Have you ever been told that licensing your invention is a great deal for everyone else – but a terrible deal for you the inventor? I'll bet you have heard this before. The narrative is that you can make dramatically more money if you venture your product (DIY) – do it all yourself – instead of licensing it. Is that true?
Maybe. Which path is better for you (licensing versus DIY) depends on your goals, your skills, your financial footing, and your tolerance for risk. Let's take a look at the business case for each path.
What to Expect When Venturing Your Invention
When you choose to venture your product, you will have to manage manufacturing, importing (probably), packaging, marketing, working with sales reps and retailers, warehousing, and handling damaged goods and returns.
You simply cannot do it all yourself, so you will need to build a team of contractors or employees.
Someone on your team will need to work closely with the manufacturer and handle all logistics including shipping and customs to get product into your warehouse. Someone else will need to work with your retailers – each will have different labeling, shipping, scheduling and payment schedules. Someone will need to closely track your product inventory: what is currently in-house, what is shipping out and what is being shipped into your warehouse – and to insure you always have sufficient, but not excessive inventory. Someone – probably you initially – must ensure that payroll is always met and all payroll and other taxes are properly handled (outside firms have this expertise).
Consumer products typically have at least a 5X mark up from manufacture to retail price. So, if your product has a landed cost of $4 (including manufacture, packaging, importing logistics, etc.), then your retail price should be at least $20. That sounds like a lot of profit for you! But, it isn't. You sell at wholesale (not retail) which is typically about 45% of the retail price – in this case, your wholesale price might be about $9. Then, you would have a $5 gross profit margin on every product sold to that retailer. That remaining $5 must pay all of your labor costs, overhead, office and warehousing costs, etc. Typical labor costs alone are often about 30% of gross revenues or nearly $3 for every product sold. That leaves $2 to cover everything else.
When the dust settles, if you watch your costs like a hawk, you may have a net profit margin of 5% – or less.
Odds are, for the first several years of your business, your pay as the owner will be minimal – just enough for you to get by. The larger your salary, the less that is available to manage all other business expenses. Some owners choose to live off savings for 1 – 2 years until their business has reached a strong growth track.
All of the above assumes that your product continues to have robust sales in the marketplace.
If your goal is to pay yourself a salary of $100,000 per year, probably you would need your business to be grossing about $5 million in sales annually. That would equate to selling approximately 46,000 units of product every month. What happens if your manufacturing costs go up 20% (which mine did over 5 years) or Amazon undercuts your prices or your largest retailer decides to no longer sell your product? Then, to quote Gary Vaynerchuk – you are going to have to hustle – a lot!
What to Expect When Licensing Your Invention
When you license your invention, you transfer virtually all risk – all the headaches of manufacturing, packaging, customs, returns, managing retailers – over to the licensee.
Unlike you, the licensee has many years of experience in operating a product based business.
Your licensee will have well-established relationships with key retailers. They have manufacturers they have worked with for years; as a result, they have economies of scale that give them leverage to manage price increases in a way you cannot. When your licensee introduces a new product – their retailers are keenly interested because your licensee already has a track record of success.
To be fair, your leverage with your licensee is limited – they hold the cards. This means you cannot demand an 8% royalty if they are only willing to pay 4%. You will be offering them an exclusive licensing agreement (so only they are allowed to sell your product). Typically, there will be a 1-year initial term and the agreement will be automatically renewed annually unless either party (you or them) elects not to continue. The licensee, in most cases, may terminate the agreement with a 30-day advanced notice to you.
Why can this be a good deal for you, the inventor – compared to venturing it yourself? Here's why.
Your licensee can quickly get your invention into a large “footprint” of retail stores. When I licensed my invention to Allstar Products, they had it selling in over 10,000 retail stores in just a few months. You do not have to manage employees or contractors. You don't have to manufacture and import product. You don't have to work with retailers. Your licensee does all of that.
There is no guarantee that any licensing deal will be lucrative.
But, if your product is attractive to a large segment of consumers (as mine was), even a small royalty percentage could pay you very well. Furthermore, you can do whatever you want with your time. You will have a degree of personal freedom few people ever enjoy – you can sip Mai Tai's in Hawaii and your royalty checks will continue to come in – as long as your product sells well in the marketplace. You can begin working on your next invention.
That is a pretty good deal.
I have done both venturing and licensing. I much prefer licensing for all of the above reasons.