Understanding franchising fees
When you buy a franchise outlet, you will be required to pay some fees to the franchisor – and you should understand what they are so there’s no disappointment or later confusion.
All franchisees should expect to pay for the privilege of using the franchisor’s brand name and continuous support. This will come in the form of a one-time fee like the initial franchising fee and there will also be ongoing fees, like the royalty fee.
Initial franchise fee
The initial franchising fee covers the cost of getting a franchise up and running and joining the franchise group:
- The documentation and business licenses – the franchisor licenses its trademarks, service marks, trade name, logo, or other proprietary marks to the franchisee.
- The site selection
- Project management of the premises retrofit
- The initial training, and
- The initial marketing
- Assistance with staff recruitment, finance applications and other aspects needed to get ready for trading
These are all actual costs to assist the franchisee with establishment, and the franchisor is not really making any money off this fee. This amount must be disclosed up-front in the franchise disclosure document.
The amount a franchisor sets as its franchise fee varies from industry to industry and franchisor to franchisor. It is usually competitive to what similar franchisors are charging as the franchise positions itself in its market. Because franchising is all about consistent replication, trust and enduring relationships, it is usually not negotiable as it would cause deep offence to other franchisees if you paid a lower franchise fee.
The capital needed to establish the franchise is provided by the franchisee. These establishment/set-up costs will typically include the following:
- Fixtures and fittings including furniture and signage
- Rental deposit
- Start-up stock
- Stationery, uniforms and marketing material
- Computer equipment and software
In addition to establishment costs, the franchisee should also provide for working capital to cover expenses while the business is getting going. The franchisor should be able to provide guidance on this.
Ongoing royalty fees
Royalty fees go toward the maintenance of the collective franchise. Each of the support activities the franchisor provides are funded through monthly royalty fees:
- Field managers providing ongoing support to franchisees
- Business strategy
- Other administrative costs of running the business are shared
- Development of training manuals
- Negotiating prices with suppliers
- Ongoing research and development
How these royalty fees are calculated vary widely from franchise to franchise, and there is no set industry formula – but it generally falls into two categories: a fixed fee; and a percentage of turnover. Fees can vary from 3% to 10%. If you are getting value for money, the actual figure should not be a concern. However, it will become a bone of contention when you figure you are not getting value.
It should be set at a level which permits you to make a healthy profit after all expenses and also be enough for the franchisor to make a profit and run a healthy franchise which simultaneously feeds back into your own business.
Where franchisors have a low royalty fee (or exceptionally, none at all) it is typically because you will rather be required to purchase products from the franchisor or designated suppliers, usually at a marked up price, which takes the place of a straight fee.
If you are uncertain about whether a royalty fee is reasonable, it would be worthwhile getting advice from a franchising consultant as this point goes to the very viability of your prospective business.
Some franchisors also require a separate advertising fee to contribute to national advertising and marketing costs. These may be monthly or periodic contributions and should be put into a separate account and used for national promotion for the entire chain. Advertising fees could be charged as a percentage of sales or as a flat fee. Although franchisees contribute to national marketing, local marketing expenses to promote their own outlets are for their own account. The franchisor should assist with this by providing guidelines and templates for local marketing campaigns.
What’s in It for the franchisee?
Although franchisees frequently complain about royalty fees, the payments create a win-win situation for both sides. Until word gets out that your product is incredibly good and worthy of purchase, the bulk of your sales will most likely come from name recognition alone. Later on, you might come to take all the credit yourself and forget that it was this that got your business up and running.
- Franchisors often provide guidelines on business plans and finance applications to help franchisees apply for finance of the initial franchise fee, start-up costs, equipment and inventory.
- They also connect prospective franchisees up with third-party financing institutions such as banks in order to expedite the loan process for their franchisees.