Defining licensing royalty rates can be tough. Often, licensors face a need for consultancy services from local agents or advice from other brand owners licensing into similar product categories.
Even the most experienced brand owners can run across the difficulty of dealing with licensing royalties, all due to a wide variety of royalty rate types applied across the licensing industry.
In this article, we'll cover the six most common types of licensing royalty rates and explain what adopting them in a licensing deal may imply.
Domestic royalty rates, a common in licensing type of royalty rate, apply to products sold through conventional distribution channels. Such licensing deals generally involve the transportation of goods from domestic warehouse to distributors or directly to retailers. The licensee's wholesale price serves as a base for royalty calculations.
Domestic royalty rate applies to virtually all categories of licensed properties, provided they will be sold to retailers on a domestic land basis. At the same time, the manufacturer would typically bear the cost of shipping the product from the point of manufacture.
The F.O.B. method implies delivering manufactured products on a free-on-board basis at retailers point of production. In a F.O.B. deal, retailers are responsible for the costs of transporting these goods to their final point of sale.
And because retailers bear these costs, they will often negotiate a lower selling price for a product compared to the usual domestic landed price. Retailers pay less for shipping than licensees, thus retrieving significant discounts, which often causes brand owners to carry losses.
To compensate for the decreased invoice amount in F.O.B. deals, brand owners have to adjust the final royalty rate by circa 4%. Lowering the rate in this scenario helps to equate the total royalty income to what it would have amounted to in a traditional deal. Therefore, the average royalty rate for this type of licensing agreements may quickly rise to 12%-14%.
In direct licensing deals, retailers may (or may not) act as licensees or partake in the licensing chain. If a retailer takes on the licensee role, their selling price (applied to direct sales) will often rise. Such alternation unfairly increases the royalty amounts if the rate remains on the same level as in standard licensing deals.
Therefore, licensors may want to adjust the rate to balance out the final royalty outcome. In contrast, if the retailer isn’t a part of the royalty stream, the brand owner will want to charge the licensee. On top of that, licensing partners may negotiate a mixed royalty deal, combining the already mentioned payment methods.
Applying a royalty rate to licensed services is a rather special case, as there isn't a single tactic that would fit each case of service licensing. Each licensor gets to decide the rate based on individual terms of their licensing agreements. The average royalty percentage applied to licensed services varies between 2%-15% of the media buy, depending on the attractiveness of the property.
Another (much simpler) method of dealing with licensed service deals is to charge an annual fee for the licensee’s right to use intellectual property. In this scenario, the chosen (fixed) fee should reflect how extensively the service is utilized in its media buys and promotional activities.
Presently, sublicensing isn’t a widespread type of licensing deals. However, when a brand sees the need to sublicense a deal comes up, both the brand owner and the original licensee are liable to royalty payments.
Generally, licensors require a royalty rate that falls within the range of 25% to 75% of the sublicensing income. Their stake usually amounts to not less than half of these profits. In rare cases, the licensee will be able to negotiate a rate split and apply their own royalty obligation to the sale of sub-licensed products.
Licensing partners may also agree to divide the rate into several percentages according to the sublicensing categories. Among other factors to consider when sublicensing a property(-s) are the administration and localization costs. Licensees usually pay these costs from the licensor’s share of sublicensing royalties.
Sometimes, several parties guard a property - for example, the brand owner and the trademark holder. In such a scenario, it’s common for these parties to agree on a lower royalty rate to ensure that licensed products remain economically viable in the marketplace.
Other examples of split licensing royalty rates may also be met in the industry. For instance, if the licensor and the licensee co-brand a licensing deal, they will normally lower the royalty rate. The rate in co-branding deals should correlate with the extent of licensee's contribution to the success of a subject licensing program.
Another example is cross-licensing deals, where multiple properties extend into one product. In that scenario, the licensee pays a higher royalty rate, which is later split into equal shares or shares respective to each party's contribution. Ultimately, such split lowers individual royalty earnings by each party.
In this post, we mentioned only a few types of licensing royalty rates that are commonly met in the industry. Licensing partners may (and ideally should) find a specific royalty rate that best represents the terms of their agreement. Often that will involve a custom-made combination of royalty rate approaches, clauses, and provisions.
Some brand owners may feel the need to dictate the rules of the royalty game. But to succeed, both partners should embrace their mutual contribution to ensure progress to their licensing program. Therefore, it makes sense to seek compromise when defining the type and amount of royalty rate.