How Revenue Sharing Works in Practice
Establishing the right business model is an important part of any business. It lays out the foundations of certain business practices, such as the products and services a company plans to sell, its target markethow it plans to advertise, the costs associated with its day-to-day operations, and how it plans to earn money or revenue.
Some companies choose to share that revenue with certain stakeholders. This is called revenue sharing. It involves the distribution of revenue or all the money that a business takes in or loses. Put simply, all stakeholders get a share of the profits and the losses when a company chooses to implement a revenue-sharing plan. This can be through a performance-based program for company employees, incentive-based for corporate partners, or award-based for players in a professional sports league.
Key Takeaways
- Revenue sharing is a business model that allows companies to share its success with stakeholders.
- It is a somewhat flexible concept that involves sharing operating profits or losses among associated financial actors.
- Revenue sharing can exist as a profit-sharing system that ensures each entity is compensated for its efforts.
- The growth of online businesses and advertising models has led to cost-per-sale revenue sharing.
- Other forms of revenue sharing include those with professional sports leagues and employee-based incentives.
Watch Now: How Revenue Sharing Works in Practice
How Revenue Sharing Works
The practical details for each type of revenue sharing plan are different, but the conceptual purpose is consistent: It uses profits to enable separate actors to develop efficiencies or innovate in mutually beneficial ways. The practice is now a popular tool within corporate governance to promote partnerships and increase sales or share costs.
Revenue sharing is also used in reference to the Employee Retirement Income Security Act (ERISA) budget accounts between 401(k) providers and mutual funds. ERISA establishes standards and implements rules for fiduciaries (or investment companies) to follow in an effort to prevent misusing plan assets. Standards can include the level of participation needed by employees and the funding of retirement plans.
ERISA allows revenue sharing for retirement plan sponsors so that a portion of earned income from mutual funds would be held in a spending account. The funds are used to pay for the costs of managing and running the 401(k) plans. The amount of money to be allocated and deposited into the revenue-sharing accounts is stipulated in the revenue-sharing agreement. The fiduciary must notify investors of how the revenue is spent. Doing so helps provide investors with transparency.
Private businesses aren’t the only ones that use revenue-sharing models. In fact, both the U.S. and Canadian governments use taxation revenue sharing between different levels of government.
Types of Revenue Sharing
Revenue sharing takes many different forms. Each iteration involves sharing operating profits or losses among different financial actors. It is sometimes used as an incentive program. For instance, a small business owner may pay associates a percentage-based reward for referring new customers. It may also be used to distribute profits from a business alliance. When different companies jointly produce or advertise a product, a profit-sharing system might be used to ensure that each entity is compensated for its efforts.
Professional Sports
Several major professional sports leagues use revenue sharing with ticket proceeds and merchandising. For example, the separate organizations that run each team in the NFL jointly pool together large portions of their revenues and distribute them among all members.
As of 2020, the NFL and the players’ union agreed to a revenue share split that would pay the team owners 53% of the revenue generated while players would receive 47%. In 2019, the NFL generated about $16 billion in revenue, meaning that slightly more than $8.5 billion was disbursed to the teams while the remaining got paid out to the players.
Various kickers and stipulations can be added to revenue-sharing agreements. For instance, if the NFL season is extended from 16 to 17 games in the coming years, the players would receive additional revenue or a kicker if advertising revenue from TV contracts increased by 60%. In other words, revenue sharing agreements can include percentage increases or decreases in the future depending on performance or specific pre-set metrics.
Company Revenue Sharing
Revenue sharing can also take place within a single organization. Operating profits and losses might be distributed to stakeholders and general or limited partners. As with revenue sharing models that involve more than one business, the inner workings of these plans normally require contractual agreements between all involved parties.
Online Business Activity
The growth of online businesses and advertising models has led to cost-per-sale revenue sharing, in which any sales generated through an advertisement being fulfilled are shared by the company offering the service and the digital property where the ad appeared.
There are also web content creators who are compensated based on the level of traffic generated from their writing or design, a process that is sometimes referred to as revenue sharing.
How are losses split between parties in a revenue-sharing program? Each party is responsible for paying a share of the losses in this type of business model.
Tracking Revenue Sharing
Participants in revenue sharing models need to be clear about how revenue is collected, measured, and distributed. The events that trigger revenue sharing, such as a ticket sale or online advertisement interaction, and the methods of calculation are not always visible to everyone involved. As such, contracts often outline these methods in detail. The parties responsible for these processes are sometimes subjected to audits for accuracy assurance.
Some types of revenue sharing are strictly regulated by government agencies. The advisory council for the Employee Retirement Income Security Act formed the Working Group on Fiduciary Responsibilities and Revenue Sharing Practices in 2007 to address perceived issues with the practice of revenue sharing for 401(k) plans.
The Working Group determined that revenue sharing is an acceptable practice, and new rules related to transparency were implemented under the authority of the Department of Labor (DOL). The Working Group also determined that it should take the lead to formally define revenue sharing with regard to defined contribution plans.
Revenue Sharing and Marketing
Marketing is an important part of any business. Having the right strategy can help set a company apart from its competition. If executed correctly, companies can use revenue sharing as a great marketing strategy.
Revenue sharing can be used as an incentive to get partners and associates to help companies build their brand and business. This is done by distributing revenue every time someone recommends a new client or customer. This allows businesses to form strategic alliances and partnerships with external stakeholders.
Adopting this kind of strategy can be fairly cost-effective. Not only does it create an incentive for partners to channel more business toward a company, but it also cuts back on certain expenses. Since these are partnerships, companies don’t have to spend on wages, benefits, or other costs related to employing workers.
Companies that use revenue sharing should ensure that the terms and conditions of this business model are clearly laid out in a written contract. They should also make sure that these partnerships lay down the foundations for exclusivity. After all, companies don’t want their alliances to stray and funnel business to their competition.
Revenue Sharing vs. Profit Sharing
People often confuse revenue sharing with profit sharing. And for good reason, too, because they sound the same. While they both involve the distribution of money from the business with certain parties, these two models are actually quite different.
Remember that revenue sharing distributes revenue and losses equally among those involved. Profit-sharing, on the other hand, only distributes profits to each party—not total revenue. This means that there is only a distribution if there is a profit, so nothing is distributed if the company nets a loss during a certain period.
Some of the most common types of profit-sharing plans offered by companies to their employees include:
Companies often use profit-sharing plans to incentivize their employees. It provides workers with some motivation to work harder and ensure that the company is a success and profitable. It also promotes loyalty, as an employee who gets a share of the company’s profits will be more likely to stay rather than jump ship and move on to work with someone else.
What Is a Typical Revenue Sharing Percentage?
The typical revenue sharing percentage ranges anywhere between 2% to 10%. This will depend on how many stakeholders are involved and the size of the company.
How Do You Calculate Revenue Sharing?
To calculate revenue sharing, take the amount of an individual’s contribution and multiply that by the percentage of revenue sharing that was set out.
What Goes Into a Revenue Sharing Agreement?
A typical revenue sharing agreement should include the parties involved, their obligations and responsibilities, the percentage of revenue sharing, exclusivity, the length of the relationship, any means of arbitration, governing laws and jurisdictions that apply, and how amendments are to be handled. The agreement must be signed and a copy must be given to all parties involved.
The Bottom Line
Revenue sharing is a common way for businesses and governments to share in their success with key stakeholders. It can be used as a marketing strategy to help channel business their way. But it can also help them spread out the risk by ensuring that their partners are responsible for their losses, too. Agreements typically have a range of 2% to 10% of revenue shared, depending on their size. But it’s important that all the rights, responsibilities, and obligations are laid out and understood by companies and their partners to avoid any problems in the future.