Licensing and Royalties

Many people are aware of ‘licensing’ and ‘royalty’ but are uncertain of their meanings.     

A license is authorization to do or use something.  For example, a driver’s license gives the driver permission to drive on public roads.     

In intellectual property context, a  license  is permission granted by the IP owner to use the IP in the authorized way.  Intellectual property includes registered rights, such as trademarks, patents, designs or copyrights.  Examples include Coca Cola giving a manufacturer the right to use the famous trademark on its lines of clothing, the patent holder for cell phone technology allowing a manufacturer to use the technology in its cell phones or a composer giving a publisher the right to publish sheet music for songs.  

Unregistered IP rights are also licensed.  These may include operational know-how, business processes or other aspects of conducting business.  For example, when McDonald’s grants a franchise, in addition to permission to use McDonald’s registered trademarks, it also allows the store owner to use its store design, furnishing styles, customized equipment, Big Mac recipe and management and operational manuals required for running a McDonald’s store.  These are McDonald’s unregistered know-how that it licenses to the store owner.     

The IP owner generally charges a fee for using its IP rights.  This is the ‘licensing fee’ and it is the price for obtaining permission to use the intellectual property.  In addition, the user is often required to make royalty payments to the owner.  Royalty payment is essentially a sharing of revenue generated by using an intellectual property.  It is generally an ongoing obligation for the duration of the term of the license.  Royalties are usually based on a percentage of sales of products using the intellectual property. 

A manufacturer may sell 1,000 plain T-shirts; but if the T-shirt bears the NIKE swish logo, 10,000 may be sold.  The famous trademark adds sales so the manufacturer should share revenue with Nike for increasing sales.  This sharing of revenue is ‘royalty’ payment to the IP owner. 

How much should the IP owner’s share be?  There are different  royalty calculations, including a flat fee or fixed periodic payments.  The most common method is giving a percentage of sales, usually net sales, to the IP owner.  While figuring percentages is more complex, it more accurately reflects the contribution of the license than a flat fee or fixed periodic payments. 

These are not the only ways for determining royalty.  Factors such as cost of product development, advertising, promotions, and other economic issues may influence how royalties are determined and calculated.  Since licensing tends to be long term and requires the parties to work together, the best solution is one that both parties consider fair and reasonable.