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How do franchisors make money?

By Allan D.J. Dick
Franchising is one way of many by which a business can expand. The key ingredient the business must have before its founder can consider expanding it through franchising is what someone else would want to license for use in the operation of an independently owned business: specifically, a brand name and trademark associated with success.

By implementing the franchisor’s business model, the franchisee’s intention is for customers to perceive no difference in the goods and services they purchase from any unit across the franchise system, whether they are visiting the original store, a corporate-run location or a franchise. Every outlet should present the same general look, feel and other fundamental attributes.

Despite this intention, however, the financial realities are very different between the original outlet, corporate locations and franchisees.

The franchisor’s corporate stores generally replicate the original business, to varying degrees, and their model for profitability is usually equivalent to the financial model applicable to the original business.

For franchisees, the profitability model may be similar, but their ability to control their revenues and expenses will be affected by the system in which they operate, as many financial aspects of the business are controlled by the franchisor. There are often costs involved that are directly linked to the franchisor’s means for making money from the franchise system.

There are various ‘silos’ of expenses the franchisor can apply to its franchisees. Each franchisor will pick and choose which of these best suit its system and its financial goals, with the understanding such choices will also fundamentally affect the attractiveness of its system to potential franchisees.

When franchisors design their franchise systems, they must understand how once they have made these choices, their ability to implement the rules will relate directly to (a) the strength of the contract they sign with franchisees and (b) their oversight of those franchisees’ performance.

The following are some of the charges and considerations that are undertaken in the preparation of the franchise agreement.

Initial franchise fee
Most franchisors charge an initial fee for the granting of the licence to operate their system, including the use of their systems and trademarks. Franchise fees range widely.

Against the fee, the franchisor must consider all of the expenses it will incur in granting franchises. These may include franchise brokerage fees and the cost of compliance with the applicable statutory disclosure regime.

Initial and ongoing training
In most franchise systems, the franchisor provides initial training for new franchisees. They may also train the franchisees’ key staff, including managers, and offer ongoing training over the longer term.

Franchisees typically bear the costs of such training by paying fees to the franchisor. These fees may also serve as a profit centre for the franchisor.

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