Many small businesses, entrepreneurs, inventors, designers etc. want to go the route of licensing because it potentially brings profits without having some of the traditional accompanying headaches, like manufacturing. Or, it can bring in additional income if manufacturing arrangements are already in place.
But you need to understand that there’s a Product Life Cycle. Your royalty rate (that is the fee your get for licensing your product, brand, etc.) is influenced by where your product is in that cycle.
All products have a limited life. At each stage the product passes through during its life, there are different challenges and opportunities that affect your royalties. Here’s an overview of four main stages of Product Life Cycle:
STAGE 1: Development/Market Introduction Stage
This is where your costs are very high, there’s virtually no sales volumes to start, there’s a lot of market uncertainty – product price, competition, market acceptance to name a few. No $$ is being generated at this stage.
STAGE 2: Growth Stage
Your costs are reduced due to economies of scale. Public awareness increases. Your sales volume increases significantly. Profits rise. For a short time. Risks rise because of increased competition. Increased competition leads to price decreases.
STAGE 3: Maturity Stage
Sales volume peaks and the market becomes saturated. In order to maintain and grow market share, branding and marketing comes into play (the brand has to be differentiated, feature differences have to be emphasized). Commodity-like returns are seen. There’s a fairly long duration of profitability.
STAGE 4: Saturation and Decline Stage
Sales may stabilize or decrease. Prices and profitability shrink. Profit becomes more a production/distribution efficiency question than increased sales. This stage is riskier than the mature stage.
Keep in mind that this model has limitations and exceptions. But you should be aware of the Four Stages when negotiating a licensing agreement so you can understand why royalties vary.
Sandra Holtzman teaches CEO 035: Licensing.