How Franchisors Can Determine Royalty Structure
Determining how to structure the royalty is not an easy task
Royalty payments are paid for the continuous use of a piece of work. In addition to initial fees, franchisees have to regularly pay an agreed share of the percentage of its sales to the franchisor. A franchisee’s main source of revenue is its daily sales. However, the regular monthly income of the franchisor is based on the royalty payments from each franchise.
However, there are various structures of royalties used by franchisors. Here are some of the common structures that are used.
This is the most common type of royalty fee structure. In this royalty setup, franchisors charge some percentage of a franchisee’s gross sales. The main advantage of this structure is that it gives an incentive for the franchisor to participate proportionately in a franchisee’s growth. There are typically three types of gross sales:
It is the most common continuing royalty agreement in franchising. Under this royalty structure, the franchisee will have to pay a set percentage of sales to the franchisor, regardless of the franchisee’s sales or income. It is the simplest royalty fee structure to administer.
Under this type of agreement the percentage of the gross sale, franchisors charge a premium to franchisees who want to open in prime locations. Location is one of the most important factors that impact the success or failure of a franchise. Some market locations are more likely to ensure higher sales than others.
Under the decreasing percentage model, the franchisee pays a lower percentage of gross sales as the total gross sales increase. This model is a win-win situation for both franchisee and franchisor. It as it provides an additional reward for increased performance and encourages the franchisees to grow and be more profitable, which is obviously a good outcome for the franchisors as well.
Percentage per transaction
In this type of royalty agreements, franchisors charge a fee based on every product sold or transaction made. This type of royalty structure is widely used in some industries, like the hospitality industry or automobile industry. Franchisors who charge this type of royalty often have their franchisees use point-of-sale systems that do the calculations automatically.
In Split profit royalty structure, the total profit of a franchisee in a split between the franchisor and franchisee at an agreed percentage, such as 40/60. Although, split profit royalty is uncommon as it is less favoured by the franchisees.
In this agreement, the franchisors do not impose any royalty fee from the franchisees. The franchisor earns its revenue exclusively from the sale of products to the franchisees. It also gets its revenue from the manufacturer or supplier that has established the franchise channel as a capture retail chain to sell their products. Recently, Amul granted franchise to its retailers without any royalty.
This article was originally published on Franchise India by Sneha Santra.