Inevitably one of the first questions asked is how much will we earn in royalty revenue. As an industry expert I wish I could rattle number off and answer this question but unfortunately, I typically go with the over used statement of “it depends”. There are so many factors that go into negotiating a royalty rate and estimating royalty revenue. The royalty rate is probably the second most negotiated term of a license agreement, the definition of sales is the first.
To determine what a reasonable royalty rate may be for your licensing agreement you should do some research. Here’s where to start:
- Industry average rates for similar categories/brands
- Category Margins
- Marketing investment needed for the product launch
- Product Development and annual sales projections
While doing this research, remember that CPG licensing partnerships are typically a long term investment and take 3-5 years for either party (licensee and licensor) to realize a significant return. Entertainment licensing deals can be more short term to help with a movie release or promotion.
- Industry average rates for similar categories/brands. The Licensing Letter Royalty Trends Report is a great place to find industry royalty rates. However, please note that they will typically give you a range so this I just a place to start to make sure you aren’t paying too much in royalties. The report can be a little pricy, you can always ask your friendly licensing agency (wink, wink, nudge, nudge) for help if you don’t have money in your budget for the report.
- Category Margins. Obviously you don’t need to research your category margins, you know them. Be careful with this information, it is your negotiating power. Depending on the margins of your product category will determine how much of a royalty you can pay and still make a profit. You will likely need to share your margins on some level but just know that they will affect how much the royalty rate will be.
- Marketing investment needed for the product launch. Make sure you have a good go-to-market plan and know how much investment it will take to launch your licensed product. Sometimes you can negotiate marketing commitment dollars in the first few years for a lower royalty rate. Let’s say for the first 3 years of your agreement the royalty rate is 4% and you will resubmit 2% back into marketing the product. Then 6% royalty rate starting in year 4 and continue to pay 2% of royalties back into marketing.
- Product Development and annual sales projections. This point ties into the one above. I have seen licensees jump into a license agreement without understanding the financial commitment of the deal and then they have to ask for relief from their contract. Please make sure you have a full 3-5 year business plan prepared for your licensing program. Taking on a brand does not guarantee that it will fly off the shelf, you still need a great product and a solid marketing plan to find success.
- Industry average rates for similar categories/brands. Similar to the advice above, finding industry average royalty rates is a great place to start but will only give you a range. The Licensing Letter Royalty Trends Report is a great place to find industry royalty rates, or you can ask your favorite licensing professional to look this up for you! Obviously this will be negotiated so you will want to start as high as you can but keep in mind it may not be the best rate for the overall health of the partnership. I have seen licensor squeeze licensee for large royalty rates only for the program to flop. The licensee didn’t leave enough margin for themselves and didn’t have money to market the product or re-invest it in product development. This leads us to point 2 below.
- Category Margins. This research can be a little tricky for a licensor but very important to understand the margins of the licensed product category. See if a retailer friend can help you out with a high-level overview on category margins so you can better understand the business opportunity.
- Marketing investment needed for the product launch. Typically the brand owner is not responsible for marketing the licensed product, the licensee is. However, the licensed products needs some marketing support to be successful. Do not assume your marketing efforts will carry the licensed product, especially at launch. Also, please don’t let your licensee assume this either. Make sure there is a marketing plan and budget for the licensed product. They will need this approved by you, the brand owner, so you can help guide them on messaging, graphics, etc. After all, isn’t this why you licensed your brand out? You want to help your licensee extend your brand message and value. If you have a strong brand and marketing team it may behoove you to help your licensee with this.
- Product Development and annual sales projections. This too is the responsibility of the licensee but it your responsibility as the licensor and brand manager to ensure that your licensee has a strong business plan. You don’t want to license your brand out for the product to fail and disappoint consumers. Make sure you have the right partner with a good plan and a great execution team!
Good luck! We love seeing new licensed products in the market place. Give us a call if you need any help with your licensing partnerships!