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How to Determine Royalty Rates

Apr 23, 2001
Bob DeMatteis

How do you determine a royalty rate when licensing a patented invention? This is a fairly difficult question to answer since it depends upon several factors. Generally speaking, royalties are based upon what the market will bear. But that perception is sometimes wildly different between an inventor and a licensee. Inexperienced inventors all too often get greedy and expect high royalty rates. They think that just because they have a patent, it is worth millions. Not true.

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How do you determine a royalty rate when licensing a patented invention? This is a fairly difficult question to answer since it depends upon several factors. Generally speaking, royalties are based upon what the market will bear. But that perception is sometimes wildly different between an inventor and a licensee. Inexperienced inventors all too often get greedy and expect high royalty rates. They think that just because they have a patent, it is worth millions. Not true.

Think about this, if you are asking for a 10% royalty, you are essentially asking for an equal amount of income as the licensee’s profit margin! A licensee will usually have a 10% profit after all costs are deducted…if even that. And the licensee is the one that must invest substantial money, time, people resources and so on, as it creates the market and builds sales and inventories. Doesn’t it seem absurd that the inventor would want as much profit as the company that is really taking all the risk? Asking for high royalties usually—and irretreivably—kills the deal. So, what’s reasonable?

Keep in mind that royalty rates tend to vary depending upon the industry and type and number of intellectual properties being licensed. The toy industry may vary from 5% to 15%, but is trendy so the earnings may be short-lived. Housewares, appliances, electronics and hardware may vary from 1% to 7%. The packaging industry tends to fall between 1% and 5%. Tools and sporting goods tend to be between 3% and 10%. Automotive aftermarket about 3% to 8%. Gimicky infomercial products may be much higher, as great as 20%. But they’re usually dead in a few months. The pet supply industry and baby goods will tend to be between 5% and 10%, with sales in lower volumes. Computer software tends to have royalty rates as high as 25%…but the life cycle is usually very short-lived. In most every field, there are too many variables to have “one standard rate for all”.

Some well-known royalty rate examples include Disney’s and Warner Brother’s copyrights, which have a 5%-7% royalty for most of its products. Michael Jordon gets 17% for his product endorsements. But these are well-known names. Are your creations as sought after as theirs? On the other hand, licensing something for as little as 1/100 of 1% may be extremely profitable due to the high volume. An example is the flip top opener on aluminum cans that stays attached to the can. The annual royalty earnings were well into the tens of millions. Or, how would you like to have been the inventor of the blinking cursur used on computer screens at 1 cent per unit? Generally speaking, products that sell in high volume will have much lower royalty rates than those in lower volumes. But the earnings can get quite interesting. In contrast to the high volume of the flip top can is the Ant Farm, which has supported a 20% royalty with its year-in, year-out, annual sales of $1 million. The anticipated sales volume of a new invention/product is one key reason why royalty rates tend to vary so widely within an industry.

There are other factors to consider as well. How easy is it to design around your patent? How broad is its scope? Will it support an invalidity challenge? Do you have one patent or several? The more patents you have, usually the more secure your position and perhaps the more you may be able to charge. If patent protection is weak or easy to design around, no one will want to license your inventions/patents…at any royalty rate. The same goes for

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