Buying a franchise can be a great way to own your own business. When you buy a franchise, you buy the right to use an established brand; as well as all the systems and processes that you will need to operate that business on a day-to-day basis. You will also receive training and support from the franchisor, who will teach you everything you need to know to run the business successfully. The obvious question then is, “how much does all this cost?”
Initial license fee
Generally, franchisees are expected to pay an initial license fee when they first purchase the franchise. The initial license fee should cover the costs to the franchisor of providing the training, inventory, and equipment that make up the start-up package. The license fee must not include any element of significant benefit to the franchisor. This is because if the franchisor makes most of its profit from the license fee, it will have a strong incentive to simply sell new franchises rather than support its existing franchise network.
In a well-managed and ethical franchise network, the franchisor will profit from the prevailing fees charged to the franchisee. In this way, the franchisor has a direct interest in the success of its franchisees: the more the franchisee earns, the more the franchisor will earn. The franchisor should not have a need to make a profit on the license fee.
After the initial fee, the franchisee is expected to pay a regular fee for ongoing rights to use the business system and franchisor support. These fees will generally be a service charge, calculated as a proportion of the franchisee’s billing and payable each month. This could represent between 10 and 12% of the franchisee’s turnover. This means that for a franchise network to be successful, there must be sufficient profit margin for both the franchisee and the franchisor to be able to take part and yet be able to offer competitive products and services to customers.
In some networks, the franchisor will earn money by selling products to the franchisee instead of collecting a portion of the billing. This is particularly common in retail food franchises where the franchisor charges a markup on the cost of menu items supplied to the franchisee.
There is a growing trend for franchisors to make the service charge subject to a minimum fee. In a pure franchise model, the franchisee’s charges would not be subject to any minimums. This is because if the franchisee is required to pay a minimum fee, then the franchisor is guaranteed to receive payment, even if the franchisee fails to earn any money. This goes against the general principle that franchisee and franchisor participate together; and that the success of the franchisor should depend on the success of its franchisees.
Franchisors will often charge for additional services provided to the franchise network and it is important for the franchisee to understand what additional payments they may have to make. For example, many franchise networks require franchisees to contribute to a national advertising budget. This could represent up to 2% more of the franchisee’s turnover.
Franchisees must attend regular training and events organized by the franchisor. While some franchise networks do not charge for the training or the event itself, the franchisee is expected to pay their own travel and living expenses. This could mean that the franchisee must budget for hotel accommodation and meals, as well as travel costs to and from the event.
Additional fees may arise in particular circumstances. For example, one-time charges may arise on renewal or if the franchisee chooses to sell their business.
Counting the costs
All of these fees and charges will add to the costs of purchasing stocks and raw materials that any business needs. This means that the costs of running a franchise business will be higher than those of an independent business. That said, many franchisors can take advantage of the purchasing power of the network as a whole to negotiate better terms with suppliers than an independent company could achieve. This may help in part to offset some of the costs; although it is not uncommon for the franchisor to retain the benefit of vendor rebates or discounts instead of transferring them to their network.
The crucial takeaway for franchisees is that before investing in any franchise business, you need to make sure you know all of the fees that you are expected to pay; And you should budget for all of this when preparing your business plans. You will need to identify hidden costs and assess whether, above all, the franchise network offers good value for money.
If you are a franchisor, the lesson is to be transparent in the fees you charge. There is nothing inherently wrong with making money with a franchise network. In fact, a franchisor must ensure that its fees are high enough to fund the support, training, and other services it must provide to its network. However, it should be clear up front what is included in the standard rates and when additional charges may be imposed. Similarly, if the franchisor is receiving benefits from the providers, these must be declared to the network.
Ultimately, as with any business, the numbers must add up. This applies to both the franchisee and the franchisor, who must be able to make a reasonable profit from the business. If one party benefits at the expense of the other, the business model will not be sustainable in the long term.