Non-equity-based methods for internationalisation
In this form of internationalisation, firms sell technology or know-how under some form of contract, often involving patents, trademarks and copyrights. These are often referred to as intellectual property rights and they now form a major part of interna-tional transactions, having grown enormously since the 1980s. These non-equity methods of internationalisation often take the form of licensing, franchising or other types of contractual agreement based on these intellectual property rights (see Chapter 4, pp. 147–53).
■ Licensing
At its most simple, licensing can mean permission granted by the proprietary owner to a foreign concern (the licensee) in the form of a contract to engage in an activity that would otherwise be legally forbidden. The licensee buys the right to exploit a fairly limited set of technologies and know-how from the licensor, who will usually have protected the intellectual property rights involved by a patent, trademark or copy-right. This tends to be a low-cost strategy for internationalisation since the foreign entrant makes little or no resource commitment. The licensor benefits from the licensee’s local knowledge and distribution channels, which would otherwise be difficult and time consuming to develop and maintain. Such agreements are often found in industries where R & D and other fixed costs are high, but where aggressive competition is needed at the local level to capture market share. The pharmaceutical and chemical industries provide licensing agreements as do the industrial equipment and defence industries. For example, McDonnell-Douglas and General Dynamics have licensing arrangements with different Japanese and European governments to produce jet fighters.
In manufacturing industries the patent is the most common form of protecting in-tellectual property rights and licensing is often used as a means of controlling indus-try evolution: for example, Japanese manufacturers have successfully cross-licensed VHS-formatted video recorders to one another as well as to foreign firms that produce them under licence. This helped the VHS standard become dominant worldwide and displaced the competing Sony and Philips’ versions. In high-tech in-dustries, where breakthroughs tend to occur discontinuously, licensing helps firms avoid excessive costs from expensive plant and product obsolescence. IBM, for ex-ample, has linked up with Motorola Communications and Electronics Inc. to ad-vance the state of X-ray lithography for making superdense chips. Licensing can be costly, however, if a firm transfers its core competencies into those of a competitor.
RCS licensed its colour television technologies to Japanese firms during the 1960s only to be leapfrogged by new but related technologies emanating from those com-petitors. Licensors (the granters of licences) may therefore find themselves under pressure to continuously innovate in order to sustain the licensee’s dependence on them in the relationship. Microsoft’s various updated Windows systems have been widely criticised as having been introduced primarily as a means of maintaining the dependence of licensees on Microsoft itself, rather than as a source of new capabili-ties for existing users.
In general, the use of licensing, with its technological associations, has tended to be less readily adopted by the service industries, where franchising and other methods of
internationalisation are more common. Nevertheless the various intellectual property rights do permit service sector licensing, as in the case of copyright protection (see also Chapter 4, p. 150) of Walt Disney characters. For example, a medium-sized UK sta-tionery company may decide it wishes to produce a range of stasta-tionery based on Walt Disney characters. In order to do this, the company would need to approach Disney and discuss the possibility of gaining a licence to sell Disney branded goods in the UK.
The licensee (in this case the UK stationery company) pays a fee to Disney in exchange for the rights to use their brand name/logo.
An advantage of licensing to licensors is that they do not have to make a substantial investment in order to gain a presence in overseas markets and they need not acquire the local knowledge which may be so important for success in such markets. Licensing is also an effective way of increasing levels of brand awareness. However, a licensor can be damaged if a licensee produces products of an inferior standard. Licensing is very common in the film and music industry. Products include calendars, videos, books, posters and clothing.
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thought 2 In 2007 the US alone issued 93,412 patents, more than double the number it issued 20 years ago. Despite the rapid growth of patents worldwide, many observers believe that because of ‘global shift’ we should pay less attention to this particular indicator of intellectual property rights than we used to. Can you explain their reasoning?
Case Study 2.2 looks at the various arguments for and against using patents as a means of internationalising sales into the EU pharmaceuticals market.
The arguments for using patent protection for internationalising pharmaceutical products are well known. They include the opportunity for pharmaceutical firms to access global markets to recoup the large expenditures on innovative R & D when only relatively few products eventually pass the rigorous and time-consuming tests to demonstrate both efficacy of treatment as well as meeting health and safety stan-dards. However a recent EU report has criticised aspects of the current operation of patents by international pharmaceutical companies operating in EU markets. On 28 November 2008 the European Commission unveiled the preliminary results of its year-long investigation into the pharmaceutical sector. The report criticised the use of the ‘patent cluster’, whereby a firm keen to defend a ‘blockbuster’ drug about to go off-patent files large numbers of new patents for slight modifications to the ex-isting product, allegedly to confuse and intimidate other pharmaceutical firms con-sidering producing generic versions of the previously patented product. The report cites an example of a major pharmaceutical company taking out 1300 new patents across the EU on a single drug about to go off-patent! Such delaying tactics have meant that generic competition in EU pharmaceuticals only begins, on average, some seven months after patent protection has lapsed. As a result the report says EU
CASE 2.2 Patents and the EU pharmaceuticals market
Non-equity-based methods for internationalisation 45
■ Franchising
In franchising the franchisee purchases the right to undertake business activity using the franchisor’s name or trademark rather than any patented technology. The scale of this activity varies from so-called ‘first-generation franchising’ to ‘second-generation franchising’ in which the franchisor transfers a much more comprehensive business package to the franchisee to help establish a ‘start-up position’. This may include detailed guidance on how to operate the franchise, even extending to specialist staff training.
In first-generation franchising, the franchisor usually operates at a distance. How-ever, in second-generation franchising, the franchisor exerts far more control on the day-to-day running of the local operations. This type of franchising is common in the hotel, fast-food restaurant, and vehicle rental industries, such as Holiday Inn, McDonald’s and Avis respectively. Mature domestic service-based industries have chosen franchising as a means of internationalising because:
■ it establishes an immediate presence with relatively little direct investment;
■ it employs a standard marketing approach helping to create a global image;
■ it allows the franchisor a high degree of control.
For instance, Coca-Cola’s franchising arrangements with its numerous partners would seem to have given it an advantage over its arch rival PepsiCo. Franchising also helps build up a global brand that can be cultivated and standardised over time. Before opening its first restaurant in Russia, McDonald’s flew all key employees to its
‘Hamburger University’ for a two-week training session. During these sessions, Russian employees learned the McDonald’s philosophy and the McDonald’s way of addressing customers and maintaining quality standards.
McDonald’s and Burger King are perhaps the two best-known examples of interna-tional franchises. However, franchising is a very popular method of market entry and taxpayers paid about €3 billion more than they would have done had the generics been available immediately the patent expired.
Nor is it merely a matter of time delay! The EU report found that when generics do eventually enter the EU market they do so at a much higher price than in, say, the US market. Generics were found to enter the EU pharmaceutical market at an aver-age price some 25% below that of the branded drug, and drop a further 40% in price after two more years. However in the US pharmaceutical market generic prices were, on average, over 80% below the branded drug price within a year.
Questions
1 Can you suggest reasons for the observed differences in generic drug prices between the EU and US markets?
2 How might the EU seek to tackle the problem? Consider the costs and benefits of any pro-posed ‘solution’?
is not limited to the fast food industry. Examples include cleaning (Chem-Dry), cloth-ing (Benetton) and childcare (Tiny Tots).
In international franchising, a supplier (franchiser) permits a dealer (franchisee) the right to market its products and services in that country in exchange for a financial commitment. This commitment usually involves a fee upfront and royalties based on product sales.
■ Advantages for the franchisee are that they are buying into an existing brand and should receive full support from the franchiser in terms of marketing, training and starting up. When customers walk into a McDonald’s restaurant they know exactly what to expect. This is one advantage of global branding.
■ Disadvantages for the franchisee include restrictions on what they can and cannot do. For example, McDonald’s have very strict regulations concerning marketing, pricing, training, etc. A franchisee cannot simply change the staff uniform, alter prices or vary opening hours as the company operates a standardised approach to doing business.
■ Advantages for the franchiser are that overseas expansion can be much less expen-sive and that any local adaptations can (with agreement) be made by those well acquainted with cultural issues in that country.
■ Disadvantages for the franchiser include possible conflict with the franchisee for not following regulations and agreements as well as a threat that the franchisee may opt to ‘go it alone’ in the future and thus become a direct competitor.
Interestingly McDonald’s reacted to more difficult trading conditions by giving franchisees in 2006 more freedom than had previously been the case. It sold some 1500 restaurants to local entrepreneurs across 20 countries, who could invest in run-ning the outlet and in introducing elements of ‘customisation’ of the product and its delivery to meet local requirements, whilst still retaining McDonald’s support in mar-keting and supply chain provision. These ‘developmental licensees’ represented a shift by McDonald’s in the direction of first generation franchising.