Will Itc Gain By Paying Royalty?

However, only the subtle details of the agreement between BAT and ITC can throw light on the final outcome about the actual gains to the common shareholders of ITC.

The license agreement with BAT gives ITC the manufacturing rights for these brands for a period of 30 years. ITC will be shelling out 5 per cent of royalty on net sales to its parent. However, the crucial question remains - who will have the marketing rights for these brands in India - ITC or the wholly-owned subsidiary of BAT in India? If BAT plans to keep its brands under the control of its wholly-owned subsidiary, then ITC's role will be restricted only to manufacturing. Here, its returns will be limited, and in that case, BAT can reap maximum returns through its marketing arm.

 

On the other hand, if ITC bears the burden of promoting the brands, it will have to put up huge investments. The market for premium brands accounts for hardly 5 per cent of the total cigarette market in India. However, the initial brand promotion costs could be largely incommensurate with the returns. Since the availability of funds with ITC is limited, the investment in the BAT brands will have to be at the cost of its very own brands. One doesn't see any reason for the royalty payment to BAT in these circumstances. Instead, logically, it should receive a compensation from BAT for its promotional activities.

So far, ITC has stonewalled BAT's proposal for a 50:50 joint venture for promoting the latter's brands as the same would have severely affected the interests of its shareholders. Its substantial investment plans for combating the international brands also stood in the way of committing huge funds for the joint venture. However, now it remains to be seen whether the additional manufacturing load can be supported by ITC's existing capacity or whether it will be done at the cost of curbing down production of its current brands. A third possibility could be that ITC sets up new capacities.