Visions of grandeur.
I get them, you get them, every inventor gets them – or we wouldn't be inventors.
You look at your product and think about how great it is, how it solves a problem for you and likely for millions of other people (can you feel your pulse racing?). So, you do the imaginary math of what you would earn with huge sales of your invention in the marketplace – so why not assume a 10% royalty rate (makes the calculations easy too).
Here is what the vision of grandeur might look like.
You picture your $20 retail product selling 1 million units in one year, for which in your wildest dreams, you'd receive a 10% royalty. Here is your mental picture:
$20 times 1 million units = $20 million in gross sales for 1 year
$20,000,000 times 10% = $2 million in royalties to me! Yippee, yahoo, Bora Bora, here I come.
Wait! Don't Pack Your Bags Just Yet!
Okay, come down off of Cloud 9, now it is time for a sanity check.
Maybe 1 million people might indeed buy your product. But how likely are 1 million people to buy a brand new product, with which they at not familiar, in the first year?
Here is the real answer: very unlikely.
Don't forget, you also have lots of competitive products already out there. You must differentiate your product from theirs. But, in the beginning, consumers have never heard of your product – so this is going to take time, quite a lot of time. Maybe 3 years or more.
Okay, so what if only 300,000 people buy it in the first year? Now your initial calculation looks like this:
- $20 times 300,000 = $6 million gross sales in year 1
$6,000,000 times 10% = $600,000 in royalties – probably still a bit more than your boss pays you!
Reality Check – The Real World
Now it is time for another reality check. Sorry.
Here are three essential facts you must face when you license a successful product into the marketplace:
- No one is going to pay a 10% royalty rate, probably much closer to 5% (or even less)
- Your royalty is not paid on the retail price, but rather the wholesale price (typically 50% or the retail price)
- It could easily take 6 months (or more) to get your product onto the first store shelves after you license it
- Retailers may take up to 3 months to get a new product rolled out into all of their stores
- You may not receive a royalty check until 9 months after licensing it
The bottom line is that, at the end of the first year, you may receive a royalty check for only 1 quarter of sales that reflects a gradual rollout into stores.
So, here is your new, more realistic, math for a 5% royalty – with a few assumptions based upon my experience:
- $20 times 50% = $10 (wholesale price you get paid on)
- $10 times 75,000 ( rollout volume in 1 quarter) = $750,000 in gross sales
- $750,000 times 5% royalty = $37,500 royalties in first year after licensing (just one quarter of sales)
Wow! What a crashing thud you experience as your previously envisioned $2 million royalty check for first year's sales just plummeted to only $37,500. Yikes!
No Bora Bora trip on that.
Are You Ready? It Gets Better – Much Better!
After such a disappointing first year, you may be ready to scream and shout how unfair the whole deal is. It seems that everyone is making money but you! But, you are the inventor, how can that be fair? Without you, they'd have nothing to sell at all!
So many inventors who license go through this emotional roller coaster of (unrealistically) high expectations and abysmally low results during their first year of licensing. The key word here is emotions. Now, let's channel our inner Spock of pure logic for just a few moments.
If that first year was a bit frustrating for you. Let's look at it from your licensee's perspective.
Sure, they notched $750,000 in gross sales of the product. But, they incurred a lot of one-time and other up front expenses to get the product rolled out into their large retail pipeline. Probably they poured around $2 – $3 million into sourcing a large number of units (maybe 500,000) to get the retail pipeline filled and gradually selling.
At least you realized a (small) profit. They almost certainly experienced a loss at the end of the first year.
But, everything gets better in the second year – much better.
Now, enough time has passed that your licensee will have filed the retail pipeline with product and sales will be brisk (we hope, anyways). It could be realistic that 300,000 units may sell during the second year.
Based upon that, here is what your royalty for the second year might be:
- $10 per unit wholesale times 300,000 units = $3 million in gross sales
- $3,000,000 times 5% = $150,000 in royalties
That is not bad! For that $150k you didn't have to do anything except check your mailbox.
IF your product is a continuing success (never guaranteed), you may collect royalties for many years.
A friend of mine has collected royalties on her product for over 15 years and has watched sales (and royalties) gradually rise as the product sold in more and more stores and inflation increased the product sales price.
So, if you have licensed your invention, congratulations! Now, just be patient and let your logic dictate your actions, not your emotions.
Finally, let the passage of time work it's magic to deposit progressively larger royalty checks into your bank!
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