Choice of fee is critical to franchising success

Central to the viability of any franchisor’s business model is the method by which it generates its income.

Most (but not all) franchisors generate their income through ongoing fees paid by franchisees for the use of the franchisor’s brand and the support provided by the franchisor.

These fees are generally set as either a fixed regular amount, or as a variable amount calculated as a percentage of a franchisee’s gross revenue.

Typically, the choice of ongoing fee will be determined by the level of sophistication of the franchisee business model, and the degree to which the franchisor monitors the franchisee’s business performance.

It follows that relatively unsophisticated businesses, such as those which provide labour-intensive services to households, such as dog washing, lawn mowing, gardening, cleaning, etc, and which have little or no point of sale computerisation will nominate a fixed regular amount as the required franchise fee.

On the other hand, retail businesses with computerised cash registers at the point of sale are capable of being monitored remotely (and often in real time) by franchisors, who are then able to calculate their fee as a percentage of the franchisee’s gross revenue.

In addition to these two methods of ongoing fee, franchisors may also receive rebates from suppliers as another source of income. Rebates are typically paid in return for endorsement or exclusivity of supply to the franchisees of a network.

In most instances, rebates reflect a genuine cost incurred by the franchisor to negotiate and maintain complex supply arrangements for the benefit of franchisees. On occasion, however, the amount paid in rebates far exceeds the benefit created, and can risk inflating the wholesale cost of goods or services to franchisees. In turn, this may force franchisees to raise their retail prices, or suffer a decline in their margins to accommodate the rebate.

Some franchise systems do not apply an ongoing fee, and instead derive their income principally from rebates. Others do not charge fees or receive rebates, but instead are themselves embedded in the supply chain and derive their income from products or services they themselves supply to franchisees.

Regardless of which type of income stream a franchisor chooses, the number of franchisees to which it is applied will always be a key factor in determining the viability of the franchisor.

If the franchisor chooses the fixed regular fee method of income, they will need a minimum number of franchisees to reach critical mass so that their fee income is equal to or greater than their costs of supporting the network.

Franchisors who choose the percentage of revenue fee will also need a minimum number of franchisees, but with the distinction that under this fee the minimum number of franchisees will change according to their gross sales (whereas the fixed fee method does not rely on the franchisees’ revenue to determine the franchisor’s break-even point).

The choice of fee model, and the fee amount or percentage itself is critical to the viability of the franchisor’s business model. Determing which type of fee, and the amount to be applied, requires careful consideration and planning before starting to franchise a business.

Jason Gehrke is the director of the Franchise Advisory Centre and has been involved in franchising for more than 20 years at franchisee, franchisor and advisor level.