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.
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.
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.
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.
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!
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).
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.
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Is there any time that a company interested in licensing your product will ask you to pay a fee in order to get a licensing agreement?
There are also licensing companies (that sometimes do some of their own manufacturing) that ask for money to develop your product. These companies typically have a bad record for the number of products that they get to market and produce royalties--they make money from licensee contributions more so than royalties. In the USA I believe they are required by law now to state their success rate somehow so that you can discern how successful they are. Depending on your relationship, risk, faith in the partnership it might make sense to help in the development, but in my experience is not common.
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Hello Bruce M. and Stephanie Tharp, I really enjoyed reading your article on the concept of licensing an idea, so I like to ask is there any sources of help to prevent a company from stealing an idea when it is patent, because a company have reach out to me about my patent and I sent the company the business plan of my idea including its features and how they to function when my idea. Now I ask because now I don't have the finance to get legal help because I'm a student studying legal studies, and I felt that the company saw the potential within my idea being that hoe it to function is totally new involving texting and emailing, and that I did not think of it tell afterward to check BBB and saw a complaint that an individual experience what I have done and stated that he/she felt or was treated as the company was a scam company. So, I appreciate whatever advice that can be given to make that company does not steal my idea and profit off of it without my permission and me not receiving nothing. Thank you.
Albert, It is possible that doing your own market research would be helpful to a potential licensee. Presumably they would need to be convinced that it is not significantly biased in any way, e.g. it's your friends and family are the respondents and the questions are not leading. Fundamentally it needs to be good information that moves toward standards of validity, reliability, and generalizability. Other marketing data can be helpful as well, like a market analysis of the competitors, though often if a licensee is in the industry they have a better sense of this than you might.
Honestly, I am not so sure that a bunch of positive comments from unknown people--just names--would have a great deal of influence. It is certainly better than if they were bad comments, but do these people actually represent those who might purchase? Have you determined a target market that would be meaningful/relevant to the licensee? Just because someone likes the idea does not mean that they are moved to purchase. Perhaps there are other ways to get user feedback, or more specific or more useful feedback. I have seen very convincing videos of people using products where it is obvious that they are amazed, or convinced, or otherwise pleased. Perhaps you want to convey that it is easy to use and you show candid videos--no need for high production. Of course you want to do the research that helps answer the most important questions that a licensee would have and that would help mitigate risk.
Your research is valuable to them when it might save them money in having to do it themselves, just like with product development efforts or marketing efforts of the designer/inventor. If i was a potential licensee I might be more concerned with how your solution compares to other competitive products--like air in a can, for example. Do people prefer yours? At what price? What are their biggest concerns or barriers to purchase?
Generally research provided by the inventor at the pitch stage would likely only nudge a licensee unless it was powerful research that was believable. Third parties are helpful, but of course add cost.
But perhaps just as much as convincing a licensee, research helps you the inventor know more and be more confident or better understand the shortcomings (which all products do) and how to address them.
Best of luck!
Thanks Bruce for checking my product out, and for your honest opinion. A couple of years ago I had done another survey on another product I invented. I got over 124 people to give me a rating from 1 to 10 and most all of my ratings I got all nines and tens. After I did the survey I decided to market it myself so I took it to Walmart. They wanted me to demonstrate my product to them. After I demonstrated my product the manager told me that he loved my idea. And he told one of the other managers that were in the room with us to take me where the beach equipment was. He showed me that he had a place on the shelf where they would display my product. I was surprised that Walmart was ready to do business with me. They were ready for me to start manufacturing my product by the thousands. But I had to tell them that I will have to get back with
them, because I didn't have any experience in marketing. that's why I am trying to put my products into a manufacturer's hands, like Stephen Key says we should do and let the manufacturing company handle everything for me. I have many great ideas but I don't know how to read or write because I had dyslexia and I also got lead poisoning when I was a kid in the Bahamas, so it makes it very hard for me to do what I am trying to do but I know one day I will be able to get my products into a manufacturer company hands.
Congrats on your deal.
The issue of indemnity is very important. This is protection if something goes wrong.
It is not uncommon for a licensee to try and put the liability for a problem onto the designer, but it is not fair in general in my opinion. It is understandable that they would try, but I have never singed a contract with this. In my experience once I raised my concerns the company changed the contract in every case, because they realize that it is unfair.
If they are actually manufacturing the product, why would you be responsible if it fails? Likely they will be doing the engineering and fabrication, which you have no control over. I suggest that you express your concerns--remember everything is negotiable. Also remember that they are making the lion's share of the profit.
The only liability that I have taken on is over the originality of the idea, to the extent that I know. It makes sense that they have no idea if you actually stole your idea from someone and would be concerned about that. While I accept liability if it turns out that I knowingly and willingly violated someone else's intellectual property, I do not accept liability for the overall originality of the idea. Independent designers are generally not in a position to enter into intellectual property litigation--this could be a frivolous claim or a legitimate one or an international one. They should be willing to take that risk on, just as they do with their own products.
My sense is that they will understand your concerns--make them known respectfully in the spirit of negotiation. But in the end you should not take on liability for anything that is out of your control because litigation can be a bankrupt-er (which is why they want to try to and get you to take it on rather than themselves if you let them).
Such a helpful article, thank you. I am hoping you or someone can direct me, I have two ideas:
Alberta, This is a tough one, at least your second question--what you should say. The first part is easy, you already know the companies so just call them and try and speak to someone on the phone. It may take a while to find the right person, but if they are game for this kind of thing, you will find them. It is certainly possible that they are not open to this as companies run a risk with 'open innovation.'
But the problem you have is that there is no intellectual property to protect. Companies are loath to pay for something that cannot be protected. Your best bet is to try and have a conversation with them--ideally protected by an NDA, but that may be challenging--to see if they are game. If they are you would need to find a way to directly measure the financial impact of your idea. The least risk for them is a royalty for that market.
In my opinion, this only has a small chance of working out for you, but is still worth pursuing because you have very little invested in it. You should always be thinking about return on investment, and if this were to hit, any money you would get from them would prove to be a high percentage. Without an NDA though they could very easily take your idea with no recourse. But, what have you got to lose if you do not try? What would you do with your idea anyway? Good Luck.
Thanks for your comments. Below is some information regarding OXO's process. I am not sure if it is still up to date or not, as these things tend to change if they get swamped with submissions. Best of luck.
Every inventor submission received by OXO undergoes an evaluation to determine if it will fit within our current breadth of product line. Feel free to submit your invention in any of the following formats: Hand drawings CD of images Photographs Video demonstrating product in use Prototype Please include a written description about your invention, and include any relevant legal information about the steps you may have already taken to patent your invention with the United States Patent Office or any foreign patent offices, as well as, information about who you may have already disclosed your idea to prior to our communication. Our evaluation process takes approximately one month to complete. At the end of this time, I will contact you with our response. Everything should be sent to my attention at: OXO
601 West 26th Street, Suite 1050
New York , NY 10001
Tel:212 242 3333
Fax:212 242 3336
Address: 601 West 26th Street, New York - NY Zip: 10001
Phone: (212) 242-3333
Types of Products Sold: Bakeware, Cookware, Organizers, Gardening, etc.
Email Here to Submit: Inventions@oxo.com
As an inventor with having ventured a product and selling it through 550+ retailers, I enjoyed and "salute" your series, Bruce. It definitely has a PhD-quality with its content and writing style.
I am going to start working with a licensing company that has connection with a lot of big name retail like Walmart , target, Walgreen and more,
they are going to help me create my product they offer me a 20 to 80 % royalty from their company meaning 20 for them and 80 for me. then they also told me that they work with retail product licensing which has a typical royalty range of 3%-7%.
now with all honesty they told me that my product has a 95% chance to be a success because of the category my product will be in which is product for dogs.
what I would like to know is how much revenue will my product make with a 3%-7% royalty.
Hi Sue, I have patent product that I am looking for licensing them, can you help by recommending licensing company that are honest and trusted.
Sue, which licensing company? These waters are shark infested and the majority of them are predatory. I might be able to shed some more light on what I've heard about them.
Ekoda, you might want to investigate Stephen Key's www.InventRight.com website.
Great series, though, numbers are right on. Most people cannot retire on royalties as product lifetimes keep shortening so you have to run constantly, not like finding oil in your back yard.
I agree with you completely, Eric. Someone at MeetUp told me about holding a Chinese knock-off BEFORE someone's crowdfunding campaign had completed.
Design is the easy part (phones at Best Buy), identifying a new problem, that is the hard part.
Which brings me to your comment on Quirky, I am very cautious of what I submit to quirky. I rarely submit a design that identifies a new problem, because that IP is very precious. And first to market with the solution to new problem is a huge advantage, even when the problem is only perceived.
As an inventor, I agree with you, Jeff.
My largest hurtle is getting my concepts in front of companies, I have several that have gotten great feedback but don't fit the reviewer's market space.
Jeff, in case you're not following this thread, I'll repeat what I've already suggested to someone else.
DAN, congratulations! After you get that first one under your belt; it can be addictive. If you are game, I would love to talk about your licensing experience. You can email me through core77.
I know someone that acts as a "matchmaker" between U.S.-based inventors. With his 10+ years of experience with developing 600+ products, he says the development cycle is generally 18 months.