Royalty rate = allocation of operating margin improvement between licensee and licensor.
Reference some definitions:
Patent licenses and operating margins
A patent license reduces competition for a commercial activity, which allows the rights holder to charge a premium price. Being able to charge a higher price allows the rights holder to generate a better operating margin.
- Licensee is considering licensing a patent for the Device.
- Licensee typically generates a 20% operating margin from its activities.
- Licensing the patent will allow licensee to generate a 35% operating margin for sales of the Device.
- Benefit = additional 15% of operating margin for sales of the Device
Running sales royalty
Let’s add a 5% running sales royalty. What happens?
Licensor receives one-third of licensee’s additional 15% of operating margin.
- Licensor receives 5%
- Licensee receives 10%
Licensee likely to receive a larger portion of the benefit.
Robert Goldschieder explains:
The licensor and licensee should share in the profitability of products embodying the patented technology. The a priori assumption is that the licensee should retain a majority (e.g., 75%) of the profits because it has undertaken substantial development, operational, and commercialization risks, contributed other technology/intellectual property, and/or brought to bear its own development, operational, and commercialization contributions1.« Go to IFRS Jargon