Advantages and Disadvantages of Licensing as a Mode of Entry Into Foreign Markets

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“Assess the merits and demerits of international licensing as a mode of entry into new markets”

Disney does not have to produce t-shirts, USB sticks and even waffles with Mickey Mouse’s happy face on it. Instead, it can license the right to use its famous character to different companies around the globe and enjoy the hefty royalties, which in 2010 totaled 28.6 billion dollars (Rorie, 2011). Does it then mean that licensing as a mode of entry into foreign markets is the best option available? Not necessarily so. Given a multitude of foreign market entry methods, all of them being used in practice in some contexts, it is crucial to determine under which circumstances licensing will pay off. The decision factors include the specifics of the foreign market; ownership, location and internalization advantages; resources and capabilities; and the general global strategy of a company. This essay will attempt to analyse what kind of environment would be favourable for the introduction of licensing and use this analysis as a context to assess the pros and cons of this mode of foreign market entry.

It is useful to start with the detailed definition of the subject matter. According to Daniels, 2003, “under a licensing agreement, a company (the licensor) grants rights to intangible property to another company (the licensee) to use in a specified geographic area for a specified period in exchange for a fee” (called royalty). The “intangible property” might encompass patents, designs, trademarks, methods and the like; we therefore see that licensing does not refer to actual physical objects or services. Hill, 2009 and Daniels, 2003 suggest a number of situations which might inspire executives to consider licensing. For example, the company’s new product or process might be potentially profitable, but too limited in scale or in duration to justify establishing production facilities abroad. However, even if the project is very promising, insufficient capital might be the obstacle. Licensing might also be taken into consideration when an asset falls outside the domain of company’s core competence or when a company cannot think of an immediate business application of the asset. An example of this is the case of Bell Laboratories, which invented the transistor circuit but then decided it did not want to produce transistors (Hill, 2009). Moreover, licensing might be the smartest idea when speed is crucial and a product needs to be introduced in many markets simultaneously, for example because of competitive pressures. Finally, licensing sometimes might be simply the only viable option. It could be either because of regulations limiting FDI or imposing tariffs, or because of other obstacles: for example, Starbucks’s only way to establish its business inside the hotels abroad is to license its model to the hotel chains.

Licensing, when properly applied under the circumstances described above, can deliver a wide array of benefits. First of all, it is frequently the cheapest option. Not only does the licensor not need to bear the costs comparable to those of FDI, but also all market research, adaptation and set-up costs are usually born by the licensee. Moreover, even though royalties are often based on the actual or projected volumes of sales, the agreement often includes the “front-end” fee, which means that the licensor is guaranteed a certain amount of money. Consequently, licensing is virtually financially risk-free for the licensor (risks other than financial are discussed later in the essay). Another type of risk which is eliminated thanks to licensing is the political risk: because the economic activity is ultimately performed by a domestic company, the “liability of foreigness” disappears (Griffin, 2007, p. 331). This factor is exceptionally relevant in the most unstable countries, where the changes of laws and authorities are frequent and sudden.

It needs to be stressed that a licensing agreement inevitably involves a second...
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