Royalty Rate Assessment - Royalty Rate and The Technology Turnover Concept

Royalty Rate and The Technology Turnover Concept

A more elegant - and algebraic - way of looking at royalty payments is to attempt some form of consolidation of the quantitative variables in a licensing proposal (See Manual on Technology Transfer Negotiation, United Nations Industrial Development Organization, Vienna, Austria, 1996 pp.256, 1996).

Table A demonstrates one form of consolidation.

It takes the case of a technology license where the royalty rate is 4% on sales value over 5 years, with rights to the licensee to continue operations beyond that period without further payment obligations. For purposes of illustration, it is assumed that that the annual sales volume and production cost are constant (later discussion allows for year-to-year changes):

Table A. Schematic of Incomes and Cost Flows

Unit:'000$
Year -->	1	2	3-5	6
Sales	100	100	100	100
Cost of Production	40	40	40	40
Royalty Due,R	4	4	4	0
Total Cost	44	44	44	40
Operating Profit OPR	56	56	56	60 OP

It is evident that in the 6th year, the Operating Profit of the enterprise increases by $4000.

The higher value of the Operating Profit in the 6th year would not be apparent if assessment was limited to the first 5 years of royalty commitment.

Algebraically,

LSEP= R/(OP_R+R) - C

where:

Expression C can be rewritten as:

LSEP = 1/ (1 + OP_R/R) - D

or as

LSEP = 1 / (1+TTF) - E

where TTF is defined as the Technology Turnover Factor. It is a measure of the profit or return that the enterprise obtains for a unit of royalty payment - the profit accelerator. A high TTF implies a lower share of enterprise profit flows to the licensor (and conversely, a higher share to the licensor when the TTF is small). The evaluation of Expression E and that of TTF provide estimates of commitments to the technology-offering party in accepting a license at a particular royalty rate (and a base for negotiations).

Expression C also defines the term 'profit' for this analysis; it is the profit before tax during the royalty-bearing period and not that of the post-royalty period. Thus, taxation rates do not come into play and it is possible to evaluate the impact of royalties independent of territory.

Of course, in normal business practice, royalty rates take on different forms, while sales, costs and profits vary from year to year. Unless they can be consolidated to single numbers, the practical use of Expressions (D) and (E) would not be feasible. This can be done by converting all cash flows to their 'Present Value'.