The word risk is linked to licensing in much the same way peanut butter is to jam – the two seem like a natural combination. With any new property, getting the merch program off the ground is something of a crapshoot. You can have a fantastic show, the right broadcast placement, A-list licensees lined up, and the marketing machine generating buzz 24/7 – and it still might not work. But licensees, who are already well aware that this is risky business, are growing more cautious these days. And licensors that haven’t cottoned on yet are in for a reality check.

Unless you’re talking about a blockbuster property, the days of 16% royalties and big fat guarantees are gone. Licensees are increasingly looking to property owners to help them mitigate and control their degree of risk, particularly when it comes to launching a program for an original entertainment property in North America. The industry is entering an age of modest expectations. Agreements characterized by tiered royalty structures and low guarantees that allow licensees to spend less capital upfront (and therefore take smaller risks) are on the rise.

The biggest factor contributing to U.S. licensee trepidation relates to retail real estate. For a program to generate significant sales volume, mass is the channel to pursue. But there just isn’t enough shelf space to house all the would-be breakout kids properties, and that’s affecting deal structures. Betesh Group VP of new business development Jonathan Breiter, who oversees licensing deals for Betesh subsids Toy Play and room décor manufacturer Baby Boom, says he’s continually bombarded with proposals for new properties. ‘I have six different programs I can jump on right now. I don’t have six retailers to take them to though, so something’s got to give. When the deals are cut for two or three of these properties, they’ll be structured in a very conservative manner.’

Adam Beder, VP of global licensing at Toronto, Canada’s Spin Master Toys, is more blunt. ‘There are so few homes. How can a licensee be expected to blindly throw seven-figure deals at these [new] properties?’

And retailers, renowned for their risk-averseness, are becoming more so when it comes to licensed goods. When buyers do take a license, they buy deeply. But they aren’t taking anywhere close to the number of licenses that they were four years ago, and they’re reluctant to try new ones.

‘A licensee used to be able to go into a retailer and get trial placement based on a relationship,’ says Cynthia Money, VP of consumer products for San Francisco-based ShoPro Entertainment. ‘Now they won’t even try it.’ Joy Tashjian, president of licensing agency JTMG, echoes this sentiment and notes that the royalty rate can be a make-or-break deal element. ‘The retailer will say, ‘You know what, you’ve decided to make [the rate] so high, it’s simply not worth it to us to test it.’ And what good is a high royalty rate if no one can buy the product?’

It doesn’t stop there. Retailers are not only inserting themselves into the royalty conversation when it comes to testing out new licenses. The mass-market drive for ever-lower prices is making them question licensing agreements and royalty rates for every kind of property on a far more regular basis.

Low prices squeeze retailer margins, in turn putting pressure on licensee wholesale prices. Retailers expect their vendors to cut excess expenditures from their operations so they can get the best wholesale price and make their margins. And a 15% royalty looks like a big lump of fat in dire need of trimming to most retailers, some of whom are starting to refuse non-blockbuster licenses if they feel the licensor’s royalty rates are too high.

In addition, industry sources say that over the last 18 months, at least one mass retailer has been openly pitting vendors of licensed goods against each other in an auction-type situation. If this retailer has 12 slots for licensed product available in a category and eight of these are set aside for preferred partners, the remaining four slots go to the manufacturers that come in with the lowest wholesale price, regardless of the merits of their properties. So again, the royalty rate becomes a deciding factor – a company paying 10% royalties is more competitive than one paying 15%.

Another contributing factor to licensee conservatism is that the market for character/entertainment licensing programs appears to be leveling off. Retail data tallied by EPM Communications’ The Licensing Letter shows that sales of licensed merch have only grown by US$799 million in the last decade – starting at US$70.01 billion in 1994 and fluctuating up and down before finishing at US$70.8 billion for 2003. Likewise, LIMA royalty figures for character/entertainment properties have hovered around the US$2.5-billion mark since the late ’90s. It’s pretty clear that the numbers are just about flat, if not in a bit of a decline. Once in a while, a monster property will give the biz a boost, but for the most part, it’s pretty much a reshuffling of consumer dollars, with merch sales for hot properties assuming the retail volume of faltering ones.

Al Ovadia, executive VP of Sony Consumer Products, points to licensee consolidation over the past three years as one last reason for their cautious behavior of late. With countless new IP owners looking to develop their properties and fewer licensees, he explains, licensors don’t have as many choices as they’ve had in the past. Consequently, licensees can afford to be choosier and demand more royalty and guarantee concessions on the licenses they do pick up.

Although not entirely new, tiered agreements that tie the royalty rate to product performance (often starting out with a lower rate that gets bumped up once sales reach a certain level) are on the rise. The good news for licensors is that despite this trend, royalty rates have stabilized since being hacked down from their mid-’90s peak of 20%-plus. According to Debra Joester, president of The Joester Loria Group and agent for happening retro property The Care Bears, licensors can now expect a more modest cap of 14% to 15% for a red-hot character. And tiered agreements on new properties start out at roughly 8% across most categories, graduating to the 10% to 12% range when they begin to prove themselves at retail.

What does seem more volatile is the guarantee. ‘Guarantees are as much as 50% lower than they were four years ago on risk-driven properties,’ says Charles Day, president of L.A. agency The Sharpe Company. ‘I’ve never seen the market so bad in terms of what people are prepared to wager.’

Spin Master’s Beder sees it this way: ‘Guarantees and advances are very short-sighted and don’t necessarily reflect which licensee is going to bring the most dollars to the table.’ Licensors, he explains, need to be willing to look at creative royal and guarantee structures because, in the end, they’ll acquire more licenses on new properties that otherwise wouldn’t have much of a chance.

Licensors aren’t insensible to this line of reasoning and concede a need to be flexible, especially when launching a new program. Sony’s Ovadia says licensors are pretty much obligated to lower royalty rates and rethink guarantees to remain competitive. ‘You can be stubborn and want 12% for this or that property,’ he says, ‘but if the market is telling you otherwise, you have to listen.’

Joester agrees, saying that these discussions are just becoming part of building a property and result in equitable treatment for both licensor and licensee. ‘You’re not asking licensees to take all the risk, and once something is performing, you’re asking them to treat the license as the A-property it’s become.’ With reference to royalty rates, she adds that it’s hard to demand more than 14% in this retail climate to keep production quality up. ‘I don’t want a line of apparel that’s all silk-screened, with nothing embroidered, because my licensee has to give me 15%. It’s just not worth it if you’re trying to keep a property alive.’

Tashjian takes this idea one step further. If the property flops, chances are you’re going to have to come back to the same set of licensees with your next offering. ‘The closest you can make it to a fair partnership is always better in the long term. You need to treat licensees with the same level of respect as a production partner or a broadcaster.’

And it’s not as though licensors are being asked to be complete contortionists, bending over backwards and sideways to curry favor with licensees. There is give on both sides. ShoPro’s Money says that sometimes with these tiered/lower guarantee deals you can negotiate for more resources to be put into product development and marketing on the licensee end. Betesh’s Breiter admits that setting aside 2% to 4% of the overall licensing agreement’s budget to market a new property is not uncommon in his deals.

In the end, licensors are also going to have to get more creative in the way they build programs to get new properties off the ground. Money, for one, says the idea of rolling out a program with 35-plus licensees lined up before a show hits market doesn’t enter into her planning anymore. She says ShoPro is spending more time on hooking up with a small team of core licensees that will produce the initial product drivers. Only when these licensees are up and running and selling at retail does she look at expanding into other categories.

ShoPro’s North American program for MegaMan Warrior NT is a good example, says Money. While the show is going into its third season on Kids’ WB!, MegaMan’s consumer products program rolled out in mid-2004 with eight licensees. The first phase was led by master toy Mattel’s MegaMan PET interactive terminals, whose gameplay is fuelled by collectible BattleChips that give players an edge as they explore MegaMan’s version of cyber space and battle other probes.

ShoPro insisted that Mattel make the BattleChips available to other licensees for promotional uses, which helped Seattle, Washington-based T-Shirt licensee Top Heavy land a promo deal with Sears for an exclusive line of shirts containing the chips. While sell-through numbers were not available at press time, the success of the program’s rollout (particularly in the toy category) has piqued new licensee interest. And with the secondary licenses that are currently being hammered out for both MegaMan and fellow ShoPro property Sonic X, Money says she hasn’t been subjected to as many requests for tiered agreements or lower guarantees as the first time around. ‘That was a benefit that we really didn’t count on,’ she says.