The Tollbooth Portfolio

While I am a dividend growth investor, my stock selection process has everything to do with the tollbooth or subscription business model. 

Why is that? Subscription is the easiest model to forecast for businesses and you can build a relationship with the customers more easily which greatly help improve the products and services offered.

The non-digital way to look at subscription is done by using the tollbooth analogy. A tollbooth can also be predictable and profitable. You can increase the fees as your costs go up to maintain the same profit ratio.

The tollbooth and subscription businesses generate recurring revenue with consistency and when managed properly, the businesses can either optimized their costs for a higher profit margin or they can increase the end user price.

Unlike regular businesses where they simply have to get more and more customers, the subscription businesses can focus on value add and staying competitive to generate higher profits.

Look at how Netflix operates vs car manufacturers; one is counting the members paying monthly and the other is counting sales. The 2 models have very different impact in forecasting financials.

In the fall of 2019, I heard Jim Cramer discuss on his Mad Money podcast how car companies are learning that we drive more but buy less vehicles. Due to the cars lasting longer, consumers don’t buy new vehicles as often.

As such, the concept of subscription for vehicle is being discussed within the car industry and, as it happens, Porsche is offering a subscription through its Porsche Passport service. The concept goes back to how much one is spending on a car annually when you consider depreciation and all. The data is all there for the car manufacturer to establish an appropriate pricing strategy.

Business Segmentation Process

When you merge the tollbooth concept with necessity of life, you end up with a really strong business model. The easiest companies to classify are the utilities. The next ones on the list are the Canadian banks and the telecom industry.

As you can see, those have some regulations in place in order to avoid gauging customers since they have a type of monopoly on the business. They are also referred to as oligopolies when a few business share a monopoly.

I have tried to look at businesses differently from the conventional models. The financial industry has classified companies a certain way within a sector and industry in order to compare more easily and assess trends with similar businesses.

While that’s is an important classification, revenue and growth forecasting is easier with the first 3 segments outlined below.

Using the segments below requires investors to understand how the business is collecting revenue. No metrics can tell you how it operates, you have to read up on it.

For example, until Disney started Disney+, it was in the consumable – discretionary segment but now with Disney+, it has entered the subscription segment.

Here are the segments I use to categorize each business.

• Subscription
• Tollbooth – Regulated
• Tollbooth – Unregulated
• Consumable – Necessities
• Consumable – Discretionary
• Durable
• Intermediate

Before we go further, I love tollbooth or subscription stocks but not all of them provide growth and profit. You still need to do more research.

Take REITs as an example, they are a tollbooth stock but have limited growth and limited distribution growth.

Sure, you get regular rent but often times, rent increases is controlled or commercial rent is negotiated. Customers also don’t just magically increase like they can for online businesses. Just a word of caution as you read on.

Subscription

To be considered a subscription stock, an important part of the business must be driven by a subscription model. It has to be a service that users or companies opt-in willingly.

Take cloud computing or software services as an example. Newspaper and magazine would fall in here as well but it’s highly competitive.

The music industry was re-invented with streaming by Spotify and also has a service.

In fact, Apple is re-investing a lot of the old business models into new subscription services such as Apple Music, News+ and TV+. I also now file The Walt Disney Company in this category with Disney+. The streaming service should become their largest revenue contributor over time.

Tollbooth – Regulated

Consumers are generally required to use the service, and pay a monthly fee. However, as a necessary service, fee increases are regulated and usually require approval by a governing body. This segment usually represents the utilities for your home.

Tollbooth – Unregulated

Banks are a tollbooth but they are somewhat unregulated. The account fees or any other fees are set competitively but since they have an oligopoly, they don’t tend to undercut each other much.

While telecoms are semi-regulated, I would say the complete suite of offerings put them in the unregulated space. Oligopoly businesses, such as the railway or credit card companies, will have a business that can look like a tollbooth.

Consumable – Necessities

This segment represents medicine, toilet necessities, and cleaning products to name a few. Food also fall in this category as we need it to survive and stay healthy.

Consumable – Discretionary

This segment represents the businesses the provide products that we consume such as clothes or any other items that are consumed by consumers (not businesses).

Durable

Growth from this classification comes from economic growth in my opinion. Most consumptions is needed to require increase production which drives growth for durables products and factories generating those products.

Without growth, no new towers are needed and no new bridges. Infrastructure can reuse what exists instead of creating new roads or buses.

Intermediate

This is a catch all for many basic materials and energy companies. It represent a company that doesn’t reach consumers directly and is instead consumed by another business before it reaches the consumer.

Tollbooth Portfolio

In the end, tollbooth and subscription businesses mean repeat customers. Back to the car business, a manufacturer would love to lock in customers with their brand, instead every time they roll over new models, they risk losing customers to another brand. Subscription implies loyalty and repeat spending which is very profitable for a business.

While the sector or industry classification could match a segment, it’s not always a 100% match. I strive to invest in companies that fit the first 3 categorization above.