Aarati Krishnan

Why this royal treatment for MNCs?

AARATI KRISHNAN | Updated on March 12, 2018 Published on March 24, 2013

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MNCs are licensing technology and brands to Indian arms to gain access to a market that is growing faster than their home markets. Shouldn’t such access be set off against the royalty or technical fee?

If it’s a multinational, it must be first-rate. That attitude, it appears, extends not just to career choices, but also to investor preferences for stocks in the Indian market.

This is probably why the average MNC stock trades at a valuation of 27 times its earnings, while home-grown companies’ stocks languish at half that level (14). That premium certainly isn’t for a splendid show on profit growth. Listed MNCs delivered just 7 per cent annual growth in profits over the last three years while home-grown companies registered 12 per cent.

Ask institutional investors why they are willing to pay so much for every rupee of profits turned in by an MNC, and they will call it a ‘governance’ premium. But that argument is wearing a bit thin after the many instances of multinationals giving tax authorities or minority shareholders the short shrift, while looking out for their promoters’ interests.

Rising royalties

Consider the recent trend of rising royalty payments made by the Indian arms of MNCs to their parents. Last week, Nestle India joined many others such as Hindustan Unilever, ACC and Ambuja Cement in inking a new agreement that hikes the royalty charges it pays to its foreign parent. Nestle India claims this new agreement was signed only after obtaining independent opinions from legal firms and independent directors.

But even if so approved, royalty payments demanded by global firms as their pound of flesh from Indian subsidiaries flag several issues for Indian investors.

What are we paying for?

The first obviously is: what does the Indian firm get in return for these payments? MNCs often justify royalties in terms of three payoffs — access to the global company’s technology and R&D capabilities, the right to use global brands and trademarks in India and the access to ‘best practices’ in manufacturing and operations.

Of these, the technology argument is the most acceptable (that too, more in certain sectors than others). The other two appear tenuous.

Let us consider brands and trademarks first. For the Indian firm to seek a global brand name from its parent and actually pay for it, that brand name should be so recognisable in India that any product launched under it should fetch immediate market share.

But are Maggi noodles such a hit with dhabas all over India, because they come from a Swiss company? One would hardly think so. Maggi is a success because it is easy to make and Nestle India has aggressively advertised the 2-minute noodle concept from the time Maggi made its debut in the early 1980s.

This suggests that, while it may be quite acceptable for Nestle India to pay a royalty for the technology that goes into making instant noodles (and too, only as long it remains proprietary), it is difficult to justify payments for ‘global’ brand value.

Multinational FMCG companies typically spend 8-13 per cent of their sales on advertising and promotion in India. Surely, that is enough proof that the global pedigree isn’t really all it takes to build a local brand?

What the global name brings to the table is particularly questionable for mass market products such as soaps, chocolates, noodles or cement, where firms rely mainly on non-metro markets for their sales.

Market access

As to ‘best practices’, that appears to be quite a sham, too. If global ‘practices’ in making soaps, drugs or cement are really all that great, why are so many MNCs rushing to set up manufacturing hubs in India for their global operations?

Maruti Suzuki offers a good instance. After shelling out royalty payments amounting to 5-6 per cent of sales to its Japanese parent in recent years, the company is now setting up a local R&D centre to contribute to global product development. With this, it hopes to renegotiate those royalties at lower rates.

Finally, it helps to bear in mind that if MNCs are willing to license their brand names, technology or ‘best manufacturing practices’ to Indian subsidiaries, they are certainly not doing so out of altruism.

They are doing it to gain access to a market of a billion consumers that offers far superior growth than they would manage in their home markets. Access to such a market deserves a price too. Shouldn’t that be set off against the royalty or technical fee?

These issues are also reasons why Indian investors could do with more specific disclosures on the royalty agreements that Indian MNCs sign with their parents. A break-up of royalty charges into components — technical fees, trademark and copyrights, service fees — would help one know whether these charges are really justified and also decide on how long they must be allowed to run on.

No-risk strategy?

The other big problem with these royalty agreements is that they offer a means for the global promoters to shield their own returns from business risks, while other shareholders are left holding the baby.

Because royalty is often levied as a percentage of a firm’s sales, they are paid irrespective of business cycles. No matter if the Indian firm isn’t registering profit growth or, indeed, even an absolute profit.

In fact, an analysis of trends in royalty payments by the listed firms since 2009 shows that by paying out a larger share of their profits as royalty to the parent companies, they have left less money on the table for their public investors.

Between 2009 and 2012, the latest financial year, the 50 listed MNCs in India have hiked their combined royalty payments at a rate of 34 per cent annually. In the same period, these firms’ profits rose only at 7 per cent and sales at 17 per cent a year.

The timing of these increases is no coincidence. MNCs hiked their royalty rates sharply as soon as the Indian government, in a liberalisation move in end-2009, did away with the statutory limits for such charges.

Tax aspect

Finally, the trend of rising royalties does no good to the exchequer either. Sums repatriated as royalty payments escape the tax on corporate profits as well as the tax on dividend distribution. They suffer only a flat withholding tax, which was at 10 per cent until recently. In the recent Budget, the withholding tax was hiked to 25 per cent.

But now it transpires that most Indian arms of MNCs will not be paying taxes at this rate, thanks to caps specified by the double taxation avoidance agreements with their home countries.

Even if the taxes are levied, though, it is local shareholders who need to worry, as royalty agreements are often inked ‘net of taxes’. So let’s hear it again. Do MNCs still deserve that premium for governance?

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Published on March 24, 2013
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