Collaborative Business Models: The Win-Win Path for Enterprises and Customers
Collaborative business models are on the rise, where customers avoid prepaid costs and enterprises take a share of savings or revenue. Using Redaptive and BusPatrol as examples, the article examines their technology-driven nature, market acceptance, and accounting valuation challenges.
In a typical transactional business model, goods or services are exchanged at an agreed-upon price. However, recent innovations in technology have given rise to the popularity of collaborative business models, where customers bear little upfront cost or risk and instead share in the resulting savings or benefits.
For example, Redaptive installs smart sensors, LED lighting, HVAC, and other renewable energy equipment at customer sites, aiming to improve energy efficiency, reduce carbon emissions, and lower utility bills. Customers pay no upfront fees but typically pay Redaptive from the energy cost savings. Another company, BusPatrol, installs camera kits on customer school buses to capture information about vehicles illegally passing. School districts bear no upfront costs, with payments coming from the resulting ticket revenue.
In both cases, the revenue that can be earned over the contract term is unknown at the start of the agreement, but the companies providing the goods or services are confident there is sufficient cash flow to cover their upfront costs. Customers are willing to accept this structure because they do not share in the risk.
In other words, if companies purchased the assets themselves, they would need to pay cash or incur liabilities. In this model, they effectively acquire assets through off-balance-sheet financing. Customers have no financial risk because if the promised return on investment is not achieved, they do not pay anything for the goods or services.
Negotiating this revenue sharing differs from typical transactional business models because pricing can be a creative combination of fixed and variable costs. What percentage of revenue is given to the customer? Who bears the maintenance and service costs of the assets?
The Role of Technology
These collaborative business models are becoming increasingly popular, and their value is often attributed to innovative applications of technology.
Redaptive uses smart sensors to collect and analyze granular data, obtaining real-time information on electricity usage. This data helps identify ways for customers to reduce energy consumption and measure the actual energy savings achieved through equipment upgrades, such as LED lighting retrofits. BusPatrol, on the other hand, uses artificial intelligence to identify potential violations and then forwards the footage for internal review.
In these and other cases, technology has made it possible to rethink business models. Companies can now offer assets to customers who pay only from the benefits or savings generated by the technology.
Market Acceptance
This model has generated enough interest that we see collaborative companies going public through traditional IPOs and special purpose acquisition companies (SPACs), and forming joint ventures. But the risk-and-reward structure is so novel that the model is difficult to value.
Valuation experts need to consider differences in the overall risk profile (i.e., retained risk versus transferring risk in a sale) and the comfort gap as investors gradually become familiar with different types of financial forecasts. Most valuations rely heavily on projected cash flows, and in these cases, cash flows are variable because they are based on the usage of the underlying assets. More effort may be needed to justify the inputs and assumptions used in the financial model.
Accounting Considerations
From an accounting perspective, the model raises new questions for both companies and customers, starting with determining whether a lease exists under Accounting Standards Codification (ASC) Topic 840 or 842.
If an identified asset is used in the delivery of services, the transaction may be accounted for in whole or in part as a lease. If it is not a lease (possibly due to a lack of control over the asset), the applicable framework would be ASC 606, "Revenue from Contracts with Customers." Under this guidance, the performance obligations in the contract must be analyzed to recognize revenue at a point in time or over time as the contract is fulfilled.
Many accounting standards are based on transactional business models, so challenges arise when companies with variable payment structures emerge. Initially, companies that leased assets with variable payment structures were forced to recognize a day-one loss because they had no contractually guaranteed payments. The Financial Accounting Standards Board (FASB) heard concerns from companies shifting to variable payment structures that their financial statements were not intuitive to investors. A company adopting a variable payment model does not mean it does not expect to be profitable. Accounting Standards Update 2021-05 modified the accounting treatment, treating such contracts as operating leases in many cases.
Companies with collaborative models still face other accounting challenges:
- Is the company a principal or an agent?
- What is the fair value of the goods or services provided?
- Do risk mitigation strategies around minimum payments constitute "substantive" fixed amounts under lease guidance?
- Is the disclosure of the transaction structure sufficient to identify the rights and responsibilities of each party?
Conclusion
As collaboration-based models become more prevalent, they may quickly gain popularity. They present challenges for companies and investors, prompting thought on how to creatively use technology to solve problems in new ways, and the new models represent a noteworthy development in the market.