To license a product, a licensor is required to give a licensee the permission to manufacture or sell the product. As the party that holds the rights to the product, the licensor is entitled to charge the licensee a royalty fee. Licensing is a good option for a company that wishes to expand its product line, because it enables the company to leverage a proven product to achieve greater profitability and growth. It is important to weigh the pros and cons of licensing before you license or obtain a license for a product.

What Is Product Licensing?

Licensing occurs when a licensee obtains permission from a licensor to produce and sell its product or products within a certain market. Referred to as the licensee, the party that obtains the rights to sell the product is usually required to pay the licensor a royalty fee.

In order to survive, a company has to continually introduce new products to replace declining ones. A company may also want to expand its product offerings to even out seasonal highs and lows, fill up excess manufacturing capacity, or increase its profitability. However, some companies may not have the money, time, or internal skills to develop new products on their own, so they may decide to quickly acquire a proven product through licensing. Licensing strikes a balance between risk and reward, because it enables you to take advantage of the success of an accomplished company to distribute your product.

How Licensing Works

Let's say you just came up with a great idea and wish to turn it into a product. In order to do so, you will most likely have to apply for patent protection and then find a company that is willing to undertake the manufacturing of the product and pay you a royalty fee. Usually, a royalty fee is five percent of gross wholesale sales or the price from the manufacturer to the retailer.

Many inventors may initially think that this rate is too low, but it is actually a good deal for them. According to market data, a well-managed manufacturer makes a bottom-line profit of about 10 percent. That is only twice the amount the inventor is earning, despite having to pay for all the ongoing investments and expenses, take more risk, and put in much more effort. Meanwhile, there is a much higher chance that the licensing deal will be a success, because the most difficult part, which is finding a distributor, is already done.

Advantages and Disadvantages of Licensing

Advantages

  • You will have access to the know-how and experience of the company that created the product. That company may be a lot bigger than yours and may possess development capabilities that you do not have or cannot afford.
  • With the new product, you will have an opportunity to enter a new market and enjoy a competitive edge with the experience you gained in another market. This is more cost-effective than purchasing a whole company.
  • You do not have to invest in time-consuming and costly research and development.
  • You are not required to pay development expenses up front. You only need to pay royalties after you start making sales.
  • You will not suffer huge losses if the product fails.

Disadvantages

  • The licensing agreement is usually valid for a considerable duration of time. Also, you may have to pay an annual minimum royalty.
  • New technologies may emerge and make the licensed product obsolete.
  • The licensing agreement may make it compulsory for you to accept certain marketing restrictions.
  • You may lose the ability to develop your own technology internally.
  • Licensors may not be able to license their products if they fail to meet certain licensing requirements.
  • In most cases, licensors will lose most or all of their rights to their inventions. The licensees get to call the shots, but the licensors may not agree with their decisions. Ideas may fail because of poor strategy or execution, so it is important for licensors to work with companies that have a solid track record in licensing.
  • Licensing is costlier than crowdsourcing because it may require licensors to invest substantially in their inventions to make them license-worthy.

If you need help understanding how to license a product, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Stripe, and Twilio.