How many people have considered that Microsoft is, at its core, a licensing company? Or that the entire PC industry owes its existence to a licensing deal, the non-exclusive license to IBM for MS-DOS in the 80’s? How different a company would Microsoft have been had they signed an exclusive licensing deal? Chances are that it wouldn’t still be around. Bill Gates certainly wouldn't have become the richest guy in the world. As a licensing guy, I can only speculate on whether it was IBM's negotiating naivete or Microsoft's chutzpah that led to the deal being structured as it was.
Having sat on both sides of the table on various occasions, I have frequently found myself in a position where I’ve been able to help get to consensus because I understand where the conflicts may be and have been able to work through them.
Licensees almost always contend that they require some form of market exclusivity for competitive advantage. “Why would I sign a deal with you today if, tomorrow, my competitors can do the same thing?”
Licensors are thinking the exact opposite, “I can’t put all my eggs in one basket? I want to capture as much of the market opportunity as is possible, not be limited to a fraction of it.”
Perhaps even more importantly, what is the impact on the company’s potential for a liquidity event for its investors? Remember, once you’ve granted exclusive rights to a 3rd-party, that prevents not only you, but any acquiring company, from pursuing that space. This may take a whole category of company off the list of potential acquirers at a later date. Try explaining that one to your investors!
So how do you reconcile these two positions?
The “need” for market exclusivity can often be a catalyst for M&A discussions, especially if the technology being licensed is the core franchise around which you’ve begun to build the company, or if the breadth of market exclusivity on the table prevents you from extracting value in other markets. But once again, these can be tricky waters to navigate. A technology acquisition requires you to consider valuation through a very realistic lens. The acquiring company will do an estimated build cost (# of person years x fully loaded cost per person year, around $200K per), and then offer a multiple based on their assessment of the value of time-to-market and your IP position, typically 3X-7X. As the inventor/entrepreneur, you need to be very realistic about their ability to get close enough to replicating that which you’ve built. Pride can get in the way, but do you really believe that Microsoft/Qualcomm/Oracle/Cisco engineers couldn’t do it?
If M&A discussions aren’t an option, then, in most cases, non-exclusivity should be the preferred path. One of the things, that the licensee doesn’t want to happen, is to invest its time and resources creating demand for a key feature, only to have a competitor come in and erode their margins selling the same widget at a reduced cost. A concession, that can help address this, is a form of price protection (MFN clause). In this type of clause, the licensor will agree to not license for less in comparable deals. The concept of comparability is key here. The consideration must be for similar product types, in similar quantities over a similar time period. If a subsequent licensee is pays a lesser royalty rate (or other form of consideration), a reduction in royalty rate will be accorded to the original licensee as well.
So, you’ve now heard that M&A is not an option at this time and non-exclusive rights aren’t either. Under what conditions can exclusivity make sense? My answer is twofold: Money solves a lot of problems, and that it is possible to tightly constrain the scope of a license, thus preserving your ability to license to others or for an acquiring company to practice in any field but the restricted field for which you’ve granted exclusivity.
How do you constrain the license grants? By placing boxes around the grants…I’ll explain more next time.
That’s my .02!
Martin Suter
martin.suter (at) iplicensing.net
The question of why IBM did not demand an exclusive licence to DOS always has bewildered me. They certainly had the bargaining power. I read somewhere years ago that it was because they were, having gone through years of antitrust battles, worried about again being taken before the courts for possibly monopolizing another part of the industry. So, when Bill Gates asked for the license to be non-exclusive to IBM, IBM relented.
I can't see that IBM was just naive or glossed over that clause in the contract. In Fact, Bill Gates has stated that it was a key negotiating point.
One also must remember that IBM expected never to sell more than 100,000 units so maybe they didn't think there was any extra value to having an exclusive license.
Posted by: Noel | April 01, 2011 at 06:53 PM