In the previous blog – Why Most Inventors Fail – Too Many Idea, Too Little Focus, I discussed both the strengths and weaknesses of creative thinkers. Inventors are great at generating large numbers of ideas (a strength) but weak at culling them and focusing upon the best ideas to go forward.
Another prime reason why most inventors fail – is inventor greed.
One of the most exciting times for an inventor – having a licensing deal pending with a manufacturer – is also one of the most failure prone. The inventor has labored for hundreds or perhaps thousands of hours on his or her “great idea” and, at long last, someone finally sees the genius in the invention and wants rights to manufacture, sell and distribute the product.
The pending deal often unravels because the inventor perceives the small royalty rate offered to be too puny and demands a higher percentage. While I fully support any inventor negotiating for the best deal they reasonably may achieve, inventors often have unrealistically high expectations because see the deal only from their perspective.
For example, an inventor may have read that a “typical” royalty rate is 5 – 7%. Actual royalty rates vary considerably based upon the type of product involved and the circumstances of the specific deal. When the potential licensee offers only 4% royalty, the inventor may feel cheated and insist that 6% is what they should get. Soon the licensee gets cold feet and elects to back out of the deal; and the inventor has metaphorically snatched failure from the jaws of success; a sad and unnecessary result.
How can such a debacle be avoided? The inventor should consider things from the perspective of the manufacturer.
The company is willing to manufacture, package, and distribute the new product throughout their entire system, assuming considerable financial costs and risks. They are willing to incur considerable cost up front, because they feel that the product can do well over over time and may yield an acceptable return on investment (ROI) for them over the long term. Much of their cost and financial risk is incurred at the beginning of the process before they have garnered any sales.
Many costs can be amortized over the life of the production run so that the more product manufactured and sold, the lower the unit cost to them becomes. This is not true, however, of the royalty rate that is paid on every unit sold. Put another way, if they have a gross profit of 12% and they pay a royalty of 4%, then they are paying the inventor $1 for every $3 in profit they obtain. This really is a sweet deal for the inventor –the inventor is effectively getting 33% profit sharing in this example even though they have zero financial risk.
Instead of arbitrarily insisting on 6%, the inventor would be wise to have asked a simple question such as “I thought royalty rates would be in the 5 – 7% range, why are you only offering me 4%?”
The company might then tell the inventor that the 4% offer is in line with their overall risk and what they are able to pay for similar products. Perhaps there are unique features of the product that will require a good deal of educating for buyers (increased cost to them). Maybe the overall product is a bit bigger and will require more packaging and shelf space than competitive products. There are a variety of valid reasons why a lower royalty rate might be offered and why paying more is not a viable option for the company.
By simply asking a few questions, the inventor could avoid scotching the deal. Also, the inventor can make a counter offer such as asking for a ratcheted rate structure where they might get 5% on every sale over 500,000 units and perhaps 6% on every sale over 1,000,000 units. In this way, the inventor has the opportunity, if the product is very successful, to share in the success with a higher royalty rate.