On Franchise Royalties
Franchise royalties are regular payments made by franchisees to a franchisor for the right to continue using the franchise company’s copyrighted materials and ideas. It is important to note that franchise royalties, which are calculated as a percentage, are distinct from the franchise fee. The franchise fee is a flat fee which is paid at the beginning of the franchise relationship when the franchisor and franchisee have signed the franchise agreement. The one time franchise fee is, not surprisingly, large in amount. Franchise royalties are much more manageable, but because they are paid on a regular basis, they could add up to more over the length of the franchise relationship, which could last for decades.
Setting the Rates for your Franchise Royalties
As you already know, franchise royalties are the source of income for franchisors in a franchise relationship. Thus it is important for franchisors to use care in determining what rates to set for their franchisees. If, in the process of laying the groundwork for your own franchise company, you set your franchise royalty rate too low, then that is the amount you will earn for the length of the franchise relationship. The only way you can change the royalty rates is to convince your franchisees to accept a renegotiation of the franchising terms. But how likely is it that franchisees would agree to renegotiate the terms of an agreement that is advantageous to them? Why would they agree to an increase in their franchise royalties unless you were offering them something additional (which would undoubtedly cost you some money) to sweeten the pot? Thus, the best time to do research on franchise royalties and to decide what levels to set them at is long before you ever sit down to sign agreements with your franchisees.
There are different models for charging royalties. One of them is to ask your franchisees for a percentage of their net sales. The other is to ask them for a percentage of their gross sales. Those who go for the former model tend to set the royalties at a higher percentage because net sales are, by definition, lower than gross sales. In both cases, it is evident that, the more that the franchisee sales, the higher the royalties that he or she will pay you. Hence, it is in your best interests to create conditions conducive to your franchisees’ success. These could include advertizing efforts to market your products or services and specific franchise locations. They could also include efforts to optimize territorial boundaries so that the individual franchises are exploiting their markets to the best possible effect, but not competing with each other.