Making a Case for Incentivizing Franchise Royalties
by Ed Teixeira
Franchisors should consider a decreasing franchisee royalty percent, based
upon the revenues their franchisees achieve.
The traditional and most common royalty fee calculation used by franchisors
is the fixed royalty percent. In this arrangement the franchisee pays a royalty
that is determined by multiplying a fixed percent to the franchisee’s adjusted
gross sales. Whether the royalty percent is 4% or 12% this methodology goes back
to the inception of franchising. Although some franchisors have introduced
variations for calculating royalties such as a fixed dollar royalty or minimum
royalty amount the traditional fixed percent remains the most popular.
One of the major criticisms of the fixed royalty percent is that as a franchisee
generates more revenues they become more successful and less reliant on
franchisor support, yet they pay more royalty fees. This approach appears to
contradict incentivizing improved performance. The flip side is that a
franchisor was there to support their franchisees during the early years of
their development when royalty fees were low and thus the franchisor deserves to
be rewarded when their franchisees become more successful and generate higher
revenues. I subscribe to rewarding franchisees for increasing their revenues.
Why a Decreasing Royalty Percentage of Sales Makes Sense
- A declining royalty percent based upon increased franchisee
revenues rewards improved franchisee performance.
- The royalty percent to revenue calculation can be structured
so that the franchisor continues to receive increased royalty
payments although the payment increase is incrementally less.
- The franchisee can receive a rebate on royalties based upon
achieving certain revenue levels. This in effect results in a
lower royalty percent charged to a franchisee.
- Despite a lack of empirical evidence, there remains
agreement among many franchise experts that some mature
franchisees resent paying more royalty fees despite requiring
less franchisee services. This arrangement can eliminate or
minimize this attitude.
- Having a decreased royalty percent based upon franchisee
sales is at the very least perceived by franchisees to be
- The revenue level for reducing royalty percent can be based
upon a monthly or quarterly result.
- The reduced royalty percent can be used as an advantage when
marketing against competing franchises with a fixed royalty
Although the majority of franchisors charge a fixed royalty percent of
franchisee revenues, a strong case can be made for reducing the royalty percent
as a franchisee reaches certain revenue thresholds. This arrangement results in
a more equitable financial arrangement between a franchisor and its franchisees.
© 2013 FranchiseKnowHow, LLC
Ed Teixeira is the President of FranchiseKnowHow, LLC. He
can be reached at firstname.lastname@example.org
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