According to Pat Upton, author of Make Millions in the Licensing Business, licensing is "the practice of allowing a manufacturer (also called the licensee) to affix or associate the idea, character, design, or other representation owned by another (licensor) to his products." In the most basic terms, licensing is the legal act of granting rights to a certain property in exchange for payment. Although licensing is often referred to as an industry, many experts claim that it is actually a marketing tool or concept.
Examples of licensing arrangements can be found in a wide variety of products and services. For instance, a you might wear a sweatshirt bearing an NFL logo, purchase a child's sleeping bag with a cartoon character on it, or relax on bed sheets or other home furnishings by Ralph Lauren. "As more companies—from Fortune 500 ones to startup companies—incorporate licensed products into their lines, licensing has become the marketing strategy of the future," Vanessa L. Facenda wrote in Supermarket Business. Some of the benefits a company might gain from licensing include increasing its revenues with a minimum of expenditure, exploiting its technology, and opening new markets for its products and services.
Licensing applies to small businesses in two main ways. First, small businesses may participate in arrangements known as licensing-in. In this case, the small business becomes the licensee and acquires the rights to a product or brand name from another company. This type of arrangement can help a small business reduce internal product development costs, get a faster start in an industry, and increase its stature based on its association with the licensor. The second way small businesses may participate in licensing arrangements is known as licensing-out. In this case, the small business is the licensor and reaches agreement with another company allowing that company to produce and market one of its products, apply its brand name, or use its patented technology. This sort of arrangement can help a small business underwrite its research and development costs, increase its visibility as well as that of its products, spread its marketing costs across more items, and add volume to its manufacturing operations.
Retail sales of licensed products in the United States and Canada reached $110 billion in 1998. The largest segments in the licensing business were entertainment (including character licensing), corporate brand licensing, fashion, and sports licensing. While licensing arrangements continue to increase in value each year, the field is becoming more competitive. "The industry has learned from the lessons of the past," Ralph Irizarry and Cory Bronson noted in Sporting Goods Business. "More and more, we're seeing a contraction in the number of licensees, thus, eliminating fringe manufacturers and product categories. We're also seeing licensors develop partnerships with their licensees, strategic relationships, whereby the licensee essentially becomes a marketing partner."
Analysts cite several reasons for the changes and consolidations taking place in licensing. Retailers have limited shelf space, and thus are unwilling to take on untested products or characters. In the mean-time, consumers are becoming more fickle and trend-conscious, which makes it more difficult to predict hot new entertainment trends. This has put a premium on licensing rights to "classic" characters like Winnie-the-Pooh, which offer lasting value and provide consistent business. In the late 1990s, other trends in licensing included: licensed goods based on established brands and trademarks, like Jeep heavy-duty baby strollers; retail stores dedicated exclusively to a corporate brand; cross-promotions featuring two licensed properties, like movie tie-ins with fast-food restaurant meals; authorized Web sites; and sports licensing, especially of video and computer games.
Given the popularity of licensing, many small businesses today must face the question of whether to manufacture a new product itself or license the production to another company. Major factors entering into this decision are the nature of the product and the relative strengths of the small business and its potential licensee. Experts recommend that small businesses examine their core competencies when deciding whether to license a product. For example, an in-depth assessment of the company's unique skills and abilities may indicate that it could make more money by licensing its manufacturing process than it could by manufacturing and marketing a finished product. Basically, if your company has the expertise and resources needed to make the product profitably in-house, then you should probably do so. If not, then it makes sense to find a licensing partner who can contribute the needed resources and expertise.
According to Dianne M. Pagoda in an article for WWD, the following factors may indicate that a small business would be best served by launching a new product in-house rather than licensing it to another manufacturer: 1) the new product is a fairly straightforward extension of an existing product or brand; 2) the new product will be sold through the same channels of distribution used for existing products; 3) the new product shares similar production and sales cycles with the company's core business; 4) making the new product will not require special technical or marketing and sales skills that would require the small business to seek expertise it does not already possess; and 5) the small business possesses sufficient resources and production capability to manage the larger operating base required to produce the new product. When these conditions are met, it is likely that the company would benefit from producing its own goods rather than licensing them to another company.
Some small business owners worry that they will not be taken seriously when they attempt to enter licensing arrangements for the first time. They assume that individuals and companies that own licensable properties prefer to work with larger, well-established licensees. But experts claim that, in most cases, successful small businesses have good opportunities to obtain licensing rights. "Manufacturers looking to become first-time licensees can expect fair but intensive negotiations and ongoing participation by the licensor during the life of the product," Teresa Salas noted in Playthings. In general, licensors like to see that potential licensees have a solid track record of making quality products, including some that are similar to the property being licensed. Small businesses interested in obtaining a license must be willing to submit to financial scrutiny, provide references, describe their available sales force and retail accounts, and make sales projections.
In the Playthings article, Licensing Industry Merchandisers Association Director Murray Altchuler made some suggestions for small businesses interested in becoming licensees. First, small businesses should try to license properties that are similar to their existing products or services, or that add an extra dimension to their core business. Second, small businesses should make sure that the licensor has a good reputation and a history of supporting the property and protecting it through legal means. Third, the small business should examine the provisions of the contract to ascertain its length, the renewal options available, and the amounts of guarantees and royalties expected.
The arrangements between the licensor and the licensee are typically laid out in a legal document known as a licensing agreement. This formal agreement is an important component in a successful business venture. "While it is impossible to determine the future success of a product, much can be done in the earliest stages to ensure that a licensed product gets the best chance possible," Salas wrote. "One might even say that the entire future of a licensed product is laid out, at least in part, during the process of negotiating a licensing contract."
Licensing agreements usually include a number of provisions designed to protect the interests of both parties. Some of the most common elements of licensing agreements are outlined below:
Financial Provisions: Payments from the licensee to the licensor usually take the form of guaranteed minimum payments and royalties on sales. Royalties typically range from 6 to 10 percent, depending on the specific property involved and the licensee's level of experience and sophistication. Not all licensors require guarantees, although some experts recommend that licensors get as much compensation up front as possible. In some cases, licensors use guarantees as the basis for renewing a licensing agreement. If the licensee meets the minimum sales figures, the contract is renewed; otherwise, the licensor has the option of discontinuing the relationship.
Time Frame: Many licensors insist upon a strict market release date for products licensed to outside manufacturers. After all, it is not in the licensor's best interest to grant a license to a company that never markets the product. The licensing agreement will also include provisions about the length of the contract, renewal options, and termination conditions.
Quality Control: In order to ensure quality, the licensor may insert conditions in the contract requiring the licensee to provide prototypes of the product, mockups of the packaging, and even occasional samples throughout the term of the contract. Another common quality-related provision in licensing agreements involves the method for disposal of unsold merchandise. If items remaining in inventory are sold as cheap knockoffs, it can hurt the reputation of the licensor in the marketplace.
In addition to products and brand names, another popular type of licensing relates to patented technology. Licensing of patents involves granting another entity the right to use an original process or type of equipment. It is important to note that licensing of patents does not necessarily require a company to give up the underlying know-how that led to creating the invention. The licensing arrangement may stipulate that the licensee only gains the right to use the invention, rather than the technical knowledge that contributed to its development. The main benefit to companies in licensing patented technology to other companies is that the fees generated may help offset the costs of developing the technology. In some cases, companies end up licensing patented technology to other entities that have already commercialized the technology. For example, the engineer who invented time-delayed windshield wipers for automobiles successfully sued the major American car makers for royalties on his patented technology years after the manufacturers had incorporated it into nearly every car on the road.
More typically, however, companies will develop manufacturing processes or other technologies that are peripheral to their core business, patent the non-core technologies, and then seek to license them in order to gain a source of revenue to help offset their development costs. In an article for CMA, Alistar G. Simpson and Martin Langloi recommended that companies look for licensing opportunities for patents that extend beyond the core of their business. Companies may have some such patents as a result of an acquisition or left over after a divestiture. The next step is to identify potential licensees, which are likely to be companies already involved in that area of business. Before contacting potential licensees, Simpson and Langloi suggest that companies study the market to see how important the patented technology is and to gauge the level of profit margins generally available. These factors will influence the life expectancy of the patented technology as well as the royalties that might be expected from licensing it.
Licensing patented technology—particularly when it involves patent infringement litigation—can be costly and time consuming. In addition, potential licensors may find that they lack sufficient knowledge of their target companies and industries to conduct good negotiations. But there are also several advantages to licensing non-core technologies. For example, companies may gain an opportunity to enter new areas of business, and they may develop strong relationships with licensees that open up further business opportunities. Finally, licensing non-core technologies is not likely to have a negative effect on the company's normal, core business.
An emerging challenge for companies involved in licensing in the twenty-first century is how licensing agreements will handle the question of online rights. The fast growth of electronic commerce on the World Wide Web has exposed a completely new area of licensing with no established rules to guide agreements. "How can you enforce geographic restrictions on a technology that is global and borderless?" Lisa Vincenti pointed out in an article for HFN. "How can you maintain exclusivity of your crown jewels if any Tom, Dick, and Harry can get your goods and put them up for sale on the Web? How can you control pricing if some Web peddlers are auctioning off your prize possessions?"
Many companies with long-standing licensing arrangements are approaching Internet licensing with caution. In some cases, large-scale, highly publicized licensing agreements simply do not include online rights. For example, the domestic expert Martha Stewart reached an agreement to develop exclusive lines of furniture, clothing, and other goods for the discount retailer K-Mart. But none of these popular items appear on the K-Mart Web site because the licensing agreement between the parties did not include online rights. In the future, Vincenti predicted that licensors will make separate licensing deals with traditional and online vendors.
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Facenda, Vanessa L. "The Power of the License." Supermarket Business. July 1999.
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Irizarry, Ralph, and Cory Bronson. "A License to Operate." Sporting Goods Business. September 14, 1998.
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Vincenti, Lisa. "Licensing Online: An Emerging Parallel Universe." HFN: The Weekly Newspaper of the Home Furnishing Network. June 7, 1999.
SEE ALSO: Inventions and Patents ; Royalties
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