Licensing Essay

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Licensing is generally considered a contractual arrangement or transaction  in which one organization, called the licensor, permits  the use of its intellectual property  by another  organization,  called the licensee, in return  for a fee or royalty payment.  To grant a license is to permit the use of intellectual property. The term license also refers to the legal document detailing the grant and usage of the license. The British term for license is spelled differently: licence.

The exchange  process  in  licensing  involves the sharing of intellectual property. The World Intellectual Property Organization defines intellectual property as the creations of the mind: inventions, literary and artistic works, and symbols, names, images, and designs used in commerce. Intellectual property has two  categories: industrial  property  and  copyright. Industrial property includes inventions that are patented, trademarks, industrial designs, etc. Copyright relates to literary and artistic works such as novels, films, music, or architectural designs. Generally, intellectual  property  includes  copyrights,  patents, and trademarks  but  could also refer to specialized creations of the mind such as circuit layout or plant breeding.

Copyrights,  patents,  and  trademarks  are actually three different types of creations, each having its own legal framework.  Intellectual  property  is a generalized term  commonly  used to denote  all of these by lumping them  together,  but care should be taken to differentiate among them as they have separate legal frameworks, connotations, and implications.

Intellectual  property  draws its legal implications from  physical property.  Just like physical property can be owned legally and the owner can derive benefit by using that property, intellectual property can also be owned and the owner can derive benefit from his or her effort. When  an individual, group, or agency invests in the creation  of something  new that  could have commercial  implications,  they have a right  to exploit the advantages of their efforts. Licensing provides the  legal framework  for letting  the  creator  of intellectual property possess the exclusive legal right to derive benefit from his efforts and for the user of that  intellectual  property  to pay for its usage. Thus licensing becomes the legal instrument to enable the creator and user of intellectual property to enter into a  mutually  beneficial  arrangement.  When  anyone uses  somebody  else’s intellectual  property  without having a license to use it, then  it is illegal because that infringes upon the rights of the creator. However, critics of the concept  of intellectual  property  argue against granting exclusive rights to creators, suggesting that it results in intellectual monopoly and intellectual  protectionism leading to  harming  of public interest  at the expense of individual rights. Further, the critics cast doubt on the claim that protection of intellectual rights really benefits the creators.

Licensing becomes especially important in the case of high-technology  industries  such  as  information technology, telecommunications, pharmaceuticals, or power generation.  There are several reasons for this importance:  high technology accounts for a substantial share of economic activity, many low-technology industries such as agriculture turn into high-technology businesses  as technology  advances,  and  high technology  products  are entering  into a wide range of businesses. Ownership  of technical  standards  in high-technology industries becomes a source of competitive advantage for companies in those industries. Battles to set and control technical standards in high technology industries are known as format wars.

Companies  hope  to  gain competitive  advantage against their  rivals by having the ability to develop high-technology  products  and  processes.  This can happen  only if they have exclusive rights  over the high-technology  products  and  processes  they create. Licensing provides the legal means of ownership of the  intellectual  property  that  goes into  creating those high-technology products and processes. By possessing the legal rights of ownership  over standards and formats,  companies  can license them  to other  companies.  The company that  helped to pioneer those standards and formats stands to gain economically  through   the  license  fees  that   flow back to  it. An example  of the  use of licensing  in high-technology  industries  is that  of Dolby, which used its ownership of the technological standards in noise-reduction technology  for the music and film industries.  It charged  a small licensing fee for letting recording companies use its technology and foregoing such fees on media recorded  using Dolby technology. This helped the company keep out rivals who could have developed their own, possibly superior, technology.

Licensing is of special importance  to organizations that operate internationally.  International licensing is a contractual  arrangement in which a foreign organization, the licensee in this case, purchases the rights to utilize another  organization’s (the licensor in this case) intellectual property for a negotiated fee or royalty payment. If the intellectual property in this case is the product  design, then the licensee can buy the rights to produce that product in its own country. The royalty payment can be negotiated on the basis of the number of products sold in that country.

Organizations  contemplating implementation of international strategies think of an option to enter a foreign market. These options are the several modes of entry  such  as exporting,  franchising,  joint  ventures, strategic alliances, and wholly-owned subsidiaries.  Licensing  is also  considered  among  the significant  modes  of international entry  and  is an important element of the strategies of many international companies.

When  used as a mode of entry into foreign markets, licensing involves little cost. This is so because an organization  that has already invested in the creation  of intellectual  property  only has  to  look  for more  opportunities  outside  one’s own  country  to utilize it. If it can license that intellectual property to some other organization  and earn revenue, then it is additional income at practically no extra investment. By licensing, an organization  extends the usage of its intellectual property without any significant risks.

There are four basic issues in international licensing: (1) specifying the agreement  boundaries; (2) determining   compensation;   (3) establishing  rights, privileges,  and  constraints;  and  (4) specifying  the duration of agreement. When entering into the licensing agreement,  the detailed contract  should  specify these four issues unambiguously.  The parties to the contractual  agreement  should  both  be clear on the limitations  imposed upon them, detailing what they can and cannot do. For instance, if the agreement limits the rights of either the licensee or licensor or both, then they should remain within such limits. The compensation to the licensee under licensing agreements is generally in the form of royalty payments. The royalty is paid in the form of a flat fee, a fixed amount per unit sold, or as a percentage of the sales of the licensed product   or  service.  The  licensor  and  the  licensee must be clear about their rights and responsibilities toward  the  contractual  arrangement. This prevents disputes  over the terms  and conditions  of licensing arising later. The time period for which the licensing arrangement is entered into must be specified clearly. This period  can be anywhere between  a short-term arrangement, say, of one year to a long-term arrangement  of even 100 years. The period depends  on the time that the licensee thinks is appropriate  to amortize its investments  and the licensor perceives to be enough for it to learn the technology involved or the perceived benefits to accrue.

Risks And Benefits

There are several benefits of licensing to both the parties involved. The licensee benefits in terms of added revenue streams with relatively little additional investment. They get the opportunity to make and sell products based on their intellectual  property  in markets that they themselves are unwilling or unable to enter. The licensor does not have to bear the development costs and risks associated with creation of intellectual property  and gets to use a tried and tested technology or product.  For organizations  that lack the technological  ability, licensing  offers a convenient,  less risky way to utilize the intellectual  property  created by other more capable organizations.

At the  same  time,  there  are some  drawbacks  to licensing.  Both  parties   forego  opportunities  that they could have used if they were not part of a mutually binding agreement.  For instance, if the licensing agreement prevents one company from entering a foreign market so long as it is in an arrangement with some local company, it cannot  do so. Similarly, the local company  is constrained  to use the technology provided  and cannot  use some other  technology  or sell some other products  of another  company at the same time if the agreement  prohibits  them to do so. Another problem with licensing is that it is based on a written contract. However carefully it may have been drafted, there is always scope for disagreement, especially if there is lack of mutual trust between the licensor and licensee. Often, disagreements  may result in costly litigation. To an organization  that offers technology through  licensing, there  is the risk of losing that technology to unscrupulous parties who may not honor  the  agreement  and  pass on  that  technology to others.  An opportunistic licensor may also learn the technology and access the confidential  information associated with it, and then could terminate  the contract to deprive the licensee of further royalty payments. From the strategic viewpoint, a licensee who grants a license to the licensor may not have full control over how the intellectual  property  is ultimately used. For instance, if the licensee uses inferior quality materials  to make products  based on the  licensor’s technology  to augment  its profits, then  the  impact may be felt on the licensor’s reputation and image.

Despite  the  drawbacks,  licensing  offers  a  good way for entry into foreign markets provided steps are taken to reduce the risks of some of the drawbacks. For example, the parties involved in the licensing agreement  could enter  into a two-way rather  than a one-way arrangement. Transfer  of technology  from the  licensor  to the  licensee can be reciprocated  by reverse transfer of technology that is the intellectual property  of the licensee, making it a cross-licensing arrangement. This binds both the parties to respect each others’ rights and reduces the risks of facing the drawbacks described above.

Related  Terms And Other Uses

There are some terms  related  to licensing that  also need  to  be understood.  Franchising,  like licensing, is another  mode of entry into foreign markets. Franchising has many similarities to licensing and is often considered  a special form  of licensing. Franchising involves not  only sharing  intellectual  property  but also brand name, business model, and operating system along with support  services such as advertising, training, and quality control. The party that grants the franchise is called the franchisor while the party that accepts or solicits it is the franchisee. Franchising is also generally a longer-term commitment compared to licensing. The application of licensing is usually in the transfer  of technology for manufacturing industries, while franchising is generally used for a package of facilities and information for service industries. International franchising, quite similar to international  licensing, is a popular  form  of international business activity. There are similar arrangement like legal contracts and royalty payments.

Licensing is used in several different contexts apart from  its  application  to  organizations  and  international business. A very familiar document  is the driving license that is legal permission to drive a vehicle. Character   and  entertainment  licensing  constitutes the biggest segment  of licensing, generating  billions of dollars in revenue  every year. Popular  characters like Mickey Mouse are licensed to users by movie studios and broadcasting  services such as Walt Disney. Designer names  such as those  of apparel  manufacturers  are licensed in the form of fashion licensing. Professional sports licensing is another  fast-growing area where sports events such as the Olympic Games, professional organizations  such as the National Basketball Association, and teams market their brand names for usage by businesses. Art licensing is a niche area where licensed artwork and artist-brand properties are licensed, bringing  much-needed revenue  to museums and artists.

Bibliography:   

  1. Richard Christou, International Agency, Distribution and Licensing Agreements (Sweet & Maxwell, 2008);
  2. John D. Daniels, Lee H. Radebaugh, and Daniel P. Sullivan, International Business: Environments and Operations (Prentice  Hall, 2009);
  3. Lee Davis, “Licensing Strategies of the New ‘Intellectual Property Vendors,’” California Management Review (v.50/2, 2008);
  4. Marcel Halpern, Susan Progoff, and Ian Feinberg, Understanding the Intellectual Property License, 2007, Intellectual Property Course Handbook Series, no. G-915 (Practising Law Institute,  2007);
  5. Adam Jolly and Jeremy Philpott,  The Handbook  of European Intellectual Property Management: Developing, Managing and Protecting Your Company’s Intellectual Property (Kogan Page, 2007);
  6. John A. Pearce II and Richard B. Robinson, Strategic Management (McGraw-Hill Irwin, 2009).

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