Commercialization: Get the Most Out of Your Intellectual Property Rights

Companies seeking to profit from their intellectual property may adopt a number of commercialization strategies, ranging from direct sales to the outright sale of their technology. Michael Diener of Hale and Dorr LLP discussed these two strategies, as well as the continuum of options in between them. In the options below, each successive option offers a decreasing portion of "up-side" to the intellectual property owner; however, the owners responsibilities and need for financing will also decrease likewise.

Commercialization Strategies

Direct sales. In the direct sales scenario, the intellectual property owner handles all aspects of the business. While the product may be manufactured by the owner itself or by a contract manufacturer, the owner will be responsible for the marketing and sales of the product. After the owner has paid its employees and expenses, the balance is profit. A newer venture may find it difficult to hire people with the knowledge and ability to market and sell the product. However, the benefit of this option is that the owner has not made a commitment to another party, so it may change its direction at any time and pursue another commercialization strategy.

Sales representative. The next scenario involves outsourcing sales to outside sales representatives. Typically, under this arrangement, a sales representative will take orders, which may be accepted or rejected by the company. If accepted, the sales representative will then obtain a commission of 5, 10 or 15% of sales. While 10% is common, the commission rate will depend on the industry and the person involved. For the company, the benefit is that it typically pays commissions out of money already received, so there's no advance investment. The company is often also getting someone with knowledge of the area. However, this type of arrangement also carries drawbacks. Since the sales representative is not an employee, that person may not be committed to the product. Furthermore, the representative may be carrying multiple products such that if another product is selling better or is more established, the representative may find it more worthwhile to sell another company's product.

Many states have regulations that require a written contract between a company and its sales representatives. This usually does not present a problem because most of the required terms (e.g., statements on how commissions will be calculated) will usually appear in any contract between a company and its sales representatives anyways. Regardless, Michael Diener recommended that all companies obtain an agreement in writing with their sales representatives. These should indicate whether the company has designated the sales representative as exclusive or non-exclusive. Exclusive representatives usually provide a greater level of service; however, this type of arrangement limits a company's flexibility.

In the European Union (EU), there may be requirements to pay compensation to a sales representative if a company terminated the representative without cause or refused to renew its agreement with the representative. Many EU countries individually also have provisions that limit the time in which a company may terminate a sales representative or require post-termination compensation. The rationale is that a company may be going into a country in which it knows nothing about. The sales representative may set the company up with a number of prospects, making future sales are a lot easier. The company may then terminate person and take advantage of relationships formed by sales representative.

Franchising. Franchising is a heavily regulated area. If a company tries to impose a lot of marketing obligations on its franchisee, it must look into many of the obligations under Federal Trade Commission (FTC) or US law. One indication that a company is operating a franchise business is if it charges the distributor for the right to use a trademark that extends above and beyond the basic price of the product.

Distribution. In distribution-type arrangement, a manufacturer sells its product to a third-party distributor, who resells it to other people. The distributor will assume some of the risk after it has taken title to the product. For the manufacturer, it will be surrendering more responsibility and profit than in the strategies above. In the sales representative option, the manufacturer may be offering a 5-15% commission. With a distribution agreement, the manufacturer may be selling at a 30-70% discount to the retail price, with the typical discount being 50%.

Common distribution agreements include OEM (Original Equipment Manufacturer) agreements where the distributor will include the OEM product as part of its offering or in a bundle with other products, VAR (Value Added Reseller) agreements where the distributor will integrate the manufacturer's product with its own services, and private label agreements where the manufacturer will produce its own product, but with the distributor's branding.

In distribution arrangements, the manufacturer does not set the minimum price of the product to the end-users because this is seen as vertical price fixing. So, manufacturers typically sell at some discount to list price or at a flat price. In its contracts, the manufacturer will want to ensure that it has some ability to change prices over time. The drawback of distribution arrangements is that the manufacturer may lose contact with its end-user. Such arrangement are also less flexible – if the manufacturer wishes to change its strategy, it may have to wait until the distribution agreement terminated. Again, in the EU, manufacturers may have issues of post-termination compensation for distributors, but distribution agreements are easier to terminate in the EU than sales representative agreements.

Joint venture. In a joint venture arrangement, the intellectual property owner licenses its intellectual property to some party in which it holds an ownership interest. A joint venture is a separate entity where an owner may receive money both from owning the entity and from royalties. The risk is that a joint venture may have a different corporate culture and goal than the intellectual property owner. The benefit is that such an arrangement may potentially shield the intellectual property owner from some liability. Michael Diener recommended that owners negotiate the intellectual property license fees at a reasonable arms-length and that they consider dividends from their ownership interest as an additional benefit. Owners who rely on dividends as their compensation may sometimes be disappointed by the results.

Licensing. Typically, the licensee will manufacture and sell the product, and pay some kind of royalty of 3-6%. In the case of a patent license, the licensor may be relying on the licensee to develop and manufacture the product. If the margins are 20%, the licensor may receive 5% out of that. The ballpark figure is that 25% of margins goes to the licensor; however, that may depend on whether the licensor is just transferring the patent and prototype, or whether it is also contributing some significant know-how or other technical information, as well as the amount of mark-up that is typical for that type of product. Licenses may be exclusive or non-exclusive. If an intellectual property owner was contemplating selling its intellectual property under an agreement that provided for downstream payments, Michael Diener recommended that the owner consider an exclusive license instead so that it would have a better ability to recover intellectual property.

The advantage of licensing is that it may be tailored to fit the owner's situation. Licenses could be quite flexible, and may be divided up geographically. Furthermore, the owner may retain some of its rights. However, this arrangement offers much less upside or downside. While the licensor may face no upfront costs, its upside is limited to the 3-6% royalty.

In the software industry, most companies use distribution-type arrangements under which they provide the whole product instead of expecting licensees to manufacture the product. In some cases, if the company has a foreign distributor, it will give the distributor a gold master (GM) – good copy of program – to generate multiple copies. The alternative is for the company to manufacture, package and sell the product to the distributor. If the company sends a GM and lets the licensee manufacture, package and ship the product, such sales may be treated as royalty income. However, if the company manufactures, packages and ships the product overseas and the distributor resells the product, that will be resale income. The significance is that many countries (including the United States) have a royalty withholding tax on licensors (i.e., if you are a licensor and sell into Japan, the licensee will be required to pay a percentage (up to 30%) to the foreign government. While the licensor may use that amount to as a credit to off-set its taxes, if it don't have enough income and in the right buckets to off-set, it may be losing revenues that it would otherwise could be receiving. The other practical problem with GMs is that the licensor may not know for sure how many copies the licensee made.

Sale of technology. The sale of intellectual property is not seen very often, except for the sale of a product line or the transfer of a business. If the intellectual property owner will be receiving an ongoing payment for the sale, Michael Diener recommended that the owner offer an exclusive license instead so that it will have a better chance of reclaiming the intellectual property if it don't get paid along the way.

Selecting the optimal commercialization strategy depends on the nature of the product, the industry, and the availability of financing, with different arrangements being appropriate for different areas. Companies may find that dividing the country into distribution areas may make sense, but that licensing is the best solution for the overseas market. Even within the United States, some companies may want to retain for themselves the right to sell through certain channels of trade (e.g., direct sales via the internet). Typically, in areas where a company knows well, it should seek to stay towards the upper end of the options listed above. For markets that are distant from the company in location or familiarity, options towards the bottom of the list may be more appropriate.