What are Franchise Fees?

The Franchise model offers a unique split of responsibilities between two groups - the Franchisor and the Franchisee - to create and develop a brand/system, and to use that system to grow businesses across various markets. This model can create a best-of-both-worlds scenario for a Franchisee, which has driven thousands of people to join Franchise models all over the world over the last century. 

In researching Franchise models, a term that you will consistently come across is 'Franchise Fee(s)'. In this article we outline what Franchise Fees are, why they are important, and what to look for when assessing your Franchisor's specific Franchise Fees.

What is a Franchise Fee?

A Franchise Fee is a sum of money that a person pays to a Franchise model to operate a Franchised branch of said model and enjoy the profits that their specific branch makes. As a Franchisee, you continue to benefit from the brand's reach and recognition, as well as new systems, policies, and procedures that the Franchisor designs and tests for you throughout the duration of your time running the business. Franchise Fees are the way that a Franchisor charges for these continuous supports/services. 

The type of fee that a Franchisor chooses to charge may vary depending on the model, but typically fees are taken as a royalty fee that is charged on a weekly, bi-weekly, or monthly basis. Many Franchisors will request pre-authorization from their Franchisees to withdraw these fees automatically on a set schedule. 

The two most common categories of Franchise Fee are Fixed Fees, Variable Fees, and "No" Fees. We will discuss both in the following sections.

Fixed Fees explained

Fixed Franchise Fees refer to models where a Franchisor charges their Franchisees the same amount of money each period. Often you will see structures such as: "$500 per location per week, automatically deducted from your accounts". While the dollar value or the period (week, 2-week, month, etc.) might change depending on the brand, all fixed fee models typically work like this.

Variable Fees explained

Variable Franchise Fees refer to models where a Franchisor charges a changing, or 'variable' amount of money each period. This changing dollar amount is tied some sort of metric on the business side, while the period is always fixed. For example, many food franchises will charge a variable Franchise Fee of 6% of the business's Gross Sales on a weekly basis. 

Other less common variants of a Franchise Fee model include structures where the Franchisor will charge a set amount of money per action by the Franchisee. For example, they might charge "$1.00 for every order".

"No" Fees explained

This one is pretty self-explanatory. These Franchisors charge no ongoing costs at all to their Franchisees. They just charge you an upfront, Start-Up fee, and then you never have to pay them again. Sound too good to be true? Read on....

Which fee model is best? 

The answer to this question has consumed many a blog, speaker, tradeshow, and more for decades, and it really shouldn't. The straight answer to this question is that variable fees are best for both the Franchisor and the Franchisee. To explain why let's go through each model.

In a 'No' Fee situation, the Franchisor only charges you one upfront start-up fee, and usually it's pretty cheap compared to other brands' startup costs ($10 000.00 - $15 000.00). Now, let's remember why you prefer the Franchise model to your own business in the first place - a history of success, strong and recognizable brand, a competitive business model with barriers to entry, continuous supports in marketing, supply chain, operations, IT, etc. Let's take just one of those things and cost it out - Marketing Support:

VP/Director of Marketing - $150 000.00/year

Graphic Designer - $40 0000/year

Adobe Photoshop CS6 Master Collection - $7988/year

Etc. 

So we're looking at having to pay at least $210 000.00/year to support a small to medium sized marketing department which would handle brand advertising and assist with franchise advertising on an on-going basis. 

This walkthrough perfectly illustrates the problem with a no-fee model: where does the Franchisor get the money to support you from? 

Furthermore, there is absolutely no financial incentive for a No-Fee Franchisor to support your on-going success. Most people can understand at a basic level the importance of having interests aligned in any long-term partnership. In this case it's in your interests to have the Franchisor as involved as possible, and in their best interests to never talk to you again. These problems are also prevalent in a fixed-fee model. While the Franchisor is at least interested in keeping your location open in this case, they are not incentivized in any way by higher profits, and likely won't help you too much to see that through. 

It's easy to guess that the new, emerging brand that 'only' charges you a fixed fee or no fee at all is probably not going to last the long haul. But what about brands that have bucked the trend are still around 10-15 years after they've started while offering crazy low franchise fees? The answer here is simply that they're getting their money from somewhere else. Most of the time, this is in the form of a supplier inducement to the corporate office, or through direct control and profit-generation in the supply chain. Put simply, this means that the Franchisor is either making you purchase all inventory directly from them and charging you more for those items than they pay, or they're signing exclusive agreements with vendors and getting paid signing bonuses for those deals (again, often not fighting for the lowest potential price for their Franchisees). 

Now, you might be reading this and thinking...so what? As long as the business makes money, who cares if the Franchisor makes an extra dollar on every item they sell to me. As long as you have a transparent understanding of how the model works, and have faith in it, there is in fact nothing wrong with this. You need to ask yourself, however, if it's limiting your competitiveness by eating into your profit margins. If you're making an 8% profit margin in your business paying no royalties, but you're food cost is 10% higher than it would be in another brand, you're worse off. You should instead pay the 6% royalty, save the 10% food cost, and come out with 4% more money in your pocket at the end of the day. 

As well, you should consider how well your model can handle adversity if it's in a fixed-fee or no-fee structure. At the time of this article being published, the world is struggling with COVID-19. The effect on many restaurants has been a serious squeeze on profit margins. Ask yourself, if your Franchisor is padding your costs, how much more wiggle room do you have if times get tough?

In a variable fee model, however, you're in the opposite situation. In these cases your Franchisor only makes money with you, and are directly incentivized to your store-level success. As well, they have a reasonable source of cash with which to provide the supports that they offered you.

While there are always exceptions to the rule, in our opinion it's quite clear that if you're interested in long-term success you should only be considering variable-fee Franchisors. If a short term 'pump and dump' strategy is what you're looking for, we recommend you consider day-trading.

Ok, variable-fee it is. But how much is too much?

Now that we're settled on the fee structure, the next question that arises is how much is reasonable to pay? To answer this question we recommend that you do two things:

1. Check what's standard in that specific industry or segment

Many different royalty percentages have emerged for many different types of product/service offering. For example, in foodservice most of the established and most successful brands use a variable franchise fee model. However, casual dining establishments might charge a different rate on liquor sales versus food sales, where quick-service restaurants will not. Similarly, one segment may charge less than another for advertising expenses.

Remember that you can use the largest players in the market to get a good average of what to expect. Let's say you're considering opening up a Pizza Hotline Franchise and you want to know if they're ongoing fees are fair compared to the competition. A quick Google search reveals the following:

• Pizza Hotline: 6% Royalty + 4-7% Advertising (www.pizzahotline.ca)
• Pizza Hut:  6% Royalty + 4.75% Advertising + 4.75% Association Dues (https://www.franchisedirect.com/foodfranchises/pizza-hut-franchise-07054/ufoc/)
• Dominos: 5.5% Royalty + 5-8% Advertising (https://www.franchisedirect.com/foodfranchises/dominos-pizza-franchise-07460/ufoc/#:~:text=Other%20Fees%20%20%20%20Type%20of%20Fee,%20%20%244%2C200%20%2025%20more%20rows%20) 

While you can keep Googling more brands to gather more data, it's fairly clear from the above that Pizza Hotline is charging in line (or perhaps a bit less) than the other market leaders. Now this leads us to the second step.

2. Compare the royalty fees against the services/supports offered

Much of the information around what kind of services and supports a Franchisor offers should be available at a high level right on their website. However, in addition to this information the best way to really find clarity here is to reach out to Franchisees. Ask them specific questions like this:

• How often do you hear from someone from the Corporate Office?
• How much marketing do you do for your store versus what the Corporate Office does for you?
• How streamlined is the inventory ordering process, are you left to finding your own supplies or is it already taken care of?
• Etc. 

Questions like these will help you really understand how involved in continuous store-level success a Franchisor really is. It's important to remember also, that Franchisors have to pay money to keep these systems in place. If you estimate that in a year you're paying $60 000.00 in franchise fees, but you get to pull on the resources of Marketing, Operations, IT, Procurement & Supply Chain, and Finance & Accounting support, not to mention have a brand name on your front door that ensures that even if you didn't lift a finger customers would still come through, surely your Return On Investment (ROI) has yielded incredibly positive.

Summary

Franchise Fees are an often poorly understood yet extremely important part of Franchises. It is critical to remember that in the world of Franchising, like most elsewhere, you get what you pay for. Fixed-fee or no-fee structures may seem to be attractive investments upfront, but if long-term continuous success is your Franchising goal then you should be much more comfortable with a steady, time-tested variable-fee Franchise Model than can realistically afford the ongoing supports, systems, and innovations that will help keep you with a leg up in the marketplace.