The question I am most often asked in the field of technology licensing is "what is a fair royalty". Unfortunately there is no simple answer to this question. I will try, however, to give you an overview of how one can approach the answering of this question.
The notion of a fair royalty involves there being a profit for both the licensor and the licensee. Theoretically it would be possible for the licensor and the licensee to agree to actually split the profit made form selling the licensed product. In practice this is not normally acceptable as "profit" is a very imprecise term. The task therefore is to determine a royalty that is based on a percentage of the selling price (or less frequently a fixed sum per sale) that will at the end of the day yield a fair split of the profit between the two parties to the deal.
A rule of thumb that I have found quite useful is that the licensor should get 25% of the profit that the licensee earns as a result of the use of the licensed technology. Put in this fashion this rule of thumb sounds simple but in practice its application can be quite complex. Firstly one must take into account that the licensee may be required to put in substantial capital or development expenditure in the early years to get the product to market. Secondly the profit margin in the early years of product launch may be higher than in the mature years of the product cycle when competitors may have come into the market with alternative products that yield the same benefits without infringing your patent.
These problems can be addressed by developing with the proposed licensee an agreed business plan. From this business plan one can postulate the net present value of the profit stream over the life of the patent. This profit stream will of course take into account the losses that the licensor may have in the early years of plant construction, R & D, and market development. It will also model the changing market size and unit profitability of sales at different stages in the cycle. One can then juggle the royalty rate to find a royalty rate on sales which, over the life of the project, yields a stream of income that has a net present value equal to 25% of the NPV of the projected profit stream. This should then be a fair royalty!
I stress that this is a thumb-nail sketch of only one way in which one can approach the determination of a fair royalty. I would be happy to discuss this further with any client who needs advice in the licensing field.