A licensing business model allows you to maximize revenue through strategic agreements. In this guide, you’ll find a detailed explanation of how such a model works, its advantages and risks for startups and businesses, as well as a series of practical examples.
What is a licensing business model
To understand how to best leverage a licensing-based business model, you must first know exactly what it is.
Definition: IP usage rights in exchange for payments
A licensing business model is a specific business model that involves developing intellectual property (IP)—such as products, services, or technologies—and granting third parties the right to use it in exchange for a payment, which can be made in various ways.
Licensor vs. licensee: roles, objectives, and typical B2B cases
A licensing agreement precisely defines the roles of the parties involved: on one side is the licensor (or licensing party), i.e., the owner of an intellectual property right, and on the other is the licensee (or licensee), i.e., the party that acquires the right to use the intellectual property by paying a fee to the licensor.
A licensor may have various objectives: among these, the ability to generate a passive income stream without the need to invest directly in production or distribution in new markets stands out, as does the ability to use licensing as a marketing tool, increasing the reach of the creation or the brand itself.
A licensee can use licensing to access products or technologies without having to create them from scratch (thereby also avoiding the associated risks) and to enter a market more quickly, as well as to diversify their offering and reach new customer segments.
Licensing agreements operate in various fields: a typical example of the licensor-licensee dynamic is a fashion brand that licenses its name for sunglasses, watches, or other accessories, or software companies that provide enterprise licenses. Another typical case, but in the technology sector, is a software company that provides enterprise licenses (ELA) to third parties for the use of its services.
Types of Licensing
There are several types of licensing for startups, which differ from one another in terms of their scope (but not only that).
Technology licensing business model
The world of technology licensing involves various types of agreements:
- Trademark License (allows the use of a trademark for specific products or services without transferring ownership);
- Patent License (grants the right to use, manufacture, or sell a patented invention);
- Know-How License (covers unpatented technical knowledge, such as processes, formulas, and trade secrets).
Software Licensing Business Model
Software licensing pertains to the specific field of computer programs and may include proprietary or open-source licenses. Here too, the models vary:
- Per-user licensing (the license is granted to a specific individual, who can access the software from multiple devices);
- Per-device licensing (the license is assigned to a specific device);
- Subscription/SaaS (provides for access to the license in exchange for a recurring payment, typically on a monthly or annual basis).
Data licensing business model
When it comes to data, there are also several licensing models:
- Dataset licensing (involves a structured collection of data to facilitate its analysis or processing);
- API licensing (involves application programming interfaces, which allow different software applications to communicate with each other and exchange data and functionality).
Keep in mind that dataset and API licenses may include specific restrictions (such as attribution requirements and limitations on commercial use) and audit systems to verify and ensure compliance with the rules.
Economic Structure: Royalties and Fees
We’ve already mentioned this earlier: the payment terms provided for in a licensing agreement vary. Below, you’ll find a list of the most common ones.
Royalty types: percentage of revenue, per unit, flat fee, guaranteed minimums
The financial consideration, where applicable (in cross-licensing, for example, the consideration consists of technology), can be fixed (i.e., not tied to the amount of profits; in this case, it is referred to as a flat fee) or variable.
Royalties are the most common form of quantifying the consideration: they can be determined based on the profits derived from the licensee’s sales, based on the licensee’s production, or based on a share of the licensee’s company’s profits. In some cases, guaranteed minimums are provided for.
License scope: exclusivity, territory, duration, channels, and fields of use
The license scope defines the limits of the rights granted to the licensee.
First of all, you should know that a license can be exclusive, non-exclusive, or semi-exclusive: in the first case, the licensor cannot grant the same license to others, while in the second case, the licensor may grant the same license to multiple licensees. In the third case, however, exclusivity is limited to a specific sector or geographic area.
The limitations may also pertain to the time period during which the licensee may exercise the acquired right of use.
Benefits and Risks for Businesses and Startups
Licensing undoubtedly offers several advantages to businesses and startups, but it also hides some pitfalls.
For the licensor: revenue growth, brand expansion, focus on core business
The main advantage for a licensor, of course, is the opportunity to be paid simply for the right to use their idea. It is no coincidence that a famous quote by Thomas Edison states:
“The value of an idea lies in its use.”
Licensing allows for the generation of recurring revenue without having to produce the goods or services that utilize the intellectual property in-house and, therefore, without an increase in operating costs. This is why the licensing-based business model is highly scalable.
Licensing intellectual property offers other advantages for the licensor: it allows them to focus on their core business and expand the brand’s presence into other markets that would otherwise be unreachable without licensing.
For the licensee: time-to-market, reduced R&D, access to strategic IP
Through licensing, as already mentioned, the licensee gains access to products or technologies that are strategic for them without having to create them from scratch. This avoids risks and saves time as well as financial resources: by reducing investments and allocations for research and development (R&D), the licensee can redirect those funds to other areas.
The other major advantage is linked to the opportunity to reduce time-to-market: licensing, in fact, allows the licensee to enter a new market much more quickly.
Common Risks: Dependency, Cannibalization, Compliance, and Quality
Beyond the economic considerations (the initial investment required to enter into a licensing agreement can be prohibitive in some cases), the most common risk for the licensee is becoming overly dependent on the licensor.
For a licensor, the main danger lies in the possibility of having their reputation damaged by the licensee. It is therefore essential to carefully select the licensee and maintain control over production quality.
Examples and use cases
Other concrete examples and use cases can help you better visualize what we’re talking about.
Software License Business Model
In the software industry, perpetual licenses are those in which the software provider sells the license for a one-time fee, while subscription licenses involve a monthly or annual payment. There are also hybrid models that combine the two approaches.
Gradually, the subscription model is replacing the perpetual license model: Adobe, for example, used to sell perpetual licenses for products like Photoshop (customers made a one-time purchase of the software and bought a new license for each subsequent version), but then switched to a subscription model for the Creative Cloud package (customers pay a recurring fee for access to the entire software suite and updates).
Technology licensing
The most classic practical example of integrating intellectual property into end products in the context of technology licensing is that of a technology company that develops a new patented chip (the intellectual property) and licenses it to a smartphone manufacturer (the end product), in exchange for the payment of royalties as stipulated in the licensing agreement.
Brand/character licensing
A practical example of brand licensing is that of Valentino Rossi’s company VR46, which licensed its brand to Packard Bell for the production of information technology products.
How to Set Up the Licensing Business Model
There are three main steps you need to follow if you want to set up the licensing business model correctly.
Preparation
The first step is preparation: before you can even consider licensing intellectual property, you must verify that there are no prior patents or copyrights on it that would prevent you from registering it and, subsequently, licensing it. Once registered, you need to develop its unique value proposition and identify potential licensees to whom you can present the business idea.
Term Sheet
The second phase involves defining the terms of the agreement between the licensor and the licensee: key points include the payment terms for the license fee, the contract duration, and territorial and sectoral limitations.
Go-to-market
The third and final step is the most operational: you must select the partner and pilot territories, that is, the strategic geographic areas where the initial launch will take place. Together with the partner, you can also develop co-marketing strategies to achieve shared objectives.
Metrics and Contract Governance
As previously noted in this guide to the licensing business model, the licensor risks serious reputational damage if the licensee becomes involved in issues or scandals related to non-compliant or substandard production, or other problems. Monitoring the entire process is therefore essential.
Quality and Brand KPIs: Complaints, Defects, and Proper Use of Assets
When it comes to production quality and brand reputation, it is essential to focus on metrics related to potential manufacturing defects and possible complaints. It is also very important to verify that all assets are being used correctly.
Financial KPIs: sell-in/sell-through, effective royalty rate, break-even
Similarly, it is also necessary to monitor the so-called economic KPIs: the main figures to keep an eye on are generally sell-in/sell-through (the percentage of goods sold overall, including retailers, wholesalers, and end customers), the effective royalty rate (the royalty rate actually applied, calculated as a percentage of revenue generated from use or sale, as established by a licensing agreement), and the break-even point (the point at which total revenue and total costs are equal).
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