Most new franchisors have very little understanding and knowledge of the different types of royalty options available to them, when deciding to purchase a franchise.
A franchisor that forms part of their own network’s supply chain might even have the flexibility to not charge any royalties at all; instead, they derive their income solely from the mark-ups on services/goods supplied to franchisees.
In this article, we aren’t viewing these mark-ups as royalties. Here we are examining three different basic royalty models that may be used in a franchised business:
This is one of the commonest types of royalty, in which the royalty is charged in the form of a percentage of the gross sales that the franchisee makes. Regardless of what the actual percentage amount is (1%, 7% or more), at the outset, the dollar value of this royalty is lower; as the sales begin to increase, the dollar value of the royalty rises as well.
This particular model links directly from the franchisor income to a franchisee’s sales performance; and so it gives the franchisor the incentive to help franchisees to increase their sales (this isn’t the case with the fixed transaction and fixed dollar amount royalty methods).
In the fixed percentage method, you as a franchisor can increase your income by either actively making efforts to increase the sales of your existing franchisees or recruiting new franchisees. However, this model will require constant and consistent monitoring for it to be effective.
This isn’t a very common royalty method, but some businesses do follow it. Under this method, the franchisee is obliged to pay the dollar value equivalent to a pre-decided number of sales transactions at regular intervals. In addition, the franchisor recommends what the price of the standard product or service will be and the royalty will be applied accordingly, regardless of the price that franchisees charge (which could be lower or higher).
In this method, no active monitoring is required as there is a fixed amount that the franchisee has to pay the franchisor at fixed times, irrespective of what the franchisee’s gross sales are. The number of products or services to which this fixed transaction amount applies doesn’t change.
The change is only in the recommended price, which can increase at regular intervals, at a rate that’s greater than inflation because of market forces. This is also why this particular franchisee model provides the franchisor greater scalability of income (compared to the next model which is the fixed dollar amount royalty).
This is the simplest of the three models; it sets a certain amount of money (e.g. – $200 per week), to be paid at fixed intervals, regardless of the levels of support the franchisor provides, and a franchisee’s business performance. No monitoring of franchisee performance is required; because regardless of whether or not a franchisee is making high gross sales, the royalty stays the same. If you opt for this model, you will collect the royalty by debiting the set amount from the franchisee’s bank account (at fixed intervals) for the duration of your franchise agreement.
The choice of royalty model is crucial to the long-term success of the franchisor and the franchisee. It should be determined post a thorough financial and operational analysis. Choosing an unsuitable royalty model, or setting the wrong percentage or number of transactions can impact your business as you may later realise that the income isn’t sufficient to meet your operating costs.
You need to conduct a comprehensive analysis before franchising your business, and also a trial royalty applied to the company-owned operations to determine whether it’s viable for you and the franchisee, ahead of launching your franchise operations.
If you want to know anything more about setting up a franchise business or want some sound and professional advice, call The Franchise Institute on 1300 855 435 or fill in this contact us form and we’ll reply as soon as we can.
Thanks for reading,
The Franchise Institute Team
1300 855 435