Who really benefits from licensing?

Pierre Dussauge, Professor of Strategy and Business Policy - May 23rd, 2014
Aerospace industry: Who really benefits from licensing?

Firms can enter a new line of business either by creating their own products or by purchasing a license to produce products developed by others. Which of these two strategies is more effective? Pierre Dussauge, Louis Mulotte, and Will Mitchell compared the two alternatives by analyzing 60 years of product launches in the global aerospace industry.

Pierre Dussauge ©HEC Paris

Pierre Dussauge is a Professor of Strategic Management at HEC Paris and is currently Dean of the Faculty and Research. He is a graduate of HEC and earned a Ph.D in management (...)

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A company that wants to establish itself in a new market segment by leveraging the experience of other businesses can develop an alliance or joint venture, or purchase a license – the right to manufacture and sell a product, or another form of intellectual property, that is covered by a patent. For example, the Indonesian aerospace company IPTN Nurtanio sought to expand its business by manufacturing aircraft and helicopters under license. Avoiding a long period of research and development by working on a proven concept and technology enabled the firm to take a position on the market quickly. Likewise, when automobile manufacturers in China set out to conquer the automotive market, they first made vehicles under license in the hope of acquiring the technical and commercial experience that would allow them to design their own models in the future. In contrast, the Korean firm Hyundai decided to develop its own vehicles from the outset. Thirty years later, the Chinese manufacturers have met with mixed success (even in China itself), while Hyundai, far from being satisfied with its virtual monopoly in its home market, has hoisted itself to fifth position worldwide. Are these isolated events or is there something we can learn from them? According to Dussauge, they are representative examples. The study he carried out with Mulotte and Mitchell indicates that the aerospace companies that entered a market directly (i.e., by developing their own aircraft) were more successful in the long term than manufacturers that started off by making their aircraft under license. How can we explain these findings?


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A product manufactured under license owes its success to both the license vendor and the company exploiting the license.



The benefits of licensed manufacturing are overstated

A product manufactured under license owes its success to both the license vendor and the company exploiting the license. But it is not easy to know exactly where the value is created. And it is even more difficult if the vendor does not reveal its design or process secrets. Since companies manufacturing under license are not in a position to link cause and effect with any accuracy, they have no way of knowing what they could achieve on their own. In addition, the research shows that firms commonly attribute success to their own expertise but blame external factors when things go wrong. This dynamic has a considerable impact on companies manufacturing under license, because it is a strategy that can yield good results in the short term. Firms operating with a license then tend to overestimate the influence of their own capabilities on the performance of the products they sell, which promotes overconfidence and thus risky technical decisions. As the managers interviewed by Dussauge and his co-authors admitted: “We thought we knew how to do it, but we didn’t.” As a result, the aircraft and helicopters developed by the former licensees were not as successful as expected.


Licenses hinder long-term innovation

A license is not the same thing as a transfer of skills: it can only be used for like-for-like production. And the benefits it brings are all the more limited if the product that the licensee seeks to subsequently design significantly differs from the initial product (manufactured under license). This is the case in the aerospace industry, where aircraft models have a relatively long service life, with the result that there is always a significant difference between the product developed under license and the new product. The same phenomenon is seen in all sectors with a high degree of complexity, which incorporate different types of technology and develop rapidly (such as the media, life sciences and telecommunications). In reality, the more complex a product is, the more a company has to work in an integrated fashion and co-ordinate various elements with different sub-contractors.


Licenses mainly benefit… whoever sells them!

The decision to engage in a new business domain using a license may have important long-term consequences, with companies that do not use this type of relay often faring better than those that do. A license may actually be worse than no experience at all, as, in the latter case, a company can progress carefully by trial and error.

On the other hand, selling licenses can be a lucrative business. First, there is little danger that a vendor will have its technology stolen; secondly, it seems that selling licenses tends to act as a safeguard against competitors emerging, as it inhibits the ability of licensees to develop autonomously afterwards.


Based on an interview with Pierre Dussauge and the article “Does pre-entry licensing undermine the performance of subsequent independent activities? Evidence from the global aerospace industry, 1944-2000” co-authored with Louis Mulotte and Will Mitchell (Strategic Management Journal , 2013).

Practical Applications
Practical Applications

Dussauge, Mulotte, and Mitchell’s study sheds light on the impact of commercial licenses on the long-term success of a company. On the one hand, the licenses do not live up to the expectations of licensees: they seem to act as an obstacle to the healthy development of an organization, especially in highly complex business sectors. The researchers demonstrate that buyers obliged to use a license need to be careful about the conclusions they draw from the experience. However, for the vendor, licenses can act as a two-fold commercial strategy; in addition to bringing in royalties, they can help the vendor to maintain competitive advantage! 

Methodology
Methodology

Dussauge, Mulotte, and Mitchell analyzed the commercial performance of 133 aircraft and helicopters introduced to the market between 1944 and 2000 by companies entering the considered segment for the first time. The researchers compared the outcomes of direct entry strategies (when a company enters the market with an aircraft that it has designed itself) and indirect strategies (when it initially manufactures an aircraft under license before developing its own product). Dussauge and his co-authors applied a statistical model that took into account the fact that the choice of entry strategy is influenced by the technical, financial and commercial resources a company has at its disposal (firms with more limited  resources make greater use of licenses). This statistical method made it possible to measure performance independently of technical expertise.