Franchise Fees – Cost of Buying a Franchise
Franchise fees can conveniently be divided into the upfront fee and ongoing fees. In addition, you as the franchisee are responsible for financing the establishment of your business, and for providing working capital.
A detailed explanation of these terms follows:
1. Upfront Fee
The upfront fee, also named initial fee, is effectively a joining fee. It grants the franchisee access to the network and its intellectual property as well as entitling him to receive initial training and assistance in all facets of setting up the business. This fee varies widely from one industry sector to the next, and even among different franchisors within the same industry sector.
Is the upfront fee the same for all franchisees?
No, it varies. It all depends on the industry, the brand and type of business. In some cases, the fee even differs among different franchisors within the same industry sector. It can also sometimes differ within the same franchise group itself, where for example, a more lucrative territory is awarded to a franchisee.
To determine whether you are offered value for money, consider the following:
- The standing of the network’s brand. There is usually a correlation between brand recognition and the time it takes a new franchise outlet to reach breakeven. It follows that it may be justified for a well-established network to charge a higher upfront fee.
- The level of initial assistance you will receive. Depending on the nature and complexity of the business sector, this may entail some or all of the following:
- Initial training in all facets of operating the business.
- Help with site selection and lease negotiations.
- Advice regarding the fitting-out of the premises and the acquisition of initial stock.
- Access to preferential purchasing arrangements the franchisor has put in place.
- Assistance with staff recruitment and training.
- Preparations for and professional execution of the grand opening.
- Initial presence of a trouble-shooter. An inexperienced operator may find it stressful to cope during the first few days after the opening. Everything is new, including the staff, and things are bound to go wrong. Having someone to lean on can be invaluable.
Now calculate how much it would cost you to achieve similar outcomes all round. Would you start a similar business independently? This will give you an idea whether you are receiving value for money. (For the purposes of this calculation, ongoing benefits of being a member of the network can safely be ignored because you will pay for these separately.)
2. Ongoing Fees
These can be divided into two, sometimes three, categories.
1. Management Services Fee
This fee pays primarily for ongoing franchisee support. It is usually calculated as a percentage of franchisee’s sales and is payable either weekly or monthly in arrears.
Fee levels vary from as little as 1% to 7%, depending on the type of business.
- Many retail type operations, for example grocery chains, generate huge turnovers but profit margins are narrow. Charging a management services fee that is higher than 1% would jeopardise the viability of the franchise. In view of the high turnover volumes, however, 1% enables the franchisor to provide adequate support to franchisees and make a fair profit.
- Other businesses, for example home repair services, generate lower turnovers but enjoy high mark-ups. In this case, a fee level of 7% or more may satisfy both parties.
In any event, the actual percentage figure is not an indication of value received. You should rather focus on the following:
- Value for money – Does the level of ongoing support offered by the franchisor justify the fee level?
- Affordability – Will the mark-ups you can achieve in the industry sector allow you to pay the fee the franchisor demands and still make a profit?
Should the franchisor you negotiate with levy a fixed weekly or monthly fee, caution is advised. Unless the franchise revolves around a product the franchisor supplies, the incentive to provide extensive ongoing support falls away. It could be a good deal, but it could also mean that once you are a member of the network, you will be largely left to fend for yourself. If this does not alarm you then why invest in a franchise in the first place?
2. Marketing Services Fund
Most franchisors levy an additional fee, generally described as a contribution to the marketing services fund or advertising fee. It is intended to pay for national product advertising and marketing activities.
- The marketing fee should not constitute income in the franchisor’s hands. It should be paid into a separate bank account that is administered by the franchisor. In practice, forward-looking franchisors spend advertising fees in consultation with franchisee representatives and grant them access to the relevant accounts.
- Fee levels usually range from 0,5-3% of sales, or a fixed fee may be levied. (In this instance, levying a fixed fee makes sense because it provides greater certainty regarding future cash inflows and facilitates the planning of marketing campaigns.)
- As spending on marketing activities benefits every member of the network, it is reasonable to expect that company-owned units should contribute at the same rate as franchisees.
- Many franchisors expect franchisees to supplement national marketing campaigns with local marketing efforts, at their own expense.
3. Other Fees
- Purchasing Fees – If a franchisor purchases products in bulk on the network’s behalf and distributes them to franchisees, a mark-up, purchasing or handling fee may be charged. This is acceptable as long as franchisees enjoy an advantage from having access to such deals. (In terms of FASA’s Code of Ethics and Business Practices, bonuses and other payments accruing to the franchisor based on franchisees making purchases from prescribed sources must be disclosed.)
- Special Services – Some franchisors offer services that go beyond normal parameters of franchisee support. A franchisor could, for example, offer a comprehensive administrative service that takes care of franchisees’ statutory returns and even writes up their books of account. It is fair and reasonable for the franchisor to charge for such services as long as franchisees receive value for money.
4. Possible Renewal Costs
Most franchises are granted for a fixed period of between 5-10 years, with an option in favour of the franchisee to extend the franchise agreement for a similar period. Granting of this option will usually be linked to certain conditions being fulfilled, some of which will have financial implications. You need to be aware of these before you sign the initial franchise agreement.
- Refurbishing Costs – It is customary for franchisors to make the renewal of the franchise agreement conditional upon the franchisee updating the appearance of the unit and, if applicable, the production equipment in use. This is fair and reasonable, after all, it is the franchisor’s responsibility to maintain the network’s image, but you need to make provision for that. Some franchisors are now charging a monthly refurbishment fee to help franchisees to save for this event.
- Renewal Fee -Some franchisors charge a renewal fee. The amount is often similar to that charged as an upfront fee at the time the agreement comes up for renewal. You should establish upfront whether a renewal fee will be charged. You need to consider this when you work out the long-term financial viability of the proposition.
All payments franchisees are obliged to make should be fully explained in the network’s disclosure document and must be incorporated in the franchise agreement. For more on this topic, please refer to the articles headed Disclosure document and Franchise agreement respectively.