Here's How to Compute Your Franchise Fee and Royalty Fee
If your business is flourishing and you’re beginning to wonder how you’re going to properly enter the world of franchising, franchise fees and royalties are probably among your top concerns.
By definition, the initial franchise fee is the amount paid by a franchisee to the franchisor upfront in order to be permitted to utilize the company’s products, system, brand, and intellectual property. Meanwhile, the royalty fee is a recurring fee being paid by the franchisee to the franchisor typically every month or every quarter and it usually amounts to a percentage of the sales.
So, why do you need to compute the franchise fee and royalty of your business before you have it franchised?
To compute your franchise fee, you need to properly determine how much your costs are to sign-up a franchisee and them until they open their franchise unit. The franchise fee should cover costs in marketing the franchise business, evaluating the location proposed by the franchisee, initial training, set-up, grand opening, and pre-opening support.
The franchise fee will basically make sure that you as a franchisor will be able to help your franchisee start their operations smoothly.
Meanwhile, you have to determine and compute the royalty fee, which is usually a percentage of the gross sales that you’re going to charge your franchisees on a regular basis because this will sustain your on-going support activities to the franchisee, activities to further the brand, product innovation through research and development, and systems improvement.
Without properly computing these fees, your business could suffer losses, and the franchisee may not get the support they need from the franchisor to sustain the business.
In terms of computation, the franchisor must look at both internal and external factors.
Things to consider
Internally, the franchisor needs to reflect on their own operations, expenses, and revenue streams. Externally, the franchisor needs to look at what the market can bear. Ultimately, the franchisor should be able to balance both their needs as well as that of their franchisees’ in coming up with an equitable franchise package.
On the other side of the coin, a prospective franchisee looking for a business to franchise should scrutinize how much similar franchise concepts are offering. If the difference is too significant, try to find out why. Ask yourself, “What does the cheaper franchise concept lack that the more expensive brands have?”
The franchise fee is just a one-time revenue and it is meant to offset the franchisor’s expenses in marketing, selling, opening, training, and supporting the store opening. A high franchise fee may become a barrier to the entry of the franchisee into the system. Once the franchisor gains considerable brand equity, then the franchise fee can be a major source of profits.
Let’s move on to the royalty fee.
Unlike the initial franchise fee, the royalty fee is a continuing source of revenue. However, it is not solely passive revenues. Earnings of the franchisor from royalty cover the operational expenses of the franchise organization.
Moreover, the royalty is there to ensure that franchisors cover their costs for support and technically, this is where their income comes from, which means that the higher the sales of the franchisee, the higher the income of the franchisor.
Here are some of the aspects that is meant to be covered by royalty fees:
- System improvement
- Brand improvement and promotion
- Product research and development
- Advertising campaigns
- Franchisee network support
- Field visits
Knowing the importance of royalty fees, you must be wondering why some brands do not charge any royalty. How could they cover the expenses?
In most cases, these franchise brands derive income from margins on supply of products, special ingredients, or merchandise crucial for the franchisee’s continuous operations. Also, these items are key to providing the continuing value that will keep franchisees within the system.
Looking at these important points, the franchisor should therefore weigh how much mark-up to add on products supplied and the amount of royalty to charge to cover all expenses in maintaining the franchise organization and generate worthwhile revenues while giving the franchisees an attractive return on its investment and still providing customers great value for their money. This is what we call win-win-win where the franchisors, franchisees, and customers all benefit from the franchise program.
Sure sign of success
At the end of the day, a successful franchise gives franchisees 90 percent chances of success over time as compared to starting up a business from scratch, based on a study conducted by the USAID. The reason why chances are higher is because the franchise is already developed and proven. And the tireless efforts of franchisors to continuously improve and strengthen their brand and system are what’s being covered whenever a franchisee pays for the franchise fee and royalties. #
Take your business to the next level via Franchising. Join Francorp’s FRANCHISE YOUR BUSINESS WEBINAR for FREE! To see the upcoming schedules, visit this site. If you want to know if your business is franchisable, please contact our franchise analysts at (+632) 8638.31.42 / 0917.835.55.30 or email [email protected].
Sam Christopher Lim is the CEO of Francorp Philippines; President of U-Franchise Sales & Management; Chairman for ASEAN Integration of the Philippines Franchise Association; and Co-author of the book “12 Strategies of Franchising."