A different approach to franchise royalty fees

A different approach to franchise royalty fees

In franchising, one generally follows the industry norm when it comes to determining the royalty fees. This is generally a percentage of sales calculated as follows: 10% of gross profit multiplied by the sales. For example, a fast-food outlet needs to generate a gross profit margin of 60% on average; therefore the royalty will be 6% of sales.

Eric Parker, industry stalwart and founder at franchise consultancy Franchising Plus, has been thinking and questioning the standard practice that franchisors have been following all this time:

  • Should the royalty/management service fees be the same for the entire agreement period?
  • Should successful and established franchisors be able to charge a higher royalty?

A franchisor can charge a higher Royalty or Management Service Fee if the franchisor:

  • Has proven the concept – a franchisee invests in an established concept that has been proven successful time and again over many years.  The Franchisee is more likely to be successful in comparison to a new franchise venture.
  • Selects the ideal franchisee – the franchisor has recruitment practices and measures in place to select franchisees that meet the franchise’s ideal profile and requirements.
  • Selects the right site with G.I.S assistance – site selection is critical for the success of a franchisee e.g., the size of the area, will there be enough customers to ensure profitability, etc.
  • Train the franchisee across all aspects of the business – an objective of any great franchise system is to achieve consistency, sustainable replication of their brand promise to consumers, and for the franchise system to be financially successful at every level. Training is a major component of achieving that objective.
  • Has an adequate support structure in place – when a franchisor has incorporated an efficient franchisee support structure in their network, it will help ensure that franchisees are more motivated, open to change and building stronger relationships. But more than anything, it assures franchisees that they are not operating on their own but have the franchisor’s support.
  • Has a well-planned marketing plan and positioning – the franchisor needs to have a national and/or regional marketing plan to create awareness and build brand equity.  Franchisors need to ensure that any marketing initiatives will benefit the network and strengthen the positioning within the market.
  • Has an Operations and Procedures Manual that is user friendly and up to date – The franchise operations manual is the blueprint and how-to guide of a franchise system. Uniformity of customer experience and quality control across locations, act as a training tool for new franchisees.  Within the operations manual franchisors provide detailed information about system standards, operating procedures, suppliers and requirements for the development, marketing, and operation of a franchised business.
  • Has adequate procurement – the quality of the product is guaranteed and the pricing of acquiring the goods is competitive.
  • Insists the franchisee is an owner operator – franchisors prefer if the franchisee is involved in the day-to-day running of operations. It is believed that an owner operated franchise is bound to be more successful than one that is run by employees.

Win-Win Scenario

If the above-mentioned points are present the franchisee should not fail!

Surely if we have a well selected franchisee that is an owner operator, that is dedicated to a single business, and who has put themselves at risk – they should not fail. So, this is a win-win – rewarding franchisees for good performance.

Has anyone ever thought of new or creative ways of dealing with Royalties/Management Service fees?

There is an opportunity to reward franchisees based on their performance:

  • Reward the franchisee with good performance with a lower royalty – i.e., the franchisor would need to spend less time and effort with the franchisee and can afford to reduce royalties.
  • The higher the turnover the lower the royalty percentage.
  • Reduce royalty over some time. More experienced, successful franchisees need less attention. The support, service and attention offered to franchisees are directly proportional to the quality of the franchisee.
  • If a franchisee is a multi-unit operator the royalty is reduced, and they pay less i.e., owning more than one franchise
  • Part of the training for staff could be subsidised by royalty.
  • As more work/meetings are online we could reduce royalty i.e., cost of travel, accommodation etc.

Rebates and Confidential Discounts

If a franchisor receives rebates and/or confidential discounts from the suppliers, it should reduce the franchisee royalty/management service fee. Franchising is all about a win: win situation and if the scale goes out of balance trouble occurs.

In conclusion

A proven and established brand for example KFC should be able to charge a higher royalty than a new chicken concept because the probability of the KFC franchisee succeeding is much higher than the new concept.  KFC will also have a bigger more established support structure.

For more information and advice on franchising, visit the Franchising Plus or email info@franchisingplus.co.za.