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Licensing and Franchising

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Page 1: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Licensing and Franchising

Page 2: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

License or integrate?

License out knowledge or integrate into production?

License in knowledge of integrate into R&D?

Page 3: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Licensing vs. integration

Licensing contracts

• Technology package

• Use conditions

• Compensation

• Other provisions

Page 4: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Licensing or Integration?

hard to sell/acquire

easy to sell/acquire

Assets held by the MNE

Wholly-owned subsidiary ofMNE

easyto sell/acquire

Hard toSell/acquire

assetsheldbya localfirm

Equity Joint Venture betweenMNEand localfirm

Local firmtakes license/franchisefrom MNE

Page 5: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Determinants of the choice

Pros of licensing

• Comparative advantage

• Management costs

Cons of licensing

• Market transaction costs

• Risk of building up competitors

Page 6: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Costs of using the market for knowledge

Property rights in knowledge are imperfect

Right of exclusive useTechnical limitations

Government limitations

Right of free transferContractual limitations

Government limitation

Page 7: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Limitations of market for knowledge

Arrow’s paradox

The property rights solution

Page 8: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Property rights in knowledge

PatentsProtect inventions (products and processes)

CopyrightsProtect form taken by literary,

musical, dramatic, pictorial, audio and audiovisual work

Page 9: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Limitations of property rights in knowledge

Right of exclusive use

Technical limitations

Knowledge tacitness

Legal limitations

Limited life

Imperfect enforcement

National domain

Page 10: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Effectiveness of Process and Product Patents In Industries with Ten or More Survey Responses

Industry

Process patents Product patents

Mean Standard error Mean Standard error

Pulp, paper, and paperboard 2.6 0.3 3.3 0.4

Cosmetics 2.9 0.3 4.1 0.4

Inorganic chemicals 4.6 0.4 5.2 0.3

Organic chemicals 4.1 0.3 6.1 0.2

Drugs 4.9 0.3 6.5 0.1

Plastic materials 4.6 0.3 5.4 0.3

Plastic products 3.2 0.3 4.9 0.3

Petroleum refining 4.9 0.4 4.3 0.4

Steel mill products 3.5 0.7 5.1 0.6

Pumps and pumping equipment 3.2 0.4 4.4 0.5

Motors, generators, and controls 2.7 0.3 3.5 0.5

Computers 3.3 0.4 3.4 0.4

Communications equipment 3.1 0.3 3.6 0.3

Semiconductors 3.2 0.4 4.5 0.4

Motor vehicle parts 3.7 0.4 4.5 0.4

Aircraft and parts 3.1 0.5 3.8 0.4

Measuring devices 3.6 0.3 3.9 0.3

Medical instruments 3.2 0.4 4.7 0.4

Full sample 3.5 0.06 4.3 0.07Mean score on a scale of 1 to 7.

Page 11: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Limitations of property rights in knowledge

Right of free transfer

Contractual limitations

Legal limitations

Page 12: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Other barriers to imitation

• Secrecy (trade secret)

• Lead time (installed base)

• Learning curve

• Sales and service effort (customer switching cost)

Page 13: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Effectiveness of Alternative Means of Protecting the Competitive Advantages of New or Improved Processes and Products

Overall sample means Distribution of industry meansb

Method of appropriation Processes Products Processes Products

Patents to prevent duplication 3.52

(0.06)

4.33

(0.07)

2.6-4.0c 3.0-5.0c

Patents to secure royalty income 3.31

(0.06)

3.75

(0.07)

2.3-4.0c 2.7-4.8c

Secrecy 4.31

(0.07)

3.57

(0.06)

3.3-5.0 2.7-4.1

Lead time 5.11

(0.05)

5.41

(0.05)

4.3-5.9c 4.8-6.0c

Moving quickly down the learning curve

5.02

(0.05)

5,09

(0.05)

4.5-5.7 4.4-5.8

Sales or service efforts 4.55

(0.07)

5.59

(0.05)

3.7-5.5 5.0-6.1

a Range: 1 = not at all effective; 7 = very effective. Standard errors in parentheses.b From the upper bound of the lowest quintile of industries to the lower bound of the highest quintile.c Differences in means significant at the .01 level.

Page 14: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Patent or trade secret?Trade secret if..

Infringement will not be detected (process)Commercial life longer than that of patentPatent makes it possible to design around itInnovator cannot sue

Patent if..Patent protects against design around itInvention can be reverse-engineeredCompany has high turnover of researchers

Page 15: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

When to license?

• Target market factors– Peripheral markets

• Firm factor– Inexperienced firms

• Technology factors– Broad, upstream technology– Fast changing technology– Old technology– Cross-licensing

Page 16: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Licensing vs. equity as mode of technology acquisition

• Licensing technology package skewed towards older and more explicit technology

• Licensors unwilling to license advanced technologies to potential competitors

Page 17: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Extent of technology package provided (119 agreements)

Licensing Joint ventures

Type of package No. % No. %

Comprehensive

Intermediate

Limited

4

25

44

5

34

60

24

17

5

52

37

11

Totals 73 100 46 100

Source: Davies

Page 18: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Provision of assistance with management functions

Licensing Joint ventures

Function No. % No. %

Engineering and production

Management skills

Marketing information

Information on sources of supply

73

10

14

16

100

14

19

22

45

16

19

20

98

35

41

44

Source: Davies

Page 19: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Franchising vs. Integration

• Reputation gained at home can be valuable abroad

• Reputation can be embedded in a property right (trade or service mark)

• Franchising is renting of trade or service mark

Page 20: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

TrademarkProtects

Trade name (distinctive, arbitrary, fanciful)

Service mark

Packaging and product features

color

sound

Must not have been taken by someone else

Must not be in common usage

Page 21: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Limitation of property rights in reputation

• Right of exclusive use– National regulations– Enforcement problems (counterfeiting)

• Right of transfer– Enforcement problems (free riding on quality)

Page 22: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Pirated Music CDs (percent of all sold) (2005)

0 20 40 60 80 100

Spain

Italy

Brazil

Greece

Mexico

Russia

China

Indonesia

Source: IFPI Piracy report, 2006

Page 23: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Source country of counterfeits seized in the US 2002*, $m

0 10 20 30 40 50

Indonesia

South Korea

Pakistan

Hong Kong

Taiwan

China

Source: US Customs * Year ending September

Page 24: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Price comparisons between fake products and genuine articles in Hong Kong

Item Genuine Fake

Gucci glasses $322 $11

Hermes wallet $1,238 $15

Louis Vuitton black ‘epi’ leather knapsack

$1,096 $45

Gucci watch $915 $11

Gucci belt $120 $28

Gucci pants $1,096 $20

Gucci sandals $322 $20

Page 25: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Potential problems of franchise contracts

1. Franchisee will debase qualitySolution: QSC standards in contract

2. Franchisor will fail to enforceSolution: Franchisor owns outlets

Page 26: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

McDonalds franchise contract

Franchisee must have $75,000 in cash, securities and investment besides home

McD chooses location of new outletsNo territorial protectionMcD provides land and building, franchisee the rest

($400 to 600,000)Franchisee pays $45,000 for 20 yr franchise +17% fee on gross sales (13% rent + 4% service)Franchisee must buy all food drink from approved

suppliers and respect QSC clauses of contract

Page 27: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

McDonalds owned vs. franchised units, 1996

Owned units Franchised units

Sales

Cash flow

Cash flow/sales

122,469 112,000

12,690 15,340

10.4 13.7

Source: WSJ, 06/26/96

Page 28: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Company-owned outlets vs. Franchised Outlets

Cost of supervising agents

Cost of specifying quality by contract

Low High

Low

High

? Franchising

company-owned outlets

no transfer of reputation

Page 29: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

McDonald’s Menu Adaptation • Norway: McLaks, grilled salmon sandwich with dill sauce on a

whole-grain bun• Canada: Cheese vegetable, pepperoni and deluxe pizza• France: Wine• Uruguay: McHuevo, a hamburger with a poached egg on top,

and McQueso, a toasted cheese sandwich• Netherlands: Groenteburger, vegetable burger• Germany: Frankfurters, tortellini and a cold four-course meal• Greece and Italy: Salad bar• Thailand: Samurai Pork Burger, marinated with teriyaki sauce,

and palm-fruit sundae• Singapore: Vanilla ice cream swirled with chocolate and

strawberry and spiced for Singaporean tastes• Philipines: McSpaghetti, a sweet tomato and meat sauce with

frankfurter bits• Japan: Chicken Tatsuta sandwich, fried chicken spiced with

soy sauce and ginger served with cabbage and mustard mayonaise

Page 30: Licensing and Franchising. License or integrate? License out knowledge or integrate into production? License in knowledge of integrate into R&D?

Pros and cons of franchising

ProsRapid expansion

Low management costs

Enlists local initiative

ConsFree riding on quality

Limited profits