Recessions are always a possibility, even when an...
Even someone with the most general Canadian franchise knowledge has likely heard of a royalty fee. This is a portion of a franchisee's sale that they are obligated to pay to the franchisor, as outlined in the franchise agreement. Although you have probably come across this term and understand it in a general sense, there is often confusion over exactly how a royalty impacts franchisor and franchisee profitability.
A necessary cost
Royalties are often the bulk, if not all, of the income a franchisor generates. Ideally, the money is used to help grow the system as well. In exchange for the royalty, the franchisor creates, oversees and improves its system, which franchisees use to get an edge in the marketplace. When a system is proven and working, it can reduce the business risk to a franchisee; this is often why franchises are appealing to entrepreneurs.
Royalty fee types
The most common format for royalties is based on a percentage of the franchisee's gross sales. The range varies widely by brand but is often in the 5 to 7 percent range. This type of royalty is often beneficial for a franchisee when they first start out and have low sales. In the long run, it also motivates franchises and franchisees to do what is needed to boost sales.
Some franchises have fixed royalties, under which the franchisee pays the same amount no matter what the gross sales are. This can be tougher for a new business with low sales but beneficial once that business has taken off and has a higher sales volume.
Royalties are part of the franchise disclosure document you receive from the brand you are considering. It's vital you completely understand the royalty format and schedule before you sign any final paperwork with a franchisor because this is an ongoing obligation that will impact your profits.
Lower or higher - Which is best?
In truth, going with the brand that has the lowest royalty may not be the right move for you. It's a line item expense for your business just like anything else, and other factors - such as the brand strength, level of support, concept, and the system itself –matter just as much, if not more, than the royalty. A lower royalty in exchange for a system that's not working that well, for example, will likely translate into overall lower profitability for you compared to a better system with a higher royalty.