Why Pay a Franchise Royalty?

By Manuel V. Siggaoat Jr. (www.franlinkasia.com)

When I was first learning about franchising eight years ago, I came across the term “royalties”. Knowing little about franchising at the time, I theorized that the business offranchising may have started with people of noble lineage – kings and queens, dukes and duchesses – or people with royal blood, hence the term “royalty”; I imagined that franchising probably started out in medieval times and royalties were homage or tributes paid to the king.

Soon after, I learned that business-format franchising started out long after aftermedieval times and that royalties were not tributes but regular payments made by franchisees to the companies who started out the brand or the business (recently, I came across a study claiming that some form of franchising may have been around during 12th century France; I was right, but that’s another story).

Very often, royalties are paid to franchisors on a monthly basis and are percentages of sales made by the franchisee’s store. For example, a franchisee may pay 5% of his P1M sales for the month of February or P50,000 to the franchisor within the first five days of the following month. Back then, I wondered why there was a need to pay the franchisor a monthly fee when a Franchise Fee was already paid at the start of the relationship for the rights to go into the business of the franchisor.

Royalties are different from Franchise Fees. Franchise Fees are paid in exchange for the franchisor’s activities and expenses at the start of the franchise agreement. This includes site evaluation, training, background check, franchise sales & marketing, and of course, the rights to use the franchisor’s trademark and business system.

Royalties are paid to the franchisor for continuing activities in support of the franchisee and, to a lesser extent, for ongoing use of the name and system. This suggests that the franchisee should be getting “continuing support” from the franchisor – regular visits, research & development, business consulting – in exchange for the royalties paid regularly. I’ve seen some cases where franchisors do not do anything for the franchisees after the initial training. In those cases, I don’t see why the franchisor deserves to be paid royalties. In my experience, franchisees will happily and willingly pay royalties if he sees that the franchisor has been doing his part to help the business grow and prosper.

Sometimes, royalties are not collected by franchisors anymore. Instead, they require franchisees to purchase inventory and/or supplies from them. In lieu of royalties, the franchisors make money from the mark-up built-in to the transfer price of items sold to the franchisees. If you think about it, the concept is still similar to royalties, however, the mark-up is collected upfront whether the inventory is sold to the end customer or not. This scheme works out well especially for retail franchises where the main inventory being sold by the store bears the franchisor’s brand and the franchisor is therefore the sole source of the item.

Advantages and Dis Advantages of Franchise

The term “franchising” is used to describe a wide variety of business systems which may or may not fall into the legal definition provided above. For example, a vending machine operator may receive a franchise for a particular kind of vending machine, including a trademark and a royalty, but no method of doing business.

The parties involved typically enter a franchise agreement, which binds the parties together through contractual provisions. This is an arrangement whereby someone with an idea for a business (the franchisor), sells to another person (the franchisee) the rights to use the business’s name, sell a product, or provide a service to someone else . A franchise agreement will usually specify the given territory the franchisee retains exclusive control over (the area protection), as well as the extent to which the franchisee will be supported by the franchisor (e.g. training and marketingcampaigns). Most franchisee agreements, however, do not provide the franchisee with area protection because of the disparity in bargaining power between franchisors and franchisees.

Advantages

As practiced in retailing, by using the business network concept, franchising offers franchisees the advantage of starting up a new business quickly based on a proven trademark and formula of doing business, as opposed to having to build a new business and brand from scratch (often in the face of aggressive competition from franchise operators).

As long as their brand and formula are carefully designed and properly executed, franchisors are able to expand their brand very rapidly across countries and continents, and can reap enormous profits in the process, while the franchisees do all the hard work of dealing with customers face-to-face. See customer service. Additionally, the franchisor is able to build a captive distribution network, with no or very little financial commitment.

For some consumers, having franchises offer a consistent product or service makes life easier. They know what to expect when entering a franchised establishment. See franchise validation.

Disadvantages

For franchisees, the main disadvantage of franchising is a loss of control. While they gain the use of a system, trademarks, assistance, training, and marketing, the franchisee is required to follow the system and get approval of changes with the franchisor.

In response to the soaring popularity of franchising, an increasing number of communities are taking steps to limit these chain businesses and reduce displacement of independent businesses through limits on “formula businesses.”

Another problem is that the franchisor/franchisee relationship can easily give rise to litigation if either side is incompetent (or just not acting in good faith). For example, an incompetent franchisee can easily damage the public’s goodwill towards the franchisor’s brand by providing inferior goods and services, and an incompetent franchisor can destroy its franchisees by failing to promote the brand properly or by squeezing them too aggressively for profits.

source: en.wikipedia.org/wiki/Franchising

Franchise Terms and Conditions

Common Definition – A method of doing business by which a franchise is granted the right to engage in the business of offering, selling or distributing goods and services under a marketing plan or system prescribed in substantial part by a franchisor and which is substantially associated with the franchisor’s trademark, name, logo and advertising.

Legal Definition – Franchising is a contract or agreement, express or implied, oral or written, between two or more persons by which:

• A franchisee is granted the right to engage in the business of offering, selling or distributing goods or services under a marketing plan prescribed in substantial part by a franchisor;
• The operation of the franchisee’s business pursuant to that plan or system as substantially associated with the franchisor’s trademark, service mark, tradename, logo type, advertising, or other commercial symbols designating the franchisor or its affiliates; and
• The franchisee is required to pay directly or indirectly, a franchise fee.

Franchisor – The parent company or operator of a franchise concept or system that grants, for a fee and other considerations, the right to use its name and system of business operations.

Franchisee – An independent business person or novice entrepreneur who has been granted by the franchisor the right to duplicate its entire business format at a particular location and for a specified period, under terms and conditions set forth in the contract (franchise agreement).

Franchise Agreement – A written contract detailing the mutual responsibilities of franchisors and franchisees. It is usually for a several-year term, and when the term is up, the contract expires and must be renewed. Some state laws require the contract to be renewable at the franchisee’s option. Usually, a franchise agreement may not be sold, transferred or otherwise assigned without the franchisor’s permission.

Operations Manual – A written document which clearly explains the franchisor’s standards of operation, and identifies the operational tasks required to establish and operate the franchise business. The operations manual supports and promotes the use of consistent and uniform day-to-day procedures at each franchise unit within the network franchise unit in order to maintain the quality of service and products in every franchise outlet.

Franchise Opportunity – A franchise opportunity is a business opportunity that involves the sale of good and services that enable a novice entrepreneur to begin a franchise business.

Master (or Regional) Franchising – A model of multi-level franchising wherein the master franchisor sells the development rights in a particular geographic market to a master franchisee, who, in turn, sells individual or single-unit franchises within the territory. In return for a front-end master franchise fee, the master franchisee has the sole responsibility of developing that area or market under a mutually agreed upon schedule. The master franchisee is rewarded by sharing in the franchise fee and ongoing royalties paid by the franchisees within the territory to the master or parent franchisor.

Area Development Agreement – This is another variation of multi-level franchising where the franchisor grants exclusive development rights for a particular geographic area to an area development investment group or an area developer. In return for the rights to an exclusive territory, the area developer pays the franchisor a front-end development fee and commits to develop a certain number of units within a specified period of time.

Initial investment – The total capital required to start a franchise business. This typically
includes Franchise Fee, Renovation, Equipment & Fixtures, Rent
deposits, and Initial Inventory.

Franchise Fee – The initial fee paid to the franchisor. The Franchise Fee usually includes training, site selection and evaluation assistance, and the rights to use the franchisor’s trademark and business system.

Royalty – This is the fee paid to the Franchisor for continuing use of the trademark and in exchange for the franchisor’s ongoing support services. This is usually a percentage of the franchised outlet’s sales and is typically paid on a monthly basis.

Advertising Fee – Fee paid to the Franchisor as the franchisee’s contribution to the marketing effort. This is usually a percentage of the franchisee sales and is often paid on a monthly basis.

Initial Term of Agreement – The length of time the Franchise Agreement is in effect. If typical revenue and expense scenarios hold, the franchisee should be able to recover his initial investment within the initial term of agreement.

Territory – The franchisee’s territory is the geographic area or domain in which his business operates. The franchisor may grant exclusivity to the territory, meaning no other franchised or company-owned outlet may open in that territory, or the rights of first refusal to the franchisee, meaning that if the area can support other outlets, the franchisee is given first option to do so. The franchisor may give rights to the franchisee only where his location stands, no more.

Franchise Offered

1. Single Unit Franchise The franchisor grants franchises to an individual or entity one outlet at a time.
2. Area Multi-Unit Franchise The franchisor grants the franchisee the right to open several units within a territory, within a prescribed time frame. Part of the Franchise Fee for the units are paid upfront, with the balance for each unit being paid upon signing of the individual franchise agreement.
3. Master Franchise (Area or Country) The Master Franchisee is both a franchisee and a franchisor. As a franchisee, he should open his own franchised units. As a franchisor, he is also responsible for finding, granting, and supporting sub- franchisees. For his effort, the Master Franchisee gets a share of the fees due the franchisor.

source: www.franlinkasia.com

Benefits of Buying a Franchise

Earn what you are worth
Thousand of franchise owner report they were handicapped in their corporate careers by Company policies and Superiors that put a cap on their earning. When you own your own Company, your efforts are rewarded and your personal income shows it!

Build equity
Financial strength comes to those who succeed in running a business. Approximately 95% of all millionaires in the Philippines own their own business. If great wealth is one of your goals, entrepreneurship is the answer.

Satisfaction of achievement
Much business owner report that seeing their actions turned into realty without stagnating for month in committee meetings as so oft happens in big companies is a major reward of owning their business.

Choose your own job description
When you’re the owner, you can delegate certain aspects of the business to others and create a job description that suits your personality, skills and interests. Naturally, the industry you choose and the size of your operation will affect your flexibility in this area.

Control your future
Business owners live the scripture “you reap what you sow”. You can manage yourwork schedule against family needs and recreation – if you’re willing to share some profits with additional employees.

Never transferred, laid off or fired
Major companies are notorious for relocating their employees and downsizing their staff at the most inopportune times! When you run your company, you’ll decide when and where to operate.

Why a franchise?
There are many reasons why franchising is the best type of operation for the majority of first time business owners. Most revolve around the increased probability that the business will succeed and provide profits to the owner in a shorter time frame than an independent business. This allows the owner to address her/his personal goals both financially and personally.

Lower costs than an existing business
When buying an existing Company, you often don’t know what you are buying or if the price is right or the existing business profitable. Starting a franchise is almost always less expensive.

Less risk than an independent start-up
One spends up to 5 years in an industry before considering owning a venture in that field. Buying a franchise eliminates this need and puts you on the road to success quickly.

Gain advice on site selection, design, operation, capitalization and marketing
A good Franchisor provides instruction and support on all aspects of running a business in its industry.

Receive a proven profitable system for doing business
When you’ve had a chance to talk to other Franchisees, you’ll recognize how important it is to have a system to follow for your venture. This plan is easily worth a few hundred of thousands of Pesos or more.

Benefit from quality research and development
Most small business owner are just too busy making money to research the future trends in the industry and develop new products or services to meet the needs of their customers. A Franchisor will always be searching for ways to make its network more successful.

Access to trained support personnel
Your royalties and advertising fees provide regular improvements in the Franchisor’s systems and these are provided to you for implementation in your venture.

Quicker start-up than independents
A proper plan outpaces an independent’s hit and miss operation almost every time. Looking at just independents that succeed – you’ll find that franchises grow quicker, reach break-even sooner and succeed more regularly than others in the same industry as depicted in the accompanying chart.

What does a Franchise Provide

The advantages of a franchise over an independent business are aplenty. A Franchisor must furnish valuable services to its Franchisees.

Business Name
Franchisee will have his own corporate name as Incorporation or individual business owner but the franchised business operates under the Trade Name of the Franchisor.

Market Studies
Franchisors should knows where franchised businesses should be opened, which locations are good for a Franchisee and which not, which may be determined generally by location, most important with food franchises or other aspects, like purchase power of a certain area, etc.

System Standards
Sensible and complete specifications, standards and operating procedures, the so-called system standards, effectively communicated to Franchisees and readily understandable.

Operational Manual
The “How To” documentation of the business operation and the implementation of the system.

Proprietary Marks
The right to use the logos, signage, slogans and Trade Marks of Franchisor. It is not enough that a Franchisor has a DTI Business Name registration or a SEC registration, he has to obtain a Trademark from the Intellectual Property Office, which is located at Sen. Gil Puyat Avenue in Makati.

Experience
Transfer of business experience is transferred from Franchisor to Franchisee

Wisdom of Franchisor
The Franchisor went through the “labor pain” of opening the business by himself some time ago. For a new Franchisee that trial and error period is eliminated.

Training
Effective initial training is critical to achieve positive Franchisee attitudes regarding system standards, the operation, the Franchisor and the value of the franchise and depending on the business can take from 5 days up to 6 month.

Site Selection Assistance and Approval
Franchisors in the Philippine usually do not provide locations and prospective Franchisees have to find them by themselves. However, Franchisors will know where a franchised business shall be located within a certain area and will inspect the site prior to the start of construction or operation, if the location is suitable for the franchised business.

Store lay out
Franchisors will provide lay out assistance and supervise the construction of a new franchised store. The entire construction cost is at the expense of the Franchisee, and has to be paid as due to either the Contractor or Franchisor, depending on the arrangement.

Exclusive Territory
Most Franchisor will award new franchises with an exclusive Territory, which depends on the kind of business can be a certain radius in meters or a floor in a mall, a whole City or a whole province or City or several of them as Area franchise or even a whole Country as Master franchise.

Procurement Programs
Franchisor will provide a listing of authorized suppliers for equipment’s, goods, materials and services.

Opening assistance
Franchisor assistance in hiring personnel for the Franchisee by giving the guidelines for needed staffing and training them, and set-up of the franchised outlet. Franchisor’s management and staff assist new Franchisee upon opening of the franchised outlet to operate it smoothly from day one onwards. Franchisors representative will remain in the Franchised Facility for a period of time as determined by Franchisor to assist Franchisee in the initial operation phase.

Marketing Strategies
Franchisee may have to contribute to a National Advertisement Fund, a Co-op Advertisement and spend some amount for the initial Opening Advertisement and the ongoing Local Store Marketing activities.

Effective Field Service
Operational support is needed by Franchisees for occasional questions and problems. Knowledgeable and well-trained personnel with positive attitudes and a willingness to help Franchisees are provided by Franchisors. Franchisors shall also be available to Franchisee via phone, email, fax or text for urgent problems arising from the operation of the franchised business. Important is also that Franchisor and his representative regularly visit the franchised outlets.

Research and Development
Businesses face tough competition and new products are constantly to be tested and introduced in the market. The job is with the Franchisor in development of new products and service, improvements of equipment’s, formats, operating efficiency and trying to beat competitors.

Author: Rudolf A. Kotik of www.rkfranchise.com