Why Do You Pay a Franchise Royalty Fee?
What is the royalty fee that franchisees are required to pay ? Continue reading and find out.
What is a franchise royalty fee? We all know that we have to pay an initial, upfront fee called the franchise fee when starting a franchise. But what is the royalty fee that we are required to pay on top of the franchise fee? Continue reading and find out.
A royalty fee is a periodic fee that the franchisee pays to the franchisor. The royalty fee for a franchise is typically required weekly, monthly, or quarterly. Michael H. Seid, managing director of Michael H. Seid & Associates, a management consulting firm specializing in the franchise industry explains, “Simplistically, you pay the franchise fee for the right to join the club. The franchisor won’t let you into the system unless you pay him the initial fee. You pay the royalty each week or each month to stay in the club.”
Royalty Fee Types
There are generally three basic types of royalty fee: gross sales percentage, fixed amount, and transaction-based. The gross sales percentage is the most common method used in calculating the royalty fee. The franchise fee could be a fixed percentage of your monthly gross sales, but this can vary. For some franchisors, the fee can be a variable percentage of your sales that will go up as your sales increase; or it could go down as your sales increase as a reward for your good work. This is one of the most common setups because it gives an incentive for the franchisor to help the franchisee grow, since they make more money when the franchisee makes more money. There are also franchisors that require a minimum royalty fee, a fixed amount, regardless of the amount of your sales. It could be a fixed percentage or a set dollar amount. Then, there’s the transaction-based method, the rarest of the three. This method requires the franchisee to pay a dollar value equivalent to a pre-determined number of sales transactions on a regular basis. For example, the franchisor might determine that the royalty will be the equivalent value of 10 standard services or products sold by franchisees.
What are you paying for?
Whatever the method used when calculating royalty fees, they are, in essence, contributions to the entire organization. About.com says, they are used to maintain the system and ensure that all avenues flow smoothly between the franchisor and franchisee. Royalty fees are paid to the franchisor to stay current on technological advances as well as to enable the creation and marketing of fresh products and services. They are also intended to pay for a variety of services. All the support provided by the franchisor through its field consultants, marketing plans, business strategies, etc., are funded through the royalty fees paid by the franchisees. All the administrative costs of running the franchisor’s headquarters and staff are also funded from the royalty payments.
Here are some of the things you get in exchange for the royalty fee according to Lawyers.com:
- Ongoing training – The franchisor will train you and your employees on any revisions made on the franchise’s system, process, or goods.
- Operating manual updates – The franchisor will update your operating manual whenever necessary.
- Ongoing advertising and promotions – The franchisor will continue to advertise and promote the franchise, products, and services.
- Sales of goods and services – The franchisor will sell to you the goods, products, or services that he controls and are necessary for the franchised business.
- Ongoing consulting – The franchisor will help you run your business. This includes giving you advice regarding the operation of the franchised business, such as preparation of the goods or services in the manner provided for in the operation manual, management of supplies, styles and type of service, operation of your shop, and development of a personnel policy.
There is no one best method of calculating royalty fees that is applicable across all franchises. Every franchisor-franchisee relationship is unique. What works for one franchise may not work for another. The trick is not to look at the method, or how much you’re paying in royalty fees. Look at what your royalty fees are paying for. What is important is not how much the fees are, but how much value the services they pay for will bring to your new business. The fees are there for a good reason – they are the fuel that enables the franchisor to drive your business, and those of the other franchisees, on to greater heights. Just remember to read the written franchise agreement closely to determine what you’ll receive from your franchisor in exchange for the royalty fees.
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