Indian franchisees pay too much royalty to their foreign HQs

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The annual royalty that McDonald’s Indian franchisee will pay to the US-headquartered fast-food company is all set to go up from three per cent of net sales now to eight per cent by 2020. Ever since the government liberalised the royalty rules in 2010, there has been a sharp increase in payouts to foreign collaborators. An analysis by this newspaper of 75 companies listed on the Bombay Stock Exchange shows that royalty payments more than trebled between 2007-08 and 2011-12, though sales grew 80 per cent and net profit a little over 30 %. Proxy advisory firm Institutional Investors Advisory Services says that while the money remitted by the top three royalty-paying companies – Maruti Suzuki, ABB and Nestle India – jumped over three times from Rs 784 crore in 2007-08 to Rs 2,495 crore in 2011-12, their collective revenue increased only 1.8 times. It said four companies had paid no dividends in the last five years, though they had paid Rs 385 crore in royalty to their overseas partners. And, in one case, the Indian company had to fork out royalty to its Japanese promoter, though it had reported a loss for the year. Recently, ACC-Ambuja Cements had to cut the royalty payment to parent Holcim from two per cent of net sales to one per cent after the independent directors on the company’s board objected to the high payout.

There are at least three issues here. One, high royalty is iniquitous to minority shareholders. It is like a super dividend to the foreign shareholder. It reduces the net profit, and therefore causes the valuation of the Indian venture to fall. Also, since royalty is a commercial arrangement, minority shareholders have no say in it. They are seldom told the reason why it has been changed. Shareholder activists have, therefore, started demanding that royalty payments ought to be decided in the annual general meeting of shareholders, and any change must be cleared by 75 % of the shareholders. Two, the negotiations for royalty are often between the foreign promoter and the managers it has put in place. These managers have no incentive to drive a hard bargain; if they do, they could simply lose their jobs. It is, in that sense, a negotiation between non-equals. That’s perhaps the reason why multinational corporations have been able to extract favourable royalty terms from their Indian ventures. Three, royalty makes the government lose out on tax revenue.

The government ought to see the overall impact of its liberalised royalty regime, and then take corrective action. Royalty is paid for the use of the foreign partner’s technology, trademark or brand name. The government must scrutinise how real the technology transfer is and if the brand name of the foreign partner is indeed helping the Indian company charge a premium in the marketplace. Royalty has been a bone of contention between Indian business leaders and their overseas partners for a while. Several collaborations have fallen apart because of squabbles over royalty.