As a prospective franchisor or franchisee, it’s important that you understand how to calculate franchise fees. Each franchise is different and as such, while one franchisor may charge a fee, another might not. The way the franchising fee is calculated also varies. Read on to learn more.
Franchisor vs. Franchisee
The company that allows an individual or a company to run a location of their business is called the franchisor. The franchisor owns the overarching company, trademarks, and products, but gives the right to the franchisee to run the franchisee location, in return for an agreed-upon fee. The franchisee, on the other hand, is an individual or company that holds a franchise for the sale of goods or the operation of a service.
How are franchise fees calculated?
The franchise fees are normally calculated in the following four ways:
- fixed fee;
- percentage of weekly or monthly revenue;
- a percentage of each specific item sold; or
- total percentage of profit.
What is Fixed Fee?
Fixed fee is a fee that a franchisee pays to the franchisor on a weekly or a monthly basis. Since it is a fixed fee, it does not vary from week to week or month to month based on the performance of the business. However, normally the franchisor has the power to increase or decrease the fixed fee on a regular basis.
How is the franchise fee calculated based on percentage of revenue?
Percentage of revenue is a common way of calculating the franchise fee. Using this method, the franchisee pays to the franchisor an amount based on the gross income that the franchisee is making. This flexibility benefits the franchisee in a way that if the franchisee is not making much revenue, the fee they are obliged to pay is then lower. However, if they generate more revenue, the fee that is payable is higher. This method also assists a franchisee to calculate product or service prices, to know what portion of the sale they should account for as cost.
How is the fee paid based on percentage of item?
Determining the fee that is payable to the franchisor based on the percentage of item is a complex method and as such, is not preferred in most of the franchisee arrangements. It works on a per item basis rather than on weekly or monthly revenue. In most cases where a franchisee uses this method, they also have a sophisticated corresponding Point of Sales system and calculations are done automatically. The main types of franchisees which use this method are those that have a low profit margin.
What is the total percentage of profit?
A less common method of calculating a fee is under the Total Percentage of Revenue Method where there are no separate fees payable on the franchise. Instead, the total profit that the franchise makes is split between the franchisee and the franchisor. Normally this split is around the 40:60 or even 50:50 ratio. Even though the fee payable under this method is easy to calculate, it is not usually put to practice since the arrangement is not lucrative to most of the franchisees.