Licensing - An Attractive Strategy for the USA Market

Murray Ansell
date: Tuesday, February 22, 2000

It’s an interesting fact that while the USA is by far the world’s largest economy, yet it is only New Zealand’s second largest export destination. Some of the many reasons for this include:

1. The US market for most products is highly diverse and expensive to reach
2. The US market is extremely competitive with most of the world’s leading companies having a significant US business unit
3. Should a New Zealand company achieve a significant market share in the US, this could be the worst thing it ever did. A targeted competitive response from a large US competitor could conceivably put the New Zealand company out of business.
4. The risk of a potentially crippling lawsuit is significantly higher in the US than in New Zealand

I would like to suggest that there are major opportunities for New Zealand companies in the USA, but that inappropriate market-entry strategy is preventing these opportunities from being realized.

A More Profitable, Less Risky Market-Entry Strategy

Because of financial constraints, there are few if any New Zealand companies with the resources to supply the entire US market for their product. Generally they could only achieve a small share of the market at best. There are, however, several US-based companies in virtually any industry that have nationwide, and even international, marketing and distribution capability.

Rather than trying to compete against these large companies in their home market, an alliance with one of these giants can be far more profitable for a small New Zealand company.

With "down-sized" research departments and shortening life-cycles for their products, these large companies have a continuing need for new, innovative products. Lewis Platt, CEO of Hewlett-Packard put it well when he said:

" …we used to say with pride that 70% of our orders came from products less than three years old. That’s changed to be products less than two years old. The lifetime of a product simply gets shorter and shorter."

American companies need to replace existing products at an ever-increasing rate and their research and development departments can’t keep up. More and more, these companies are being forced outside of themselves to meet their insatiable need for profitable new products.

Opportunity for Innovative New Zealand Companies

Perhaps because of our geographical isolation, New Zealanders have developed an innate ability to find innovative solutions to pressing problems, often using limited resources. Often, the same problem exists in the US and the New Zealand solution turns out to have international application.

The logical way to get an innovative, new product from New Zealand to the entire US market is usually not by making it in New Zealand and exporting it, but by licensing a major US company to make and market that product in the US market.

Some of the benefits of using a licensing strategy include:

1. High Income Potential

In the following table, I demonstrate mathematically that licensing the right to make and market a new product to a large US company can increase the product developer’s income potential fifteen-fold relative to the traditional alternative of New Zealand manufacture and export.

This reflects the huge difference in market size between New Zealand and the US and the inability of most New Zealand companies to supply more than a small percentage of the US market within their own resources.

2. Reduced Risk

At the same time, exporting to the US involves major business risks. Under a licensing arrangement, the large US licensee assumes the considerable risks involved in commercializing a new product (e.g. finance, market acceptance) as well as other significant risks such as product liability lawsuitsbusiness management responsibilities, the technology developer is freed to focus on enhancing its product line, while the licensee uses its strengths to successfully develop the market for these products. Both parties need each other on an ongoing basis, which is important for the ongoing forming their alliance.

Benefits of an Experienced Licensing Consultant

While US licensing is potentially far more rewarding than exporting, it is also considerably more complex to arrange and manage than exporting. The following issues that arise during every licensing are not nearly as significant to an export deal, if at all:

(i) Strength of Intellectual Property

By licensing, you are granting possibly exclusive use of your proprietary intellectual property to another party. Prospective licensees will only pay for the use of intellectual property you can prove that you own. If they find that the property is not original, they are free to make the product without paying royalties. Any licensing to a large US company will involve a thorough examination by their legal counsel of the status of your intellectual property.

2. Valuation of Intellectual Property

How much is your intellectual property worth? It is a common assumption that a fair royalty is 5% of turnover from the licensed property. This almost always under-estimates the true value of the property, especially for an exclusive license. You need to have an accepted and transparent method of valuing your intellectual property so that the projected benefits from its exploitation can be agreed and shared fairly.

3. Apportionment of Benefits

Given the respective contributions of the licensor and licensee, how do you determine what is a fair sharing of benefits? While every licensing is unique, there are accepted norms and guidelines that can be used as benchmarks.
4. Performance Monitoring

Unlike exporting, you are licensing another company to make your product. You therefore need to monitor manufacturing quality to ensure that acceptable standards are being maintained. If quality is not good, this will dramatically impact sales and the image of your product in the marketplace.

An experienced licensing consultant will be familiar with all of the above issues and be able to work through them successfully with his counterpart at the prospective licensor. I can’t stress too greatly the importance of using a qualified and experienced licensing professional when licensing in the USA. The cost of not doing so in the past has resulted in under-estimation of license fees and royalties by millions of dollars, licenses that stop paying royalties prematurely, or failure to reach agreement with excellent prospective licensees.

Other important contributions that a good licensing consultant will contribute include a broad network of high level contacts within prospective licensees, ongoing feedback about the market for your product, as well as new product or market opportunities they come across in the ordinary course of business activities with other clients.

So, when you’re thinking about the US market for your products, seriously consider licensing as a market-entry strategy. Contact an experienced US based licensing consultant and compare their proposal with the exporting alternative.



ASSUMPTIONS

1. NZ company is operating at 50% of production capacity and wants to use the remaining capacity for exporting to the US.
2. NZ company can earn a gross profit margin of 40% on its exports.
3. US licensee has a distribution network that covers the entire US market.
4. NZ company can license to this US company and earn a 5% royalty.