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A Critical Review of Franchise Fees

By Eric Parker

Franchising is a very effective marketing and distribution tool if implemented well.  Unfortunately, due to the lack of legislation and case law that sets precedents, franchising can, and often is abused.

Why should a franchisor who has perfected their concept and got their concept franchise ready i.e. documentation, support structure, etc, receive the same fees as a franchisor who is not fully franchise ready, where the concept is not optimal and there is no intention to invest in a suitable support structure?

Franchising Plus insists that a business has to be fully franchise ready before it starts to franchise, otherwise the franchises will rebel down the line and probably not succeed, resulting in the brand failing in the medium to long term.


Example

Let’s imagine a franchisee who has just invested R3 000 000 in a concept.  This will include an upfront fee of R150 000 paid to the franchisor.  The franchise agreement stipulates:

  • a management service fee (royalty) of 5% of turnover and
  • a marketing fee of 3% of turnover.

If the first month’s turnover is R700 000 then the payment terms are:

  • R35 000 in management service fees (royalties) and
  • R21 000 in marketing
  • which = R46 000 in total

This amount of R46 000 will be more than the franchisee draws out of the business.  Surely then they have the right to ask: “What value am I getting for this investment?”

Even worse if the turnover is only R500 000 as the franchisee will be losing money.


A well experienced franchisor will have an experienced “A” team who will go in an assist the franchisee upon opening and stay in the outlet for at least the first month i.e. they will demonstrate the value for the management service fee (royalty) paid. A badly established franchisor will not be able to add value to the franchisee, resulting in the franchisee falling behind on management service fee (royalty) payments and the start of conflict.

It is our observation that in most of the less established, under serviced brands franchisees are behind on management service fee (royalty) payments.  This position is even more problematic if the franchisor supplies the franchisees from a central distribution point and the franchisees fall behind on repayments for the purchase of stock.

We are often copied on advertisements where a franchisor is trying to sell an existing franchisee’s business and they request a high price, large upfront fee, maximum management service fee (royalty) and marketing contribution.  Are they justified? – only if the brand is well developed and training and support is offered to ensure that the probability exists that the new franchisee will succeed and achieve good returns on their investment.

Franchisors have to earn the right to charge the management service fees (royalties) that they do by offering support so the result is a win-win for both the franchisor and franchisee.

Don’t under estimate the franchisees.  Work with them and listen to them as they can contribute a great deal.  Trust franchisees as your business partners.  Don’t think they are going to carry on paying high franchise fees without receiving value, especially if they are not achieving a satisfactory return on investment.

In the current economic environment, there will be a consolidation of brands who are not proven and fully supportive of their franchisees.

So here are some rules to help a franchisor succeed in these difficult economic times:

  1. Get your concept optimum – you can’t paper over cracks or continue selling products or services that are not in line with market demands
  2. Prepare comprehensive franchise documentation that comply with the Consumer Protection Act
  3. Have a fully experienced franchisee support structure in place
  4. Carefully select suitable and qualified franchisees
  5. Good training is critical to the success of the franchisees – not just initial training but ongoing training
  6. Be fully involved with your franchisees including receiving and benchmarking their financial reports on a monthly basis
  7. Continually develop the brand in line with market conditions. How are competitors and the internet effecting your business?
  8. Franchising only works if we achieve a win: win scenario. It is up to the franchisor to service their franchisees to ensure that they achieve a satisfactory profitability
  9. Fixed fees are not ideal, as this is a mechanism that allows franchisors to stay at arm’s length of franchisee businesses and receive their fees regardless of franchisee performance.
In conclusion, it is our opinion that a franchisor cannot charge high fees on an ongoing basis unless the concept is sound and fully geared up to offer franchisees support and guidance. Franchising Plus does not advocate for reduced franchise fees but rather that franchisors intensify support efforts to ensure they offer value for the fees they are receiving.