Walk the length of any high street on the internet and you will find the same goods sitting in a great many windows, the identical handful of products in shopfront after shopfront with a different name over each door, and hardly one of those shopkeepers made the thing they are selling you, they rent it by the unit from somebody whose name you have never once heard, and that somebody gets paid every single time you pick it up.
That somebody is running a royalty business.
It is the least glamorous arrangement in the whole of consumer digital and it is very often the best one, on account of the owner having done the expensive part once, years back, with everything since being a question of how many doors the thing gets carried through.
And almost none of this is visible from the shop floor, which is where most of us do our looking.
Nobody in the chain is selling what you think they are selling
Two companies are involved in nearly every product of this sort, the one that made it and the one that hands it to you, and the useful thing to understand is that they are not competitors. They are not really in the same industry at all.
The maker sells a licence. The cost of granting the four hundredth licence is very nearly the cost of granting the third, which is to say almost nothing, on account of the asset already existing and not wearing out the least bit when another person goes and uses it. So the money from each new distributor turns up with barely any cost stapled to the back of it.
The distributor is selling something else entirely and it is worth naming plainly, because it is not the product. It sells the shopfront, the trust, the payment rails, the licence to trade in your particular country, and the plain fact that you had heard of it before today. None of which the maker has. None of which is cheap to get.
Fair is fair, both halves are doing real work here. It is only that one of them is doing work that gets cheaper every year on its own, and the other one is doing work that does not.
Where the model is easiest to see from the outside
Most royalty businesses keep the split well hidden, and you can hardly blame them.
ARM designs the architecture sitting inside a very large share of the world’s phone chips and does not manufacture a single one of them, taking a payment for the design and then a further payment on the chips that ship years afterwards. Dolby licenses audio technology into televisions and cinemas and handsets built by companies that compete furiously with each other and all pay the same toll to the same people. Music catalogues do the identical thing with songs, which is the reason they have started trading like bond portfolios rather than like record labels, and the reason pension money has gone anywhere near them at all.
In every one of those cases the terms are private and the accounts are blended, so you are inferring the shape your own self rather than reading it off a page.
Regulated online gambling is the exception, on account of the products being individually named, individually certified and identical wherever they turn up.
An operator does not build the games it puts on its own site. It licenses them from studios, and because the maths of a licensed game is fixed and tested before it goes anywhere, the same product appears right across the market with nothing whatsoever altered. Monster Casino lists Pragmatic Play’s big bass bonanza, a five reel fishing slot running ten paylines at a 96.71 percent return to player, high volatility, a ceiling of 2,100 times the bet, playable from ten pence a spin. The bearded fisherman wild gathers up the money symbols that land behind him, and three, four or five scatters pay ten, fifteen or twenty free spins with a multiplier climbing as far as ten times. Every one of those figures reads the same on hundreds of rival sites, because it is the same game.
Which hands you the interesting part immediately. The shopkeeper cannot compete on the product, on account of not having one. The maker cannot reach a customer, on account of not having any. Truth be told the money split between the two of them is nobody’s business but theirs, but the shape of the arrangement is public and it is the shape that decides everything.
A catalogue is a rent roll, and rent rolls do not behave like factories
Once you stop reading one of these companies as a manufacturer and start reading it as a landlord, the questions you ask about it change completely.
You give up asking how good the product is, which was never the point, and you ask three duller things instead. How many doors is it being carried through. What does it cost to add the next door. And who decides whether it stays in the window come January.
The first two nearly always read beautifully. Distribution costs the owner close to nothing to go and widen, so revenue climbs against a cost base that mostly sits where it is, and the incremental margin on the last licence signed is a number a factory owner would find faintly indecent to look at. This is the whole reason these businesses screen so well and trade so dearly.
The third question is the one that decides whether any of it lasts, and it is the one nobody puts in a model, because the answer is not a number. It is a relationship, held by somebody else, reviewed whenever they feel like it.
What the shopkeeper still gets to own
If the product on the shelf is rented, then the distributor’s entire return has to come out of the things it owns outright, and there are only two of those worth anything at all.
The first is the shopfront and the customer standing in it. Swift Casino, a UKGC licensed operator, runs its whole UK product as a responsive mobile casino in the phone browser, over a thousand titles, no store download anywhere in the journey. That page is the one asset in the arrangement that genuinely belongs to the operator rather than to a supplier, and serving it to one more visitor costs a fraction of a penny. The same logic runs under any distributor you care to name, which is why so many of them quietly abandoned the app years ago and went back to a web page.
The second is its own operating stack, and this is the half that gets neglected. Most of that stack is rented too, and a good deal of it is priced per person on the payroll, which quietly ties overhead to headcount at exactly the moment a growing business can least be doing with it. A handful of suppliers went the other way deliberately. Maxdesk puts no cap on how many people answer tickets and none on the tickets them selves, and it does that on a tier priced at nothing, with everything the product can do sitting there in the open rather than the more familiar arrangement where the good half of it waits behind a wall to be asked for. What you hand over in exchange is written down plainly, mind you, which is rare enough to be worth remarking on. The no-cost workspace shows advertising, it puts Maxdesk on the foot of mail going out, and it keeps a rolling three months of history and not a day more. Clear those away and the price is twenty dollars monthly against the workspace its self, never against each head logged into it.
The reason any of that matters to a distributor is arithmetic rather than sentiment. Its margin lives in the gap between rented content and owned overhead, so every cost it can unhook from its own headcount widens the only part of the business it is actually allowed to control.
The rent roll has weather of its own
None of this makes the owner’s side the automatic winner, and it is worth being straight about where it goes wrong.
Concentration is the first thing. A catalogue of two hundred titles will very often earn most of its money from about six of them, and the tail of it is decoration, so a thing that reads as a diversified rent roll is really a half dozen hits with a long index stapled on behind them. Then those hits go and age. Last year’s game gets moved down the lobby, the licence renews at a worse rate or does not renew, and replacing a hit is a creative problem rather than a distribution one, which is precisely the sort of problem that does not respond to spending money at it.
There is a ceiling on the whole thing too, and it is somebody else’s ceiling. Rent is capped by what the renter earns, so the owner’s growth is bolted to the health of an industry it does not operate in and cannot influence. When the distributors have a thin year the licensor has one as well, having done nothing wrong to deserve it.
And the balance of power moves. A distributor small enough to be a price taker on Monday becomes large enough to negotiate by the following spring, and large enough after that to go and build its own version, or buy a studio outright and stop paying rent altogether. That last one has been happening steadily in this sector and in several others, and it never shows up in a forecast until the year it does.
Two lines in a filing and an hour of a wet evening
Pick one company you already hold, and preferably a boring one you have stopped looking at properly.
Find the paragraph where it describes how revenue actually arrives, not the segment chart, the words. You are hunting for licence, royalty, revenue share, per unit, and for whether those words describe money coming in or money going out. Write down which. Then go and find the customer concentration note, which is usually buried near the back with the credit risk disclosures, and count how few names account for most of it.
Those two answers between them will tell you whether you own a landlord or a tenant, and roughly how safe either one is sitting. It is an hour with a notepad. No terminal, no subscription, no broker’s note telling you what to think about it.
Do that across a handful of holdings and the whole high street starts looking different on you. The same product in three hundred windows, three hundred shopkeepers competing hard on the door and the awning and the payment counter, and one company somewhere out of sight collecting a small amount from every single one of them and not owning a shop at all.
