When you franchise a business, you're offering many different services to your franchisees to help them get off the ground, like your recognizable brand name and business strategies. Of course, these resources have a cost, and royalty fees represent one of the ways that franchisees pay for those resources. Determining how you'll charge these fees will play a significant role in your earnings from franchisees.
You have several options, so let's take a look at what goes into royalty fees, how to calculate them and how to communicate them to your franchisees.
What Are Franchise Royalty Fees?
Franchise royalty fees are the regular payments that a franchisee pays to the franchisor, usually charged on a monthly or weekly basis. The average franchise royalty fee percentage typically ranges between 4% and 12%, but this value can vary based on industry, revenue and other factors, which we'll discuss later.
This fee can go toward many different resources you might provide, covering costs associated with administration, recruitment, product research and development, marketing, and other benefits of working with an established brand. Royalty fees for franchises also go toward the franchisor's profits, compensating them for licensing out the brand name.
Royalty Fee vs. Franchise Fee
One of the big costs for a franchisee opening a unit is paying franchise fees. These fees are one-time, upfront costs the franchisee pays to own and operate the business. It allows them to use the franchisor's established name and have access to proprietary business systems and other resources. This expense is typically between $25,000 and $50,000, but it can also vary widely.
While the royalty fee covers ongoing costs, the franchise fee is the cost of admission. It only gets charged once and helps pay for certain services related to opening the business, like marketing, training, and assistance with site selection and build-out.
How to Calculate Franchise Royalty Fees
Determining your royalty fee calculation can be tricky because there are many different ways to do so. Two common approaches include fixed or variable percentages of gross sales, but you could also use fixed royalty fees or transaction-based fees:
- Fixed percentage of gross sales: This royalty fee calculation is simple to administer and charges the franchisee a percentage of their gross sales. This percentage doesn't change, but it may not be well-balanced for either party. It's easy to understand and track.
- Variable percentage of gross sales: The variable-percentage model works similarly, except the percentage changes based on how much the franchisee sells in a given period. The franchisor might charge a lower percentage on higher sales, incentivizing franchisees to improve performance while still providing good returns for the franchisor. Alternatively and less commonly, the franchisor might charge a higher percentage as sales increase. This tactic can help keep fees fair when franchises are placed in locations likely to see high sales, such as high-volume downtown buildings.
- Fixed royalty fees: This approach gives the franchisor a fixed amount each period, allowing the franchisee to reap the benefits of higher sales. Usually, the franchisor adjusts these fees based on the Consumer Price Index (CPI). The fixed option isn't very popular because it can be difficult for the franchise to meet during low periods and may not fairly compensate the franchisor when locations achieve higher sales volumes.
- Transaction-based fees: Sometimes, an a la carte fee schedule gives the franchisee access to specific resources as needed. Franchisees pay individually for extra services they use, such as staff training from company headquarters. In the hospitality industry, for instance, the franchisee might pay a fee every time a guest books through the franchisor's centralized reservation system or dials into their call center.
Some other elements to consider when determining your royalty fees include the following:
- Minimum royalty fees: By setting a minimum fee, you can ensure that you receive a specific amount every period. Franchisors commonly look to the CPI to adjust their minimum. If the franchisee would pay more under another fee schedule you've specified, like the ones outlined above, that fee would apply instead of the minimum. While this option offers more security for the franchisor, it can cause hardship for the franchise at a time when it may already be struggling with lower sales.
- Startup period adjustments: A newly established business will likely have lower sales and need more support. To help these franchisees get off the ground, many franchisors will waive or reduce royalty fees for an introductory period. You could remove the fees entirely or have the franchisee pay them back later, like a loan or deferral.
These models offer some insight into common approaches, but ultimately, your fee schedule is up to you. Some businesses might charge based on gross profits, and some don't charge royalties at all. Think about what's right for you and your organization.
Communicating Your Royalty Fees
Setting your fees is just one part of the puzzle. You'll also need to consider how you'll communicate them to your franchisees and potential franchisees. Think about communication from advertising and logistics perspectives.
If your royalty fees are lower than the rest of the industry, be sure to highlight them when recruiting new franchisees. Low fees can serve as a unique selling point that sets you apart from other franchise opportunities. Mention it in your marketing materials and in ads when targeting potential franchisees.
When it comes to charging your royalty fees every month or week, you'll need a dependable franchise management platform that can handle calculations and invoicing. These fees can get complex, so make sure your system can accommodate intricate rules, rate structures, and fee schedules. It should also provide transparent invoicing that communicates fee calculations with your franchisees. When they can see the breakdown of their charges clearly and concisely, you can prevent misunderstandings and reduce friction.
FranConnect, for example, automatically calculates royalty fees based on imported or franchisee-entered sales information. It makes journal entries in the franchisor's and franchisee's systems, including point-of-sale, QuickBooks, and other finance management tools. Understanding the fees is simple and straightforward, and franchisees can access detailed fee information at any time.
Harness FranConnect's Royalty Manager
Deciding how to charge your franchise royalty fees might be difficult, but invoicing and managing them should be simple. FranConnect is a robust franchise management platform with a wide range of resources, including our Royalty Manager. The Royalty Manager offers a single source of truth for the financial terms of your agreements with franchises and provides automatic calculation, invoicing, and payments for royalty fees. The process is accurate, transparent, and streamlined, so you and your franchisees can focus on boosting performance rather than figuring out charges.
See everything the Royalty Manager and FranConnect have to offer by requesting a demo today!