FRANCHISE: Revenue streams for franchisors

Thursday January 10 2019

Wambugu Wa Gichohi

Wambugu Wa Gichohi 

Following an earlier article regarding funding considerations queries emerged requiring further clarifications.

Deeper insights here are on franchisor’ revenue streams, an understanding of which would help prepare business plans that stand a better chance of approval by funders.

Many potential sources of revenue are available to franchisors, using a combination of which will ensure optimisation of the franchise opportunity. First are royalty fees, normally the main source of revenue. They are the ongoing fees paid by franchisees for using of the franchisor’s wealth of intellectual property, business operating methods and the entire success formula. They are payable when business starts operations, either weekly or monthly.

Royalties are the lifeblood of the franchisor’s business. They should be set in a manner to provide adequate revenue to support the franchisor while being affordable to franchisees. Striking this balance makes all the difference in the success or otherwise of the franchise system. Different criteria may be used in setting royalties. First, as a percentage of gross revenue less VAT. This is the most common criteria and percentages differ between industries, from 2.5 per cent for high volume sales to 12.5 per cent for services. Second, as a percentage of net profit-not advisable because a franchisee who cannot control costs will deny earnings to the franchisor.

Third, as a fixed amount-not advisable because once franchisee pays, effort ebbs out. Fourth, as a percentage of gross revenue with a minimum amount. This ensures a minimum earning for the franchisor, but franchisees might find the minimum amount genuinely unattainable, hence get discontented. Fifth, rebates from suppliers upon bulk buying for the franchise system.

This means such rebates should not accrue only to the franchisor since the franchisees contribute to the volumes needed to negotiate the rebates. Finally, proprietary product sales to franchisees. Fuel companies use this through marking up on products sold exclusively to franchisees.

The second revenue stream is the advertising/marketing levy, paid by all franchisees into a marketing fund controlled by the advisory board/franchisee council.

The fund applies exclusively to the franchise system at the national level and covers advertising, promotional expenses and other marketing communications such as PR. It is normally a percentage of gross revenue or a fixed amount. In South Africa, it averages at 2.4 per cent and varies from 1.4 per cent to 4 per cent. These activities are funded by individual franchisees at territory level.

Third are renewal fees. At expiry of franchise period, franchisees wishing to renew pay a renewal fee. This is set low because it ideally only covers documentation for the new franchise period, it is not a new acquisition.

Fourth, transfer fees are applicable where a franchisee wishes to transfer their franchise rights to another.

Having charged joining fees to the franchisee, and given that the franchisee will most likely identify the transferee and charge the initial cost of acquisition of the franchise, the franchisor can only charge a small transfer fee.

Fifth is training fees, mainly for ongoing training where needed (initial training is covered by upfront fees). Sixth is on-site management assistant fees.

This is applicable when a franchisee is red-flagged for correction before possible expulsion. The franchisor seconds a manager at the franchisees cost.

Seventh is the grand opening fees. Franchisors will deploy, at a cost, human and other resources to ensure successful franchisee store opening.

Finally, where franchisees use common services such as accounting, ERP, stock management, HR and others from the franchisor, an administration charge is applicable.

The writer is a Franchise Consultant helping indigenous East African brands to franchise, multinational franchise brands to settle in East Africa and governments to create a franchise-friendly business environment.

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