As a franchisor much of the costs for ongoing services such as marketing, training, research & development, and brand awareness & reputation, that are provided to franchisees are covered by franchise royalty fees. Apart from the one-off franchise fee, royalty fees are the main revenue that a franchisor makes from its franchisees, in exchange for the services and support it offers.
As a franchisor, determining how to calculate your royalty fee can be challenging as there are many ways of doing it. When a prospective franchisee assesses franchise opportunities that they might be interested in, seeing a fair and transparent franchise royalty fee calculation goes a long way in gaining trust and securing them as your next partner.
Four common approaches to calculating it include fixed or variable percentages of gross sales, fixed royalty fees, and transaction-based fees.
Fixed percentage of gross sales: This calculation is easiest to understand as it charges a franchisee with a fixed percentage of their gross sales. That percentage doesn’t change which makes it straightforward, however, some argue that it may not be well-balanced for either party, given the costs of running the business vs supporting the franchisee, and how those costs may scale at different rates.
Variable percentage of gross sales: The variable-percentage model works similarly, except the percentage amount changes depending on how much the franchisee sells in each period. The franchisor might charge a lower percentage on higher sales, therefore motivating franchisees to improve performance, while still providing good returns for the franchisor.
Alternatively, the franchisor might charge a higher percentage as sales increase. Although this sounds counterproductive, this tactic can help keep fees fair when franchises are placed in high-volume locations that are likely to see high sales.
Fixed royalty fees: This approach gives the franchisor a fixed dollar amount each period, allowing the franchisee to reap the benefits of higher sales if they achieve them. Usually, the franchisor will adjust the fees annually based on inflation.
The fixed option might guarantee a franchisor a set amount per month, however, it might not be fair to the franchisee who might struggle to meet the fees during low sales periods. This might affect their cash flow and then have a negative effect on the business. Likewise, it could also unfairly benefit franchisees who are in high-volume areas.
Transaction-based fees: Sometimes, an ‘a la carte’ fee schedule gives the franchisee access to specific resources they pay for as and when they need them. In this model, franchisees pay individually for extra services they use, such as staff training from company headquarters. In the hospitality industry, for example, the franchisee might pay a fee every time a guest books through the franchisor’s centralised reservation system, or dials into their call centre for assistance.
There are no right or wrong answers when deciding which system to go for, it really depends on what is best for your business. Some other elements to consider when determining your royalty fees include:
Minimum royalty fees: By setting a minimum fee, a floor so-to-speak, franchisors can ensure that they receive a base amount every period, even when times are low. Again, franchisors can look to inflation figures to adjust this floor every year. While this option offers more security for the franchisor, it can again cause hardship for the franchisee at a time when they may already be struggling with lower sales. Lowering the minimum fees during these periods can help.
Start-up period adjustments: A newly established business will likely have lower sales and need more support. To help these franchisees get off the ground, many franchisors will waive or reduce royalty fees for an introductory period. You could remove the fees entirely or have the franchisee pay them back later, like a loan or deferral.
Think about what is best for you and your organisation.
Sharing Your Royalty Fee Structure
Once you have decided on your fee structure, communicating this to your franchisees and potential franchisees in the best way is very important. If your royalty fees are lower than the rest of the industry, be sure to highlight this when recruiting new franchisees. Lower fees can serve as a unique selling point that sets you apart from other franchise opportunities. Mention it in your marketing materials when targeting potential franchisees.
If your royalty fees are higher, then make sure you communicate the value that they offer and why franchisees get more for their money from your higher fees. Showcase how your organisation supports more than a competitor would.
When it comes to charging and collecting your royalty fee every month or week, ensure this process is automated and robust, such as through a franchise management platform. As your franchise grows, these fees can get increasingly complex, so make sure your system can accommodate intricate rules, rate structures, and fee schedules. It should also provide transparent invoicing that communicates fee calculations with your franchisees.
By Paul Sharpe, General Manager ANZ at FranConnect.
For more information on FranConnect and how it can help your business please visit: https://www.franconnect.com/request-a-demo/