CONSIDERATION OF LOCAL VALUE ADDITION AND COST OF IMPORTED

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CONSIDERATION OF LOCAL VALUE ADDITION AND COST OF
IMPORTED COMPONENTS IN DETERMINATION OF SALES
ROYALTY RATE IN FOREIGN TECHNOLOGY LICENSING
CONTRACTS By Engr. O.E. Essien Deputy Director
(TADI) Presented at 2nd NOTAP MANAGEMENT
RETREAT Crystal Palace International Hotel Area
11, Garki, Abuja 10-11TH DECEMBER 2004
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INTRODUCTION High cost of imported
components, sales royalty rates and low value
addition in acquisition of foreign technologies
introduce heavy financial burden on the
operations of the licensee companies in
developing countries like Nigeria. The purpose
of the paper is to derive a formula that will
assist parties in technology licensing contracts
to determine appropriate sales royalty rate with
due consideration of economic parameters like
profit of the company, local value addition and
the cost of imported components in order to
reduce the aforesaid financial burden.
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2. DERIVATION OF
FORMULA According to UNIDO (1979) sales royalty
rate during direct technology licensing is
expressed as follows
P1 Lo R1s
. (1)
S
w here R1s is sales royalty rate
P1 is the gross profit of
the company S is
the total sales volume Lo is the
percentage of profit that flows to licensor due
to payment of royalty based on sales royalty
rate R1s.
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According to UNIDO (1979) and NOTAP
questionnaire paragraph 6.7 (1979) the local
value addition is expressed as follows
q
(1-C.) x 100 (2)
S
Where q is the local value addition expressed in
percentage (see figures 1 2 ,Annex A attached)
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LOCAL VALUE ADDITION From equations (1) and (2)
we have
(1-q) P1 Lo
R1s . X 100
(3) C


1-q The parameter --------- will be
very low when C is high and q is constant .

C
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Worked Examples Problem No. 1 Given q 25
P1 500 Lo 20 C 200 Find sales
royalty rate R1s Solution No. 1 By substituting
the given values in equation (3) we have
(1-0.25) x 500 x 0.2 x 100
R1s .. .
200
37.5 Problem No. 2 Given q 25 P 500
20 C 800 Find sales royalty rate
R1s Solution No. 2 By substituting the given
value in equation (3) we have
(1-0.25) x 500 x 0.2 R1s
800 9.4
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EVALUATION OF GIVEN SALES ROYALTY RATE TO
DETERMINE PERCENTAGE Lo OUTFLOW OF
PROFIT TO LICENSOR Proposed sales
royalty rate can be evaluated viz a viz the
percentage of the profit outflow to the
licensor by using the following
formula. CR1s
Lo . (4)
P1 (1-q)
Equation (4) shows that at constant profit of the
company P1, local value addition q and
sales royalty rate R1s the percentage
outflow of profit to company increases as the
cost of imported component increases.

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CONCLUSION Parties to foreign technology
acquisition agreements in developing
countries should consider the cost of imported
components in technology licensing agreements
when negotiating sales royalty rates. High cost
of imported components should bring down the
rates especially at low local value addition.
Care must be taken in accepting high sales
royalty rate because of high local value
addition. This should only happen if the
increase in local value addition is due to the
effort of the licensor in reducing the imported
components and not by effort of the licensee in
increasing sales at constant or increased cost of
imported component. Incentive remunerations
should always be considered if the local value
addition is due to reduced cost of imported
components but not increased sales due to effort
of the licensee companies.
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LITERATURE UNIDO (1999 Guidelines on Evaluation
of Technology Transfer Agreements in Developing
Countries. New York. NOIP (1979) Questionnaire
to be completed for registration of Technology
Transfer Agreements paragraph 6.7, Iponri, Lagos.
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