"Franchise Royalties Are Too Expensive!" . . . Are they?

Passing up the opportunity to buy a franchise because you didn’t want to pay a royalty fee might be a costly mistake. Here’s why: Left to your own devices in business, there’s a pretty good chance you’ll fail. All the statistics online and offline say the same thing: Most business start-ups fail in America! Why? Because the owners run out of money.

But given that billions of dollars annually are invested in business start-ups in America, how is it possible that so many businesses – the majority – run out of money? Author Michael Gerber, who wrote The E-Myth: Why Most Small Businesses Don’t Work and What to do About It, says businesses run out of money because the owners work “in” the business and not “on” the business. “The owners are so busy doing, doing, doing,” says Gerber, “that they have no time to focus on what’s important, which is figuring out how to make the business successful.” Before they know it, the owner runs out of money and the business must be shuttered.

Saving Franchisees Money

Franchisees are fortunate because they don’t have to worry as much about how to make a business successful. Their franchisors have already figured out how to do that, and they transfer that knowledge (and the skills sets) to the franchisees for as long as the franchisees continue to be franchisees.

In the previous column I discussed the franchise fee, the lump sum payment that a franchisee pays in exchange for a franchisor’s initial business training, which may require 2 to 20 days of schooling. Training is costly and the franchise fee underwrites most of it. But what happens after a franchisee is trained? Ongoing support is imperative to the franchisee’s success. In fact, it’s the ongoing support that saves many franchisees from running out of money.

Who Pays for Franchisee Support?

Ongoing support comes at a cost. Franchisors must hire and train a staff to provide support, which may occur in the field, over the phone, via email, or at regional and national meetings. Franchisees are generally entitled to as much support as they need, which may mean they’re on the phone with their franchisor several times a day, and that’s not unusual in the early years of a franchisee’s development. To provide support, franchisors generally need an office, a bank of phones, money for travel, etc.

Who pays the cost of ongoing support? That’s the franchisor’s responsibility. And where does the franchisor get the money to pay these costs? Royalties!

The Value of Research & Development

“Franchise prospects often get the idea that royalty payments are the franchisor’s profit,” explains Dr. John Hayes, who teaches The A to Zs of Buying a Franchise at the annual IFE. “But the facts do not support that assumption.” Dr. Hayes points out that in addition to training and support, many franchisors provide Research & Development for their franchisees. “The R&D department is busy looking three to five years down the road figuring out how to improve the operations of the franchise,” Dr. Hayes explains. “Franchisees never have time to plan ahead and so this is a huge benefit that the franchisor provides. How do McDonald’s and Pizza Hut come up with new menu items? R&D! Service businesses develop or source new products through their R&D departments. R&D is a huge benefit to franchisees and it comes at a tremendous cost – a cost that a franchisee could not afford on his own. Royalties from the franchise network pay these costs, along with ongoing support.”

Franchising is a way for you to learn how to operate a business successfully. You’ll have to pay a franchise fee for that opportunity. And then you’ll have to pay royalties to continue gaining the educational benefits of the franchise system. Next time I’ll discuss another franchise fee: the advertising or marketing fund fee.