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.
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.
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.