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Making a Case for Incentivizing Franchise Royalties

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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 fairer.
  • 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 arrangement.

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 franchiseknowhow@gmail.com

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