PRICING YOUR IP MATERIAL FOR LICENSING

“So, what’s the price of that license over there?”

In every licensing course or seminar I have conducted on the topic of licensing, and there have been many, I always make it a point to remind those in attendance that licensing is all about the money. That is the most significant reason that most undertake the effort to make their intellectual property rights available for use by third parties.

I know, someone reading this is muttering to himself, that I got it wrong. The real underlying reason is based on the concept of “use it or lose it,” putting IP material into the market in order to keep trademarks current by proof of use in various categories. As logical as that may sound, for most of us the real reason we pursue licensing of our properties is that we want to see profit from such use of the material.

Looking objectively at a property, mark, trademark, or IP material – I list them all here as I plan to use them interchangeably and figure that by telling you this up front I will lessen the chance of any confusion – it is hard to know what if any value that raw mark has. Frankly, it may not have much value at all. Did I just hear someone spit up? Simply because you spent a bunch of time and some money to create a property, then spend a wad of cash to have it trademarked, more bucks on slick artwork and sales materials does not guarantee that you have produced something that has significant monetary value.

Return for a moment to the statement above concerning IP materials not being guaranteed a value. The value being referenced here is that which pertains to its value in the marketplace as a licensed property; specifically, what the property is worth in terms of advances, guarantees and royalty percentages. What should not be inferred from that statement is that if a (new) property does not have an established value then likely it has no value. The very fact that as a trademark a property acquires certain legal protections accords it some added value.

The question then becomes what is the key element that determines whether or not a property has value or will become valuable in the sense that it translates to the generation of royalty income? The answer: demand. Properties that can: capture attention, fulfill a need, touch the heart, entertain, provide services, or maybe just evoke laughter on a scale sufficient to attract the attention and desire of qualified third parties to obtain certain rights, generates value.

This all sounds good, trademarks have an inherent value, and demand is the key ingredient in establishing a market for a property, but where do you locate a licensing industry rate card that provides the guidelines for the sale and purchase of a license in a particular product category? You will not find it on Goggle, or on any other search engine out there, or by calling LIMA, the licensing industry trade association. No such thing exists.

Name an industry, a product, service, or any thing else bought and sold that operates on the scale that the licensing industry does (about 110 billion worldwide) without the benefit of any pricing guidelines whatsoever. As an example, a T-shirt license deal can closes with no advance or guarantee, whereas a license for the identical product rights for a disparate license can fetch a seven figure advance. Clearly, it is not the product category that is the determining factor in setting the financial terms. If it were, then there would be some consistency between the costs of licenses within each product category, which there is not. However, the product category does play a role in formulating the level of financial terms.

We are going to digress for a moment (NB: digression is like a literary bump in the road, but without the need to hold on). I often say that there are no dump questions, only stupid answers. Actually, there is one dump question: “how much is that license?” You would be amazed how often that question is asked. As proof that my statement above is true regarding dumb answers, I know many of my fellow licensors who would be ready with to respond with a price quote.

How in the world can anyone quickly respond with what the cost would be to obtain the exclusive rights to a property for use in say the T-shirt product category? The only answers I have ever come up with are the following:

• Department budgets demand that each licensing deal negotiated generate not less then “X” dollars per deal. Therefore, every deal has base terms which any license cannot drop below. This base level price becomes the licensor’s “bargain basement” structure, the cheapest deal that can be offered.
   
• Department budgets demand adherence to a set of negotiating standards by which each category of product will generate not less than “X” dollars. Therefore, in order to meet the year’s projections, the licensor must obtain not less than “X” for any deal he/she negotiates for that product category.
   
• Licensor simply makes up a number, hoping the potential licensee will say yes.

In my opinion, none of these are acceptable methods of negotiating a license for the reason that the word “rational” can be applied to whatever terms the licensor is seeking. There is simply no means by which the licensor can rationally explain what his terms are based on, other than the old department favorite, “we just cannot do a licensing deal for less than that.” Personally, I have never understood the logic of that response.

I will share with you my method of negotiating a license, which quite frankly, is a relatively easy formula to comprehend. It is based on placing the licensee in the position as the party most responsible for developing the terms (advance and guarantee) of the offer, as it is dependent on understanding what the potential sales volume of the license product will be over the life span (term) of the license. The following are the steps:

1. Determine the royalty rate.
    
2. Obtain the licensee’s estimated wholesale price per unit.
    
3. Multiple the royalty rate times the unit’s wholesale price to determine the royalty per unit cost.
    
4. Obtain from the licensee his estimated sales of licensed article(s) during the term.
    
5.  Multiple the per unit royalty times the estimated sales figure – this will provide you with the estimated gross royalties you should receive during the term of the license
    
6. Use this gross royalties earning figure as the basis for negotiating the guarantee and advance. As it is doubtful that any licensee will commit to a guarantee and/or equal to the gross royalty number, most likely the both will be a percentage of that number, often 50%-25% of the estimated gross sales.

EXAMPLE:

1. Royalty rate: 10% (EXAMPLE IS BASED ON WHOLESALE COST
2. Wholesale unit price: $1.00 (LICENSED ITEM WHOLES COST)
3. $1.00 x 10% = $0.10 (ROYALTY PAID PER UNIT)
4. Gross sales estimate: 1000 units (ESTIMATE PROVIDED BY LICENSEE)
5. 1000 units x $0.10 = $100.00 (GROSS ROYALTIES ON 1000 UNITS)
6. Guarantee: 50% of $100 = $50.00 (GUARANTEE FIGURE IF USING 50% OF ESTIMATE AS BASIS) or 25% of $100 = $25.00 (GUARANTEE FIGURE IF USING 25% OF ESTIMATE AS BASIS)
7. Advance: Based percentage of Guarantee: 50%-25% of $50-$25 = $$25-$12.50 (ADVANCE FIGURE BASED ON 50%-25% OF GUARANTEE)

There are several important factors to consider when negotiating a licensing agreement. As a property owner, in most insistences the income you will derive from licensing your property will be from royalties paid by the licensee. For the vast majority of these licenses the royalty is based on the wholesale price of the licensed product not the retail price point. Furthermore, royalty rates can fluctuate not only between categories, but also within the same product category.

Before you begin the negotiating process, you should already know the royalty percentage figure you want to achieve. If you are unfamiliar with what royalties are for a certain product category, I highly recommend the following publication: “LICENSING ROYALTY RATES.” The book is published yearly by Aspen Press, and it features a complete listing of just about every conceivable product and (separate) corresponding average royalty rate for: Art, Celebrity, Character/Entertainment, Collegiate, Corporate, Designer, Event and Sports categories. A marvelous work, this handy guide will help insure that you do not make a mistake by accepting a royalty that is below industry standards for the category for which you are negotiating.

Another important factor is whether or not you are in agreement with the sale estimates as provided by the licensee. As the licensee’s sales estimates provide the basis for negotiation of the financial terms under the formula presented, the question is how accurate/believable are sales estimates provided by the opposing side of a negotiation, knowing that such numbers could or will have impact on negotiating the financial terms of the agreement? Simple, knowing that any sales estimates provided are going to be below actual sales forecasts (perhaps by as much as 50%), it means that the sales estimates already provide a discounted sales percentage, which you can then factor into negotiating the advance and guarantee figures based on the sales forecasts provided.

All too often we place a disproportionate importance on the obtaining a high advance and/or guarantee, when in fact the most important factor in most licensing agreements, in terms of generating income to the licensor, is the question of the royalty level. An extra point of royalty well may be far more valuable over the term of a successful license, then a securing a few more dollars in advance or guarantee commitments.

One note of caution concerning the level of royalties, there is a very real limit on what the licensor can or should demand in terms of the level of royalty. It is very important to remember that the cost of the royalty is actually borne by the consumer, as it will be reflected in the sales price of the product; the amount of which will be twice the sum paid by the licensee to the licensor. As the royalty is calculated on the wholesale cost of goods, the licensee will factor the royalty cost into the product cost when quoting a wholesale sales price. If for example the royalty per unit is ten cents, when the manufacturer adds that cost to his product, when the product reaches the consumer, the retail price is likely to have doubled due to the retailer’s markup. Thus the ten cents of royalty has now become a cost to the consumer of an additional twenty cents added to the product’s cost.

While this may not sound like much difference, consider that in some cases, generic (non-licensed) product – which may be very similar to the licensed version but minus a cartoon character or nifty graphic adorning its packaging and sitting not too far away -- can retail for twenty cents less, and still provide the consumer with the same basic product. Also, as the royalty cost ads to the overall cost of goods, it may impact on the ability of the licensee to place the product with retailers. This is especially true when licensees are selling into mass market retailers. At this level of retail where margins can be razor thin, the royalty level is even more critical. In many cases, licensees will often negotiate for a lower royalty level on sales of products to the mass market due to the need to bring down the wholesale price point to the lowest price point possible. The rational for agreeing to a stipulated lower royalty for mass market sales is that the potential for high sales volume compensates for the reduction in the royalty rate.

“How Much Is That License?” Hopefully, based on what you have read above, you have a better perspective on that question. The answer is it cannot be found on any rate card, nor should it be a knee jerk response from the licensor based what the needs are to meet some internal income forecast projection.

The answer can only be achieved through meaningful dialogue between the licensee and the licensor based on an understanding of what is a likely and reasonable quantity of product that is likely to be manufactured, produced and distributed throughout the territory during the term of the license. It is the only basis, in my opinion, to reach a fair and rational licensing deal between the parties.

As always, wishing you happy licensing.

Danny Simon
The Entertainment Licensing Desk