Methods of Calculating Reasonable Royalty Rates: "
A few weeks ago, Stephen of Patent Baristas fame, wrote a very interesting article on calculating reasonable royalty rates called What’s a Reasonable Royalty Rate?. Although the article is in the context of royalty rates for licenses with universities for therapeutic technologies, I believe the objective points regarding calculating royalty rates are worth repeating here at IP Counsel Blog.
Three methods of calculating royalties were described:
1. The Market Method – royalty rate is based on what others have paid as a reasonable royalty for similar technology.
2. The Cost Method – royalty rate is based on the cost of developing or obtaining the technology or intellectual property.
3. Income Method - royalty rate is based on the total revenues the technology is likely to produce.
The article further mentions that a practical way of deriving a reasonable royalty rate is to first develop an economic model that factors in the cost to develop the technology and the overall revenues expected from sales of the technology. The model should also include risk factors, such as expensive processes that may also delay time to market, or any other potential risk factors. For example, sales my start out slow at first for a few years before reaching higher levels of expectations. Lastly, duration of patent terms should be included.
It seems to me that a good starting point would be to develop an economic model that utilizes information from all three methods of calculating royalties. Develop a model that takes into account estimated or realized revenues, cost of development and bringing the technology to market and compare royalty rates for similar technology under similar or related circumstances. From a more inclusive model, you can glean a great deal of information about the technology and what its ultimate value would be to you in order to determine what you are willing to pay and whether you can obtain alternative technology for less.
It is not surprising that a great deal of effort must be used to evaluate a license agreement before negotiating a reasonable royalty rate given the increasing costs and other pressures researchers and manufacturers face when developing new technology.
Three methods of calculating royalties were described:
1. The Market Method – royalty rate is based on what others have paid as a reasonable royalty for similar technology.
2. The Cost Method – royalty rate is based on the cost of developing or obtaining the technology or intellectual property.
3. Income Method - royalty rate is based on the total revenues the technology is likely to produce.
The article further mentions that a practical way of deriving a reasonable royalty rate is to first develop an economic model that factors in the cost to develop the technology and the overall revenues expected from sales of the technology. The model should also include risk factors, such as expensive processes that may also delay time to market, or any other potential risk factors. For example, sales my start out slow at first for a few years before reaching higher levels of expectations. Lastly, duration of patent terms should be included.
It seems to me that a good starting point would be to develop an economic model that utilizes information from all three methods of calculating royalties. Develop a model that takes into account estimated or realized revenues, cost of development and bringing the technology to market and compare royalty rates for similar technology under similar or related circumstances. From a more inclusive model, you can glean a great deal of information about the technology and what its ultimate value would be to you in order to determine what you are willing to pay and whether you can obtain alternative technology for less.
It is not surprising that a great deal of effort must be used to evaluate a license agreement before negotiating a reasonable royalty rate given the increasing costs and other pressures researchers and manufacturers face when developing new technology.
"
(Via IP Counsel Blog.)
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Posted by: miami web design | March 12, 2011 at 09:42 PM
The misleading word in this debate is "calculating". It gives the impression that this is a mathematical problem of finding something which exists. But that's not right. Firstly, we talk about the future and not something existing: a potential. And secondly, we are dealing with a business or even artistic skill in negotiating a deal rather than bean counting.
From practice (mine and others) I claim that the potential of an invention can only be negotiated albeit the strength of your negotiation position can be improved by a method I call "where's the Beef?" :-).
Consider some arguments: an invention or a new technology is rarely the basis for commercial success alone- much like a hammer is not a sufficient ingredient for getting the nail in place (if you turn it upside down it won't work).
Chan Kim's work on Blue Ocean Strategy shows that successful businesses innovate all aspects of the value chain, not just the technology side ("value innovation"). Follow links elsewhere on this site.
Research into so-called gazelle companies (eg. studies in Denmark, cp. www.borsen.dk) show that the most profitable businesses are not based on new technology platforms (new) but also/more on shrewd HR, organisational,marketing etc innovations.
I recommend dealers to use Michael Porter's "value chain" concept or Five Forces to approximate the cost and profit levels in a given industry. Firstly, the new invention must be placed in the value chain, then average cost and profit profiles in the relevant link of the chain can be found. You use this information to establish your position: if you sell technology, you'll argue that the buyer can improve his competitive position and ask a high price. If you are a buyer you'll use the same information to claim that technology is not all and that average profit rates must be the standard. Not much calculation in that!
Apart from practicing the method I offer a course on using it. Cp.: http://www.icnet.dk/Beef%20University
Posted by: Max | December 02, 2005 at 10:54 AM