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BW Businessworld

Paying Your Parent

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There is much debate on whether the existing norms that govern royalty payments by companies operating in India to their foreign promoters are good enough. This  has followed the recent nod by the board of Indian consumer goods giant Hindustan Unilever (HUL) to increase royalty and other fees to its Anglo-Dutch promoter Unilever. Industry insiders are worried that the fallout for local investors, minority shareholders in particular, will be to make do with lesser dividend.
Under the new agreement for the provision of technology, trademark licence and other services (effective from 1 February), the existing royalty cost of 1.4 per cent of turnover will increase, in a phased manner, to 3.15 per cent by 2018. In the new agreement, HUL is also expanding the scope of royalty to what the company calls “other services” — receiving global support and guidance in marketing, supply management, media buying, etc. HUL had not responded to specific queries sent by BW till this edition went to press. 
HUL currently has a Technical Collaboration Agreement (TCA) and a Trademark License Agreement (TMLA) with Unilever. While TCA provides for payment of 1 per cent royalty on net sales of specific products manufactured with technical inputs developed by Unilever, TMLA provides for the payment of trademark royalty at 1 per cent of net sales on specific brands, where Unilever owns the trademark and HUL is the licensed user. The total impact of both the agreements is a royalty cost of 1.4 per cent of turnover that is given by HUL to Unilever. 
In fiscal 2012, HUL paid Rs 307.24 crore (1.38 per cent of the firm’s net sales) as royalty to its parent, up from Rs 268.89 (1.36 per cent) the previous year. Against this, the local operation received Rs 1.41 crore in royalty from international operations, up from Rs 58 lakh the year before. Despite the increase in payouts to its parent, HUL will still be better off than other FMCG firms like Nestle (4.21 per cent of sales in 2012), Procter & Gamble (4.7 per cent) and Colgate-Palmolive (5.14 per cent), since they paid their respective foreign parents much more, as per estimates by proxy advisory InGovern. 
At the outset one can argue that there is nothing wrong in firms paying their parent firms for brand and technical inputs. After all, as Unni Krishnan, MD of brand valuation advisory firm Brand Finance in India, says, “In the FMCG business brands have a disproportionate share in the creation of value for a corporation.” And if those brands are owned by the foreign promoter, obviously they deserve a larger slice of the profits.
While no one objects to compensating foreign promoters for their services, it’s the method by which most of these increases are approved, that brings the issue under closer scrutiny. The first objection is the role of the board as the sole authority to approve such hikes. The argument is that since nearly half of a company’s board is made up of employees who, in turn, report to the promoter company, they may be compelled to say “Yes”. Some like InGovern founder Shriram Subramanian say that since it’s the minority investor that feels the maximum impact in this case, they should also have the most say too. “We’re not against payment of royalty. Firms need to articulate in a lot more detail on what justifies this increase in royalty,” he says.
Subramanian says that in related-party transactions like this, the issue should be put to vote only among minority shareholders, and controlling shareholders (like foreign promoters) should be barred from voting since their high stakes makes it likely for them to get a majority for an “ordinary resolution”, and may not serve the intended purpose from a governance point of view.

(This story was published in Businessworld Issue Dated 04-02-2013)