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A survey of Licensed Royalties, Stephen Degnan, Corwin Horto

A Survev

Royalties
Authors’ sunlal xiz~esinsight into
running myaliy rates negotiated
in 12-month period b.y .firms
rying to explain the factors that
go into the valuation of an invention or technology only
convinces people that licensing is
three parts witchcraft and one part
common sense. Inventors and top
management want to know what
their technology is worth to their
organizations. Prospective patent
licensees want to know what to pay
for such technology. Licensing executives understand that the answer
to these questions from both sides,
is that it depends.
Technology transfer is not a “zerosum game.” A negotiation between
licensor and licensee has to be a
“wimwin” situation. Both have to be
fairly compensated. This article, and
the survey underlying it, were designed to investigate how patent licensing executives deal with this
challenge.
The authors decided that it would
be an important addition to licensing
technology knowledge if a survey
were undertaken whose primary
focus was on what comparable running royalty rates, both licensed-in
and out, were negotiated by licensing executives within the past 12
months. The authors would like to
acknowledge both the seminal work
done in this area by McGavock,
Haas and Patin in their June 1991 lcs
Nouvelles article “Factors Affecting
Royalty Rates” and the assistance
provided by Arthur Andersen.
To this end, a patent licensing
survey was composed and mailed to
over 2,100 licensing executives
worldwide. All executives were
members of the Licensing Executives
Society and were asked to answer 37
questions. A total of 428 useful sur-

T

BY STEPHEN A . D E G N A N *
iirrri C O R W l N H O R T O N * *

veys were returned and tabulated.
IIEMOGRAI’HIC’S OF THE Kb
SJ’ONDENTS
Three out of four of the respondents work in “for-profit” businesses while one out of four work in
academia, research or government.
Three-quarters are executives,
owners or inventors in their organizations.
Over 70% of executives are located
in the United States or Canada, lSO%
work in Europe, 3% work in Japan,
and 3Oh in Australia. Of the “forprofit” respondents, 40% worked for
companies that had less than $50
million in total gross revenues, 5%
for companies grossing between $51
and $100 million, and 18% for companies grossing between $101 million
and $1 billion.
The remaining 37% worked for
companies that had gross revenues
of $1 billion or more. The “nonprofit” organizations had smaller
gross revenues with about 44%
working for organizations with
revenues of $20 million or less and
the balance, 5h0/o, for organizations
\%,ith
sales greater than $20 million.
Some 39% of the respondents
function as the main negotiator for
their organization in the technology
transfer licensing process. Some 20%
are involved in the marketing of
technology and 17% are legal advisors. In the past year, 96% of all
respondents have negotiated at least
one license, while 58% negotiated
more than five licenses during that
time period. Some 17% reported
having five or fewer active technology licensing agreements, 46%
had between h and 50 agreements,
and 37% had more than 50 technology licensing agreements currently
in force.

EXCHANGE OR TRANSFER OF
TECHNOLOGY
The respondents were involved in
a variety of different technology
transfer vehicles. They reported that
their organizations were involved in
the following technology transfer
areas (Table 1):
1-icensing-Out
88%
Licensin In
68%
~o-Dev&~ment
61%
Sh.dtegic Alliances
58%
joint Ventures
54%
Cross Ixense
40%

Table 1
It is interesting to note that 5% of
the respondents only licensed-in
technology, while 24% only licensedout, and the majority 71% did both.
Of all respondents, 59% of their
licensing-in agreements are with
U.5.-owned businesses and 4l0/0 are
with foreign-owned businesses. In
contrast, the licensing-out agreements by the respondents are evenly divided between U.5.-owned and
foreign-owned businesses.

W1ierc~
Art, U.S. Companies Licensing
Respondents whose organizations
are based in the United States reported licensing technology to and
from all corners of the world. The
most frequently mentioned countries
are listed in Table 2.
The dichotomy between where
U.S. companies licensing-in and out
overseas is considerable. While the
United States is a net importer of
goods from abroad, it appears to be
a net exporter of technology know*Ci’A, Dqyiiari h Associates, Daiir~ilit,,
Califinlia.
**Atfoniq/-at-Laze; Kt?itfit.ld, Califoni~.
Paper rilrittcv for preserrtation at fht, LES
( U S A b Canada) Anrlriai Meeting, San
D i c y ~ Gliifoniia, Nownlber 2-5, 1997.
,

USA
Japan
Great Britain
Germany
France
Canada
Korea

In

67%
32%

34%

28%
25%
19%

4%

Out

84%
55%

43%
42%
38%
36%
23%

FINANCIAL MEASURES

Table 2
how abroad. The largest differences
in licensing-in and out were found
with the AsialPacific countries.
THE LICENSING PROCESS
The number of departments involved in the negotiation, evaluation and approval of technology
transfers was greater than expected. The respondents reported
that within their organizations the
following departments normally
provided input and advice o n technology licensing matters (Table 3):
Legal and Regulatory
Research
Licensin
and Engineering
Sales and Market~ng
Finance and Accounting
Manufacturing and Product~on

Technics?

70%
60%
59%
55%
50%
38%
29%

Table 3
Given the number of departments
consulted, it is remarkable how fast
license agreements can be completed. The average time to negotiate a patent license (from initial inquiry to the consummation of the
agreement) was three to 12 months,
with the median time period being
slightly less than six months.
There are several reasons for an
organization to engage in technology licensing. The majority of respondents identified their organization’s primary patent licensing
strategies as the generation of royalty income.
Royalty Income
Developing a Business
Advantage
Product Profit Maximization
Increased Technical
Proficiency
Defensive
Deterring or Delaying
Others

reported that Royalty Income was
their only licensing strategy. Furthermore, 69% of the pharmaceutical
executives reported that Product
Profit Maximization was their
primary goal.

61%

54%
44%
32%
20%
13%

Table 4
With the exception o f academic
institutions, very few organizations

There are various financial considerations relevant to determining
an appropriate royalty rate. These
considerations form the underpinnings of the respective bargaining
postures of the parties. The pertinent financial measures frequently
are used as initial starting points for
negotiations. They can subsequently be used to project a range of
negotiations and finally to fine tune
those figures leading to a mutually
satisfactory royalty from both the
licensor and licensee perspective.
T h e financial m e a s u r e s t h a t
surveyed organizations use in
determining the appropriate royalty are as follows:
In

Discounted Cash
Flow
Profit Sharing
Analysis
Return on Assets
“25% Rule” as a
Starting Point
Capital Asset Pricing
Model
Excess Return
Analysis

Out

56%

49%

52%
38%

54%
27%

24%

30%

11%

10%

8%

7%

Table 5
In determining an appropriate
royalty, Discounted Cash Flow and
Profit Sharing Analysis are clearly
more prevalent than the other measures in both licensing-in and out.
This might be expected since the
data for such analysis is more readily available to the licensee and this
type of analysis is routinely used,in
investment evaluation decisions.
O n the other hand, the “25% Rule”
is more easily used as both a starting point and a benchmark by
smaller organizations without the
in-house licensing expertise. The
Capital Asset Pricing Model
(CAPM) and Excess Return Analysis may be too sophisticated and
academic for common use, and
may be too difficult to present to the
other side.
The respondents were asked to

rank the importance of the following factors in their determination of
the amount of initial upfront fees or
running royalties to be paid or
received. The responses are on a
Likkert Scale where 1 equals “Not
Important” and 5 equals “Very Important.”
In

Out

4.3

4.2

4.2

Nature of the Protection
Utility Over Old
Methods
Scope of Exclusivity
1.icensee’s
Antici ated
prolts
Commercial Success
Territory Restrictions
Comparable License
Rates
Duration of
Protection
Licensors’
Antici ated
I’ro&s
Commercial Relationship
Tag Along Sales

4.2
4.1

4.1

3.7
3.7

3.4
3.7
3.5

3.6

3.7

33

3.1

2.6

3.1

2.6

2.6

2.1

2.1

3.0

Table 6
These 11factors were intentionally written to parallel the factors first
elucidated in the case of Georgia
d
Pacific- 71s. U. S. P l , ~ / i c ~ oCorp., now
being used in the U.S. Federal
Courts to determine appropriate
royalty rates in patent infringement
cases where there is no previously
negotiated royalty rate or when an
established royalty rate appears inappropriate. The authors believe
that these Georgia-Pacific factors can
be used as a useful check list to
assist negotiators in the determination of an appropriate reasonable
royalty rate.
LICENSING AGREEMENTS
Almost all licensing arrangements
are reduced to writing as a way of
evidencing the mutual assent to certain rights and obligations by the
parties. Respondents were asked
what terms and conditions they
generally included in their licensing
agreements.
The results show that eight of the
10 listed terms and conditions are
normally included in most licensing
agreements. The infrequent usage
of the Non-Contest Clause may be
d u e in large part to the illegality of
this clause in certain jurisdictions.
And the low usage of the Warranty
les Nouvelles

a Nt,r/
MIII~:) Clark Roardman Company. Ltd.,
1978.

Fixed Period Amount

B Gross or Net
Fij

Profit Percentage

Gross Revenues times Royalty Rate

D

F.
lxed Amount Per Unit

,.
–

Net Revenues times Royalty Rate

L.

1

1.5

2

2.5

3

3.5

4

4.5

5

Table 9
velopment process the technology
is, (2) how ingenious and commercially successful is the technology,
(3) how profitable this technology
is or will be, and (4) how easy is it
to design around the patent claims.
When asked, “Does your organition license-in technologies that are
not completely developed?” 10%
answered “never,” 52% said
,,
sometimes,” and 37% responded
“frequently .” The follow u p question was, “What percentage discount rate would your organization
use when evaluating technologies
still in the pipeline?” They were
asked to rate on a product development scale based on three phases.
The Lab Phase is when research is
completed and development of the
concept is reduced to practice. The
Detailed Design Phase involves
conceptual ideas being fully develed, engineering designs completed
and technology protection applied
for. In the Pilot or Prototype Phase,
the prototype has been tested and
the product test marketed. At this
point regulatory approvals are being sought. The percentage discounts, based on these phases,
were as follows:

nology can garner. For example, it
a fully developed patented technology was worth a 10% rovaltv
then a comparable technology in
the Lab Phase would garner a 5%
royalty. The same technology in the
Detailed Design I’hase would receive a 6l/2% royaltv, while if in the
I’ilot or Prototvpc Phase \ v o ~ ~ l d
receive an 8% royalty.
RUNNING ROYAI>TIES
Not all patents are alike. In tact,
over 90% uf the over 100,000 pdtents issued in the U.S. each year
have little or no value to anyone
other than the patent oLvner. On
the other hand, some patents produce great value, V.S. the Gordon
Gould Laser Patent. To measure a
patent’s innovativeness and the impact of that innovativeness on
royalty rates, we designed a scale,
which we call the Innovativeness
Scale, as follows:
Revolutionary
Satisties a long felt need or creates 1
‘

whole new industry

Major Improvement

Significantly enhanccs quality or

In ,In ex~sting
produit or wr\ itc

Using the Innovativeness icalt.,
respondents were asked to list thtx
range (–‘X,
to ‘ 4 1 ) ot running royalty rates their organization
licensrd-in during the last fivc.
years.
AVERAGE RUNNING ROYALTY
– LICENSING-IN
l
Major Iniprovcrnent
Minor Impr,ivcnirnt

Low
7 to
1 to
7 to

High

13’%1
H%,
5%

Table 11
‘The 7O/r1 Revolutionary patents
for
is an average of the lo~ver
number
reported by the respondents. 13%)
is the average of the higher number
reported by respondents. Since a
few exceptionally high or low rest~onscs
could have a tendency to
skeiv thv averages, the median running royalty rates \vcre calculated
and presented.
MEDIAN OF RUNNING
ROYALTY – LICENSING-IN
High

Low

lie\ olut~(inar\
5
Malur Inipro\ernt~nt 7
M~norImprovement 1

to
to
to

lO”4)

7%
4%

Table 12
Using the same innovativeness
scale, respondents were asked
what were the range of running
royalty rates their organizations
licensed-out during the last five
vears.
Lab Phase

product superiorlt, I n
existing prcld.
uct, process or ser\.ice.

AVERAGE RUNNING ROYALTY
– LICENSING-OUT
lie\zolut~onary
7 to
14%
MaiOr Inlpr(l\.enlent
(0
Minor Improvt.mt~nt ? t o
6%

Minor Improvement
Creates an incremental irnprovcrnent

Table 13

Detailed Design Phase

Pilot or Prototype
Phase

Table 10
Table 10 shows that the further
along in the product or technology
development cycle the technology
is the higher the royalty the tech.

MEDIAN RUNNING ROYALTYLICENSING OUT
Low

Revolut~onary
5
Major Improvement 4
Minor Improvement 2

High

to
to
to

8%
5%)

Table 14

RELATIONSHIP OF PROFITS
AND ROYALTIES

To
the
between anticipated gross profits and
running
rates
were asked if their organizations
were offered a license or a new
product or service with 10 to 100%
Gross Profits, approximately what
running royalty rate on Net Sales
would their organization be willing
to pay.

80%
60%
40%
20%
10%

COST SAVING TECHNOLOGIES

Ill O
/

We know that occasionally even
what would be categorized as a
minor improvement to an existing
product or service will have a large
economic payback and hence command a substantially higher royalty. Nevertheless, the results here,
which are averages and medians of
all the data, show a close correlation
between the innovativeness of a
product and the eventual running
royalty the patent can be licensed
for. The data also appear to show
that LES members negotiate slightly higher rates when licensing-out
than when licensing-in.

Gross Profit
Percentage
100%

a rate that is higher than “normal.”

Respondents were asked, when
they were evaluating “Cost Savings” technologies that will reduce
manufacturing costs, or improve
output or quality, what percentage
of the cost savlngs would their
organizations be willing to pay (as
a licensee) or demand (as a licensor). Table 16 illustrates their responses.
Percent of
Costs
G e d

o\;&

50°/”

Total

In

Out

o0/~
100%

1%
10Oo/o

Table 16
These amounts are lower than we
anticipated. We were expecting the
resvondents to s ~ l i t
the cost savings equally between licensors and
licensees. The difference may arise
becaust. the licensee is bearing the
majority of the risk that the cost
savings are not achieved.

One of the respondents, Timo
Ruikka, VP Nokia Telecommunica-

Net Sales
running Royalty
15%
10%

Licensor’s Portion
of Licensee’s Gross Profits

44)

15.0%
12.5’Yo
10 .OO/”
10.0%

2%
1O/o

10.OO/o
10.OO/”

h%

Table 15
S o m e 10% or h i g h e r o f a
licensee’s gross profits tends to be
the predominant rate that is being
used by a majority of the respondents when consummating
licenses. It is interesting that the
profit sharing tops out at only 15O/o.
The explanation for this might be
that these are anticipated gross
profits, which may not prove out,
So the lower licensor’s portion is a
hedge compensating for the risk
taken. Another explanation may be
simply that licensors are uncomfortable paying running royalties at

tions, underscores that any simplified licensing paradigm can ,not
automatically be applied across the
board: “Where the product of a
given company is a system (c.s.
airplane, nuclear power plant, telecommunications network) then the
number of patents utilized in such
a situation is fundamentally different from, say, the pharmaceutical industry where one patent
equals the product,”
To test whether there are significant differences in royalty rates between industries and more specifi-

cally the pharmaceutical and nonpharmaceutical industries, the
authors sorted the survey results by
industry. Pharmaceutical companies represented approximately 20%
of the survey respondents.
The median running royalty rates
for pharmaceutical and non-pharmaceutical organizations were as
follows:
Pharma- Non-PharL,

ceutical maceutical

Revolutionary
10.15%
Major Improve5-1O0L>
ment
Minor Improve2- 5%
ment

5-10%
3.7%

1.3%

Table 17
Clearly, Mr. Ruikka and others
are correct. Industry does matter
when setting running royalty rates.
Because of t h e special circumstances in which each industry
operates, economic realities often
dictate the range of royalties within
that industry. For example, pharmaceuticals generally invest significant sums in research and development and regulatory approval for
new medications that often are exposed to the market exclusively
through patent protection. However, although significant variations
in royalty rates may exist between
industries, there may also be a wide
range of royalty rates within each
industry.
The authors recognize that royalty rates from the past are seldom
the touchstone to setting a royalty
in a new situation. Royalties are
seldom, if ever, “pure.” Rather,
they are contextual. They are forged in the crucible of arms-length
negotiations where the royalty rate,
although a vital component, is frequently not the only important
issue.
Each royalty is only a single data
point and the relevance of a prior
negotiation by others to your case
(even if for the same technology)
depends crucially o n the comparability of the issues and the
economics. Seldom will they be
“on all fours,” and frequently all
you will know is the category of
technology ( e . g . “medicine”) and
the royalty rate that resulted.
Reducing this data to generalized
ranges is a further dilution of it.
Moreover, some “data” is merely
hypothesizing c8.g. “reasonable

royalty” determinations in infringement or tax litigation. Although
useful, this information does not
have the same meaning or value as
actual arms-length negotiated
royalties.
Having thus disclaimed, we still

feel that the past experiences of
specific royalty agreements bargained for by others can be a useful
guide, a reality check (“are we in
the ballpark?”) and a reassurance.
As a tool of persuasion, even
generalities from the past (royaltv

ranges) may help not only with
those on the other side of the table
but o n your side as well. And, at
times, where the ability to generate
a profitability prediction is limited,
prior royalty rates may even be the
best guide available.