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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
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
Determinants of the choice
Pros of licensing
• Comparative advantage
• Management costs
Cons of licensing
• Market transaction costs
• Risk of building up competitors
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
Limitations of market for knowledge
Arrow’s paradox
The property rights solution
Property rights in knowledge
PatentsProtect inventions (products and processes)
CopyrightsProtect form taken by literary,
musical, dramatic, pictorial, audio and audiovisual work
Limitations of property rights in knowledge
Right of exclusive use
Technical limitations
Knowledge tacitness
Legal limitations
Limited life
Imperfect enforcement
National domain
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.
Limitations of property rights in knowledge
Right of free transfer
Contractual limitations
Legal limitations
Other barriers to imitation
• Secrecy (trade secret)
• Lead time (installed base)
• Learning curve
• Sales and service effort (customer switching cost)
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.
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
When to license?
• Target market factors– Peripheral markets
• Firm factor– Inexperienced firms
• Technology factors– Broad, upstream technology– Fast changing technology– Old technology– Cross-licensing
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
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
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
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
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
Limitation of property rights in reputation
• Right of exclusive use– National regulations– Enforcement problems (counterfeiting)
• Right of transfer– Enforcement problems (free riding on quality)
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
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
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
Potential problems of franchise contracts
1. Franchisee will debase qualitySolution: QSC standards in contract
2. Franchisor will fail to enforceSolution: Franchisor owns outlets
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
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
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
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
Pros and cons of franchising
ProsRapid expansion
Low management costs
Enlists local initiative
ConsFree riding on quality
Limited profits