It was the other way round till FY10, when MNCs’ dividend income from their Indian subsidiaries exceeded royalty income.
In the past five years, royalty payments by these companies have grown at a compound annual growth rate (CAGR) of 31.1 per cent, much faster than revenue and profit growth. Net sales during the period expanded at 15 per cent yearly and the annual growth in net profit was even lower, at 10.3 per cent.
This was largely due to an increase in royalty payout by the MNCs’ subsidiaries. In six years, royalty payments have doubled from 1.3 per cent in FY08 to 2.5 per cent in FY13. This is likely to rise further, as many subsidiaries such as Hindustan Unilever, ACC and Ambuja Cement step up royalty payment as asked for by their parents.
Experts say royalty payment is standard practice globally. “MNCs all over the globe, including Indian companies, charge royalty from their foreign subsidiaries for using parent services. Access to parents’ brands, technology and processes helps subsidiaries scale up faster and they are well within their rights to ask for a share of the revenue. The rate of royalty payment is, however, debatable and varies from company to company,” says Avinash Gupta, senior director at Deloitte India.
According to Gupta, a problem would start if MNCs start giving differential treatment to different subsidiaries. “As long as all subsidiaries are treated on an equal footing, it should be treated as another cost head,” says Gupta.
Analysts say by increasing reliance on royalty over dividend, MNCs are de-risking their returns from the Indian markets. “Royalty payments are calculated on revenues, while dividend income depends the profitability of local subsidiaries that can vary a lot during a business cycle,” says
G Chokkalingam, founder Equinomics Research & Advisory. Besides, dividend income has to be shared with non-promoter (minority) shareholders, unlike royalty payments.
A higher dependence on royalty to get returns from India also incentivises MNCs and their local subsidiaries to focus on revenue and sales maximisation, rather than only looking at profitability.
The flipside is that this hurts minority shareholders, especially during an economic downturn when profit and dividend grow much slower than revenues. A royalty payment, on the other hand, is a cost and reduces a firm’s profitability.
This is evident in the case of the 71 MNCs in the sample. There has been a decline in operating margins for these and royalty payment has been the fastest growing item on the cost side. Operating margins declined to 14.2 per cent last financial year from 16.4 per cent in FY08.