Business owners looking to distribute some of their revenue to stakeholders and employees will often do so via revenue sharing or profit sharing plans. Although these two incentive programs may seem similar, there are a few distinct features that affect how these plans work and how distributions are paid.
Whether you're a fresh startup or an established company, this article will help to guide you in picking the right one for your company. We'll break down what these models are, where they're used, their pros and cons, and more.
What Is Revenue Sharing?
Revenue sharing is a performance-based business model where a company divides a part of its total revenue between various parties who are involved in its operations and overall success. It’s a way of working that incentivizes all parties involved.
A typical revenue-sharing agreement will offer a business partner or employee a distribution of revenue from a set project or sale. The revenue sharing model can be used in several different scenarios. Here are a couple of revenue sharing examples:
- When a software company works with third-party developers to create an app, the software company could share some of the revenue from the app with the developers. This is a way of saying 'Because you helped us make money, you should get a share of the total revenue'.
- Another form of revenue sharing is affiliate marketing. Companies will often team up with affiliate marketers who help to promote their products or services. When the efforts of these marketers lead to sales or new customers for the companies, they get a cut of the revenue.
Revenue-sharing agreements can also be shared within a company and can be used to motivate employees.
When a company does well, some of the company's total revenue gets shared among the employees as a reward. This is a great way to give back to employees for a job well done.
The biggest advantage of a revenue-sharing program is that it encourages everyone within a company to work together. In turn, this helps to increase the company's revenue.
This is a fantastic way to align employee interests with the company's success, which can lead to better productivity and, of course, success.
However, as with anything in business, there is also a downside to revenue share deals. Revenue sharing doesn't guarantee a regular income. Instead, it can sometimes shift the focus from long-term profitability to immediate gains. Also, when the cost for a company to make money is too high, it can end up eating into the profits.
What Is Profit Sharing?
A profit-sharing model is one where a portion of the company's profits is shared among different people who are connected to the business, such as shareholders or employees.
In simpler terms, a profit-sharing system is like a bonus that depends on how well the business is doing. If there are more operating profits or bottom-line profits, then they may get a bigger bonus.
There are also different ways to share the business profits:
- Employees may get extra money in their paychecks (which is the most common way).
- Employees may receive company shares, which is similar to owning a little piece of the company. This means that when the company does well, the value of these shares will improve.
- Employees may recieve their profit-sharing income as part of a 401(k) or retirement plan.
Because profit-sharing plans offer a clear incentive, employees are more likely to work hard to ensure that the company does well. When profit-sharing in in place, employees have a vested interest in seeing the company succeed, which means that they'll be more productive.
Being invested in a company also means that employees are less likely to resign or look for other job opportunities. So, it's a great way to lower the rate of employee turnover within the business.
Like the downsides of a revenue-sharing model, there are still some challenges to this approach.
Figuring out how to split the profits can be tricky, since some people may feel as though they should get more than others. Making sure that everyone is comfortable with the approach the company wants to take is crucial.
Want to know how profit sharing could work for your business? Check out ShareWillow’s Profit Sharing template.
What Differentiates Revenue Sharing From Profit Sharing?
Revenue sharing and profit sharing differ in when stakeholders receive compensation. In a revenue-sharing plan, earnings are divided before expenses are paid and don't rely on the overall profit. However, profit sharing is only possible when the business makes a profit.
Revenue Sharing vs Profit Sharing: How To Decide What’s Right For Your Business
Understanding your business model and goals
Choosing between a profit and revenue-sharing deal is like picking the right tool for the job; it all depends on what your business is like and what you want to achieve. Let's break down profit sharing vs revenue sharing:
- Startup phase: If you're in the start-up phase, a revenue-sharing agreement could be a much better choice. Startups often don't make big profits right away, so sharing the revenue that is made helps to get early partners and employees excited without dipping into those limited profits. For example, if you’re a plumbing firm, you might offer a “finders fee” for any new clients someone refers your way.
- Established corporations: When a business is already a well-oiled machine and is consistently making a profit, profit sharing may be the best option. You can offer a share of these profits to keep stakeholders happy.
- Different sectors: Every business has its own way of making money. For example, tech companies often have big profit margins, so profit sharing would work well. But if your business depends on partnerships or affiliates, a revenue-sharing agreement could be smarter decision.
- Short vs long-term goals: It's important to think about what you want to achieve. A revenue-sharing model is great for short-term projects or quick wins. However, if you're looking to grow and keep your team motivated over time, profit sharing might be a better fit.
In the end, it's all about aligning your sharing plan with your business's unique objectives. And it doesn’t have to be one or the other — you could offer profit sharing for your internal team/employees and revenue sharing with key external business partners.
Employee and stakeholder incentivization
Profit sharing
- Performance-driven incentive: In a profit-sharing program, stakeholders are tied to the performance of the company - when the company does well, stakeholders can enjoy much bigger payouts. This system encourages everyone, as the entire company's employees and shareholders benefit when the business does well.
- Long-term retention: One of the biggest benefits of profit sharing is its ability to foster long-term stakeholder retention. In other words, when stakeholders anticipate higher payouts in profitable years, they're more likely to stick around.
Revenue sharing
- Steady incentive: A revenue-sharing plan offers steadier, more predictable incentives regardless of the company's profitability. Stakeholders receive a share of the revenue, which can be really reassuring when profits fluctuate. For example, if you run an online business selling furniture, a revenue sharing affiliate agreement will deliver payouts to your partners whether your business is profitible or not.
- Immediate gratification: What sets a revenue-sharing deal apart is its ability to offer more immediate rewards. Stakeholders can enjoy their benefits sooner, which can be beneficial for those who want short-term gains.
