A recent report by franchise system data provider FranchiseGrade indicates that both the average (mean) and typical (median) franchise upfront fees at a “healthy” franchise system are higher than that of an “unhealthy” franchise system – 12 percent higher in the case of the average system.
Why the difference in the franchise upfront fees?
Academic research suggests that the answer is quality. Systems with higher franchise upfront fees tend to have better brand names, stronger franchisee training, and are more selective in picking outlet operators.
Franchising is a business model in which one business — a franchisor — gives another business — the franchisee — the right to use its operating system and brand name to produce and sell products and services for end customers in a specified way. In return for the right to use the brand and the system, the franchisee usually pays the franchisor a one-time upfront franchise fee and an ongoing royalty, often set up as a percentage of gross sales.
The franchisor makes most of his or her money off the royalty. The franchise fee is small — in the $25,000 to $30,000 range for the typical system — and is designed to cover upfront costs to get the franchisee into business. With the franchise fee, the franchisee is really paying his or her proportional cost of developing the operating system and obtaining training.
FranchiseGrade defines “a healthy franchise system” as one at the higher end of its proprietary performance standard. While only Franchisegrade knows that standard exactly, one of its major components is growth in the number of outlets in the system. (The company says, “A healthy franchise system is one where the franchisor exhibits sustainable growth, is financially stable, and where franchisees who invest into the system have a reasonable chance of success, profit, and a fair return from their investment.”)
Academic research explains why faster growing franchise systems tend to charge higher franchise fees than slower growing ones:
- They have more valuable brands and so can charge a premium to franchisees to access the brand.
- They have better training and operating systems and need to charge higher fees to recoup those higher costs.
- They can attract franchisees more easily and use the higher fee to weed out franchisees who are a lesser fit for the business culturally or operationally.
- They are less cash-constrained and do not need to use franchise fees to stay afloat.
Money Exchange Graphic via Shutterstock