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February 26, 2017

Profit sharing and royalty rates options found here.


How Long to Expect Royalty Rates / Profit Sharing from Software Development

Whether the software royalties should continue indefinitely, one should figure out what happens after developing version 1.0 of the application.  If the software developers' input stops there (and other developers end up taking the application further), perhaps the software developer should expect royalties to stop at some point too.

This becomes tricky when the client insists on owning the adapted source code which you originally owned. The client should pay for the initial source code if he wishes to take ownership of the final "adapted program." For example, if the client wishes to enter a limited contract period of development, such as 3 to 5 years, what happens when the contractual period expires? Therefore, software ownership must be clearly defined at the beginning of the contract.

Consider Software Development Costs for Royalty Rates / Profit Sharing

Normally, 55%-70% of total project cost is spent in development, especially in the initial version. This high proportion is because new products require "basic foundation development" (R&D, refining/defining business processes and more.).  Marketing software typically consumes 20%-40% of the budget. The software developerment phase is more risky because the software developer needs to have a saleable application before earning revenues to recover sunk costs.  When adapting existing applications the developer owns for clients, the astute software developer should consider "how much work do you need to put in before the application becomes "saleable" and whether the clients pay for additional software development. Don't forget the latter phases of the SDLC process. There will be technical support, training, deployment, etc.  Who will pay for this? These costs should not be supported by software development royalties.

One advisable approach is to enter in a contract agreement with the understanding that the software developer and marketing partner develops the program for substantial discount (less risk to both parties).  Having a satisfactory software development agreement, software developers are more apt to ensure the application will be saleable and lessen the risk for both parties.

With regards to the structure, if software developers assume all risk of software development cost, they may refer to the simplified formula below. 

Consider the following:

  • Total software development cost
  • Break-even cost
  • Target profit margin per year. 

For example, total software development cost is 500K.  Total cost to initial development and make the sale is 750K.  The application is sold for 100K per license/server and at least 8 sales are needed to recover the total initial software development cost. Consequently, the marketing team needs to provide some assurance that at least 8 apps will be sold or the team will incurr a loss.

On the marketing side, they haven't spent anything substantial until the application is available (however, they may attempt to acquire a contract with prospects while negotiating with the software developer).  Even when the application is sold, you still need to provide technical support, training, bug fixes, etc.

If that is the case, try to approach 50%-70% of the profit after tax excluding total development cost and marketing cost (on their end).  If it is a big company with estimated millions on dollars in sales, compute the target profit over two years (tends to be 5%-15%).  The bottom line of the negotiation is really how much risk the software developer is taking and how much effort  is being expended and nature of the compensation.


Profit sharing and royalty rates options found here.