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Developing and licensing technology: another source of revenue.


Merchandizing and Licensing

There is a multi-billion dollar industry, merchandizing, which can create additional revenue sources for franchisors and franchisees. Merchandizing occurs when:

* McDonald's franchisees sell Ronald McDonald toys and games.

* The Little Gym franchisees sell children's clothing with logos.

* Butterfly Fitness franchisees sell fitness and health books.

* H&R Block develops "Tax Cut" software, and licenses it to consumers to prepare their own tax returns (technology licensing, a form of merchandizing).

* Seattle's Best Coffee sells its coffee beans through wholesale channels.

Merchandizing and licensing are terms that are sometimes used interchangeably, as both involve the use of intellectual property by the user under a license agreement. Merchandizing generally refers to trademark licensing of branded goods, while licensing often refers to licensing of technology, including copyrights, trade secrets and patents.

How does merchandizing work? A trademark is a commercial symbol that distinguishes the goods or services of its owner from the goods or services of others. A trademark is usually synonymous with a brand, and it represents the value (goodwill) of a particular product or service. Goodwill in the trade mark sense is intangible, and may include such things as name familiarity, consumer loyalty and the associations that the public has with the trademark. An assignment of a trademark is a complete transfer of ownership, in which the trademark owner assigns the mark and all its rights in the mark to another party, together with the goodwill of the mark. A license on the other hand is a grant of permission from the trademark owner to another party to use the trademark. A license is a way of extending the value of the brand to a variety of disparate goods and services.

Technology licensing works in the same way. A copyright or patent used as a part of a franchise system can be licensed to create other goods sold for other purposes. For example, with the H&R Block Tax Cut software, the franchise system has its own software for preparing taxes with the help of a franchisee's employees. The software provides an H&R Block brand extension to the growing number of consumers who want to prepare their own returns. Franchisees receive referrals from such customers who have questions about their returns or who want help with tax audits. H&R Block has also extended its brand to other financial products and services.

Licensing can occur in a variety of contexts and industries, for example:

* Merchandizing of clothes, toys, games, giveaways (advertising specialties industry), with a franchisor's trademarks;

* Sales of products through wholesale distributorship channels;

* Joint ventures and strategic alliances to develop new technology from existing systems, or for new applications of existing technology;

* Co-branding using an existing trademark, for a new product or service; and

* Business consulting, using a know-how license, to extend franchisor expertise to other industries and markets.


Licensors often charge royalties based on a percentage of gross revenue derived by a licensee. Elaborate mathematical models can be constructed to attempt to compute a fair or optimum royalty. Royalties may also be based on other factors, such as:

* Net profits, gross sales, or net sales;

* Royalty minimums or maximums or floating based on averages; and

* Allocation to different goods or services in combination licenses (trade secrets, trademark).

The type and amount of royalty to charge depends on the industry and the type of intellectual property. The Licensing Executive Society,, publishes royalty rates, from which one could calculate an equivalent up-front fee, segregated by types of projects, as do other publishers. For off-the-shelf software and certain other technology, the payment may be only an up-front, paid-up royalty.

Terms of the License

The license grant can be limited to certain geographic, marketing or distribution channels, and there can be limitations on assignment or sublicensing. Licensees may be permitted to delegate specific functions, like manufacturing, to third parties. In these situations, the licensor should reserve the right to approve the third parties, and the third parties should be required to abide by the license. In the unusual situation that sub-licensing is permitted, the license should require the licensee to subject the sub-licensee to the same provisions that the licensee is subjected to, and to inspect and police the sub-licensee's use to ensure that he complies with the original license. Exclusive licenses often include reservations of rights, including the licensor's express rights to use and license the marks with other goods and services.

For a license involving copyright, such as software, there are additional considerations. For example, the contract should grant or limit warranties, specify or limit obligations for updates, new versions, and other derivative works, and limit the number of users and copying.

Licensor Must Maintain Control

A hungry customer bites into a Big Mac hamburger at a McDonald's restaurant on a trip to Minneapolis. She expects her Big Mac hamburger to taste the same as it did when she last ate a Big Mac hamburger at a McDonald's restaurant in Seattle.

A desperate customer calls the Geek Squad at the Best Buy store near her hotel on a business trip to solve her computer meltdown. She expects to have a similar experience as she did when she called the Geek Squad near her home for help.

A girl who loves Groovy Girls dolls convinces her father to buy her a Groovy Girls board game. She expects that the board game will be fun to play and made of high quality materials, like her Groovy Girls dolls are.

A taxpayer uses H&R Block's "Tax Cut" software to prepare her tax return. She expects to receive the same accuracy of advice from that software as from a franchisee that prepares the return.

One of the main purposes of trademark law is to protect these customers and to make their expectations of quality reasonable. If customers experience variable quality, the goodwill of the mark obviously suffers. And if the lack of quality control and consistency persists, customers may naturally become confused as to whether the ownership of the mark has been split or otherwise changed.

Whenever a trademark owner licenses another entity to use its trademark, it should exercise control over that licensee's use of the mark. This is simple business sense. A licensor wants to maintain the value of its mark and positive customer associations with its mark. It does not want a licensee using its trademark in a manner that will reflect negatively on the licensor and will devalue the mark. In addition, the law requires trademark owners to control use of their marks by others. When a licensor fails to exercise sufficient quality control over the licensee's goods or services sold under its mark, it is referred to as a "naked license" and can result in an involuntary abandonment and loss of rights in the licensor's trademark. On the other hand, a licensor who "fully clothes" its license with controls, to the point that it exerts too much control over a licensee's use of a trademark risks becoming subject to franchise laws unintentionally, for non-franchise licensing deals. Thus, to avoid losing trademark rights and to avoid having to comply with franchise regulations, trademark licensors must exert enough, but not too much quality control over licensees.

Licensors often want to maintain discretion to set and approve or disapprove quality of goods and services, but licensees may want a reasonable discretion standard. Inspection rights can be restricted to inspection on reasonable notice. Inspections can be at licensor or licensee's cost. Inspection rights should include all advertisements, marketing materials, goods and services. Inspections can include audits of relevant business records. Inspection and samples can be at various stages, e.g. preliminary design or concept, final design or layout, script for textual materials and production samples. All modifications should be subject to approval. The licensee normally must provide representative samples. Length of time and manner of communication of approvals is also negotiable.

A licensor of trademarks should control size, color, placement (including with other marks), texture and all other standards of use in its sole discretion. It is advisable to leave the detail to a separate graphic standards (trademark usage) manual. It is recommended that the manual not be incorporated by reference, since that may limit the flexibility to change the manual, and may give the licensees input into the manual. Rather the manual should be carefully defined, and described, and licensor's rights to issue, modify and revoke mandatory trademark usage rules and specifications should be made clear. Licensors will normally require a notice to the public that the licensee is producing goods or services under license, and the notice will use the licensee's independent name.

Copyright and patent licenses also must have carefully-drafted controls. For example, reverse engineering, copying, sublicensing, assignment and distribution are normally limited. Registration of patents and copyrights should generally occur in advance of licensing, and for patents within the one-year statutory bar period.


Avoid conflicts with franchisees

* Licensing should be complementary to the franchise system, and often provides revenue to franchisees from sale of additional goods or services.

Make sure that the franchise agreement allows the licensing; most franchise agreements reserve such rights to the franchisor to exploit new markets.

To control the quality of a licensee's goods or services, licensors could:

* Review and approve promotional materials, packaging and advertising.

* Provide style guides.

* Analyze and approve sample goods.

* Inspect and approve manufacturing facilities and equipment, service processes, product components and records.

* Provide manufacturing standards, service standards or product specifications.

* Conduct regular testing of products.

* Track and handle consumer complaints.

* Appoint an independent quality control agent.

* Create technology that prevents copying, reverse engineering and distribution.

Always include quality control provisions in the written license.

* Include standards and describe how quality control will occur.

* Include a right to terminate the agreement if such standards are not met.

Exert quality control over the licensee's goods or services.

* Do what is described in license agreement in terms of quality control.

* Keep records of all quality control efforts.

* Appoint a third-party quality control agent if inspections of numerous licensees are too burdensome.

* Communicate with the licensee regarding complaints or problems regarding licensee's goods or services.

* Terminate the license if the licensee does not meet the specified quality standards.

Gary R. Duvall, CFE, is a partner of the Seattle-based law firm Dorsey & Whitney LLP. He can be reached at 206-903-8700 or
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Comment:Developing and licensing technology: another source of revenue.(FW FOCUS: TECHNOLOGY)
Author:Duvall, Gary R.
Publication:Franchising World
Geographic Code:1USA
Date:Apr 1, 2008
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