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Outline the usual kinds of business model and how they set prices

CFA® Level I · Corporate Finance · Business Models · CI.6.b

The idea

Recurring models such as subscriptions and licensing trade lower initial revenue for predictability, which supports more debt capacity than a one-off sales model of the same size. Razor-and-blade models sell the durable item cheaply to capture a stream of consumables. Platform and marketplace models earn a take rate on transactions they do not own, so revenue and gross merchandise value differ sharply. Pricing approaches range from cost-plus through value-based to dynamic and freemium, and each implies a different sensitivity of revenue to competitive pressure.

Formulas

Platform revenue

revenue = GMV × take rate

GMV
the gross merchandise value, the total value of goods sold through the platform
take rate
the share of each sale the platform keeps

The platform's revenue is its cut, not the value of the goods sold.

Break-even volume

Q = F ÷ (P − V)

Q
the units that must be sold to break even
F
the fixed costs
P
the price one customer pays
V
the variable cost of one more unit

Each unit contributes P − V towards the fixed costs. Above Q the business makes a profit.

A practice question

From the question bank, with the reason each wrong option is wrong.

A marketplace platform matches buyers and sellers but never owns the goods. What does it mainly earn on the transactions it facilitates?

  1. The full transaction valueWhy not: The operator never owns the goods, which is why its revenue is a fraction of the value transacted.
  2. A take rate - correct
  3. A fixed subscription feeWhy not: Some platforms add subscriptions, but a percentage of the value transacted is the defining income of a marketplace.

A marketplace never owns the goods, so it cannot count the whole sale as its own income. It keeps a slice, called the take rate. Formula: revenue = take rate x value of goods sold. For example, buyers spending $100 million on a platform with a 10% take rate give revenue of 10% x $100 million = $10 million. This is why a platform's revenue and the value of goods sold through it, called gross merchandise value, differ so sharply.

A harder one

Tallis Market operates an online platform on which independent sellers list their goods. Over the year buyers paid $2,000 million for items sold through it. Tallis never owns the goods and charges sellers a 12% commission on each sale. An analyst comparing Tallis with a retailer that buys and resells its own stock needs Tallis's revenue. What revenue does the platform model imply?

  1. $240 million - correct
  2. $2,000 millionWhy not: The total transaction value (gross merchandise value) has been treated as revenue. Tallis does not own the goods, so most of that value belongs to the sellers.
  3. $1,760 millionWhy not: The commission has been deducted from the transaction value, when the commission is what Tallis earns. The 88% that remains is the sellers' share and is not Tallis's revenue.

Tallis never owns the goods, so it is an agent: it only arranges the sale. Under both IFRS 15 and US GAAP (ASC 606), an agent reports just its fee as revenue, not the full price the buyer pays. Formula: Revenue = Commission rate x Gross merchandise value (GMV, the total spent by buyers). Revenue = 12% x $2,000 million = $240 million. The other $1,760 million (88%) belongs to the sellers. Counting all $2,000 million would overstate revenue more than eight times and make Tallis look like a retailer that owns stock.

The hardest tier

Why can a subscription business typically support more leverage than a transaction business of the same revenue?

  1. Because subscription revenue is taxed at a lower rateWhy not: Tax treatment follows the jurisdiction and the profit, not the billing model.
  2. Because its revenue is contracted and recurring - correct
  3. Because subscriptions require no fixed costsWhy not: They often carry heavy fixed costs in platform and service delivery; the advantage is predictability, not their absence.

Lenders care about how reliable a company's cash flow is, not just how large it is. Customers on annual contracts let a lender see next year's income in advance, so the ability to cover interest is easy to forecast. Formula: Interest coverage = Operating income / Interest expense. A business that must win its sales again every period may have the same revenue but a much wider range of outcomes, so lenders allow it less debt. Idea: contracted, recurring revenue supports more leverage.

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