Make Sure to Understand the Impact of Royalty Fees on Your Franchise Business
Becoming a franchisee of a well-known brand comes with both its perks and costs that one needs to examine before entering the franchise agreement. A franchise agreement allows you, the franchisee, to use the franchisor’s brand and operating plans to run your local business. And for the term of the agreement, most franchisors charge an ongoing royalty fee equal to some percentage of your sales.
Some of the major benefits of becoming a franchise owner are that the advertising, marketing, and training and support is provided to you. On the other hand, you give up a bit of the control and creative freedom when it comes to the store design and operations of the franchise.
But with overhead costs as well as the royalties, how do you make a profit? In this post, we tell you the purpose of royalty fees, how they are calculated, and how you can make money despite having to pay royalty fees.
What is the purpose of a royalty fee?
Before you say being charged a royalty fee is unfair, look at all the franchise system gives you. Firstly you have the use of an established name brand to use and represent your business. In addition, they provide training for you and your staff, and in some cases, staff is provided or hired for you too. Secondly, you can benefit from the franchise's buying power and receive discounted pricing.
Thirdly, the franchisor’s prescribed local marketing plan should provide potential customers to you. With all these services, it is easy to see how the franchisor justifies its royalty fees.
How are royalty fees calculated?
The most common way royalty fees are calculated is through a percentage of the franchisee’s top line sales. Typically this percentage may range anywhere between four to nine percent. This fee is a percentage of the sales of services, goods, and any other products sold through the franchise.
The percentage of royalty fees may vary depending on the franchisor’s industry and business model. Some franchisors give you a grace period before you pay the first royalty fee.
How to make profits despite paying royalty fees
1. Understand your numbers!
Carefully review the franchisor’s Financial Performance Representations in its Franchise Disclosure Document. If the franchise is well proven in other markets similar to your own, you can use this information to create your own forecasts and test how your bottom line shapes up given some different top line sales scenarios and accounting for your costs, including royalty fees.
2. Open multiple locations
One great way to ensure that you earn profits after paying royalty fees is to open numerous franchise locations. What this does is achieve a more substantial revenue pool to even the percentage payment of the royalties. Having multiple locations of the franchise widens your market outreach and penetration.
Taking a leap to own a franchise is a big decision. And one you hope brings you financial success and growth. Take the tips highlighted above into account when negotiating your contract and start your franchising journey on the right foot.