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Making money as a franchisor: Royalties

This post is the third installment of the post dated March 17, 2015, titled “How Do I Make Money as a Franchisor?”  This installment will treat Royalties.

Most franchisors charge a “Royalty.”  The “Royalty” is the continuing fee franchisors charge franchisees for the license to use the trademarks and the system.

Royalties are usually based on the franchisee’s sales.  The franchisor may refer to the sales as “gross” sales or “net” sales.  There is no set definition of these terms.  Regardless of the term franchisor uses, however, the franchisor usually allows the franchisee to deduct some or all the following items from the sales from which Royalties are calculated:

  • Sales taxes and other add-on taxes
  • Gratuities customers give
  • “Comps,” which are usually complimentary services, discounts, cash refunds to customers, coupons customers use, and credit card fees

Franchisors often place caps on Comps franchisees may deduct from their total sales.  For example, franchisors may cap Comps at 2% to 5% of the franchisee’s total sales.  Obviously, franchisors want to minimize the deductions from total sales; franchisees want to maximize them.

There is no “standard” Royalty percentage.  However, in most markets, a Royalty percentage higher than 6% is considered to be on the high side of normal; a percentage below 5% is considered to be on the low side.  These are not absolute.  One large regional pizza restaurant franchisor charges 12%; a global competitor charges 6%.

Franchisors may also use a “sliding scale” Royalty: a Royalty that varies depending on factors that may include the length of time the franchisee’s outlet has been open, or the dollar volume of the franchisee’s sales.

  • Length of Time.  As an example of a Royalty that depends on the length of time the franchisee’s outlet has been open, one franchisor I represent does not charge any Royalty for the first six months the franchisee’s outlet is open.  The franchisor calls this its “Ramp-Up Period.”  The Ramp-Up period helps the franchisee reach profitability quickly.  After six months, the Royalty percentage jumps to 5.5%, the franchisor’s standard percentage.
  • Sales.  As an example of a Royalty that depends on the dollar volume of the franchisee’s sales, one franchisor I represent has the following Royalty schedule:  
Sales of Outlet Royalty Percentage
Below $400,000 per year 3%
From $400,000 to $650,000 per year 4%
From $650,000 to $900,000 per year 5%
$900,000 or more per year 6%

The Royalty percentage will vary depending on factors that include:

  • The franchisor’s revenue requirements.
  • The amount of services the franchisor provides, and their value.
  • What the market will bear.  Franchisors usually monitor the Royalties their competitors in the market charge to ensure they are charging competitive fees.

The Royalty is often the largest moneymaker for the franchisor.  Take a few minutes to estimate the number of outlets your franchisees may open and their sales at each outlet.  Multiply the total outlets by the sales per outlet.  Then, multiply that figure by various Royalty percentages.  You will see why Royalty revenues are a major source of your revenues and, ultimately, your success as a franchisor.

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