What is the concept of royalty fee?

Question

Is it true that if there is a rip off company, like a company that makes fake Gucci clothing, they have to pay some “royalty fee” to Gucci?

In: Economics

Answer 1

Royalties are basically a back end payment structure based on the actual profits. Typically, royalties are a % of the profits.

For instance, in the USA mineral rights belong to property owners. If an oil company wants to drill on your land, the typical deal is a per acre bonus and a royalty. So, the deal might be an upfront bonus of $1,000 per acre plus a 12.5% gross royalty on production. That means on a 100 acre plot, you would get a check up front for $100,000 and then 12.5% of the gross value of every barrel of oil produced from each well on your land. So if a typical well makes 100 barrels per day at $50/bbl, the land owner would receive a royalty of $625 per day. This royalty will be paid out perpetually until no more oil is produced.

This is a good deal for both the landowner and the oil company. For the oil company, it means they don’t have to pay huge sums up front and can invest more capital into drilling wells. For the land owner, it means that they don’t have to accept a one time payment and can enjoy positive fluctuations in the market, like a rise in the price of oil.

In the example you give, you are talking about a licensing fee. This is similar to a royalty, but it typically refers to allowing another company to use your intellectual property or patented technology for a fee. So, a good example is in the car industry. GM invented magnetorheological shocks a few years ago, which outperform anything currently on the market. They were so good that Ferrari approached GM for a licensing agreement. Since GM doesn’t really make any cars that directly compete against Ferrari, they realized it would be better to get paid for every car Ferrari makes with these shocks. So, for every car Ferrari builds with these shocks, GM gets paid a flat rate (maybe $150, for example).

With knock-off Gucci bags, they are not made with Gucci’s permission. The knock-offs don’t pay anything to Gucci. Even if they asked Gucci for permission, Gucci would say no for several reasons. Gucci bag are valuable because they are high quality and rare.