What Is Product Licensing

In many regards, it's quite similar to leasing, wherein a company acquires the right to hold and make use of any asset that will contribute to the company's bottom line. This is sometimes referred to as "technology transfer", "patent licensing" (though many successful licensed products have never been patented) or "intellectual property licensing". The basic arrangement is quite simple. One party, an inventor, patent holder or product development firm, owns and controls the rights to a new, improved or innovative product or invention.

A second party, perhaps a consumer goods company, wishes to add the item to their own product line. The company's assessment is that this new item will be a profitable one for whomever brings it to market. So rather than making the often uncertain investment in developing a new product of equal potential, or risk having a competitor acquire the innovative item and bring it to market, the firm opts to secure rights to the products at its current, advanced stage of development. Licensing is the means by which this is accomplished. Through a formal, contractual arrangement, called a "licensing agreement", the owner of the property (product, invention or innovation), grants to the company the right to manufacture, market and profit from the product or invention. Such arrangements are common. Moreover, while there are great many variations from one agreement to the next, a few principles are generally accepted across the board: Since the company acquiring the rights will ultimately make a far greater dollar investment to manufacture and market the product than the inventor made in developing it, the company will retain the lion's share of any profits generated.

A loose rule-of-thumb states that in addition to an acquisition fee (upfront payment), royalty payments to the developer should equal roughly 25% of profits, which, depending on the specifics of the product, translates to a royalty rate of anywhere from 2% to 20% of invoiced selling price. . The less developed the product, the less royalty the inventor is entitled to, and visa versa.

The larger the geographic territory or number of distribution channels included in an agreement, the more royalty the company should pay, and visa versa. . The best agreements are cooperative, not adversarial. Each party is making a critical contribution. Maintaining a respectful and trusting relationship paves the way for other, equally profitable agreements in the future. . Some companies, once they have successfully worked with a product developer, will actually "order" new inventions from that developer by discussing the parameters of the types of products they would like to acquire. . Such an arrangement essentially provides a low cost R&D department for the company, while providing the inventor with an almost guaranteed outlet for his or her innovations.