Inventors: To License or To Manufacture – That is the Question

By Gene Quinn
May 20, 2011

It doesn’t roll off the tongue quite like the famous Shakespearean line — “to be or not to be: that is the question” — the opening line of Hamlet’s soliloquy in Act 3, Scene 1, but the question that some inventors will ask themselves is whether they should seek out licensing opportunities or follow the path of manufacturing and selling.  Truthfully, many inventors probably don’t ask this and instead jump past this fundamental question and straight for the licensing revenue, but is that the best thing in the long run?  Licensing takes a lot of work out of the monetization equation and minimizes risk, but foregoing manufacturing and pursuing licensing can significantly cut down on profit realized by the owner of the invention rights.

The question about whether to license or manufacture is one that should be asked by all inventors because there is no “right” or “wrong” answer.  As a result, one-size-fits-all advice is not at all helpful.  It is largely a question of resources, time commitment and personal preference.

According to Trevor Lambert, of  Lambert Licensing, licensing may be the way to go for those who are not independently wealthy.  When discussing with me the “Cashflow Comparison” graph (see below), Lambert explained: “The cashflow comparison shows that you go well deeper into the negative cashflow when you are going to manufacture it yourself, but your likely returns on investment are much higher.  So licensing is more of the safer bet for those who are not independently wealthy.”

You can clearly see from Lambert’s exemplary illustration, the amount of money necessary to generate, develop and commercialize  is far less for those pursuing a licensing path than it is for those following a manufacturing path.  Through idea generation the cost is roughly similar, but starts to diverge to significant degree during development and even greater during commercialization.  Of course, when licensing a product a royalty of 1% to 2% is not uncommon in many industries, so the long term profitability for licensing has an up-side cap that is much lower than the up-side potential for those who pursue manufacturing.

It is probably worth circling back and commenting on the 1% to 2% royalty comment above. There is no better way to end licensing negotiations before they really start than to announce unrealistic expectations in terms of a royalty rate that is simply not within the industry norm.  In fact, one of the biggest mistakes I see from inventors is the unrealistic expectation that they are going to get royalty rates of 50% or more.  That is unheard of and simply does not happen, so the sooner you can come to terms with that the sooner you can get on to making money.

Inventors frequently argue something like: “I was the one with the idea and without me they would have nothing, so I deserve a 50% royalty at a minimum.”  The truth, however, is that the companies do not need your invention or idea, if you are pursuing a licensing strategy you need them.  Stop and look again at the Cashflow Comparison above.  One of the most attractive things for inventors pursuing the licensing strategy is that they can spend less, which means less of their own money is at risk.  That necessarily means that the risk of manufacturing, together with the associated costs, are borne by the party licensing your invention rights.  It is simply unrealistic to believe that the party taking the risk would ever agree to a 50-50 split.

Another reason that licensing is more attractive for many inventors is because they simply do not have the ability (or desire) to pursue the manufacturing and commercialization of the invention. One major stumbling block for inventors, even for those who have the funds to engage in a manufacturing path, is the lack of distribution channels. Without distribution you will not be able to sell the invention, and those who will license your product and sell if for you are distribution machines. For example, if you can get your invention into Target or Home Depot you are going to sell numerous units.  Quite frankly, almost no inventor could compete with the distribution of a major big-box store.

[Enhance]

When deciding to pursue a licensing strategy it is critical to understand why you are choosing that path. You are choosing that path because the licensing party brings a lot to the table.  If they cannot bring a lot to the table then why are you engaging in licensing discussions with them?  And if they do bring a lot to the table they are the ones holding the cards, not you.  So a 50% or even a 25% royalty is completely unrealistic. Those big-box stores that you want most to be in don’t really need to make a deal with you, they can simply make a deal with someone else.  They will sell units just because a product is on their website and on the shelf in the aisles of their stores nationwide.  Of course, I’m not suggesting you attempt to negotiate the best deal possible, but working with a reputable licensing agent is critical because they can tell you what the industry norms are for products similar to yours.

Now that you have realistic expectations for licensing, how can you increase the possibility of obtaining not only a licensing deal, but a good licensing deal?  Proof of sales.

Wait, doesn’t proof of sales require pursuing the manufacturing path?  Yes, it does, and that is one of the numerous reasons why picking between licensing and manufacturing is not at all easy or obvious.  Even if you are going to want to pursue a licensing path you might not want to put all of your eggs in one basket, and even if you are more than happy to put all of your eggs into a single basket you still need to catch the interest of those who will be the ones pulling the trigger with respect to licensing your invention rights.

There is essential one primary question that will be going through the mind of those who are being asked to license your invention rights: Will anyone buy the product?  What better way to demonstrate people will buy the product than to demonstrate that people have already bought the product.  In fact, Lambert says: “If you have any sales history, that’s what we lead with.” Lambert went on to tell me about a product he has worked with where the inventor sold almost 600,000 units throughout Europe.  “Now you’ve got my attention,” says Lambert.  Indeed!  If an inventor or small business has strong sales the primary question in the mind of the executive you are pitching the license to has been answered.

You don’t actually have to get involved in the complex world of finding a manufacturer overseas and importing into the United States to acquire the units needed for sale.  It is likely far more economical to do what is referred to as a “short run” right here in the United States.  Yes, it might be quite a bit more expensive per unit, but if you are pursuing a licensing strategy the goal is not to make money selling each unit, but to demonstrate that each unit can be sold.  So you would be better off having 100, 500 or 1,000 made here in the United States and paying more per unit versus having tens of thousands made overseas and imported at a lower per unit cost.  You will spend far more total when importing, you will have to find storage, and you have no idea whether you will sell any let alone tens of thousands.

Of course, Lambert cautions that it doesn’t make sense to jump right into buying 1,000 units for sale without any idea where to begin selling.  Lambert says: “If you are just going to buy a thousand units, make something like an aluminum tool for example, it is good to know what venues you will be selling at before doing that just so you are not sitting on stock.  Do the research.  Maybe make a website.  Start generating interest.”  And I would agree with that.  I have worked with one client in particular who did this particularly well.  He did his research, went around to specialty shops that might be interested in carrying his product and started making sales.

I guess the moral of the story is that even for those pursuing the licensing path there are things that you can and should do that will make it easier to demonstrate viability of your product. Pursuing some reasonable and cost efficient manufacturing strategies can be a very good idea. Who knows, you might find out that the licensing strategy turns out to be less attractive as you gain traction through manufacturing.

The Author

Gene Quinn

Gene Quinn is a Patent Attorney and Editor and President & CEO ofIPWatchdog, Inc.. Gene founded IPWatchdog.com in 1999. Gene is also a principal lecturer in the PLI Patent Bar Review Course and Of Counsel to the law firm of Berenato & White, LLC. Gene’s specialty is in the area of strategic patent consulting, patent application drafting and patent prosecution. He consults with attorneys facing peculiar procedural issues at the Patent Office, advises investors and executives on patent law changes and pending litigation matters, and works with start-up businesses throughout the United States and around the world, primarily dealing with software and computer related innovations. is admitted to practice law in New Hampshire, is a Registered Patent Attorney and is also admitted to practice before the United States Court of Appeals for the Federal Circuit. CLICK HERE to send Gene a message.

Warning & Disclaimer: The pages, articles and comments on IPWatchdog.com do not constitute legal advice, nor do they create any attorney-client relationship. The articles published express the personal opinion and views of the author as of the time of publication and should not be attributed to the author’s employer, clients or the sponsors of IPWatchdog.com. Read more.

Discuss this

There are currently 8 Comments comments.

  1. Mark Nowotarski May 20, 2011 4:25 pm

    There’s a new way to jump over the funding crunch of pre-commercialization, and that is to presell your product over the internet to a minimum number of buyers who will commit to buying it if enough other people signup. That way you have your cash in hand to go ahead and manufacture. If you don’t get the minimum to sign up, no one gets charged and you get valuable market feedback.

    http://www.kickstarter.com is one example. One guy presold $80k worth of patent pending titanium bike locks. Another has presold $96k worth of solar powered electronic toys. These are extreme examples, however. Most projects are seeking $1k to $10k in funding.

    Not only are people preselling product, they are also preselling certain product rights. One project is preoffering wholesale discounts for the higher pledge levels.

    This could be a very valuable tool for independent inventors who want to raise funding to build their products and demonstrate market acceptance to potential licensees.

  2. Stan E. Delo May 21, 2011 12:33 pm

    Gene-
    Excellent article about a decision that all independent inventors should be made aware of. Hula Hoops, for instance, would have been a great example for the manufacturing route, as they are so simple to manufacture, and the inventor could possibly see a 50% profit margin on the retail price. If they licensed, they *might* see a 5% margin of the wholesale price, IF they could license, and that is always a very big IF.

    Mark-
    A very interesting approach that I was unaware of till now. It might be worth a try in my case, since the products are somewhat expensive in nature, and I could perhaps seek funding for a startup that way, without having to give up large amounts of the profits to VC’s or Angel investors to understandably cover their risks of investing. Once I can demonstrate a good sales history, it will make it much easier to then either license the invention or sell them the IP and the startup business with all the tooling and a ready-to-go starting market. Or maybe just keep going if things look good, and use the sales demonstration to seek much less expensive funding.

    Hasta la vista-
    Stan

  3. Gene Quinn May 22, 2011 11:10 am

    Stan-

    That is a great point about Hula Hoops. I think I will have to follow this article up with some examples in a future article.

    -Gene

  4. Gene Quinn May 22, 2011 11:12 am

    Mark-

    Thanks for bringing up this point. This is sort of the direction Trevor was going when he talked about knowing what channels you would sell your invention in. I don’t know that I put it in my article, but he did mention setting up a website and taking pre-orders or at least interest of intent.

    I wasn’t aware of kickstarter though. I will have to take a look.

    Cheers.

    -Gene

  5. Larry MacDonald May 22, 2011 12:42 pm

    The question also revolves around whether the inventor is in fact an inventor or has just one idea. A serial inventor will not be served by going into manufacturing when what he wants to do is invent. Even a single invention inventor won’t be well served if they are incapable of running a company profitably.

    Invention royalties are often calculated as 25% of the net profit. If you think that way, the percent against retail is not relevant.

  6. Gene Quinn May 22, 2011 1:09 pm

    Larry-

    I would love for you to prove that 25% of net profits is at all realistic.

    Looking forward to your answer.

    -Gene

  7. Stan E. Delo May 22, 2011 1:42 pm

    I have heard of royalties in the 20’s a very few times, and they were generally all games. The products cost nearly nothing to produce, and sales can skyrocket sometimes, like Monopoly did back in the day. They initially were refused in a licensing deal, then boot-strapped it and it took off, and the licensee decided to license it after that. Hard to prove anything about royalties though, as they might tend to be kept confidential/trade secret by the licensee. Good observation about the types of inventors Larry… Very few really prolific inventors make good business managers in my experience.

    Stan~

  8. patent enforcement May 23, 2011 5:32 pm

    This is a great article, and it also raises interesting questions regarding the myth of the “patent troll,” or non-practicing entity. Thomas Edison, for instance, held over 1,000 patents, but practiced none of them. He invented, which is what he did best, and let others manufacture products from his inventions. Does that make him, or any other non-practicing inventor, a patent troll?
    http://www.youtube.com/watch?v=LkQELhZeDYQ