Higher fees, lower royalties may spell successful formula
Higher upfront fees lead to greater franchise success, a new FRANdata study suggests. The reason? More training offered by the franchisor in the early days may reduce the number of lackluster performers.
Want a better-performing franchise system? Increase your franchise fee. And, perhaps, lower the royalty.
That was the lesson from a study by the Arlington, Virginia-based franchise information firm FRANdata, on the relationship between how much operators pay for the right to own a franchise and their chances of success. In short: The study found that investing in franchisees up front, and then perhaps keeping their ongoing costs low, helped ensure their success—and the brand’s overall growth.
The study’s findings were presented at Franchise Times’ annual Franchise Finance & Growth Conference at the Four Seasons in Las Vegas in April.
Darrell Johnson, CEO of FRANdata, said there is a definite link between fees and brand performance. Brands with higher fees grew average unit revenue, and number of units, at a faster rate than did brands with lower fees. Those brands also had fewer closures—from 2009 to 2011, closure rates at lower-fee concepts were as much as twice the rate of closure of higher-priced concepts.
The reason is simple: training. Higher-fee brands typically had more than twice the initial number of training hours than did lower-fee brands.
“One could infer that they’re trying to prepare franchisees so they don’t have as many underperformers, and they’re charging for it,” Johnson said. “Brands with higher initial fees are providing a lot more in the way of training and support. Maybe you are getting what you paid for. Maybe you are getting a higher level of preparation.”
Initial fees on the rise
In short: The training prepares franchisees for success early on, and those franchisees go on to have units with higher revenue that make more profits and are thus less likely to close. And franchisees that make more money are far more likely to invest their profits back into the brand by adding more units.
Perhaps franchisors have already figured this out: Initial franchise fees have increased over the years, Johnson said. He analyzed 11 brands in one sector and found that, between 2008 and 2011, their fees increased from 1.87 percent to 21.76 percent. The average fee across industries was $35,185, but the fees ranged from $29,500 to $43,571. On average, franchisors spent 12.7 percent of a franchise fee on training.
Johnson was less confident about the impact of royalties on franchise success. That’s because what a franchisor does with royalty payments, in terms of support, is not measured as easily as what a franchisor does with an initial franchise fee. But, at least based on his study’s findings, “more is not better.” In a study of 100 brands, 59 of them food franchises, 41 “non-food,” franchises with higher royalties had a higher percentage of unit failures.
In addition, those franchises’ revenues were higher, and their revenue grew faster.
As simple as the franchise fee is, royalties are complex and vary greatly. In some cases they build over time, such as a service franchise that charges 3 percent of gross revenue in the first year, 5 percent in the second year and then 7 percent thereafter.
Among sectors, the average royalty fee was just over 5.5 percent. Full-service restaurants had the lowest average royalty fee, at 4.47 percent. Automotive franchises charged the highest royalty, just under 7 percent, according to the FRANdata study.