Franchise Fees – The Ongoing Costs of Managing a Franchise
You can spend a lot or a little for a franchise in upfront or initial fees. As to whether or not you make money depends to a considerable degree on the level of ongoing fees.
Once you’ve bought a franchise, you as the franchisee are still responsible for establishing your business, running it and providing its working capital. This is one of the more emotive aspects in the franchisor/franchisee relationship. The setting of ongoing fees is a balancing act that has to take into account the need of both the franchisor and the franchisee to a respectable reward for their respective contributions to the business. This has to be set at a win-win level if the relationship is to endure. Neither party can expect to get rich at the expense of the other.
Management Services Fee
Of the management services fee (or on-going franchise fees) only a small proportion will be profit to the franchisor. The bulk goes to pay for the support and back-up that the franchisor is contractually obliged to deliver to its franchisees. Check the franchisor’s obligations.
This is usually calculated as a percentage of a franchisee’s sales and can be payable either weekly or monthly in arrears. The quantum of the fees varies widely depending on the type of business and its profit margin. The spread is from 1% to 10%.
Be aware that in low margin businesses such as retail grocery chains, a management fee higher than 1% could make the business unviable. The high turnover volumes would make 1% adequate support for the franchisees.
Lower turnover businesses would enjoy high mark-ups, and a fee level of 7% to 10% may be necessary to both parties a fair return. The actual percentage figure, therefore, is less important than your own evaluation of what level is value for money.
By interviewing existing franchisees you may determine if the requested level of management fee is justified based on the level of ongoing support offered by the franchisor.
You also need to know something of the industry sector of the franchise. Does it allow sufficient mark-ups to justify the fee the franchisor demands and still make a profit?
The level of the management fee may also be governed by whether or not the franchise revolves around a product the franchisor supplies, as in most fast food franchises. If it does not the need for extensive ongoing support may not exist and may mean that once you are a member of the network, you will be largely left to fend for yourself.
Marketing Services Fund
An additional fee may also be levied for national product advertising and marketing activities. Marketing fees also vary extensively, ranging up to 6% of sales. Many franchisors expect franchisees to supplement national marketing campaigns with local marketing efforts, at their own expense, as this is one of the most successful ways to boost an individual business.
Varying from one franchise to another, there are other possible charges:
Where a franchisor purchases products in bulk on the network’s behalf and distributes them to franchisees, a handling fee may be charged. This is common practice as long as it benefits the franchisees’ business. (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.)
A fee may be charged wherever franchisors offer services beyond the normal parameters of franchisee support. These could be legal or administrative in nature, and should be based entirely on whether value for money is received.
Possible renewal costs
Most franchises are granted for a fixed period of 5 to 10 years. There typically is an option for the franchisee to renew the franchise agreement for a further period. Granting of this option is often conditional. These conditions may have financial implications. For instance, it is not uncommon for franchisors to make the renewal of the franchise agreement conditional upon the franchisee updating the appearance of the outlet, or refurbishing production equipment. You need to make provision for this.
This is not common, but some franchisors charge a renewal fee similar to that charged as the upfront fee. Check for this and consider its implications.
All payments should be fully transparent. They 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.