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Licensing is a form of strategic alliance which involves the sale of a right to use certain proprietary knowledge (so called intellectual property) in a defined way. The intellectual property may be registered publicly, for example in the form of a patent or trademark, as a means of establishing ownership rights. Or, it may be retained within the firm: referred to as know-how, it is commonly based on operational experience.
Know-how for licensing purposes may include commercial and administrative knowledge as well as technical knowledge. The licensing agreement is the legal agreement setting out what is to be transferred from licensor to licensee and under what conditions.
The licensee usually pays a lump sum (front end) payment. Additionally there is normally a royalty rate which tends to vary around a ‘rule of thumb’ of 5%, depending on the type of industry and rate of technological change. A minimum performance (payment) clause is considered essential and some firms allow the licensee a ‘period of grace' to get production and marketing started. There are also some companies that agree on a cross-licensing deal, whereby they just swap licenses instead of paying.
According to UNCTAD, flows of royalties and licence fee receipts amounted to US$ 72 billion in 2001.
Licensing is often used where there is a barrier to trade or constraints on and risk in foreign investment. Licensing can serve as a Trojan Horse in the meaning that it opens the possibility for a company to enter a foreign market where it otherwise might have been forbidden. Problems with licensing is that it can create a potential competitor, and that it's often seen as a last-resort strategic alliance when other options are not available.
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