OEM (ORIGINAL EQUIPMENT MANUFACTURER) AGREEMENTS

OEM and licensing agreements can be a quick, low-cost way to generate revenues, but beware of the potential risks.

How They Work
Under a typical OEM agreement, a software vendor licenses its technology to another software vendor with complementary technology. In some cases they license the technology to provide specific features that it would take the company too long to develop on their own. For instance, a vertical market software vendor might license a web-enabling technology so that it can integrate a portal into its current offering. In other cases, a vendor might license a technology in order to sell a new module to its existing clients. For example, a company selling system utilities might license a database utility that it can sell as an extension of its own product line.

In most cases the company licensing the technology would re-brand the technology under its own label, and pay a licensing fee to the licensor. License fees can be a combination of up-front fees and on-going royalties, and the agreement will often have a minimum volume requirement that is tied to the prices that have been negotiated. Per unit prices can be a fixed price per unit purchased, or a percentage of the overall product sale. In the latter case, if the licensor's technology represents 10% of the total solution, they would receive 10% of all sales revenues.

Why They Make Sense
There are many advantages to an OEM agreement:

*Lower overall cost
The licensee is usually responsible for its own marketing and tech support expenses, since they are selling it under their own brand

*Rapid market penetration
The licensees will normally be selling the technology to its existing customer base, which should result in faster market penetration

*Can co-exist with other channels
Because the technology is being sold under another name to a defined market, OEM agreements are not necessarily a conflict with other channels. Resellers and distributors are not thrilled with these arrangements, but there is usually limited overlap with their own marketing efforts

Potential Risks and Challenges
With the proper structure the advantages of OEM and licensing agreements will normally outweigh the disadvantages, there are a number of issues that should be considered:

*Branding
The technology is sold under a name other than the original vendor, so the supplier does not benefit from brand awareness. Investors tend to place a higher value on companies with an established brand, so to the extent a significant portion of revenues comes from licensing, a company will be penalized in terms of market valuation

*Source code ownership
When a piece of code is integrated into someone else's technology, great care must be taken to maintain the integrity of one's intellectual property rights. If a licensee is allowed to build significant enhancements into or around that particular code, at some point they may own the derivative technology. This has implications for IP ownership as well as revenues if per unit pricing is based on the relative value of the code in a larger solution

*Reverse engineering
There have been many cases of companies entering into OEM and licensing negotiations simply to allow them to look at the code. Unscrupulous companies could then build similar technology without having formalized an agreement with the original supplier

*Integration costs
The agreement might require significant changes to the supplier's product in order to facilitate integration with other products. The amount of work, and who pays for it, should be clearly spelled out in the contract

*Tail wagging the dog
If an OEM agreement becomes hugely successful, and a small supplier is reliant on a single licensee for a substantial portion of its revenues, they will have reduced their leverage when it is time to renegotiate the terms of the agreement, and could find themselves squeezed on pricing.