How Much Does It Cost to Buy A Franchise?

Buying a franchise can be a fantastic way to own your own business. When you buy a franchise, you buy the right to use an already established brand; as well as all of the systems and processes that you will need to operate that business on a day to day basis. You’ll also receive training and support from the franchisor, who will teach you everything that you need to know to run the business successfully. The obvious question then is, “how much does all this cost?”

Initial Licence Fee

Typically, franchisees will be expected to pay an initial licence fee when they first buy the franchise. The initial licence fee should cover the costs to the franchisor of providing the training, stock and equipment that make up the start-up package. The licence fee should not include any significant profit element for the franchisor. This is because if the franchisor makes most of his profit from the licence fee, he will have a strong incentive to simply sell new franchises rather than supporting his existing franchise network.

In a well-run and ethical franchise network, the franchisor will make a profit from the on going fees charged to the franchisee. In this way, the franchisor has a direct interest in the success of his franchisees – the more the franchisee makes, the more the franchisor will make. The franchisor should not need to make a profit on the licence fee.

On-going Charges

After the initial fee, the franchisee will be expected to pay a regular charge for the continued rights to use the business system and support of the franchisor. These fees will usually be a service charge, calculated as a proportion of the franchisee’s turnover and payable every month. This could be anything up to 10 – 12 % of the franchisee’s turnover. This means that for a franchise network to be successful there must be enough profit margin for both the franchisee and the franchisor to be able to take a cut and yet still be able to offer competitive products and services to customers.

In some networks, the franchisor will make money from the sale of products to the franchisee instead of charging a proportion of turnover. This is particularly common in food retail franchises where the franchisor charges a mark-up on the cost of menu items supplied to the franchisee.

There is an increasing 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 minimum. This is because if the franchisee is obliged to pay a minimum fee, then the franchisor is guaranteed to get paid, even if the franchisee fails to make any money at all. This goes against the general principle that franchisee and franchisor are in it together; and that the franchisor’s success should depend on the success of his franchisees.

Other fees

Franchisors will often make charges for additional services provided to the franchise network and it is important for the franchisee to understand what additional payments they may be required to make. For example, many franchise networks require franchisees to make a contribution towards a national advertising budget. This could be up to a further 2% of the franchisee’s turnover.

Franchisees will be required to attend regular training and events arranged by the franchisor. Whilst some franchise networks do not make a charge for the training or event itself, the franchisee would be expected to pay for his own travel and living expenses. This could mean that the franchisee must budget for hotel accommodation and meals, as well as the costs of travelling to and from the event.

Further fees may arise in particular circumstances. For example, one -off charges may arise at renewal, or if the franchisee chooses to sell his business.

Counting the Costs

All of these fees and charges will be on top of the costs of buying stock and raw materials that any business needs. This means that the running costs of a franchise business will be higher than for a stand-alone business. Having said this, many franchisors are able to leverage the buying power of the network as a whole to negotiate better terms with suppliers than an independent business could. This may go part way to off-setting some of the costs; although it is not uncommon for the franchisor to retain the benefit of supplier rebates or discounts rather than passing these on to their network.

The crucial take away for franchisees is that before investing in any franchise business, you must ensure you are aware of all the fees that you will be expected to pay; and you must budget for all of these when preparing your business plans. You will need to identify any hidden costs and assess whether over all, the franchise network offers good value for money.

If you are a franchisor, the lesson is to be transparent in the fees that you charge. There is nothing inherently wrong with making money from a franchise network. Indeed, a franchisor must ensure that his fees are high enough to fund the support, training and other services he must provide to his network. However, it should be clear from the outset what is included in the standard fees and when extra charges may be levied. Similarly, if the franchisor is receiving benefits from suppliers, these should be declared to the network.

Ultimately, as with any business, the numbers must add up. This applies to both franchisee and franchisor, both of whom need to be able to make a reasonable profit from the business. If either party is benefiting at the expense of the other, the business model will not be sustainable in the long term.

China Franchise Industry and Economy Overview

At a Glance

Growth is expected to be 7.5% in 2014 and 7.3% in 2015, yet as China ranks 93rd in the world on GDP per capita, there is significant room for consumption growth. The long-term outlook is positive.

Franchise Glance

During the past 30 years, there has been dramatic economic growth in China and while franchising only started in the 1980’s it has also displayed rapid development. By 2012 the number of franchised stores exceeded 400,000 with 5,000 systems averaging 83 stores. The total annual sales of CCFA (China chain store & franchise association) members reached nearly US$300 billion in 2010 and represented about 13% of total retail sales in China.

The growing wealth, consumption, density of population and rising 2nd/3rd tier cities makes China a lucrative and, for the foreseeable future, growing market. It is odd when we talk about a slowdown in China yet GDP growth is still above 7%-not to be sniffed at.

China’s retail sales grew by 13.1% in 2013 (National Bureau of Statistics of China) and according to Euromonitor is expected to continue to grow year on year by 8.7% until 2018. This rapid growth, compared to the rest of the world, has resulted in a growing middle-class society with increasing disposable income.

As China becomes more open, their desire for foreign brands and new experiences grows in parallel. There are a range of hot sectors a franchise should be aware of. They value foreign brands higher than domestic brands as they are very much seen to be a status symbol. The resulting demand from these factors should be filled by savvy franchisors looking to expand out of their domestic market.

Only around 13% of American franchises have entered the Chinese market though 15 of the world’s top 20 franchises are already active in China. With foreign companies comes new business systems and despite foreign companies accounting for a relatively small share of the retail market, their business experience produces highly improved operating efficiency and profit margins which outstrip their domestic peers.

The growth of China and the franchise market in such a short time combined with consumer potential bodes well for new companies looking to enter China. The market and demand are much bigger than almost any other country so a franchisor can expect a premium for a regional or country agreement as a franchisee’s profits will reflect the ratio of investment.

The rise of the Chinese consumer

With the ever increasing growth in the middle-class (300 million as of 2012) combined with a maturing consumer, the Chinese are becoming a demanding society for new products. These economically empowered, sophisticated consumers require more than basic goods to satisfy their desires and many display their wealth through the purchase of foreign brands. To be seen carrying a Starbucks coffee on the way to work is really middle class cool.

In a nutshell, these ripe malleable consumers are young, often have a double income, are forward thinkers looking to attain a modern lifestyle and broaden horizons. As an international franchisor there is a great opportunity to introduce exciting cross-overs targeting these new adventurous Chinese consumers.

The bottom line

Many signs indicate that franchising will become easier in China over the next few years. China’s rapidly growing, sophisticated, affluent consumer base has a desire for imported brands that offer convenience, quality and service.

Finding a partner in China does involve effort but there are more potential partners than before and this number will continue to grow. Business risks are mitigated with the increase in the number of foreign brands and the tightening of business regulations ensuring better practice. The basic economics, size of the consumer market and recent trends, provide great country potential.

It is our opinion that China’s franchise market will show very healthy growth and all franchisors must view it as a challenging but primary target for international expansion.

To conclude: Trends and the economy display all the outward signals that the Chinese market and consumers are ready for new imported franchises.

Franchise Meets reckons: 8.5/10.

Overview of Korea Economy and Franchise Business

Franchise Glance

“We consider South Korea as a developed market, meaning it is no different to the UK or the US… Korean consumers are demanding and expect high-performing products.” Hari Nair: Managing Director, Kimberly-Clark’s.

Recently everything seems prefixed with a K: K-Pop, K-food, K-beauty, K-movies; why not go to your local K-culture festival, sure there must be one near you, or coming soon. Korean culture is on fire at the moment and has been warmly received. Domestic franchisors have, quite rightly, been riding this wave and rapidly expanding internationally-China being a Korea franchisors first choice. However for an overseas franchisor looking in, what is this market like?

GDP was US$1.2 trillion in 2013 and predicted to rise as consumer spending and confidence grows through 2014 and 2015. The Hyundai Research Institute latest report predicts Korea will expand by 3.5% in the first half of 2015 and 3.6% in the second half.

Considering Korea’s comparatively slower Asian growth, it remains a good target for franchisors owing to historical years of stable growth, an affluent consumer base and early advancement of the country. The average disposable income per household per month was US$3150 in the second quarter 2014, a rise of 2.8% from the second quarter 2013, with significant rises in bakery, confectioneries & snacks, coffee & tea, and juice & beverages sectors (Statistics Korea).

The demand for foreign brands spans a range of sectors and recently a broader range of channels. 65% of the population is classified as middle-class (OECD) so unlike many other Asian countries there is not the general trend of a new, emerging middle-class. Supported by media and a relatively high degree of travel experience, the Korean consumers are knowledgeable in a developed, globalised market.

Korean consumers have a strong purchase history of foreign brands so as well as valuing money, they have a high understanding of brand philosophy and marketing channels. They will readily try new products and are always seeking new tastes and ways to improve their lifestyle and image.

For a franchisor, the marketing has to be more sophisticated to match the level of the consumer. For example, nearly 80% of the population is online, making it the most connected country on the planet! and they love their credit cards. Annual credit card transactions are over 65% higher than the USA. This combination means a high proportion of online spending and retail ecommerce is predicted to touch $25.3 billion by 2017 (Borderfree). Any marketing strategy has to be multi-channel and use aspects of social media to advertise brands and utilize the technology to offer more efficient shopping channels and delivery.

Korea’s population is ageing and urbanized. The median age in 2012 was 39.1 years and the over 60 group is predicted to account for nearly 25% of the population by 2020 (Statistics Korea). Some franchisors may already target this older market whereas others may be able to easily adapt or extend to target this group. However for the rest of us do not despair, as PwC reminds us, 70% of the population remain within most retailers target demographic of 15-64 years old.

With over 90% of the population living in urban areas, these conurbations are massively populated, wealth dense spaces and retail premises come at a premium. The 4 main population areas: Seoul metro-15 million, Busan metro-4 million, Daegu metro-3 million, and Daejeon metro-2 million.

Key retail players are set to open mega malls outside of the main cities over the coming years but presently Gyeonggi (the area directly surrounding Seoul) and Seoul account for 42% of the total shop space in all Korea (www.kintex.com). Supermarkets and hypermarkets lead retail channels and this lead will increase as it matches the 3 main purchase drivers of choice, convenience and price.

Despite economies of scale enabling big shopping complexes to effectively compete with smaller stores, operators are always seeking to differentiate themselves from each other. Enhancing shoppers experience by offering the latest trend brands are a main way they do this. They are not only looking for exciting overseas tenants, these operators are also willing to take on Master agreements and roll out concepts across their formats.

If this is an entry strategy of interest, bear in mind that these companies are looking for a brand that will drive traffic, so the product or service either has to an established name or have a strong unique factor attached to it. Quirky with long term viability can be good USP and malls, a very effective way to introduce your brand into Korea-mainly as the cost of educating the population will be borne by the mall operators and you can be assured it will be done with a high level of proficiency.

The franchise market in 2013 was estimated at US$89.8 billion with nearly 3,000 franchises. There were 283 retail franchises, 601 service franchises and 2,089 food service franchises (export.gov). Even with recent downgrades of GDP, the franchise industry has displayed respectable growth over recent years with on average 200 new franchises opening annually since 2010.

Koreans are very open to partnering with overseas franchisors, especially with those that have an existing reputation in Korea or core values which reflect their origin country. Koreans aged 55 and over have recently proved themselves to be good franchisees as they have more capital and knowledge, and being a family orientated culture, will pass the business down to their children. The franchise industry regulations ensure business generally runs smoothly and Korea is regarded as a straightforward place to franchise into.

The normal investment range is between US$4,300 and US$8,700 with a 2 year contract period. Such a low average franchise fee can make it more difficult for an overseas franchisor to recruit a multi-unit or bigger partner. There will also be a good deal of negotiation around royalties as they are usually lower for domestic Korean franchises.

Brief breakdown of sectors:

  • The Korean food market is expected to be US$53.5 billion in 2013 and account for 25% of total retail sales; a growth of 5.5% from 2012 (JLL).
  • The organic food market is anticipated to grow to US$6 billion by 2020 (Organic Trade Association).
  • The online channel is forecast to grow at CAGR 11.38%, 2013-2018 (Research and Markets).
  • South Koreans spent US$17.9 billion on private tuition in 2012.
  • The beauty and personal care retail market posted 5.8% growth year on year to 2013.
  • The cosmetic sector was the best performing sector in 2012.
  • Korea is the 8th biggest luxury market worth almost US$4.5 billion.
  • Households spent 12.4% of total consumption expenditure on eating outside the home (GAIN).
  • In 2012, imports of chocolate based confectionary products from the United States were up 12% from the previous year (GAIN).
  • Korea has become the largest men’s cosmetics market in the world. The US$635m spend in 2013 was nearly a fifth of the global figure (Euromonitor).

Korean consumer

Koreans are educated, sophisticated, relatively well-off and well informed. With advanced consumers comes a choosy, higher demanding buyer. Strategy and approach should parallel other advanced countries. The consumers are not looking for just a global brand, they are seeking a brand that has a distinct USP and they will pay more for this. That USP can be in reputation, quality, ingredients or innovativeness, but it must stand apart from the crowd in a specific way.

This does not mean all markets are saturated and there is no opportunity for new sectors. As mentioned, there is an ageing population and the affluent 50+ baby boomer generation is far from complete. Other noticeable changes that are opening markets:

  • Increase of dual income families.
  • Rise in single parent households.
  • Increase in single member households.

Korean consumers are very used to being informed across a variety of channels about a product before they purchase it. A 2012 survey by Embrain Trend Monitor found that 79% of customers check user reviews before purchasing and 74% have written evaluations and reviews. Therefore, the more information you can provide across a variety of channels will only be a good thing. The surprise or curiosity advertising strategy will either have to be carefully moulded or have a very solid budget behind it.

Koreans are image conscious in all aspects and they have the experience to understand what lifestyle or status a brand portrays. They closely follow and are influenced by the media and celebrity styles and trends. Although these fads can be short lived, it is good advice to have the ability to quickly adapt and run campaigns or introduce extension products that connect with the latest trends.

Overview of where demand lies and where future demand could lie:

  • Due to the wealth of recognised foods, innovative and premium foods will appeal.
  • Franchises providing efficiency in shopping and delivery will match consumers convenience needs.
  • Koreans are educated and understand the need for their children to be. Within this market exists high demand for vocational and language services.
  • An older, fairly affluent demographic presents a growing market for targeted services and products.
  • Think of Koreans as discerning consumers. They seek organic, natural, fresh, high quality products.
  • Health improving and anti ageing foods and businesses will show high demand.
  • Health benefitting herbs will be trend ingredients.
  • Koreans prefer food with brighter, more saturated colors (Origin of human colour preference for food).
  • Specialty stores stocking a range of niche, higher priced, quality items that tie in with the above are spreading across Korea and cover a range of sectors from beauty to bakeries to grocers.

The bottom line:

A solid market but with competition, and commercial estate can be expensive. This has to be balanced with the sophistication and affluence of the market. It can not be denied that at present there is more of a trend of coming out than into Korea, however, with a developed market that has a proven globalised view, it is an easy country to enter.

To conclude: Although potential may not be as great as their Asian neighbours, reduced time and costs from having educated consumers and well versed franchisees are key points.

Franchise Meets reckons: 7/10.