A royalty rate is the percentage of sales revenue that the licensee pays the licensor for the right to use their brand. It is one of the core commercial terms in any licensing deal and is applied against defined sales models.

Purpose:

Royalty rates ensure the licensor is compensated based on the commercial performance of the licensed product. The rate structure may vary based on how and where the product is sold.

Sales models explained:

Direct to consumer (DTC)

Definition:
Royalty is based on full revenue from direct sales to consumers - typically through the licensee's own e-commerce site or owned retail.

Use case:
Used when the licensee sells directly to end customers without intermediaries.

Example:
If a product is sold for $30 on the licensee's website and the royalty is 12%, the licensor receives $3.60 per unit.
Freight on board (FOB)

Definition:
Royalty is calculated based on the price at which the licensee sells goods to the retailer or distributor - typically at the factory or warehouse gate. This excludes downstream markups like retail margins or shipping to the consumer.

Use case:
Common for mass retail, when the licensee sells to a distributor or retailer.

Example:
If FOB price is $10 and royalty is 10%, the licensor receives $1 per unit sold.
Domestic

Definition:
Royalty is calculated on the licensee's domestic sales revenue, usually at the invoice price to the retailer, including any domestic markups (such as freight-in or handling costs), minus standard deductions like returns and discounts.

Use case:
Often used when the licensee is a brand owner or manufacturer distributing through multiple retail channels.

Example:
If retail price is $20, but after discounts and returns net sales are $16, and the royalty is 10%, the licensor receives $1.60 per unit.

Key notes:

Royalty rate ranges vary by category, brand strength, and channel
The sales basis (DTC, FOB, Domestic) must be clearly defined in the licensing agreement, as it directly affects how much royalty is paid per unit.
- Direct to consumer (DTC) usually carries the highest royalty rate because the licensee retains full retail margin.
- Freight on board (FOB) typically carries the second-highest rate, as it reflects wholesale pricing and upstream distribution.
- Domestic generally has the lowest royalty rate, since it includes less markup and reflects netted-down domestic invoicing.
The appropriate basis depends on the licensee's sales model and market approach.