The third broad issue in technology strategy is technology licensing, a form of coalition with other firms.6 Firms with a unique technology are often asked for licenses, or are forced to license by government regulations. Licensing is also a way to gain access to technology. Where technology is an important source of competitive advantage, decisions on licensing are vital. Yet many firms have squandered technology- based competitive advantages through inappropriate licensing decisions.
WHEN SHOULD A FIRM LICENSE?
If technology is a source of competitive advantage, a firm must treat licensing other firms as a risky step that should be taken only under special conditions. Licensing fees are rarely large enough to offset a loss of competitive advantage. However, awarding licenses may be strategically desirable under a number of circumstances.
Inability to Exploit the Technology. Awarding licenses is appropriate if a firm cannot exploit the technology itself. This may be because a firm lacks resources or skills to establish a sustainable position, is harvesting the business unit involved, or competitors are too entrenched to yield market position. The first motivation for licensing is at work today in biotechnology and electronics, where creative startup firms lack the capability to commercialize innovations. Even where the firm has substantial resources, it may be unable to gain a substantial share on the basis of its new technology because competitors are too committed or because of government demands for local ownership. The former seems to be one reason why Standard Brands widely licensed its technology for high fructose corn syrup, a sugar substitute.
Where the firm cannot exploit the market itself, failure to license will create the motivation for competitors to invent around its technol-ogy. Eventually one or more competitors may succeed, and the firm will be left with a small market position. By licensing, however, competitors gain a cheaper and less risky alternative to investing in their own technology. Thus, instead of being imitated, the firm licensing its technology may be able to set the standard and collect licensing royalties in addition to profits from its own market position.
Tapping Unavailable Markets. Licensing may allow a firm to gain some revenue from markets otherwise unavailable to it. This includes other industries where the technology is valuable but where the firm has little possibility of entering, or other geographic markets a firm cannot or does not want to enter.
Rapidly Standardizing the Technology. Licensing may accelerate the process by which the industry standardizes on a firm’s technology. If several firms are pushing the technology, licensing not only will legitimize it but also may accelerate its development. The pioneers of the VHS and Beta formats in video cassette recorders licensed them widely to promote standardization, for example, because standardization was so critical to increasing the availability of software.
Poor Industry Structure. Licensing can be desirable where industry structure is unattractive. In such instances, a firm may be better off collecting royalties than investing in a market position that will not yield high returns. The more bargaining power a firm has in extracting high licensing fees, the more attractive it is to license and retain only a modest position in the industry for itself.
Creating Good Competitors. Licensing may be a vehicle for creating good competitors, which in turn can play a variety of important roles such as stimulating demand, blocking entry, and sharing the costs of pioneering. Magnavox widely licensed its video game patents, for example, reasoning correctly that it could expand the market faster through encouraging competitors to introduce a wide range of products. Entry barriers were also low enough that Magnavox was unlikely to be able to develop a sustainable position. Chapter 6 describes the potential benefits of good competitors in detail, along with how a good competitor can be identified.
Quid Pro Quo. A firm may award a license in return for a license of another firm’s technology, as ATT and IBM are prone to do. A firm must ensure that the trade is a fair one, however.
CHOOSING A LICENSEE
Firms should award licenses only to noncompetitors or to good competitors. Since noncompetitors can rapidly become competitors, a firm must minimize the risk of this through the terms of the license or convince itself that a noncompetitor will remain so. To ensure that a potential licensee is a noncompetitor, a firm must consider not only the existing markets or segments it serves, but also markets it might want to enter in the future. Licensing buyers to make some of their needs internally can sometimes be desirable to shrink the available market for competitors or potential competitors.
Where a firm licenses a competitor, it should be a good competitor and not just anyone. The same is true when a firm is compelled to license by governments. When licensing noncompetitors, a firm ideally should license noncompetitors that would be good competitors if they later decided to enter the industry. Similarly, licenses should contain renewal clauses, when possible, in order to avoid a perpetual commitment to turn over technology in the event that a licensee becomes a competitor.
PITFALLS IN LICENSING
Firms often hurt rather than help their competitive position by awarding licenses. The two most common pitfalls in licensing are to create competitors unnecessarily in the process, and to give away a firm’s competitive advantage for a small royalty fee. Licensing often is an easy way of increasing short-term profits, but it can result in a long-term erosion in profits as a firm’s competitive advantage dissipates.
Firms often fail to perceive who their potential competitors are, and thus award licenses that come back to haunt them. They may license foreign firms that later enter their home markets. Similarly, many firms have licensed firms in other industries only to have the licensees ultimately enter their own industry. Often the process by which a license agreement sours can be quite subtle. A firm licenses another amid talk of a long-term alliance that will strengthen both. Over time, though, the licensee learns everything possible, not only about the licensor’s technology but about its other value activities. The licensee then decides it can attack the licensor successfully and becomes a serious competitor. Asian firms, which have licensed widely, have sometimes used licenses in this way.
Source: Porter Michael E. (1998), Competitive Advantage: Creating and Sustaining Superior Performance, Free Press; Illustrated edition.