The Hindustan Unilever (HUL) board’s decision to hike royalty to the parent company, Unilever, by 80 basis points over a three-year period was received negatively by the Street; HUL has since indicated that it could lower the rate at the next review. Royalty payments by subsidiaries to parent MNCs have often stoked debate. Sarthak Ray examines the matter

What is royalty

A royalty is a contractual payment made by one party (in this case, the subsidiary company) to another (the parent company) for use of the latter’s intangible assets, including intellectual property such as patents and copyrights, or franchise model agreements, brand and trademarks. The terms of royalty are laid out in a licensing agreement, with the rate specifically decided on the basis of how exclusive the rights conferred under the agreement are. It is typically set as a percentage of the gross or net revenue of the subsidiary. For the licensor (the parent company), this represents a steady source of revenue, while for the licensee (the subsidiary), this is the consideration paid for the use of  intangible assets of the established parent, which enjoys wide renown.

The HUL case

HUL has been paying royalty to Unilever, which holds a 62% stake in the Indian subsidiary, for use of its brands, copyright, and technology,  as  well as raw materials procured at the parent level (this brings down costs for the subsidiaries). Just before the 10-year licensing period under the agreement between HUL and Unilever expired on January 31, the Indian arm’s board reviewed the royalty payment on the parent company’s directions and increased the rate by 80 basis points, taking it to 3.45% from 2.65% of sales—in FY22, this amounted to a little over `1,330 crore. Investors didn’t take too kindly to the decision, given the implications for earnings per share and the fact that the parent, through its stake in the emerging market subsidiary, was already getting impressive dividends from the latter. 

Riled investors

The street made  clear its unhappiness with the proposal, with the HUL stock price falling despite a brighter earnings outlook in the coming fiscal. The stock price has since stabilised, showing that investors, despite their unhappiness, have taken the increase in their stride as HUL remained firm on it, and likely see the hike as the cost of sound management and R&D investment, experts say.

HUL’s rationale

The company said that the new rate will ensure “HUL continues to receive” technology, services and IP support from Unilever. It urged investors to see the royalty payout as an operating cost with intangible benefits. The new licensing deal has been signed for just five years, and there was a worry that  the rate could be hiked sooner than the pace earlier. HUL, however, said that it could cut the rate at the next review if the situation warranted this, as per a note by Jefferies.

The royalty payment debate in India, and what can be expected

Royalty payments are an old debate in India. The country has been debating a cap on such payouts for years now, particularly since these payments spiked after 2010 when foreign investment rules were liberalised and the caps on them were removed. In many cases, regulators and investors feel Indian subsidiaries are paying large royalties for technology that is quite old, or even when their brand value in their own right is high or they are contributing significantly to the brand value of the parent company. 

Experts also say that some subsidiaries’ growth in the Indian market is propping a significant chunk of parent companies’ financial health and operations globally. Even as some subsidiaries’ payouts to the parent companies have been termed “extortive” (Maruti Suzuki’s royalties to Suzuki Japan, for instance), a report by the Institutional Investors Advisory Services says royalty payments have been moderating. 

Subsidiaries, on the other hand, say that the royalty must be seen as more than a cash transfer to the parent, as the payment is for “operational support” and borrowing of “science and technology”. Unilever, for instance, invests up to 1.6% of its turnover in R&D.

* 3.45% of sales is the new royalty rate HUL has agreed to pay Unilever

* 80 bps hike in rate, to be implemented over the next three years

* 1.6% Of turnover invested by Unilever in Research & development (~ €850 million)