Revenue Sharing

Revenue Sharing is a business arrangement where a company distributes a portion of its top-line earnings, or revenue, to its partners. Think of it like a band agreeing to give the concert venue 20% of all ticket sales. The venue gets its cut right off the top, regardless of whether the band's travel, sound equipment, and pyrotechnics expenses left them with a profit or a loss. This direct link to sales is the defining feature of revenue sharing and sets it apart from profit sharing, which is based on the bottom-line profits after all costs are paid. This model is incredibly common across various industries, from app developers sharing sales with Google and Apple, to franchisees paying a percentage of their revenue to the parent company like McDonald's. It's a powerful tool for aligning interests and encouraging all parties to focus on a single, clear goal: making the sales number as big as possible.

The mechanics are usually straightforward: a pre-agreed percentage of gross revenue is automatically paid to a partner. This percentage can be fixed or tiered (e.g., the percentage decreases as revenue grows). The beauty for the recipient is its simplicity and predictability—there's no need to audit complex expense reports, as revenue is a much harder number to creatively account for than profit. You can see revenue sharing in action all around you:

• Tech Giants & Developers: When you buy an app, the developer typically shares around 15-30% of that revenue with the platform owner, like Apple's App Store or the Google Play Store.
• Franchise Models: A local Subway or 7-Eleven owner pays a continuous royalty fee to the corporate franchisor, which is a percentage of the store's sales.
• Content & Media: YouTube shares advertising revenue with its content creators. Movie studios split box office receipts with cinema chains.
• Professional Sports: Leagues like the NFL and NBA pool certain revenues (like national television rights) and distribute them among all the teams to ensure competitive balance.

For a value investor, a company's use of revenue sharing is a double-edged sword that requires careful analysis. It's not inherently good or bad, but its implementation reveals a lot about a company's business model and competitive standing.

When a company gives away a piece of its revenue, you should ask: What are they getting in return?

• The Good: A well-structured revenue share can create a powerful network effect. By giving developers a cut, Apple incentivized millions to build apps for its ecosystem, making the iPhone indispensable. In this case, sharing revenue was the fuel for building an impenetrable fortress, or a wide economic moat. It aligns the incentives of thousands of partners to grow the mothership's top line.
• The Bad: Giving away revenue can crush profitability. It directly reduces a company's gross margin (the profit left after selling the product itself). If the company's other costs are high, there might be very little left for shareholders. A value investor must be wary of companies that give away too much revenue without getting a lock-in or a sustainable competitive advantage in return. It can be a sign of a weak negotiating position.

For the partner receiving the cash, the model looks attractive on the surface.

• The Good: It provides a direct, often passive, stream of income tied to the success of a much larger partner. A small game developer gets access to a global market via the App Store they could never build themselves. This can lead to what we call a 'capital-light' business model, which can be very attractive.
• The Bad: This dependency is also its greatest risk. The larger company holds all the cards. They can change the revenue share percentage at any time (as we've seen in the app world), or even kick the partner off the platform entirely. A value investor would look for diversification, ensuring the company isn't dangerously reliant on a single revenue-sharing partner.

While they sound similar, the difference between sharing 'revenue' and sharing 'profit' is a chasm. As an investor, you must know which model a company uses.

• Revenue Sharing is Top-Line: It's a cut of the money coming in the door before any expenses (salaries, rent, marketing, taxes) are paid.
  • Pros: Simple, transparent, and hard to manipulate.
  • Cons: The payer is on the hook even if the venture is unprofitable.
• Profit Sharing is Bottom-Line: It's a cut of what's left over after all expenses are paid. The 'profit' can be defined in many ways, from EBITDA to EBIT to net income.
  • Pros: Protects the payer from losing money on the deal; incentivizes all partners to be cost-conscious.
  • Cons: Less predictable for the recipient and can be subject to accounting games—aggressive expense allocation can shrink the “profit” pool to zero.

Essentially, a partner who trusts the core business to generate sales but not necessarily control costs will fight for revenue sharing. A company that wants its partners to have skin in the game for both sales and efficiency will push for profit sharing.

There's no better modern example of revenue sharing than the mobile app store. Let's look at Apple. Apple built the App Store, a secure and massive marketplace. In exchange for access to over a billion potential customers, payment processing, and development tools, Apple requires developers to share a piece of their revenue. For most sales and subscriptions, Apple takes a 15-30% commission.

• Investor View on Apple: This is a genius move. Apple incurs very little incremental cost for each additional app sold, so that 15-30% cut is almost pure profit. It created a vast and sticky ecosystem where both users and developers are locked in, generating billions in high-margin services revenue. It's a cornerstone of Apple's investment case.
• Investor View on an App Developer (e.g., Spotify): An investor in a company like Spotify, which historically paid a 'tax' to Apple on subscriptions made through the app, must factor this in. That 30% cut went straight from Spotify's top line to Apple's. It directly impacted Spotify's profitability and was a major point of contention. This highlights the risk of building your business on someone else's platform, a key due diligence point for any value investor.