You may have to wait six months to a year to get on the shelves after a buyer agrees to sell your product
So let's talk money.
In the first article in this series about product licensing for industrial designers, I presented a vision of what is possible—positive, encouraging, optimistic but slightly cautionary. Here, I am interested in throwing out some numbers so that you can decide if licensing might make sense for you (or under what conditions it would).
It is important to understand that there is no "standard" contract across industries or even within a company. Everything is generally negotiable and there are many ways that compensation can pan out. The most common mode is for a company to compensate through royalties only, which helps mitigate their risk that the product may not sell well. It is also possible for the designer to receive up-front cash in addition to royalties, but often this is just an advance payment deducted from future royalties. But this is still good if you can get it, because there is no guarantee that there will be future royalties. Hence, companies usually only agree to advances if the amount is relatively small and/or if they are confident that the product will sell. Insisting on significant money up front is often a quick way to sour a deal.
OXO offers licensors both cash buyouts and royalty deals
Some companies prefer to buy the intellectual property outright in one lump sum—as with Ikea, for example. This is more of a gamble for the licensee, but saves the administrative hassle of calculating and cutting royalty checks, as well as the risk and cost of potential contract re-negotiation or disputes with the licensor (you). But with this risk comes the reward of saving all the royalties they would have paid out if the product proved particularly successful. Some companies like OXO consider both the royalty and cash-buyout options.
Companies can also offer an equity stake in the business that surrounds the product. This is much less common, however, and occurs usually when the designer brings more to the table than just a single new product idea (e.g. name cache, design services for a whole product line, expertise and connections, or even money). More established designers/consultancies do this, like Yves Behar's fuseproject that has had at least 18 equity partners including, more recently, with Core77 Design Awards 2012 Notable for Consumer Products, Sabi.
Fuseproject's recent joint venture, Sabi pill products
I am going to focus however on the most common approach—royalties-only. In doing so, I want to emphasize the need to understand the licensee's position. Being in the mass-manufacturing business is tough! There are high start-up costs with tooling and initial inventory, increasing pressures from mass retailers (like having to take back product if it does not sell!), overhead costs of product development and sales teams, stiff global competition, changing regulations, expensive and lengthy certifications, insurance, etc. Young designers often gasp when hearing that a good royalty rate might be 5% of wholesale cost (around 2% of retail price)—"but it is MY idea!" Seasoned designers understand that a designed product (not to mention one that is not engineered, sourced, and fully developed and tested) is but a small part of the business equation. While important, good product design needs so much more to be a lasting commercial success. At the heart of the numbers is the issue of risk. Designers, in most cases, have very little to lose beyond their time and relatively small development costs. In the business world, the bigger risk-takers earn the bigger the rewards.
I mentioned in the last column that many of the design-y companies (like the big European furniture and furnishings enterprises) often fail to yield substantive paychecks. They can be good for the portfolio, but not the pocketbook. This is in large part due to a lack of substantive intellectual property being offered for license. Much of what sells is not particularly novel. Look at the similarities in product lines at Crate and Barrel, West Elm, Room and Board, Restoration Hardware—these companies are going after the same basic market, and when one has a hit product, the others follow suit with their own derivations.
This is certainly not unique to furniture and occurs to some degree in probably every industry. My (tragically) favorite demonstration of this sameness is the telephone aisle at Best Buy. Overwhelmingly there are just slight aesthetic differences, that possibly could be protected by a design patent, but that would ultimately not afford much protection. I am an advocate of design patents when approached and drafted strategically, but in a mature product category where there is a great deal of prior art, they aren't so effective (or would take hundreds of thousands of dollars to enforce with litigation). Manufacturers must navigate these treacherous waters and understandably are wary of paying significant sums for product ideas that cannot be protected.
Design patent enforcement can be more challenging in a mature product category
I advocate designers getting into the game of novel functionality, rather than just form (or secondarily producing form that can be well protected through design patents). If designers can produce robust intellectual property, they have access to a greater pay out, otherwise licensing is a bit of a crapshoot. [Ed Note: For more on Design Patents check out our full series here!]
While some complain about the intellectual property protection as impeding innovation, it is intended to spur advancement by offering a reward (a short-term monopoly) for the risk of investing in something new. Like it or not, these are the rules of the game, and for product design, they are generally fair with generally equal access. Enforcement of patents, however, is problematic, as litigation is, as my attorney puts it, "the sport of kings." Luckily for more traditional product design, as opposed to information technology and electronica, disruption by patent trolls is less problematic.
Crocs recently won a major design patent infringement
While admittedly the patent system is far from ideal, product designers can more easily get aboard on the front end—securing IP for licensure—while the licensee is usually at the more troublesome back end of enforcement. (But going after infringers may still not be cost effective, and both licensor and licensee lose with reduced sales.)
So let's say you have a protectable new product idea—how much money is in it?
The answer depends on a few major factors: royalty percentage, the amount the royalty percentage is based on, cost of the product, number of units sold, and time period. The wise licensor considers all of these at the outset, when vetting a new product idea and before investing too much time and energy.
Royalty rates vary per industry, but a good rule of thumb is between 2-3% on the low end, and 7-10% on the high end. I have licensed consumer products for as low as 3% and as high as 7%, with 5% being the most common and a generally fair number.
But 5% of what? Usually this percentage is on wholesale cost, often "net sales" for the manufacturer. This is not the price tag in the store, but is often less than half of this—40% is pretty typical with larger retailers. (So, $10 retail price tag is sold at a wholesale price of $4; the retailer has a "60% margin"). And be careful, especially with the big-name European furniture and furnishings companies. Their notion of "net sales" is often actually at or near the cost of manufacturing, sometimes called "first cost," which is generally half of wholesale cost—ouch!
"Net sales" may be closer to manufacturing cost than wholesale price. Photo by Mike Roelofs.
Price-point of the product must next be considered. If the retail price of product is especially low (less than a dollar) or is especially high (hundreds or thousands of dollars) then royalty rates often reflect this. Both parties generally have their eye on the final cost of the license, and purchase price has some relation to sales volume. Understandably fewer $3000 products are sold than $3 products. In my experience it is tougher to make a decent paycheck on a $9 item than a $19 item. While more people can afford a $9 item, a $19 item is still accessible and the units sold can be equivalent, but usually the royalty rate is the same. So, within a range, you are often better off shooting for a product that sells for more.
As mentioned, number of units sold is a critical component. This is why distribution is so important and why mass retailers are often the key to a nice royalty check. If a retailer has 1000 stores (like Bed Bath & Beyond) and they sell 1 product per store per week, then this is 52,000 products per year. (Usually if your product is not selling at least at this rate, they will drop your product.) With a fairly successful product, you may sell 3 units per store per week, or 156,000 units each year. If the product sells for $25, wholesales for $10, and you have a 5% royalty deal, then you are looking at $.50 per unit sold, for a total of $78,000 per year. Nice payout. If it sells at the minimum of 1/store/week, this is $26k per year. This is not to say that getting a product into a mass retailer is easy—it definitely is not. And many of them test in a small number of stores, slowly getting, if ever, to a full national rollout.
But the idea is to begin with the market in mind (and likely a mass market), which is often not the designer's propensity. When in licensing mode, the successful designer abandons the many cool product ideas that she has which do not have a chance at mass appeal and large distribution. Please check out my royalty calculator to help estimate the potential licensing payoff—do this before working too much on the idea, as it just may not be financially worthwhile for you. Remember you not only have to develop the idea, but will have to sell it, which takes time (and is the topic of a future article).
Use a royalty calculator to vet new ideas for licensing potential
The last issue to consider in the calculus is time. How long will the product sell? Product lifespans vary by industry, but usually there are growth-, maturity-, and drop-off-stages. You should probably not expect more than 3-4 years of strong royalty checks for a given product before sales begin to slide. If a product is successful, you are assured of sales dilution from knock-offs or derivations that quickly follow. And financial derailment can easily happen at any turn, given the vagaries of corporate politics and strategy as well as innumerable external threats. For an excellent inventor's account of the rise and maturation of an innovative electrical power strip, read Christopher Hawker's "The Song of the PowerSquid".
The other time element to consider is the wait for your first royalty check after signing a licensing agreement. Plan on 1-1/2 to 2 years, if at all. Firstly, licensing deals fall through all the time, even just weeks after the agreement is inked. This is because the company wants to sign an agreement before they invest time and money in actual product development—when things usually fall apart. Licensees also want a contract signed before they present the idea to potential retail buyers. If there is not enough initial interest, the project gets dropped, and the contract is nullified. (You may be able to negotiate a "kill clause" in the contract that offers a small fee if the licensee chooses not to move forward.)
If there is preliminary interest from buyers (often based on renderings or prototypes), you still have to wait for product development, packaging, certifications, manufacturing and shipping. You may also have to wait up to a year to get into a mass retailer depending on when they update their store-shelf planograms. And then you wait at least three months as royalties are commonly paid quarterly.
So licensing is not a quick and easy road to riches, just as with all other legal enterprises. But it can pay off and work for you if you have the right expectations. In my experience and in speaking with other licensors, making $20-30k/year licensing a $15 mass-market item is doing pretty well. Of the 8,000 new kitchen products introduced each year, as many as 95% of new products "fail", according to the Food Network's Invention Hunters. There is a lot of competition, and flailing products may generate just $1000 royalty dollars per year. A dental company with a large catalog that I licensed a product to, even maintains that a product with $6k of net yearly sales is average and worth keeping in the catalog—dhello there, $100 quarterly royalty checks! This is why you usually need to maintain a number of licensed products, inevitably in various stages of growth, maturity and decline, to make a proper living out of it.
But you can certainly hit it big too. And this is what keeps the dream alive and can make product licensing exciting. Like all other forms of work, you are better off being energized by what you do, most especially if there is no guaranteed payoff. And, it is important to have the right expectations about the chances of getting a license, getting a product to market, getting sufficient distribution, and ultimately getting a decent royalty check. You should always run the numbers on what your payday might be with a new idea, given the price-point, distribution, and likely royalty rate, before investing your time and certainly your money on prototypes and intellectual property protection. It can be a fun and lucrative ride, but it's not get-rich-quick for the overwhelming majority of new product licensors.