To ensure a smooth relationship with franchise owners, it is important to understand what a franchise royalty fee is. In short, franchise fees include the initial franchise fee and the franchise royalty fee. The initial franchise fees are seen as the upfront cost to be a part of the franchise system. Royalty fees are different in that they are ongoing fees that the franchisee pays to the franchisor to fund their expenses. Royalty fees are usually a percentage of the gross sales made by the franchisee and serve as the primary source of profit for the franchisors. These fees are typically paid monthly but sometimes are paid weekly. These fees can either be a fixed amount or are a mixture of the percentage of gross revenue and the minimum amount due.
Why Do Franchise Owners Pay Royalties?
Franchise owners must pay royalties to the franchise owners to pay for actions that they provide for the franchisee. For example, entitlements that the franchisee can reap the benefits of after paying the franchising fee include the ability to continue using the franchisor brand to uplift your business, get ongoing training and education, and get software updates used the franchise, and get business and administrative support. Depending on the franchise agreement, these entitlements may differ, but the bottom line is that since the franchisee pays for the franchisor, both benefit from the partnership. The franchisor relies on these fees to run their headquarters and staff and continue building their brand to bring in new franchisees. The franchisees receive this help to become a more successful business and get the help they would not usually have access to without being in the franchise business. Other helpful features funded by these royalty fees are marketing campaigns and business strategies that are helpful to both parties.
What is a Typical Franchise Royalty Fee?
A typical franchise royalty fee may fall anywhere between 5 to 8 percent of the franchisees total gross sales, however some franchisors may expect more after the income after expenses, which is anywhere between 6 and 10 percent. However, as mentioned briefly before, since the royalty payments are not always dependent on the number of gross sales that the franchisee receives, they may have to keep up with fixed-fee payments.
Many different franchise types also have different royalty fee rates depending on the kind of business. For instance, service businesses often have higher royalty fees because of the lack of inventory. In comparison, food service businesses tend to have lower fees because they are making more money from the food business than from the money they would receive as a franchisor. Businesses like the food industry can afford to lower their royalty fees since they do not rely on them as their main source of profit. The value of the company’s service may also affect the percentage of royalty fees that must be paid. If the franchisee benefits from ongoing support, the franchisor may choose to charge more for the convenience of the partnership.
How is Franchise Royalty Fee Calculated?
The most common way to calculate franchise royalty fees is to choose one of the usual percentages of the franchisee’s gross sales seen above. The royalty percentage asked would also be contingent on the number of gross sales the franchise received since it would make sense to ask for more money knowing that the franchisee is successful. Many franchisors may also choose to set a minimum royalty payment for each month that must be paid regardless of differences in revenue. Different franchisors may stray away from this and prefer to charge based on the number of sales for each month. If the sales are in a higher range, the franchisor will ask for a higher royalty payment. After the percentages or rate of the royalty fee is calculated, the franchisee must abide by the set due date agreed on, whether weekly or monthly, or risk legal consequences or termination of the franchise agreement.
Types of Franchise Royalty Fees
While some of the most common kinds of royalty fees were mentioned above, there are additional fees that franchisors may use to ensure the continuation of their business in the most efficient manner.
Fixed Percentage of Gross Sales
This would be the most common kind of ongoing royalty fee where the same percentage of the gross sales is asked for by the franchisor every time it is due.
A Variable Percentage of Gross Sales-Decreasing Percentage
This would be less common because the franchisor is changing the amount they are taking from the franchisee. The mentality behind this decision would be that a lower royalty fee would be fairer to the company and would thus, increase motivation and reward for better performance. Some instances show that reducing the royalty fee may also increase reporting total sales more accurately. These percentages vary month to month since this kind of agreement accounts for the varying levels of monthly sales. As the monthly sales increase, the royalty rate would then decrease. The cumulative sale approach is also utilized in that annual sales are analyzed instead of individual monthly sales to determine the percentage of royalty fees.
The opposite of the decreasing percentage, increasing the ongoing franchise fees allows the franchisor to make a bit more money to continue to give helpful services to their franchisee. Franchise companies that use this model see this to provide adequate compensation to their franchise brand for their performance and contribution to the franchisee’s success.
A minimum fixed rate is established to ensure that the franchisee keeps performance at an acceptable level and gives back to the franchisor regardless of the level of business they are receiving. Minimum royalty fees are often established if the franchisee does not meet the minimum royalty quota.
The royalty fee is not contingent on the number of sales of the franchisee at all, while the franchisor is guaranteed the same amount of money each month.
No Royalty Fee
This would apply to those franchises that do not rely on the income from merchandise or services.
After reading this, we hope you are more knowledgeable about franchise royalty fees, why franchises have to pay them, and how they can benefit businesses! Many royalty types depend on the industry you may want to get involved with. So while it may seem tiresome to pay another expense for your business, instead consider how much more it can help you to get your business immediately off its feet to get recognized much quicker! Royalty fees help in aiding your business by having more seasoned companies over you, handing you resources. Be sure to check out more franchising information at WhyFranchise.com for any of your franchising needs!