Franchising Consultant: Earning fair reward from balanced initial

If the fee structure is right, franchisors should earn from the success of their franchisees. Franchise Consultant Tony Urwin discusses how to best structure initial and ongoing fees

When we help business owners to franchise their operations, we always take a keen interest in the long-term viability of the franchise systems that result. That is why we pay particular attention to franchise fees. If you think that franchise fees are only an issue for franchise owners, think again.

Exorbitant franchise fees reduce the profitability of individual franchises and put off potential buyers, all at a cost to the franchisor. Fees that are inordinately low undermine the profitability of the franchisor, and hamper its ability to provide quality support. Reasonable fees make franchising a win-win proposition and augur well for the future of a franchise. So how does a franchisor find that sweet spot for its fees?

First, we must differentiate between them. A typical franchised company has three revenue streams: a Franchise Licence Fee, a one-time fee paid to the franchisor to 'buy into' the franchise; an ongoing Management Service Fee, commonly a percentage of gross sales that is payable monthly; and finally, Pipeline Profits, the margin made by the franchisor on items sold to its franchise owners - effectively, a distribution fee. When set correctly, all the above fees benefit both franchisor and franchise owner.

The Franchise Licence Fee

It is only natural for a franchisor to levy a Licence Fee. The business practices, methodology and knowledge used by franchise owners are the franchisor's, after all. The franchise buyer is seeking to profit from the franchisor's intellectual property and he or she can be expected to pay for the privilege. However, the licence fee must reflect the value of the opportunity. Franchisors have borne important costs developing and marketing their franchise concepts, and invest further to support current and future franchise owners.

Many are understandably tempted to offset their costs with sizeable Franchise Licence Fees. Conversely, some franchisors are tempted to discount their Licence Fees to attract franchise buyers by the dozen. Both temptations must be overcome. A high initial franchise licence fee can push franchise owners deeply into debt and discourage potential franchise buyers. A cheap franchise licence fee can devalue the franchise opportunity and attract candidates who care more about the price than the franchise.

Priced properly, the franchise licence fee should contribute to the franchisor's costs while attracting serious, motivated franchise buyers who find that potential benefit justifies the cost.

Management Service Fee

Many new franchise owners pay their continuing fees grudgingly because they cannot see how it benefits them. Strangely enough, many new franchisors also fail to appreciate the importance of these fees to their business. The percentage of monthly sales that franchise owners are obliged to pay is the franchisor's main source of income. They fuel the entire franchise system by allowing the franchisor to:

  • meet its overhead costs (including rent and payroll) and therefore stay in business;
  • pay for the many services that it provides;
  • allow investment back into the business;
  • expand its market penetration, and with it, the profile of the brand;
  • collect a reasonable reward for its efforts.

Continuing fees should be pitched at a level that allows the franchisor to do all of the above without compromising the franchise owner's abilities to do the same. Unfortunately, I occasionally come across systems where the continuing fees cause a marked imbalance. Either they are set so high that franchise owners find it hard to profit from their hard work, or the fees are so low that a franchisor struggles to provide the advice, guidance and support its franchise owners rightfully expect. As it is the franchisor who sets these fees, the problems are invariably of their own doing. My advice to franchisors is:

  • 1. It is the duty of a good shepherd to shear his flock, not flay them. Distinguish your need from your greed.
  • 2. In the long term, you will make money from continuing fees, and not initial fees. Never rely on the latter.

Set properly, continuing Franchise Fees benefit both parties. They allow both franchisor and franchise owner to thrive and support each other. Balance is the key.

Pipeline Profits

Sometimes the franchisor nominates itself as the supplier of the products required by franchise owners. In such cases, the franchisor also acts as a commercial distributor and has the right to achieve a commercial margin for its services. However, it is a distributor unlike any other: the franchisor can stop its 'customers' from switching their purchases to another agent.

Franchisors must be cognisant that they abuse this privilege at their peril. While franchisors have a right and natural desire to profit from their activities, so do franchise owners.

I advise those franchisors who hope to make pipeline profits to price their products with care, and to ensure that franchise owners can not buy comparable products elsewhere for less. Franchise systems can have formidable buying power. It is frequently possible to beat the competition on price and still make a profit. But if you cannot, do not try to force overpriced products on your franchise owners. With no choice, nor room to manoeuvre, franchise owners will resent you for it, and can be counted upon to rebel.

A franchise system is a living organism, with the franchisor as its heart, franchises as its organs, and money as its bloodstream. When either the heart or the organs are deprived of blood, the system will fail. Like it or not, fees are essential to the maintenance of a healthy franchise system. As its heart, it is the franchisor's responsibility to ensure a regular, balanced flow.