What is Revenue Sharing? How is it Different from Profit Sharing?
Businesses may decide to give a part of their total revenue to various stakeholders as a reward for their efforts. They may also do this to attract more business and expand their channels. This is referred to as revenue sharing.
In everyday business practices, you will see many revenue sharing examples. Let us understand this in greater detail.
What is Revenue Sharing?
Revenue sharing is the division of the total revenue generated by the firm among its stakeholders. The percentage of revenue shared is pre-determined and is bound by a legal agreement. Besides, if the business incurs a loss, the same is also divided among the stakeholders in the agreed percentage.
When done correctly, revenue sharing can be advantageous for growth. Companies are constantly looking for innovative strategies to promote new sales, connections, and growth. This makes revenue sharing one of the most commonly used business models by organisations throughout the world.
Businesses looking for more partners to expand their network and sales usually opt for the revenue-sharing model. If a big firm employs smaller businesses on a revenue-sharing basis, they shall give these businesses a part of its income. This works as an added incentive for the partner businesses.
Companies may even share revenue with their employees as an added incentive to improve their productivity and performance. In India, the government also has a revenue-sharing model in place. They partner with private enterprises and extend services to the public.
Now that you know what revenue sharing is, let us see how the revenue-sharing model works.
How Does Revenue Sharing Work?
Revenue sharing is a practice that is common throughout many industries, particularly where the projects require heavy investments and also generate large amounts of revenue.
For example, a company wants to develop an app but does not have the necessary resources and infrastructure. They may partner with an app developer on a revenue-sharing basis and decide on the percentage of revenue that they are willing to share. Say, for instance, they decided to share 45% of the total revenue generated via the new app with the developer. If the company makes Rs. 10,00,000 through users on the app, they shall share Rs. 4,50,000 with the developer.
This concept also lies at the heart of affiliate marketing. A business may partner with agents to refer its products to new potential customers. For every conversion, they shall be given a percentage of revenue generated via that new customer.
Another revenue-sharing example can be restaurants opening pop-up stalls at a food festival. While they have to pay to set up a stall, they can ask for a revenue-sharing deal. Here, the organiser of the festival may give a predetermined percentage of the total revenue generated at the festival to the restaurant owner. It works as an added incentive for the restaurant and they can earn additional revenue over and above what they make from the sale of their food items at the fest.
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Importance of Revenue Sharing
Revenue sharing is beneficial for all the stakeholders involved. The business gets the required infrastructure, skills, expanded network, or additional funding. The stakeholders get a stake in the revenue as a reward for extending their services.
There may be cases where two partners have a brilliant idea but not enough capital to execute it. They may onboard a third partner who only provides the funds in exchange for a part of the revenue.
Additionally, the firm may get involved with online ad agencies, which may get a cut in the revenue generated via ads published on their websites. It is usually done on a pay-per-conversion basis.
Concepts of Revenue Sharing
The main concepts of revenue sharing are – the revenue sharing business model and the total revenue sharing model.
Revenue sharing business model
Under the revenue-sharing business model, there is an agreement between the business and a stakeholder to share revenue at a set percentage. For example, a sports organisation signs a contract with an online ticketing platform to sell tickets for an upcoming sports event. In a revenue-sharing model, the sports organisation agrees to give them 5% of the revenue generated from the sale of tickets through that particular platform. It incentivises the platform to sell tickets while helping them cover operational costs.
Under this model, the revenue sharing percentage is calculated while accounting for the direct costs of production. Direct costs include expenses on material, labour, and direct expenses that go into producing the product. The total revenue share indicates the part of the revenue that is absorbed by the direct costs. The figure is given in percentage terms, and its formula is:
Total revenue share = Production and marketing costs / Total revenue
Advantages of Revenue Sharing
The following are a few advantages of revenue sharing:
- Shared growth: The revenue sharing framework enables revenue to be distributed fairly among the stakeholders, rewarding them for their contribution.
- Increased scope for financing: Because the emphasis is on revenue growth, this strategy increases the likelihood that businesses will receive funding.
- Better risk management: Since all the funds are not put up by the business owners, the risk gets divided. It spreads over to other stakeholders who are investing in the business. However, revenue is shared only up to the predetermined percentage. Anything above that goes solely to the business.
Disadvantages of Revenue Sharing
The following are some disadvantages of revenue sharing:
- Long-term objectives: Businesses may start focusing only on getting high revenue in the short term. Teams may become distracted by smaller, more immediate goals instead of long-term goals. The incentive of getting a cut in revenue may come at the expense of overall profitability.
- Expenses: When revenues are shared with employees, they may lose sight of other expenses involved in generating this revenue, since they can realise revenue before deducting expenses. Eventually, very high expenses incurred to generate this revenue may adversely affect the profits of the business.
Revenue Sharing Vs. Profit Sharing
The basic difference between revenue sharing and profit sharing models is that in the former, the entire revenue is distributed among stakeholders. However, under profit-sharing, the profit, which is calculated by deducting expenses from revenue, is distributed.
Thus, expenses are absorbed in the profit-sharing model, unlike in the revenue-sharing mechanism.
Moreover, revenue has to be shared every time it is generated. It does not regard the actual profitability of the business. However, when a profit-sharing system is in place, the amount is distributed only when the company generates a profit from its business operations.
Thus, while revenue may always be generated when the business functions and makes sales, there may not always be a profit. This changes the frequency of sharing the amount in both cases.
Profit-sharing plans are frequently used by businesses to motivate their staff. It gives employees the incentive to put in more effort and works towards a business’ success. On the other hand, revenue sharing is mostly undertaken to get more funding, expand the customer base, get more leads, and avail skill-based services.
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Final Word
Businesses and governments frequently share their revenue with important stakeholders through revenue sharing. It may be used as a marketing technique to attract new leads and customers. However, it can also assist them in distributing the risk by ensuring that their partners are also accountable for their losses. Additionally, all stakeholders must understand the rights and responsibilities of the deal. Moreover, everything must be mentioned in a written agreement.
FAQs
Ans. The distribution of revenue, or the entire amount of income a company generates, among its stakeholders or shareholders, is known as revenue sharing. Revenue sharing is important because it ensures all financial actors are compensated for their contribution.
Revenue sharing involves allocating the revenue earned to the stakeholders. It is governed by a revenue-sharing policy that outlines how the percentage will be distributed among the various stakeholders.
Under the profit-sharing model, shareholders are only compensated when the business earns a profit. In contrast, revenue sharing involves splitting revenues before expenses are factored in, thus does not depend on the overall profit or loss.
A typical revenue sharing agreement outlines the names of the parties, their roles and duties, the percentage of revenue to be shared, the duration of the partnership, and any other material information or rule by which the parties will be bound.
Disclaimer
This article is solely for educational purposes. Navi doesn't take any responsibility for the information or claims made in the blog.
