Royalty rates often are a stumbling block in the licensing workflow. Previously, we talked about royalty rate approaches that apply in the industry. This time, we decided to explain what are the factors affecting royalty rates in brand licensing. Many questions remain a mystery for licensors, especially the ones who have recently engaged in licensing. Those are:
- How are royalty rates shaped?
- What are the primary and the secondary factors affecting them?
- Who has the bigger power in making a final decision?
In this first part of an article series, we're striving to answer these questions by outlining key factors that affect licensing royalties.
Frequently, the individual royalty terms that the licensor and the licensee arrive at depends on the power of intellectual property which is to be licensed. Based on the property position in the market, the negotiation between partners may or may not be difficult. Nevertheless, the chances of complexity increase if there’s competition in the property’s field. Licensing stakeholders widely use the following criteria in the process of evaluating the property’s strength:
- Property’s position in the market (the dominance factor)
- Existence of an identifiable customer base
- Audience demographics
- Strength of the license holder
- Property’s commercial past
Once licensing partners understand the worth of the property in the figures above, they can start discussing the final royalty terms for the license. The average royalty rates in a property’s industry also directly influence the ultimate rate. Here’s the range example of rates by industry:
- Art: 3% - 8%
- Celebrity: 6% - 10%
- Entertainment: 7% - 10%
- Collegiate: 6% - 9%
- Corporate: 6% - 9%
- Designer/Fashion: 3% - 7%
- Events: 9% - 14%
- Sports: 8% - 11%
It's important to understand that these are average ranges, and it's thus not recommended to base the rate decision on them. Nonetheless, these ranges can be very helpful in situations where licensors find themselves hesitating to determine the final percentage.
For the licensing partners to come up with a fair royalty rate percentage, they need to know what average royalty rates exist in different product categories. The following describes the standard percentages among the most commonly met product categories:
- Accessories: 3% -18%
- Apparel: 5% - 17.5%
- Consumer Electronics: 3% - 10%
- Food/Beverages: 3% - 12
- Gifts/Novelties: 5% - 17.5%
- Health/Beauty: 5% - 12%
- Publishing: 5% - 15%
- Sporting Goods: 2% - 15%
- Toys/Games: 5% - 15%
- Video Games/Software: 1% - 20%
While more often than not the royalty rate it's licensors who determine the royalty rate based on the success of their properties, in some rare cases the licensee can dictate their figures. This scenario takes place, for instance, if the product (or product category) is highly successful in its market, or the intellectual property of the licensor is fresh.
Importantly, these days licensors tend to be unwilling to agree on the rate of less than 10%, whether or not the rate relies on the product’s or the property’s dominance. In compromising situations, the last word in the royalty rate decision is likewise licensors.
Exclusivity (or lack thereof)
Exclusivity usually implies strict royalty income from the property category which is subject to licensing grant of rights. In this connection, exclusive deals are always a subject of high returns to the licensors. If licensing partners agree on exclusivity, the royalty rate may or may not increase.
Yet, the minimum guarantee tends to always be higher in exclusive licensing agreements. The reasoning behind this move is such that the licensor must be sufficiently and timely rewarded if they face the terms that will limit the revenues from licensing their property.
Higher guarantee amounts also serve to motivate licensees to put their best effort into promoting and selling licensed products. By boosting this motivation, licensors hope to justify the limited commercial capacity of their exclusively licensed properties.
Besides, it requires more effort from licensors to check that multiple exclusive deals within the same category don't overlap. Hence, exclusive deals are crafted to be very specific as to product category description.
Marketing matter is top among the factors affecting royalty rates in brand licensing. It’s common for brand owners to require a small fee from every licensee as a contribution to a pooled marketing fund. This contribution involves a small percentage of licensee’s net sales of the licensed products.
It’s also not unusual for licensors to claim a minimum payment on a quarterly or yearly basis. The average percentage of marketing contribution ranges between 1% to 2%, yet it is likely to grow substantially with time.
Licensors distribute the marketing budget amounts to purchase media and advertising space for the collective benefit of all participating licensees within a licensing program. Additionally, licensors may require license holders to pay a small advertising fee separately (usually the same 1-2%).
Unlike in the case with the Central Marketing Fund, licensees are typically able to choose how the advertising contribution is spent.
Notably, it’s also a common practice for licensors to require separate minimum guarantees for the CMF needs. Alike with the royalty rate, the need to invest a part of the minimum guarantee might increase its amount. With the expanded advertising possibilities, licensees can spur sales in the early licensing stage.
Deductions are a significant matter in licensing and often an apple of discord in the licensor-licensee collaboration. Licensees want to secure as many deductible clauses as possible to lower the net sales number and, consequently, the royalty amounts. Contrary, licensors look for maximum profit, hence many of them limit the licensee’s deduction right.
Similarly, some licensors eliminate any reimbursement clauses from the agreement and require royalty calculation based on the gross sales figures. In this case, allowable deductions include retailer discounts, returns, and freight, each amounting to no more than 2-5% of the first billing amount. Other factors include retail and licensee situation, market size, product margins, and security measures.
Following, we will talk about these factors in our next article covering the royalty rate affecting factors.