Franchising and profitability: How it works

24/05/2018 08:00 | Start a business

Article on franchising and profitability

For the franchisor

If you’re a successful business owner and you have ambitions of growth, franchising can be the perfect solution if you do it right. However, the most profitable franchises require you to invest significantly in building a robust system and infrastructure. If you’re considering making a franchise investment to become a franchisor, then you’ll want to understand how you’ll make your money.

Here is a quick guide to how you’ll achieve profitability as a franchisor.

Franchise fee

Once you’ve selected the ideal franchisee, they’ll pay the franchise fee. The amount of this initial payment will vary depending on several factors. The franchise fee is reimbursement for the money you've invested in recruiting and training the franchisee. In return for the franchise fee, the franchisee is granted the right to use your brand name, sell your products and services, and receive the support they need to succeed.

It can be tempting to charge a high initial fee to recoup your franchise investment at a faster rate. However, this quick fix may cause more problems in the long run. Setting your franchise fee too high will see you excluding many prospective franchisees that may have been a perfect fit for your business. If you focus more on making money from the initial payments franchisees make, rather than the royalty payments, you may fall into the trap of recruiting anyone that can afford to invest instead of choosing the right franchisees.

Royalty Fees

Most franchisors charge a royalty fee to cover the ongoing support that they offer their franchises as well as the upkeep of the franchise system. Charging franchisees royalty fees is the way that most profitable franchises make money. There are many ways you can work out the royalty fee, but the most commonly used method is to charge a percentage of the franchisees' gross sales. This way, the more money your franchisees make, the more money you make.

Using this method to calculate the ongoing fees also reassures your franchisees that you'll offer them adequate support. After all, it’s in your interest to help make your franchisees as successful as possible as this equates to more profit for you.

Marketing Fees

As well as franchise and royalty fees, you may also choose to request a contribution from your franchisees towards marketing costs. The marketing fee funds the placement of national advertising to promote the brand which ultimately benefits all franchisees. Like the royalty fee, the marketing fee tends to be paid on a monthly basis and is calculated as a percentage of gross sales. You should view the cost of marketing campaigns as a necessary franchise investment rather than seeking to profit from the payments received from your franchisees.

For the franchisee

Franchising isn't just about making money for franchisors. It's also an excellent opportunity for wannabe entrepreneurs to open their own business with more support and less risk than if they started an independent business from scratch.

Expectations versus reality

Unfortunately, it’s difficult to provide an answer to “how much money will I make as a franchisee?”. There are lots of different factors that affect the potential profit that can be made and how much franchisees as individuals can earn. The industry, the size of the franchise, the location, the support the franchisor provides, the ambitions of the franchisee; the list of differentiating factors is endless.

Before you commit to becoming a franchisee, you must fully understand the difference between how much money your franchise will make and how much of that you will take home. It’s a common misconception that if you become one of the most profitable franchises, you’ll be richer than you could have imagined.

However, the truth is, your personal income is likely to be significantly lower than the profits your franchise will generate. This is due to the outgoings that you're obliged to cover before you can pay yourself. As well as royalty and marketing fees, you may have rent to pay for your business premises, wages for your employees, insurance, taxes, loan payments, and more. It's essential to have a good understanding of how franchise cash flow works before you sign on the dotted line.

The numbers add up

The good news is that franchising appears to be going from strength to strength and franchisees are more satisfied than ever. According to the British Franchise Association / NatWest 2015 Franchise Survey, a massive 97% of franchise-owned businesses reported profitability, with 56% saying they are 'quite' or 'very' profitable. Even more impressive is the fact that over 50% reported an annual turnover more than £250,000.

Not only are the majority of franchises profitable but they're proving to be pretty recession-proof too. In 2015, just 1% of franchise businesses had to close their doors due to commercial failure. Combine this with the fact that franchisees have never been happier and it’s easy to understand the appeal of franchising. A record 91% of franchisees stated that they’re ‘mainly’ or ‘definitely’ satisfied with their franchisor.

Things to consider before investing

Even though the figures look encouraging, buying a franchise is no guarantee of success, and you'll have to work hard to become profitable. Ask yourself the following questions before you invest to ensure that the franchise opportunity is right for you.

  • What is the total investment cost to open the franchise?
  • How will I fund the costs?
  • What is the business model and how can a profit be made?
  • How long will it take to break even?
  • How much are the ongoing fees?
  • How much working capital will I need?

The franchisor will be able to help you answer most of these questions, but you should also speak with existing franchisees to get a realistic view of the costs involved in running the franchise. Active franchisees are ideally placed to give you an honest opinion of how accurate the costs and projected earnings are that the franchisor has provided. This is an integral part of your due diligence checks and should not be overlooked.

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