The Franchise Business
Fees, Royalties and Marketing Funds
How franchisors charge franchisees through upfront fees, ongoing royalties and advertising contributions, and why royalties on sales create tensions.
Franchisors earn money in several ways.
Charges
- Initial franchise fee: paid upfront for rights, training and setup.
- Royalty: typically a percentage of sales, often 4 to 8 percent.
- Marketing fund: a percentage of sales for national advertising.
- Supply margins: profit on goods franchisees must buy from the franchisor.
- Technology and renewal fees.
Why royalties on sales
- Easy to measure.
- Harder to manipulate than profits.
The tension
- Royalties on sales mean the franchisor benefits from higher sales even if the franchisee’s profits fall.
- For example, discounts and promotions can raise sales but cut franchisee margins.
Supply markups
Franchisees sometimes complain that mandatory supplies cost more than market prices.
Economic lesson
The design of payments shapes incentives. Profit-sharing would align interests better but is harder to verify.
The discount campaign
A national brand launches a heavy discount campaign. Sales rise, increasing royalties, but franchisees earn thin margins on each discounted sale.
Thinking franchisors and franchisees always want the same thing
Royalties on sales can create conflicting interests.
Key takeaways
- Franchisors charge fees, royalties and marketing contributions.
- Royalties are often 4 to 8 percent of sales.
- Sales-based royalties can conflict with franchisee profits.
- Supply markups are another source of tension.
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