How does a franchisor make money from its franchisee network?

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 very substantial costs 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 that a franchisor has in a franchisee’s business at the beginning of a franchise. If a franchisor charges a substantial profit element in the initial fee, then there is a real danger that the franchisor will want to take on franchisees whether or not the franchisor believes that that franchisee is capable of operating a successful franchise simply in order to receive the initial fee containing the up front profit element.
Further, franchisors should not make hidden profits. Every income stream for a franchisor must be entirely transparent. Where this is very 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 on to franchisees. The British Franchise Association has issued a technical bulletin on this indicating that the practice is not wrong provided that 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%. That fee reimburses the franchisor for the assistance that it provides franchisees and should also contain a profit element. No other fees should contain a profit element.

Written by: John Pratt

Partner, Hamilton Pratt