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May 6, 2020

Size and profitability affects bargaining power in license negotiations

The relief from royalty method is premised on comparable licensing transactions and their underlying royalty rates. Royalty rates found in such transactions are assumed to represent a market price surrogate for the licensed assets.

However, license agreements are not traded on active markets; typically, they represent random transactions between two market participants, lacking a pricing mechanism like with numerous participants in oligopolies. Reservations about the market price surrogate have been widely expressed by solicitations to consider the particular circumstances that lead to a license agreement, including information asymmetry, distribution of power, relatedness between the parties, timing and the like.

Recently, researchers of Cornell University and University of Hong Kong have published a study on the effects of market power of licensors and licensees on royalty rates (Gaurav Kankanhalli and Alan Kwan; Bargaining Power in the Market for Intellectual Property: Evidence from Licensing Contract Terms”). Market power is measured by relative firm size and margins. The results demonstrate that firms with higher market power can command more favorable royalty rates – licensors higher rates, and licensees lower rates.

These findings are plausible and expectable. They are yet another evidence that the market price tenet with royalty rates is a tricky illusion. However, the applicability of these findings in practice is hampered because timely market power data for the parties to a license agreement often do not exist.

The MARKABLES dataset meets these challenges. Each case includes size data (revenues) and profitability data (sales multiple or enterprise value / revenues), allowing for an analysis and adjustment of the market power effect in each peer group.

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