Breaking Down Franchise Royalty Fees
When people think of the costs of opening a franchise they typically just think about the franchise fee. That makes sense, seeing as the franchise fee is typically a substantial cost, ranging from a few thousand to a few hundred thousand dollars. But, this isn't the only payment a franchisee needs to make to the franchisor. Once operations start a franchisee typically needs to pay some form of ongoing royalties to the franchisor.
While the initial franchise fee pays for training, initial marketing efforts, and the right to use things like the franchise name, trademark, logo, and processes there are many ongoing support efforts from the franchisor that this fee doesn't cover. Things like recurring marketing, appointment setting, technology licensing, and business supplies often need to be paid for through ongoing royalty payments. As with many things in the franchising process there are differences from franchise to franchise with how royalty agreements are structures but here are the general royalty setups.
Gross Sales:
This model is the typical royalty setup that most people think of when they think about franchise royalties. In this case a franchisee pays the franchisor some percentage of every dollar that the make in sales. It is the most common setup in the franchise industry because it creates an incentive for the franchisor to help the franchisee grow. These royalty models typically come in one of three forms:
Increasing Percentage:
This type of franchise royalty setup allows for a variable percentage of gross sales to be owed to the franchisor depending on factors that impact the likelihood of a franchises success. Probably the most common factor that comes into play for this type of model is franchise location. If a franchise is located on a busy street in a city with high foot traffic then they might have higher royalty rates than one in a more rural location.
Decreasing Percentage:
Despite sounding like the opposite of Increasing Percentage Royalty models these are actually almost completely unrelated. Decreasing Percentage Royalty models make the required royalty percentage dependent on the sales a franchise has. If the franchisee is selling more then the royalties paid to the franchisor are less (percentage wise). This model is typically viewed as a good option for both sides because it gives an incentive for franchisees to grow and be more profitable, which has obvious benefits for franchisors as well.
Fixed Percentage:
The simplest and most common type of royalty agreement in franchising. With fixed percentage royalty agreements there is a constant, set percentage of sales that a franchisee will have to pay a franchisor. It's easily the simplest royalty setup, although it isn't necessarily the best option for franchisees and franchisors
Transaction Based
Not all royalty agreements are based on direct sales revenues. For some industries that involve a larger scale transaction (like the hotel industry) royalties might be owed by a set fee per transaction. These royalties are similar to fixed percentage royalties, but don't take a percentage with each sale, just a flat amount.
Fixed
Not to be confused with Fixed Percentage Royalties, Fixed Royalties are just a flat monthly fee a franchisee owes to the franchisor. These types of royalties remove all the risk for the franchisor by guaranteeing them a monthly payment. But, they also allow successful franchisees to keep a much higher proportion of the profit than under other models.
Minimum Royalty
Minimum Royalty setups are used alongside another type of royalty, typically some type of percentage based agreement. Under these setups a franchisee must pay a minimum amount every month to the franchisor, even if their monthly sales aren't generating enough revenue to require that payout under the percentage based model. Similar to a Fixed Royalty arrangement a Minimum Royalty agreement shifts all the risk to the franchisee and away from the franchisor.
No Fee
These aren't technically royalty agreements because there are no required payments between franchisee and franchisor. Under this type of arrangement a franchisee is typically required to buy certain goods or supplies from the franchisor.
Searching for the Best Franchises for Minorities
Many franchises incentivize minorities to join their systems. As president of the World Franchising Network Rob Bond puts it, these franchises "grease the skids" on behalf of minority candidates because they see value in promoting diversity among their franchisees. On account of a still-languid economy, however, many franchisors' approach has changed significantly in recent years. As Bond explains, “African Americans and Hispanics were being aggressively recruited five years ago to fill vacancies.” But today most franchisors are more concerned with trying to grease the skids for foreign investors with significant piles of investment capital.
Common Mistakes Made By the Franchisor Buyer During the Due Diligence Investigation
Franchise merger and acquisition talks always start with the best of intentions. After all, a well-executed franchise system merger can lead to enhanced scale (for increased buying power and leverage over suppliers), reduction of overhead and operating costs (through elimination of duplicate staff, departments, and locations), and increased revenue (through cross-selling of products or services, optimization of distribution channels, and bolstered brand recognition and standing in the eyes of prospective franchisees).
Choosing Between a Product and a Service Franchise
There are basically two types of businesses that can be offered by an individual. They can offer Products to their customers which are tangible goods meant for the customer's consumption or they can offer them Services which are intangible and work to make the life of the consumer easier and more convenient. With technologies advancing rapidly and the global demands of consumers changing there is a very thin line dividing the service and product segment of the consumers demands. An example of this can be the purchase of a car from an auto dealer. The dealer not only offers the vehicle at a competitive rate but now has to offer different services as well, such as financing options, after-sales services, ready documentation and other non- tangible services. This kind of merging has made it very difficult to draw a clear line as to the service and product industry but for the sake of argument we will consider a theoretical perspective where you have to choose a traditional product franchise or a service franchise.
