My answer to How do I start up a small business (for now) where I have to manufacture the product?
Answer by Ken Larson:
Product entrepreneurs all face the same challenges. Those who succeed recognize they need to visualize themselves in the product development business, structuring an enterprise, generating a business plan, protecting intellectual property and then seeking industry partners and investors to bring the product to market.
In the process, copyrights, patents and royalty issues may come into play and development and distribution agreements are formed. Pricing is finalized based on cost and expense projections and competitive factors unique to the company as negotiation results are achieved with industry teaming partners, developers, manufacturers and distributors.
Financing is always a factor and can be achieved through loans or investors with a good business plan. The remainder of this article will address the basic elements of a framework within which to succeed with your product development for federal government contracting.
Locate teaming companies to further the objective that they would market your product as part of their offerings with your company licensing and sharing in the proceeds.
A business plan and the guidance above for its generation is the road map for developing ideas, laying out how to expand the sales of your product and researching your market to do so. It will also assist in developing pricing to considering the direct costs of product development, service implementation and distribution as well as the indirect costs of the enterprise itself (operating expenses).must be considered and financed.
A negotiation position for a given product will be driven by certain strategic factors:
1. Does a developer or teaming partner have a strong but realistic incentive to actively make the product a part of the marketplace?
2. Does market research indicate the idea will have strong sales volume once it is developed and distributed?
3. How much will a prospective teaming partner or investor have to invest in the product to get it to market? Does the product require testing?
4. Which is the better deal? Is it better to receive a 7% royalty on $5,000 worth of sales or a 1% royalty on $500,000 of sales? Even though 1% does not sound too impressive, of course it’s the better choice in this example.
A negotiation position should be based on support by for the argument that a concept will experience a certain level of sales and the royalty should be based on a % of estimated end user volume sales, discounted for the investment that the developer and distributor must make to get it to market.
The royalty should be outside of the distributor cost breakdown and the end user cost breakdown. It is simply a deductive factor the manufacturer will have to introduce into their profit equation after the costs have been tabulated. They should not view royalties as a cost factor; they should view them as a share of the profit on the total estimated sales.
Chances of succeeding with a negotiation with a developer and/or distributor are increased by showing understand the prospective market for the product and drawing some comparisons between the product and other similar successful products.
Naturally there will be some give and take with the other side about estimated costs to get the product to market. Be forthright in acknowledging their investment but also support a position with some research and comparative data on the product potential.
Lastly, settle on a % of the end user sales volume based on an estimate to which is agreed with the other party and insures that the purchase agreement for royalties entitles the agreed upon % on all future sales.