Learn about building revenue streams and find out how to generate income from your franchise system.
Franchising can be an excellent way for entrepreneurs to expand their brand and generate steady revenue over time. For new franchisors, though, the process of generating income often comes with a lot of questions.
New franchisors wonder how they’ll make money, which sources of revenue they should focus on building, and how they can make their franchise profitable. The truth is that franchising is about long-term wins. Generating profits takes time and effort to grow the brand, build up unit-level economics, and establish recurring revenue streams that will increase cash flow and add value to the franchise system in the long run.
In this article, we’ll explore ways franchisors can make money by building up multiple streams of revenue and making the right choices while growing their franchise systems.
Franchisors should plan to build three primary revenue streams into their franchise system. These include the initial franchise fees, ongoing royalties, and supply chain rebates. Each stream will generate income for the business and provide financial support for business growth and development over time.
Initial Franchise Fee
The initial franchise fee is the fee a franchisee pays to the franchisor when they sign a franchise agreement and purchase a franchise opportunity. While amounts may differ depending on the business, initial franchise fees typically range from $25,000 to $45,000. Although that may sound like a lot of money, franchisors should be aware that initial franchise fees aren’t likely to become a profit center for their business.
Although the initial franchise fee does provide compensation to the franchisor for granting a license to the franchisee allowing them to join the franchise system based on the term length of the franchise agreement (typically between five to 10 years), franchisors should view the initial fees as a means of recouping the expenses associated with selling a franchise.
As a franchisor, you should expect the initial franchise fees to cover the costs of marketing your franchise and recruiting franchisee candidates, as well as the costs of training and providing pre-opening support to new franchisees.
In situations where a franchisor has worked with a franchise broker during the sales process, it’s also important to remember that the initial franchise fee will include the broker’s commission, which is typically 50% or more of the initial fee.
Royalty Fees
Although the initial franchise fee is an important source of cash flow that supports business growth, franchisors should also plan to build additional revenue streams to generate income on an ongoing basis over time.
Royalties are recurring fees paid by franchisees to the franchisor, typically on a monthly or weekly basis depending on the terms of the franchise agreement. In addition to being an important profit center for the company, royalty income also allows franchisors to continue supporting their franchisees. Because of that, royalties are the most important asset for franchisors to focus on building.
Royalty structures can be determined by franchisors in several ways. In general, royalty fees are usually based on a percentage of the franchisee’s gross sales. However, depending on the industry, some franchisors charge a flat-rate royalty fee. Alternatively, franchisors may elect a hybrid system that requires recurring royalty fees amounting to the higher of the two.
No matter what industry you operate in or which royalty structure you choose, selecting quality franchisees is critical when it comes to building revenue streams based on royalties. Because royalty amounts will typically depend on the success of each franchise location, franchisors should be on the lookout for qualified franchisees that will be able to succeed for themselves. When signing on a new franchisee, remember to take into account the sale’s deal value: the term length of the franchising agreement, the estimated revenue potential of the new franchisee, and the ongoing royalty fees that will be derived from it over time.
Supply Chain Rebates
Supply chains can also provide franchisors with another important stream of recurring revenue in the form of rebates.
Rebates are payments made by vendors to the franchisor based on a percentage of what their franchisees have purchased. In addition to providing important income for the franchise organization, many franchisors also reinvest rebates into their brand development fund to continue growing their business.
It’s important to note that while rebates are legal, franchisors are required to disclose the revenue they receive from rebates annually on their Franchise Disclosure Document (FDD), in addition to the percentage of their overall annual revenue that comes from rebates. Because of that, franchisors should carefully track the rebates they receive each year.
It's also important to remember that franchising should be a win-win situation for everyone. As a franchisor, you don’t want rebates that are simply driven by higher prices for your franchisees. Instead, you should make sure your franchisees also benefit from the company’s supply chain. This can mean selecting suppliers that offer more efficiency, higher quality products, better delivery services, and even more cost-effective options to ensure good unit-level economics and lower supply costs for franchisees.
In certain industries, franchising can offer other indirect financial advantages for leaders and innovators with employees that want to start their own companies. By transforming entrepreneurial employees into franchisees, you can organically grow your brand and support existing talent.
By making smart business decisions and building up strong streams of revenue over time in the form of initial franchise fees, royalties, and rebates, franchisors can make money doing what they love.
If you’re ready to take the next step in franchising, contact us to learn about how our firm can help you succeed.
