Question

In: Economics

Answer all questions! 1. Explain what are royalty rate contracts and fixed-fee contracts. What is the...

Answer all questions!

1. Explain what are royalty rate contracts and fixed-fee contracts. What is the main difference between them?

2. Give an example of each of the two types of contracts. Explain which type of contract is used in your organization. (If you are not currently employed you can give a hypothetical example or an example from your experience).

3. Describe the differences in the incentive effects of the contracts. What are the advantages and the disadvantages of each of the contracts? Explain the reasons why one of them and not the other is used in your organization. Describe the consequences for your organization of changing the existing contract.

Solutions

Expert Solution

1. Royalty rate contracts: The contract under which a payment is made to the legal owner of the property, patent, copyright or franchise by those who wish to make use of it for the purpose of generating revenue is "Royalty rate contracts". In other words, it means it is the contract under which the payments are made by licensee to licensor in exchange for the right to use intellectual property or physical asses owned by the licensor.

Fixed free contracts: It is the contract under which a price is fixed which is not subject to any adjustments unless certain provisions are included. This contract places minimum administrative burden on the contracting parties, but subjects the contractor to the maximum risk arising from the full responsibility for all cost escalations.It is slao called "Firm price contract".

2. Royalty rate contracts: For example- companies like IBM or Compaq pay royalty to Microsoft in exchange to use Window operating system. Also, Music royalties have a strong linkage to individuals – composers (score), songwriters (lyrics) and writers of musical plays – in that they can own the exclusive copyright to created music and can license it for performance independent of corporates.

Fixed free contracts: For example, a web designer can offer a fixed-price contract for the design of a website.

3. Advantages of Royalty rate contracts: a)Revenue opportunity- The owner of the Intellectual property can have a continuous stream of income while having to do anything himself. In other words, the licensee has to do all the work to make the profit and the licensor gets a percentage of anything made. b) Licenses lead to profits- The licensee also has the advantage of potentially increasing his own profits greater than the amount he would otherwise have enjoyed. By paying for licensing rights instead, the licensee has to put down less money up front in order to enjoy the benefits of having access to the technology or property.

Disadvantages of Royalty rate contracts: a) Rising loss of IP- The owner of the intellectual property assumes a big risk when licensing his product. He might open the doors for piracy or having the technology stolen from him if he doesn't have good legal representation. a) Overdependent on the licensor- The licensee assumes a big risk by accepting a licensing agreement rather than purchasing the intellectual property outright. First, when it's time to renew the license, the licensor might demand more money or stricter terms if he knows the licensee is dependent on the revenue. In addition if the licensee does not have an exclusive license, he could have competition that wouldn't exist if he owned the property. This could affect his ability to profit off the agreement.

Advantages of  Fixed free contracts: a) Predictability- It gives both the buyer and seller a predictable scenario, offering stability for both during the length of the contract. b) Higher cost- While a fixed-price contract gives a buyer more predictability about the future costs of the good or service negotiated in the contract, this predictability may come with a price. The seller may realize the risk that he is taking by fixing a price and so will charge more than he would for a fluid price, or a price that he could negotiate with the seller on a regular basis to account for the greater risk the seller is taking.

Disadvantages of Fixed free contracts: a) Market changes- When market forces change the value of a good or service, including any materials or supplies necessary in the production of the good or service, the fixed-price contract can be a detriment. b) Budgeting & Ability to pay- When the costs of the good or service increase dramatically, the buyer may no longer have the means to honor the contract, meaning the seller must take a loss and weigh the option of legal action. If the good or service is necessary to a buyer’s business process, then the buyer’s business may be adversely affected.


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