When thinking about purchasing a franchise, individuals may not be aware of the number of potential sources of revenue available, as well as the many fees, costs and penalties associated with purchasing a franchise. One of the main expenses that franchisees incur is a royalty fee, which is regularly paid to the franchisor.
Why so royal?
Royalties are paid for the continual use of a piece of work, such as paying a designer for the rights to sell their clothing.
These are additional experience to one-time fees, such as property. Royalty fees are regular contributions to the entire organisation and are used to maintain the overall system, including rent, utilities and employee compensation.
What’s in it for the franchisee?
Royalty payments may seem like a steep price for a brand name; however, the payments help create a winning situation for both parties.
In exchange for royalty fees, a franchisee can advertise the franchisor’s name and utilise their reputation to gain revenue.
A local pizza shop may do a lot better financially with a well-known brand name on their business sign. Royalties are important for any franchise and can be achieved in a variety of models.
Models of royalty
This form of royalty is charged in the form of a percentage of gross sales that the franchisee makes. Whatever percentage that is agreed upon is the percentage of sales that generates the fee. If a franchisee’s business improves, that fee will increase based on sales performance.
For example, if a franchisee generates $10,000 in sales the first year with a fixed percentage of 5%, the royalty fee will be $500. If the business improves and generates $20,000 the following year, the percentage will still be 5%, which will incur a fee of $1,000. The percentage will not change as business improves, which can be beneficial for the franchisee.
A less common method, fixed transaction, involves the franchisee paying the dollar value equivalent to a pre-decided number of sales transactions at a regular interval. The franchisor recommends the price of the standard product or service and how the royalty will be applied accordingly. This is determined regardless of the price that the franchisee charges, which could be lower or higher than the recommendation.
No active monitoring is required in this method since there is a fixed amount that is required to be paid. What can change, however, is the recommended price, which can increase at regular intervals depending on inflation and market pressures.
The simplest method is the fixed dollar method, which sets a certain amount of money to be paid at fixed intervals. This should be a determined agreement, such as $150 per week. This can be a benefit for companies since it does not require monitoring; however, the same payment is required regardless of sales.
Even if sales are poor, the same payment will need to be paid, so many companies may find this to be riskier than the other models.
Analyse your royalty
Choosing a royalty model is critical to the success of both the franchisor and franchisee. Utilising a financial and operational analysis is imperative when determining a method. If you select an unsuitable royalty method or agree upon the wrong percentage, the fees could outweigh the benefit of owning a franchise.
- (2017). What Are The Different Types Of Franchisee Royalty Models. The Franchise Institute. Retrieved from https://thefranchiseinstitute.com.au/different-types-of-franchisee-royalty-models/
- Daszkowski, D. (2017). About Franchise Royalties. The Balance. Retrieved from https://www.thebalance.com/franchise-royalties-1350411