service at? The product or service must be patented intellectual property and must be in demand in an international market.
What type of compensation is acceptable to you? The company must be happy with periodic payments based on a percentage of sales by the licensee.
What competition do you face? There should be no competing companies in the market because the product, process or service is patented. However, the company must be comfortable with the potential for competing companies to steal its intellectual property. The market should ideally have a low level of competition.
Do you have access to intermediaries? The company must work with a reputable law firm experienced in international trade to negotiate and develop the license agreement.
What level of control is acceptable to you? The company does not need to have substantial control over production, marketing and selling activities.
What is the total cost of investment? The company wants to avoid having to invest substantially in international trade.
How quickly can you bring your product to market? The company wants to enter a market rapidly.
Can your company handle the risk? The company must be able to deal with the risk of business losses from theft of intellectual property.
Can your company lock into a contract? The company must be able to remain in the trading relationship for a set period of time.
Case study: Increasing power generation
In June 2008, Salamon Group, a U.S.-based manufacturer of electrical generating equipment, announced it had made an international licensing deal with a Canadian company. Under the terms of the deal, the Canadian licensee gained exclusive rights to produce, market and distribute Salamon’s products in Canada. Salamon was paid an initial fee of C$15,000 and agreed to receive royalty payments of three percent of gross sales value.
Licensing can be a quick, low-investment and financially lucrative market entry strategy.
To be successful at licencing you need a high-demand product or service, limited competition and the willingness to give up control of some of the promotional and logistical aspects of selling your commodity.
If licensing isn’t right for your company, there are lots of other investing entry strategies to choose from including franchising, subcontracting, greenfield investment, joint venture, branch office and more.