Royalty is an ongoing payment which a franchise owner is contractually obligated to pay the franchisor a fixed share of their sales over the tenure of the agreement
Franchising is an excellent opportunity for those starting a business. With its minimized risk and already-established model, franchising is always a viable business model. If you are considering taking franchising, you must be familiar with the concept of Royalty. It is to be duly noted that the franchise fee completely differs from Royalty. Franchise Fee is a one time, upfront payment to join the franchise system. While royalty is an ongoing payment which a franchise owner is contractually obligated to pay the franchisor a fixed share of their sales over the tenure of the agreement.
However, there are many royalty structures which can be quite perplexing to a first-time franchise. Below are some commonly used royalty structures which one needs to understand before buying a franchise.
It is not the most common continuing royalty agreement in franchising but still preferred by many franchisors. Under this royalty structure, the franchise will have to pay a set amount to the franchisor, regardless of the franchisee’s sales or income.
Well, it may be gruesome to have a fixed-fee approach, especially in the beginning when you are in the process of establishing a business and the sales are low. However, fixed royalty structure makes sense in the long run. This is because as your business grows, your royalty will go down. Thus, if the franchise has great success potential and you are able to make subpar sales, you are definitely going to benefit from this type of franchise.
This is the most common type of royalty fee structure. In this royalty setup, franchisors charge a fixed share percentage of a franchisee’s gross sales. The main advantage of this structure is that it gives an incentive for the franchisor to participate proportionately in a franchisee’s growth. It is the simplest and most popular royalty fee structure to administer.
It is a win-win situation for both the franchisor and the franchise. Many franchisees chose this structure over others as it keeps their costs lower at the beginning where you tend to have lots of extra out-of-pocket costs and the royalty fees only increases when the business and profit grows.
Transaction-based royalty can be often seen in certain industries like hospitality or automobile. In this type of royalty agreements, franchisors charge a fee based on every product sold or transaction made. Franchisors who charge this type of royalty often have their franchisees use point-of-sale systems that do the calculations automatically.
In this agreement, the franchisors do not impose any royalty fee from the franchisees. The franchisor earns its revenue exclusively from the sale of products to the franchisees. It also gets its revenue from the manufacturer or supplier that has established the franchise channel as a capture retail chain to sell its products. While zero-royalty or no- royalty structure is alluring to every aspiring franchisee but it is quite rare.