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What is Franchise Royalty Fee and What Does It Cover?

  • Manish Khanna
  • Buying
  • April 06, 2021
What is Franchise Royalty Fee and What Does It Cover?

Acquiring a franchise is a long-awaited dream of many who want to invest in the low-risk business model. It offers the safety and security of putting money in a proven system that can be replicated for maximum gains. However, buyers are often confused about the investment amount, which comes with a variety of components. While the one-time costs are understandable, the ongoing costs are a bit puzzling for the potential buyers.

If you are looking for a franchise for sale in Australia, you must be aware of the fact that the franchisor will be collecting the royalty fee regularly. The ongoing fee is usually charged monthly or quarterly and accounts for a fixed percentage of the gross sales or the revenue. Thus, it is essential for aspiring franchisees to get acquainted with the expense and understand what it covers. Here is a rundown on royalties and everything related to them.

What Is Franchise Royalty Fee?

The royalty fee is an ongoing payment that is made to the franchisor after the transaction of the franchise is completed. The details of the fee should be conveyed to the buyer before the sale along with the calculation criterion. The buyer can consider it as the monthly membership fee to remain a part of the franchise network. The cost associated with royalties must be counted as a significant expense while securing finances and making the final decision of purchase.

The royalty fee is a percentage of the total sales and has to be paid at regular intervals decided by the franchisor. The terms of the payment are laid down in the franchise agreement. The franchisee must be aware of the fact that it is different from the initial franchise fee, which is a one-time expense and has to be paid upfront. The buyer must consider all these costs carefully to determine if he/she can afford it or not.

What Does It Cover?

The franchise royalty fee covers the ongoing support provided by the Head Office, the amendments made to the operations manual, business strategies, marketing plans, ongoing training, administrative costs, etc.

The fee collected by the franchisor is utilised to pay for the corporate-level and franchise-level expenses. It helps the franchisor to earn from the network and put the money back into the system for the growth and development of each unit. All the benefits offered by the Head Office are funded by the royalty fee. It is also needed to further expand the network by establishing new units and recruiting more franchisees that help in improving the flow of cash.

How Is It Calculated?

Most franchisors charge five to nine percent of the gross sales made by a franchise unit. However, it can be higher or lower than these numbers depending on the type of business. It varies from franchise to franchise. Also, some franchisors maintain a fixed percentage while others utilise accelerating or depreciating percentages.  The remaining amount stays with the franchisee.

The percentage of gross sales does not include tax or discount adjustments. The royalty fee gives the franchisee the right to use the trademarks, processes, and policies of the parent brand without any issues. Potential franchisees must check for this component while researching franchises in uncertain times. Here are the ways in which it can be calculated.

Fixed Percentage of Gross Sales

In this royalty fee calculation system, the franchisor fixes the percentage of the gross sales that is to be paid as the fee. It is the easiest system to follow and is preferred by most franchisors for the same reason. The franchisor does not change the amount even when the unit is performing well or is going through a rough phase. It keeps the income of the franchisor safe even during the dry spell.

Increasing Percentage of Gross Sales

In this system, the franchisor will charge a higher percentage on the basis of a variety of factors, such as the location of the unit. If the territory chosen by the franchisee is expected to bring higher returns because of its strategic location, the franchisor may charge a higher rate.

Decreasing Percentage of Gross Sales

The decreasing percentage system is usually employed by the franchisor if the franchisee is generating excellent income from the unit. The franchisor lowers the royalty fee rate as an incentive for outstanding performance. However, this happens only at a later stage and not in the initial phase.

Minimum Royalty Fee

Sometimes, if the franchisee is unable to achieve the desired sales and is not making the required profits, the franchisor will ask for minimal contribution as a royalty fee. Thus, it is not fixed but offers the franchisors the advantage of gaining a certain amount from the unit in any financial situation.

No Royalty Fee

There are some franchise networks that do not charge any royalty payment. However, the franchisor usually includes other terms and conditions in the franchise agreement, such as buying the goods from the franchisor or a specific supplier.       

How Franchisors Determine Royalty Fee

The franchisor can keep changing the rate of fee regularly. However, they have to ensure that they do not increase it too much as it can become unmanageable for the franchisee. With other overheads and increasing royalty fee, the franchisee may find it challenging to retain any profits and may go into losses that can affect the franchisor too. Also, you must check with the franchisor whether the marketing and advertising fee is included in the royalty fee or will be paid separately as it adds to the ongoing expenses.

Some of the franchisors may not pay attention to the calculation methods and randomly assign a percentage. In some cases, they may follow the amount used by the competitors without putting any thought into it. However, this is not the right approach. The franchisor must determine the payment threshold in a manner that allows the franchisee to take home a sufficient amount of revenue after deducting the costs. The percentage must be in accordance with the stability and the financial health of the particular unit so that the franchisee is able to manage the finances in any situation. The royalty calculation method is also dependent on the type of the industry and the revenue model. Thus, the franchisor needs to make an informed decision when deciding the payment threshold.

Conclusion

The royalty fee is a significant part of the ongoing expenses and should not be ignored by the franchisee while considering the costs. Thus, if you are planning to purchase a franchise for sale in Australia, make sure to check every detail about this payment.