How does a franchisor make money from its franchisee network?

Author: John Pratt

answered by John Pratt

Senior Partner at Hamilton Pratt

In a nutshell, franchisors make money by having successful franchisees. Franchisors should not make money from their network by charging a high initial fee with a large profit element. The purpose of the initial fee is to reimburse the franchisor the substantial cost of recruiting and training franchisees, providing the initial obligations to enable a franchisee to set up in business and to reimburse the high amount of involvement a franchisor has in a franchisee’s business at the beginning of the relationship. If a franchisor charges a substantial profit element in the initial fee, there is a danger the franchisor will want to take on franchisees whether or not it believes they are capable of operating successfully, simply in order to receive the initial fee containing the upfront profit element. Further, franchisors should not make hidden profits - every income stream for a franchisor must be transparent. Where this is often an issue is where franchisees are required to purchase products from a franchisor or the franchisor’s nominated suppliers. In such circumstances, franchisors can charge a mark-up and/or receive commissions or discounts from suppliers, which are then not passed onto franchisees. The British Franchise Association has issued a technical bulletin on this indicating the practice is not wrong, provided the franchisor is entirely up front about it. Where franchisors should earn a profit is in the management service fee, which is usually a percentage of a franchisee’s turnover. The average in the UK is approximately 8.5 per cent. That fee reimburses the franchisor for the assistance it provides franchisees and should also contain a profit element.

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