I have gotten a number of email questions about royalties so I would like to point out a misconception by many Inventors pertaining to how they are calculated. The actual portion of your royalty if you are licensing a product is NOT based on the price of the product in the store. Your royalty is based on the sale price the company manufacturing it sells it to the distributor or stores.
That item you see in the store for $12 might have been sold to the store for $4 or less. Your royalty is based on the $4 NOT the $12. This also plays into the other statement I hear from many Inventors when an Inventor states their idea/product is a million dollar idea.
Let me say up front yes there have been million dollar ideas. But, I want everyone to have realistic expectations of what that takes. Using the $4 sale price above and your royalty is on average between 3% and 5% of that $4. So you can be making 20 cents per item sold on the high side. Using that royalty return think about how many items do you need to sell in order to reach the 1(one) million dollar mark in take home royalties? And don’t forget to add to your calculation as if it is after your taxes are taken out? This will give you your true ending profit. For this example let’s say your tax percentage is typically another 33%.
Another thing to keep in mind about royalties is they generally do not start as soon as you sign the licensing deal. You have the wait time from when they say yes to the licensing deal for it to be manufactured, which can be a year or more. Then they have to get purchase orders, fulfill those orders, get paid and then pay you 30 days after that. Once you get the first royalty check they normally show up every 4 months after that.
That is why I always stress having patience and don’t rush out and buy a new car as soon as you sign a licensing deal.
Based on the example above if you are getting $0.20US royalty per unit it would take 6,650,000 units to return $1,330,000US. One third of which goes for taxes. $1,330,000US – $330,000US = $1,000,000US.
So you can see it is possible to make a million dollars from your idea if the unit volume is high enough. The question you need to ask is your market large enough to meet that demand? Where I see Inventors having unrealistic expectations is in their expectation of their market. For example if your market is 10 million consumers of a particular type item you cannot expect that all 10 million will purchase your product. It will be a percentage of that 10 million. Will it be 1%,10%, 50% or higher?
A problem most Inventors neglect to take into consideration is the fact that if the majority of consumers that have a product similar to yours are not likely to throw out the current working item just to purchase yours. Consider if Bridgestone came out with a new advanced tire that will last longer than your current tires you have had for 6 months. Would you run down to the tire store and get rid of the four tires on your car that still have 50,000 miles left on them? That is what you are expecting consumers to do when you think an entire market will 100% buy your product. What really happens is the consumer will wait until those tires are worn out then when it is time to replace them they will compare yours to their other options and make a decision.
So, when you consider your possible earnings from royalties it is better to wait for the check to be in the bank before you spend it.