royalties on really large quantities

hi all -

i’m new to the discussion board here, although i’ve been imbibing on core77’s news section everyday for a few years now. so as to fill in a little bit more, i’m actually an architect by training and by practice, so parts of the design world are familiar, parts are not.

reason i’m posting is to see if there is anyone who might have some insight into a situation we’re currently in: four years ago, while working on a project, we stumbled onto (or into) a packaging idea which seemed really strong, as well as completely unconnected with the work at hand. so, we put it aside but over time would come back and work on the ideas, eventually getting a reasonably broad method developed that would improve the sustainablity features for whole classes of product types. we did more research than should be allowed, realized no one had patents on work even close to this, and, thus, we consulted with attorneys, filed utility and design patents over all the key components and features, etc.

in the meantime, we started trying to figure out how to capitalize on this and who to begin approaching all this with. we’ve started out with the biggest we could find and, lo and behold, they were indeed interested. very interested.

my question is this then - we’re just about at the point where we’re going to the final contract (beyond nda’s, development agreements, etc.) and, for all the research we’ve been able to do, we (our team) are having a hard time determining a metric for royalty payments. mostly, this is due to the sheer quantities involved - this company along produces almost 1B of a single packaging type, globally, each year. and we may do 2-5 lines of their packaging over time.

setting a % royalty on gross sales is impossible since they produce the packaging for their own use (for other goods they produce). setting it on a per-unit basis makes some sense, but since each package only costs 8-9C to produce, the amounts would have to be really small (say 1/10th’s of a cent) to make any sense, at least from their perspective. i’m sure they would be thrilled to set a ‘fixed’ licensing agreement of ‘x’ amount per year to produce as much or little as they like, if that ‘x’ is smaller than what any royalty agreement would produce.

anyone have any experience something of this kind? this is completely different metrics from what my day job does, as well as completely different from anything i’m familiar with (furniture, etc. - larger priced pieces, smaller quantity runs). the company is rock solid, blue-chip and, while they’re way too savvy to overpay, they have a very long, deep history of appreciating what design can bring to their equation and, seemingly from everyone we’ve talked to who’s worked with them, are ‘fair’ in their dealings.

thanks in advance (and no, this isn’t some kind of fantasy scenario - it’s really happening and it’s the craziest, most wonderful thing to happen in my long career).

cheers -

Congrats! Sounds like a very exciting opportunity. I would highly recommend hiring a lawyer experienced in the area of royalty and licensing agreements. There are a lot of gotchas with these types of agreements, and the person who wants to get paid (that’s you) is the one who needs the legal protection.

With that being said, in my experience, setting the royalty/licensing agreement comes down to 3 factors:

  1. The minimum you need to make from it (could even be 0 for simple, one-off projects) to make it worth your while.
  2. The maximum benefit you will realize if everything goes according to plan.
  3. The likelihood that the return will be closer to 1 or 2.

These same factors are important to the client, so you both have a common baseline from which to negotiate. Their negotiating goal is to minimize the amount paid, and your goal is typically to maximize the amount paid (although the goal could also to be get repeat business, or to be able to license to other clients, i.e. non-exclusivity).

Other factors include:
a. Will the client honor the agreement in the future?
b. How will you police/enforce the contract?

These two factors of course directly effect factor 3 above.

The main problem comes from that fact that the client will almost always have a much better understanding of factor #3 than you, since they know more about the product, potential volumes, and costing. In my opinion, the safest way to do a royalty/licensing agreement is based upon a per unit %, e.g. 5% of the manufacturing cost of each item. This allows the client to have a clear idea of their operating costs, and makes your success tied to the success of the product. Agreements often have a reduced % over time, so it may be 5% for years 1-3, and 3% for years 4-6, and 1% or nothing after that. To determine the proper %, look at factors 1-3 and see what makes sense for your business.

sfpd - hi. thanks for the reply. i wrote out a longer reply to your thoughts but screwed something up while posting…

have no issues with if/how any eventual agreement would be honored or enforced. since our design is essentially a container for another, primary product, there is a long, documented record of past sales. we don’t know if our contribution will help drive additional sales or not - people probably aren’t buying our container but the product itself.

hence the murkiness on setting a rate. it can’t be measured by the end product itself but could, in theory, be measured against the costs of the container itself (of which they know the exact costs to produce it). given the sheer numbers involved, though, it would be a really, really small amount per container. also, i wouldn’t be a fan of the reduced % over time, since, again, the quantities are so large, any numbers would have to be small. and, our patents would, in theory, allow them (or us) to develop more designs based on the technology involved for any number of years.

to answer your first three questions: since this was more of a ‘side’ project for us, we do have some costs in that we’d need to recoup but they aren’t crazy amounts (2-300K). the max we could currently envision depends on twenty factors out of our control. suffice to say, part of the reason i’m inquiring on the board is that we don’t really know how to measure the high end on something like this. we’ve seen published reports of other container designs this company has developed and some crazy astronomical figures attached to it (which we simply don’t believe). so, somewhere in the middle would be just fine.

thanks again and we’ll let you know how it turns out…

Good info. With regards to your first point, your innovation/product doesn’t necessarily have to contribute to new sales to be valuable. It could reduce costs, or offer better performance, over other solutions. Or it could offer a solution that is not available anywhere else. All of these would theoretically have similar “value” to the customer, so I don’t think this should necessarily be the criteria for setting the royalty/licensing rate.

Nothing wrong with making a small amount if the volumes are large. Again, your goal should be maximizing how much are you paid per month/year/lifetime, with an analysis of worst and best case scenarios.

Agreed that the reducing % over time is not ideal, but I threw that out there because it is typically something the client will want, so it is good to factor it in. If you can negotiate no reduction in the royalty/licensing rate then that is of course better for you! Similar situation with the life of the agreement. Clients will typically (at least in my experience) want some sort of finite time limit for the contract, after which you would renegotiate terms. This could be good or bad for you, depending on how things play out with the client and your technology/product/IP.

I would definitely be interested in hearing how things come out (and when you buy that tropical island, an invite to the house-warming party).