A ''licensing agreement'' is an arrangement whereby a licensor grants the rights to intangible property to another entity (the licensee) for a specified period, and in return, the licensor receives a royalty fee from the licensee.9 Intangible property includes patents, inventions, formulas, processes, designs, copyrights, and trademarks. For example, as described in the accompanying Management Focus, to enter the Japanese market, Xerox, inventor of the photocopier, established a joint venture with Fuji Photo that is known as Fuji-Xerox. Xerox then licensed its xerographic know-how to Fuji-Xerox. In return, Fuji-Xerox paid Xerox a royalty fee equal to 5 percent of the net sales revenue that Fuji-Xerox earned from the sales of photocopiers based on Xerox's patented know-how. In the Fuji-Xerox case, the license was originally granted for 10 years, and it has been renegotiated and extended several times since. The licensing agreement between Xerox and Fuji-Xerox also limited Fuji-Xerox's direct sales to the Asian Pacific region (although Fuji-Xerox does supply Xerox with photocopiers that are sold in North America under the Xerox label).10 !Advantages In the typical international licensing deal, the licensee puts up most of the capital necessary to get the overseas operation going. Thus,a primary advantage of licensing is that * The firm does not have to bear the development costs and risks associated with opening a foreign market. ** Licensing is very attractive for firms lacking the capital to develop operations overseas. * In addition, licensing can be attractive when a firm is unwilling to commit substantial financial resources to an unfamiliar or politically volatile foreign market. * Licensing is also often used when a firm wishes to participate in a foreign market but is prohibited from doing so by barriers to investment. ** This was one of the original reasons for the formation of the Fuji-Xerox joint venture (see the Management Focus for details). Xerox wanted to participate in the Japanese market but was prohibited from setting up a wholly owned subsidiary by the Japanese government. So Xerox set up the joint venture with Fuji and then licensed its know-how to the joint venture. * Finally, licensing is frequently used when a firm possesses some intangible property that might have business applications, but it does not want to develop those applications itself ** For example, Bell Laboratories at AT&T originally invented the transistor circuit in the 1950s, but AT&T decided it did not want to produce transistors, so it licensed the technology to a number of other companies, such as Texas Instruments. Similarly, Coca-Cola has licensed its famous trademark to clothing manufacturers, who have incorporated the design into their clothing (e.g., Coca-Cola T-shirts). !Disadvantages Licensing has three serious drawbacks: * First, it does not give a firm the tight control over manufacturing, marketing, and strategy that is required for realizing experience curve and location economies. ** Licensing typically involves each licensee setting up its own production operations. This severely limits the firm's ability to realize experience curve and location economies by producing its product in a centralized location. When these economies are important, licensing may not be the best way to expand overseas. * Second, competing in a global market may require a firm to coordinate strategic moves across countries by using profits earned in one country to support competitive attacks in another ** By its very nature, licensing limits a firm's ability to do this. A licensee is unlikely to allow a multinational firm to use its profits (beyond those due in the form of royalty payments) to support a different licensee operating in another country. * The third problem with licensing is the risk associated with licensing technological know-how to foreign companies. ** Technological know-how constitutes the basis of many multinational firms' competitive advantage. Most firms wish to maintain control over how their know-how is used, and a firm can quickly lose control over its technology by licensing it. Many firms have made the mistake of thinking they could maintain control over their know-how within the framework of a licensing agreement. RCA Corporation, for example, once licensed its color TV technology to Japanese firms including Matsushita and Sony. The Japanese firms quickly assimilated the technology, improved on it, and used it to enter the US market. Now the Japanese firms have a bigger share of the US market than the RCA brand. Similar concerns surfaced over the 1989 decision by Congress to allow Japanese firms to produce the advanced FSX fighter plane under license from McDonnell Douglas. Critics of the decision fear the Japanese will use the FSX technology to support the development of a commercial airline industry that will compete with Boeing in the global marketplace. There are ways of reducing the risks of this occurring: * One way is by entering into a cross-licensing agreement with a foreign firm. ** Under a cross-licensing agreement, a firm might license some valuable intangible property to a foreign partner, but in addition to a royalty payment, the firm might also request that the foreign partner license some of its valuable know-how to the firm. Such agreements are believed to reduce the risks associated with licensing technological know-how, since the licensee realizes that if it violates the licensing contract (by using the knowledge obtained to compete directly with the licensor), the licensor can do the same to it. Cross-licensing agreements enable firms to hold each other hostage, which reduces the probability that they will behave opportunistically toward each other.11 Such cross-licensing agreements are increasingly common in high-technology industries. For example, the US biotechnology firm Amgen has licensed one of its key drugs, Nuprogene, to Kirin, the Japanese pharmaceutical company. The license gives Kirin the right to sell Nuprogene in Japan. In return, Amgen receives a royalty payment, and in addition, through a licensing agreement, it gained the right to sell some of Kirin's products in the United States. * Another way of reducing the risk associated with licensing is to follow the Fuji-Xerox model and link an agreement to license know-how with the formation of a joint venture in which the licensor and licensee take an important equity stake. ** Such an approach aligns the interests of licensor and licensee, since both have a stake in ensuring that the venture is successful. Thus, the risk that Fuji Photo might appropriate Xerox's technological know-how, and then compete directly against Xerox in the global photocopier market, was reduced by the establishment of a joint venture in which both Xerox and Fuji Photo had an important stake.