Rising royalty payments hurting India Inc

Tue, 8 Oct Pre-Open

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Royalty payments are made by one party for allowing the other the right to use its intellectual property. The intellectual property could be anything ranging from a brand to technical knowhow. There are many companies in India that pay royalty fees to their parent’s located overseas. As long as the local subsidiaries are making decent profits royalty payments is not an issue. However, once the local profitability comes under pressure increasing royalty payments becomes challenging to honor.

As per an article in Livemint, roughly 25 local companies saw their royalty payments increase at a pace faster than their growth in sales and net profits in FY13. Royalties are important source of income for the foreign parents. However, increasing royalties when the local subsidiaries are suffering does not bode well for the domestic shareholders. And this is what has happened with quite a few Indian companies in the past few years. Though domestic profitability has been under pressure their royalty commitments to foreign parents increased. And this has been a major cause of concern amongst domestic shareholders.

Increasing royalty payments during downturn when the local subsidiaries need cushion from their parent is worrisome. It is not that reducing royalty payments or keeping it constant would have changed the fortune of all the domestic subs. The domestic environment is so weak that even if the royalty payments were waived few companies like ABB would have not fared any better. However, increasing royalty payments during such times certainly does not help either. It hurts the profitability at the domestic level and thus minority shareholders.

While there is no harm in increasing royalty it should benefit the domestic subs in the form of increased knowhow from the parent. However, this is not happening. On the other hand, foreign parents are increasing royalty rates just to increase their income. This has led to a debate whether there should be a cap on royalty. This would ensure that there is no blatant increase in rates.

Also, it may be noted that there have been quite a few companies like 3M India, Whirpool India etc who have increased their royalty rates in the last few years but have not paid dividends excluding one off instances. This means that the foreign parent enjoyed increased income while minority shareholders were aloof of dividend income. It appears that if the royalty rates keep on increasing disregarding the profitability aspect of the local subs some sort of cap should come into place. If that is not feasible then there has to be some kind of a voting mechanism which shall allow the minority shareholder to vote against such a provision. If not, foreign parents will keep on extracting more money from their local subs in the form of royalty payments.