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)Â 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%Â = $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!
Your Turn
If you like these posts, please give me your feedback and comments below!
It helps me to focus on topics that most interest you!
Stay tuned.
Great article!
Thanks, Judith. What did you find most helpful about the article?
This is a real world article, I love it!
One question: I heard that the royalty is based on net sale. So what is the difference between the net sale and gross sale? it seems to me the whole sale is the gross sale , retail(sale)is a net sale. If I am wrong? Thank you.
JC,
Royalties are almost always paid based upon what the licensee gets paid. It is paid on net sales (not the same as net income or profit). The licensee is paid
wholesale. So, if the retail price is $20, the licensee likely sold in for $9 or $10 wholesale. If $10, then a 5% royalty would be $0.50 to the inventor.
Thank you very much, Alan.
I am so glad that I found your site.
Great help!!
Thank you for writing this article, Alan. I was surprised. Having no clue and to avoid disappointment, I actually guess-timated royalties at .01%. 🙂 Furthermore, I’m always considering the best way to invest earnings. Royalties that keep pace with inflation remind me of gold and silver investments. There are different parameters of course and royalties are based on product demand. If I’m correct, your friend’s success over the long term means her rate of income keeps up with the economy…better than depending on the company for a pay raise.
Hi, Tam. Let me know if I can help you. My email is alan-beckley@msn.com
Great article !
Alan, Is the assumption that the licensee will “manufacture” the licensed product themselves, or sub-contract to others? If so, then they will develop their own wholesale price based on their own cost to produce? Correct?
Thank you,
Roger Scharf
***please copy me an email with your response.
Roger, the licensee will “manufacture” the product themselves (likely a Chinese manufacturer). They will treat it like their own product
once the license deal is consummated. This means they will make decisions on the wholesale prices they will use. Such prices will likely
very from vendor to vendor. Walmart might get a better deal than Target, for example.
Alan
Dear Alan:
I am currently negotiating a license agreement with a mid-size pharmaceutical company. They are interested in marketing some formulations that I have developed. So far I have negotiated a modest advance payment upon signing the agreement, a consulting fee of $x per hour for help they may need with my “Know-How” products which I have not patented. I am giving them the right to patent any formulas of mine that they want to and agreed to help prepare such patents. I agreed to a 1% royalty of “gross sales” for years 2 through 6 inclusive (5 years total). In the latest iteration of the agreement they have changed the royalty to be 1% for 5 years based on “Net sales”. Since Net is less than gross the % I get should be higher. Can you provide any guidance as to how much I should ask the revised % to be? Thank you.
Jim,
Congratulations! This sounds quite encouraging. I have a couple of questions and suggestions.
First, I think they aren’t actually renegotiating so much as clarifying. Royalties are typically paid based on “net sales” as long as:
Net Sales = Gross sales – returns
So, if total (gross) sales were $100,000 and they had $5,000 in returns, then the royalty would be paid on $95,000 or net sales (not gross sales).
This is appropriate as the company should not pay royalties against things that were returned to them (and there are always returns).
My question is what happens in Year 1? Why are you paid no royalties during Year 1? Perhaps they anticipate it will be 1 year before the product is out there?
So, if the above is how they are calculating “net sales” then there is not need to adjust the agreed upon 1% royalty.
Also, my suggestion is that you have a contract attorney the agreement they provide you before you “sign on the dotted line.”
You can reach out to my email at alan@alanbeckley.com if you’d like to follow up further.
I have been following you on the Internet and I have a Question I hope you can answer for me.
I am selling a Baby Product which was my Invention and has been on the Market since 2013.
( Pat.pending)
What would be the most profitable way Royalty wise, by the Piece or or a % at the end of a Month of gross Sales.
Is it okay to ask for a small Advance.
For how long should the Royalty be paid?
Thank you for any Advice you can give me.
Helga, the key is to first and foremost focus on EXACTLY what your product would do for a potential licensee (company). Will it be a product line extension?
Can it help them to reach a desirable demographic (they aren’t reaching currently)? Also, you really need a 5X mark up (or close) from manufacture cost to the
retail price for it to be profitable to a company.
Think of the pitch to a company being a bit like a job interview. You must know about the company, their product line, what is important to them so you can focus
your pitch on that.
To answer your questions, I’m not sure what you mean by “by the Piece.” Royalties are paid on net sales of a particular product and are paid quarterly to the inventor.
It is always okay to ask for a small advance, but we willing to give in if they say no. The length of time the royalty will be paid is driven by the success (or lack
of it) of sales in the marketplace. License deals typically are set for an initial term of 1 year, then extended each year for another term (of 1 year) as long as both
sides are happy with the results.
You would really benefit by coming to my The Inventors Bootcamp that kicks off on Mon 8/9. It is a full week of training via Zoom meeting for only $37.
Just go to this link for all the details and to register to attend: http://www.alanbeckley.com/bootcamp
Good luck
Dear Alan,
I finished writing a book, and I would like to publish it. What is the best way to do it? Self-publishing or a company publisher?
Can you advise me? I was offered 40% from sales from a company. They told me that I keep 100% royalty. Why am I getting only 40%?
Thank you so much for any advice.
Lumi,
I’m no expert on book publishing. But many people have written about the pro’s and con’s of self-publishing versus traditional publishing.
Just do a Google search. I believe Pat Flynn has done both types.
Hello Alan,
I was interested in purchasing your inventors 5-day bootcamp class. I noticed it was for mid septembre. If I buy the class, will be able to watch recordings for the class? Will I be able to email you after the class for specific questions?
Mame,
Your timing is great!I have better news! You can attend LIVE in the October bootcamp.
I just opened the registration for the OCTOBER bootcamp. It starts soon (Mon 10/11).
For the first time, I’m offering it in evening hours (as many cannot attend in afternoon).
Here is the link to register now:
http://www.alanbeckley.com/bootcamp
Hello Alan,
I have a quick question. What access does the licensor have to the licensee’s accounts in order to verify that the level of sales on which royalty is calculated is accurate?
Great question. The licensee must provide a spreadsheet of all sales each quarter to the licensor. That way he/she can validate they were
properly paid.
Hi,
I have an invention that I am very proud of. Could I search out manufactures who might be interested in making the product and packaging it. I am 93 years old and am not interested pursuing a patent that takes time nor looking for royalties which take more time. Question: Could possibly sell the rights to one of these manufacters for say $10,000 or what have you and just get out of the whole thing and hit the recliner? The product is a extended hand rail fashioned onto the shower wall to give greater access to something to hold on or catch a fall. I know the products on the market today but they don’t do the job that my unit does.
Thanks for your reply.
Arnold, marketing of an invention is always the toughest part. The work to sell the rights outright is no less than to license it.
Generally, licensing is a better deal as you can collect royalties for an extended period. However, without a patent, companies are not so inclined
to take on a product any competitor could legally copy. Inventing is a very risky venture: costs tend to be weighted up front, and any profits could
be years later, if ever.
Sorry not to give you a more pleasing response!
Alan, thanks for your wisdom and insight. I saw a company (bestbath) that in 5 minutes could adapt my project into their line with no problem. But for me to apply for a patent and spend that kind of money and worry about it for maybe months to see if it would result in a patent, it is probably a little more than I desire to do at this point in my life.
I hate to let my project just sit in my bathroom and not get exposed and not benefit other people who could be using it to their benefit. Older people falling is a big deal these days and even in the shower could be worse. I guess for that matter, I could buy all the parts from Lowe’s or Home Depot and box it up myself with instructions and just spread the word and sell them myself. At this point we are still a free country and entrepreneurship is still alive and ongoing. I am interested in your comments. Thanks
Kindest regards,
Arnold