Profitability and Royalty Rates Across Industries: Some Preliminary Evidence

Abstract

Is the licensing market efficient such that royalty rates reflect the costs and profitability across industries‘ This paper tries to answer the question through exploring the relationship between royalty rates and profitability. Our analysis shows that the reported royalty rates across industries do not converge with the rates generated by the 25% rule, although they tend to fall between 25% of gross margins and 25% of operating margins. Regression analyses indicate that there is a linear relationship between the reported royalty rates and various profitability measures, which suggests that the licensing market is efficient and that cost structure and profitability across industries have been factored into royalty rate negotiation. Therefore, the 25% rule is simply a special case of such a general linear relationship. A revisit to the data in Goldscheider et al (2002) further demonstrates that a 'forced' linear fitting seems to make the average royalty rate equal to 23% of the average operating profit margin, rendering indirect support to the 25% rule. However, such a conclusion should be taken as for the purpose of illustration and contrast only, because no general linear relationship was found between the reported royalty rates and operating margins as defined by Goldscheider et al (2002).

Keywords: royalty rate, profitability, the 25% rule, regression analysis, linear relationship, industry, royalty negotiation, profit margin

JEL Classification: O32, O34, C13