Column : Royalty runs in an MNCís bloodstream

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SummaryOn January 22, 2013, the board of Hindustan Unilever announced that it will enter into a new agreement, effective February 1, 2013, with Unilever for the provision of technology, trade mark licence and other services.

gradual increase in technical know-how, royalty, consultancy fees, etc, by foreign partners since 2009, without a commensurate increase in either sales or margins.

An analysis by our firm regarding the royalty paid by Indian companies since 2007-08 shows that:

* The three highest royalty paying companies are now remitting R2,495 crore, up from R784 crore in 2007-08. While remittance has gone up 3.2 times, their revenues have gone up by only 1.8 times. Further, the margins of two of the three companies have shrunk, suggesting that market does not attribute a similar value either to the technology or the brand.

* The top 20 royalty paying companies now remit R3,601 crore as royalty payments, up from R1,196 crore five years ago. While royalty paid is up threefold, sales have grown by just over 70%.

* Companies donít declare dividends, but pay royalty.

Companies pay royalty for the brand. This should mean that consumers grabbing at labels should be more than those paying for unbranded or weaker brands, resulting in higher sales than competitors. It may also mean superior pricing power and higher margins. Paying royalty for technology should also mean higher margins. Again, evidence on the ground does not support this hypothesis as shown in the accompanying tables.

This data might also partially answer the question what is the right amount of royalty to be paid? The first-cut answer is, if a company is paying for a brand, its sales need to grow faster than others who are not paying for the brand. If it is paying for technology, its margins need to be higher than others not paying for technology. If not, there is no justification.

So, if companies are not seeing faster sales or higher profits, why are they paying so much more today?

The ownership structure goes a long way in explaining why this increase in royalty payments is asymmetric to the increase in sales or margin. The managements that negotiate the royalty arrangements are employed by the company with whom they negotiate. Loyalty runs in their bloodstream as they sit to negotiate with their own bosses. This is not conducive to head butting.

Investors, too,

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