How Do Franchises Make Money?
Franchise systems are quite different than operating a traditional kind of business. There are many different types of demands than a traditional business system, as well as other variables to consider. However, there is money to be made in a franchise for both the franchisor and the franchisee. There are numerous franchises out there, from sandwich shops to 24-hour gyms. Read on to find out how they make money.
How Franchisors Make Their Money
A franchisor stands to make money in many different ways by playing the long game and ensuring each franchisee they work with has the ability to run the franchise appropriately.
Franchisors tend to make money from the franchise fees and royalties that they sell to franchisees, and not just from goods or services sold. The franchisor doesn’t actually make much money if any at all from the upfront fee that a franchisee pays to purchase a franchise business.
The investment cost of a franchise opportunity is simply there to cover the cost for the franchisor in terms of bringing a new franchisee on board. Making strong investments in new franchisees will ensure they get off to a great start. The following fees are usually covered:
- Recruitment Costs
- Training Fees
- Legal Costs
- Additional Website Development
- Marketing Plan Development
- Technology Implementation
- Document Writing & Consultation
- Additional Support Systems/Personnel
Some franchisors will use the franchise fee to receive some profits, although this is rare. The primary source of income for a franchisor is usually the ongoing fees (also known as royalties) that franchisees pay on a regular basis, which may either be a flat rate or a percentage of turnover or profit. For an example of the former, rather than make a profit when a new franchisee decides they want to run a gym in their hometown, the franchisor will make a profit when people join the gym and pay for their memberships, taking a percentage of the profit from the franchisee or agreeing on a flat rate in advance. This will all be defined in the franchise agreement beforehand.
In fact, the actual selling of a franchise itself tends to result in a loss for most franchisors. The loss is only short term, however, and they do this in the hopes of making a long-term profit from the franchisee via royalties and other sales. This is why it’s so important to know who you’re working with. If the potential franchisee is not qualified to run a franchise business, the franchisor will end up making a loss – this is why one should never just sell the franchise to the first person that offers cold hard cash.
Of course, how much you stand to make over time will vary depending on the industry, sector, and many other variables, and it usually takes around 2-5 years to break even (restaurants at 2-3 years, hotels closer to 5 years). A few things each franchisor should do to ensure they make money include:
- Stay proactive and communicate with franchisees – it is often crucial to have difficult conversations with them.
- Invest in a strong start for new franchisees.
- Make exceptions for high-performance franchisees.
- Offer boost programs for franchisees that may be struggling.
- Identify poor performance as soon as you can.
As a franchisor, your ideal situation is to have your royalties cover all the overheads of the franchise system. To get to this point, you want to make it your goal to receive the maximum amount of royalties as you can from each franchisee.
How Franchisees Make Their Money
Franchisees must work hard to make money and ensure they run the business the way it was intended. A franchise tends to have a ready-made look and brand that must be adhered to. one will need to learn the necessary parameters in regards to this and do their due diligence. Know that satisfaction matters – customer satisfaction should be of the utmost importance to a franchisee. Many businesses, franchises included, endeavor to be known as customer-focused businesses today. This often earns word of mouth recommendations from happy customers.
Having experience and qualifications in running a business will be useful, as well as domain expertise. However, the biggest determinant of whether someone will be successful at running a long term business is their attitude and work ethic, with a sprinkle of luck. A franchisee must have a willingness to accept guidance from your franchisor. Similarly, a franchisor should provide the franchisee with the correct tools and guidance to be successful. Though the two are separate entities, it takes both of them working together to run a successful business.