# The method of determining the royalty rate, based on the profitability...

## The method for determining the royalty rate, based on the profitability of the licensee's production

As noted above, the income of the franchisor (licensor), obtained by him from granting intellectual property rights to a third party (), can be represented as a share (α )

of the additional profit is higher than the franchisee (licensee) obtained before acquisition of the subject of the license ().

Therefore, the royalty rate (R) can be represented as the ratio of the profit of the franchisor (licensor), i.e. due to him a share of the additional profit of the franchisee (licensee), to the royalty base (BR).

Taking into account the fact that the franchisee's (licensee's) revenue is the most frequently used royalty base, which can be represented as the sum of the cost of production (C) and profit (Pr), the previous formula can be written in the following form:

In order to calculate the additional profit of the franchisee (licensee), it is necessary to compare the profit received before the acquisition of the subject of the license (franchise) with the profit received after. If after the conclusion of the license (franchise) contract the profit does not change, and consequently, the additional profit is zero, the conclusion of the contract is economically impractical. Calculation of the additional profit of the licensee (franchisee) is given in the following formula:

where - the actual profitability achieved by

through the use of a license; - base annuity

whiteness obtained without taking into account the use of the license.

If we represent the denominator in the form: ,

we get the formula for calculating the royalty rate:

After making the necessary cuts, we get the final formula for calculating the royalty rate using a method based on the profitability of the licensee's production:

The share of the licensor in the profit of the licensee (a) is determined on the basis of Table. 8.10.

In the case of the complexity of obtaining information on the profitability of the licensee, it is possible to use the profitability index of the relevant industry.

Table 8.10

Recommendations for determining the licensor's share in the licensor's profits

 Degree of Validity License Exclusive Non-exclusive Patent Non-patentable Patent Non-patentable Highly Valuable 40-50 30-40 25-30 20-25 Average value 30-40 25-30 20-25 15-20 Low-value 20-25 15-20 10-15 5-10

The advantage of the method is that the calculations use objective information from the accounting documentation of the licensee or official statistical sources, which makes it more convenient to justify the royalty rate.

Of the three most common ways to determine the royalty rate, the most rational method is to use the method of accounting for the share of the licensor (franchisor) in the additional income of the licensee (franchisee). In this case, the grantor is able to take into account in the royalty rate the economic benefits received by the licensee. This is especially true in the framework of the franchise agreement, when the additional profit of the franchisee also arises from the possibility of establishing a higher price for branded products, and is generated using the tried and tested technologies of the franchisor.

The second way to justify payments for granting intellectual property rights is a lump-sum payment. Reasons for its use:

• Lack of industrial development of the subject of the license. In this case, the production risks of the licensee are high. The economic incentive for him is that if the technology is brought to the industrial readiness and business organization on its basis, all income will belong to it. In part, this form can be beneficial to the licensor, since one hundred revenue depends on the success of the technology implementation;

• conclusion of an agreement with a little-known licensee (uncertainty that he will be able to establish a profitable business on the basis of acquired intellectual property rights);

• the complexity of control (too high transaction costs for monitoring the timeliness and proportionality of royalty payments);

• the lack of possibility to determine payments in the form of royalties (for example, with the assignment of intellectual property rights, which allow to optimize the business processes of the licensee, but nevertheless do not generate direct revenue);

• Sale of the full license.

A lump-sum payment can be paid to the licensor once, and may be prolonged to minimize the risks associated with the development of acquired intellectual property rights:

• 10-15% of the amount when signing the contract;

• 15-20% after mastering the technology;

• 65-75% at the end of the first year of release of licensed products.

In case of assignment of rights to tested technology, the technical and production risks of which are largely minimized, and the application of the lump-sum payment scheme (P) is primarily due to the complexity of controlling the licensee, the most appropriate way to calculate a lump sum is to bring hypothetical future revenues from royalty by the time of valuation (PV (royalty)).

where PV - is the present value.

If the reason for using a lump-sum payment is an insufficient level of technology development, a low degree of incarnation, and lack of any approbation, the most appropriate approach to determining the cost of a license will be a costly approach, in which the licensor's primary goal will be compensation for the costs incurred to create the item licenses (Cost) with a certain percentage of the profits (Fee).

In conclusion, it should be noted that in addition to calculating the cost of a license or franchise, when planning pricing for the target technology, it is necessary to take into account the calculation procedure, the discount system, as well as other price incentive measures.

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