The True Cost of Franchising Your Business

17/04/2018 18:00 | Start a business

The real cost of franchising your business

So, you’ve had a business idea which you’ve been running successfully for some time. You have growth ambitions, but how can you achieve this alone? Well, you don’t have to. Franchising your business is a great way to expand a proven concept by using the capital of your franchisees to fund the growth.

Of course, proving that your business is capable of being franchised through a pilot and then developing the business model takes significant franchise investment.

Here we’ll review the true costs associated with franchising your business.

The pilot phase

Before you can even consider whether you could become a franchisor, you have the job of creating a tried and tested business model which will provide an adequate return on investment for prospective franchisees. It's your responsibility to prove your franchise idea, and the cost of doing so is also down to you.

The best way to demonstrate that your business is capable of being franchised is to run a pilot operation. To do this, you'll need to develop a franchise model which can be replicated in due course if the pilot is a success. It’s tough to put an exact number on the cost of setting up a pilot operation. It will vary hugely depending on the type of business you’re piloting. Also, if you’re trying to prove an existing business, then only a few tweaks may need to be made to adapt it into a franchise. However, if you’re starting a new venture from scratch, the cost of developing a pilot will be quite substantial.

When the pilot is up and running, the purpose is to demonstrate that your product or service will appeal to your target audience. It must also prove that the business can be a success in your absence. If the achievements of your existing business are down to you, or factors that can’t be transferred to a franchisee, then the model will not be able to be replicated, and therefore shouldn’t be considered for franchising.

From a financial perspective, the pilot must show that the business is capable of providing a sound return on the investment for your franchisees. Making a franchise investment is a big decision. Unless prospective franchisees can see that they'll start to make a profit within a reasonable timeframe, your new venture will be unlikely to attract the investors that it needs to succeed.

The advantage of performing a pilot is that you can give prospective franchisees an idea of how it will perform financially. The cost of franchises that your franchisees will be investing in will be based on actuals, rather than estimates, which can help your business stand out from other new franchises entering the market.

The development phase

So, you’ve created, funded and completed the pilot phase. If it has been a success and you’ve proven the viability of your business, then the next step in franchising your business is to develop the franchise package that will attract prospective franchisees.

Of course, this phase also requires funding for which you are responsible. The initial costs that need to be financed are generally incurred up to the point where the first franchisee is recruited.

The typical initial costs associated with the development phase are:

  • General development costs - market research, professional fees, insurance, and protection of the brand and other intellectual property.
  • Franchise package development costs - includes the creation of the systems, processes, training programmes and operations manuals.
  • Recruitment costs - production of your prospectus, advertising, franchise exhibitions, and interviewing expenses.

The franchise investment needed to fund these elements will vary massively depending on factors such as the type of business and how many amendments need to be made to the pilot operation.

The British Franchise Association / NatWest 2015 franchise survey found that the average investment required for a new franchisor to establish their franchise is £170,000.

How you’ll make a profit

The income that you’ll make as a franchisor will come from both the initial franchise fee and on-going fees that your franchisees pay. But how do you know at what level to set these fees? Too expensive and the cost of franchises will be too much for franchisee candidates to consider but set them too low and you risk not being able to make enough profit to invest time and money back into the franchise system.

You have to find the right financial balance as to what is fair for the franchisee and what is reasonable for you. Getting the amount of these fees right is the key to building a successful franchise model where all parties can make a profit.

Initial Fees

The initial fee is a payment from the franchisee to cover the expenses that you have incurred to recruit, train and support them during the set-up phase of their new franchise. You shouldn’t profit from the initial franchise fee as the full amount should be invested in preparing the franchisee to run a profitable business. Keeping the franchise fee as low as possible also enables you to compete with other franchise opportunities on the market.

On-going fees

There are also fees that fund your on-going relationship with your franchisees. The regular royalty fee, also known as a management fee, is generally charged as a percentage of gross sales achieved by franchisees. This covers the cost of the on-going training and support that you provide, as well as the upkeep of the franchise system.

You may also choose to charge a marketing, or advertising, fee which all franchisees contribute towards. This enables you to run nationwide marketing campaigns at a brand awareness level that benefits the franchise system as a whole. Franchisees usually complement this with local promotional activity which they are responsible for funding.

Franchising your business is no quick and easy task. It takes time to develop a viable franchise model which will generate profit for both you and your franchisees. But the investment of your time and effort will be repaid in the long run. You’ll be able to expand your business much more than you could do alone, resulting in a very lucrative and rewarding franchise business.

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