Mint Explainer: Why Nestle failed to raise royalty payments while rivals did

Mint takes a look at how recent proposals to increase royalty payouts fared in the consumer goods space in India.

What are royalty payments?

The Indian subsidiaries of major foreign fast-moving consumer goods, or FMCG, companies often pay a fee known as royalty to their parent companies. This grants them access to resources, including globally recognised brands, technology, research and development capabilities, and shared services used throughout the entire organisation.

In the case of Hindustan Unilever Ltd, Nestle India and Colgate-Palmolive India, the royalty ranges from 3% to 5% of their net sales, analysts at Jefferies said in a note last month. In absolute terms, this implies an annual payout of ₹300 crore for Colgate-Palmolive, ₹900 crore for Nestle, and ₹1,900 crore for HUL, they added.

Also read | Why royalty payout as a percentage of revenue needs to be relooked

While investors appreciate the access to brands and tech know-how that Indian businesses gain from the parent, increases in royalty payments have always been an area of contention for them, Jefferies said in its note.

“A strong parentage by itself does not guarantee outcomes as local strategies and execution play a very important role," analysts at Jefferies said. “Also, it is not that MNC firms in India have outperformed peers on growth over the years. Companies like ITC, Tata Consumer have been able to generate significant scale at investments which are perhaps lower than what MNCs would have done in these categories."

What HUL has done

In January last year, HUL's board approved an increased payout to European parent Unilever Plc for providing technology, trademark licences and services. This entailed paying royalty and central services fees at 3.45% of HUL’s revenue, up from 2.65% in FY22.

The new arrangement was approved for a period of five years. To reach the new royalty fee arrangement, a detailed evaluation and due diligence was carried out by senior HUL executives. The company also engaged Deloitte Haskins and Sells LLP to conduct an independent benchmarking exercise.

HUL had a royalty and central services arrangement with Unilever, which was signed in January 2013 for a period of 10 years. This arrangement granted HUL the right to use Unilever-owned trademarks, technology, and the corporate logo and gave it access to central services provided by Unilever.

The company received an “increasing" stream of benefits that equipped it to meet emerging consumer needs, the company said in its annual report for FY23, outlining the reason for the increase in royalty payout to the parent.

As a result, it is common for multinational companies to hike royalty payment to the parent company, given the size and scope of their business.

Several companies have sought approval for increasing royalty payments in the past few years and most of these resolutions have been passed with a comfortable majority. 

In the case of HUL, when the company sought shareholder approval, 67% of the votes were in favour of the new royalty fee arrangements, analysts at Jefferies said. This wasn’t the case with Nestle.

What's the issue for Nestle?

In 2019, the local arm of the Swiss consumer goods company said it would seek shareholder approval every five years for higher royalty payments to its parent company, after receiving investor and proxy firm feedback on the issue. 

The company had then added that while its General Licensing Agreements are reviewed periodically by the audit committee, “the resolution has been modified to provide for shareholder approval every five years in accordance with applicable laws and regulations."

In April this year, Nestle India’s board of directors approved a staggered increase in royalty rate by 0.15% per annum over the next five years. 

This effectively meant hiking the payout to parent Société des Produits Nestlé S.A. to 5.25% of the net sales of products sold by the company, net of taxes, up from the earlier 4.5% per annum. However, shareholders opposed this proposal last month.

Mint earlier reported that two of the largest money managers in Europe opposed the decision of Nestle India's board.

“The performance of the company does not sufficiently demonstrate the benefits of the royalty payments over the years, which have grown at a rate higher than the company's revenues and net profit," said Legal & General Investment Management (LGIM), UK’s largest fund manager. Additionally, Nordea Asset Management, the investment arm of the Nordic region’s largest banks, also opposed the resolution.

On Wednesday, Nestle India approved continuation of royalty payment at the current rate of 4.5%.

The move is positive for Nestle India as the overhang of the fresh proposal on royalty goes away, said Abneesh Roy of Nuvama Securities.

Additionally, the Nestle episode probably reflects growing shareholder activism in India, similar to that in the developed world, a natural outcome that should continue as the Indian market matures, Jefferies said in its report in May.