How to Create Reasonable Franchise Fees - 4 Tips

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What was in the air yesterday?

Two people called to discuss converting their business to the franchise model (which, considering my business, is not unusual) and both wanted to offer very low franchise fees. That's discouraging because I don't think they are doing the research necessary to be a really good, sustainable franchisor.

Let's look at both sides of that decision.

The potential franchisors said they were offering part time or adjunct businesses to people who weren't "professional business people" and so, couldn't afford a higher price.

They also felt that they could award more franchises at the lower price. On face value, those seem to be sound reasons. But let's look deeper. Franchise fees are a combination of value statement, practical cost containment and marketability.

We'll address the marketability first.

Many new franchisors do only this step without realizing what goes into the price and we will address that next. When you are shopping franchise fees look beyond your direct competitors.

When people look at franchises they look at several different verticals that share a common start-up cost, so you need to look beyond your market and see what's out there. Once you know what the market will bear, you have to look at the components of those fees.

The franchise fee is a buy-in fee. The franchisee gets the right to use the brand, marks and system of the franchisor for a defined time, so long as he abides by the system rules. As it gains fame and following, its value increases. That takes time and huge market share to move the proverbial needle.

The second component is cost containment and this one takes work. The franchisor has to determine the opportunity cost for selling the franchise. The opportunity cost includes the marketing costs, sales costs (commissions/bonuses, pro rata payroll costs, broker fees, etc.) and training costs, including a pro rata share of the trainer(s) payroll, training material, space rental if needed and start-up materials.

Think it through, price it out: You might not make money on franchise sales, but you shouldn't lose money. Now that you know what goes into a fee structure, let's look at the downside of low ones.

1) The perceived value of the brand is diminished by the lower price. No matter how you justify it, the perception is that the franchise not only costs less, it is worth less. Even if a part-time business, the brand has value.

2) Low barriers to entry are also low barriers to exit. If the franchisee is not significantly vested in the franchise, it will be too easy to walk away the moment things get tough. At the very least, it will be too easy to drop at renewals.

That means the franchisor constantly to pay full opportunity costs to keep franchise levels steady - there are no economies of scale. You will also have to disclose your turnover for years, and that can deter sales.

3) If your franchise fee does not cover your opportunity costs, you will start every franchise relationship at a loss. Before you decide to do this, calculate how long the average franchisee will take to ramp up, pay adequate royalties and offset the initial loss. If you sell several at once, can your company absorb the loss? Can you wait that long? And will the lower cost result in enough sales volume to offset the amount of time you wait to be positive on that investment?

4) No matter the size and return of the franchise, be sure to choose only those candidates who embrace your values, respect your system and have a true commitment. Every time you bring in a franchisee that is not qualified or dedicated, you wound the brand and the good franchisees you do have. That will drive out those good folks fairly soon. Bottom line: Price yourself in a way that makes financial sense for you, creates value for the franchisee and markets the respectability of the brand.

Think long-term and be proud of what you built. If you are not ready for that, you might not be ready for franchising.

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1 Comment

Franchisors very often miscalculate the cost per franchise sale.

And subsequently their franchise recruitment budget is too low to market effectively.

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