Hidden and open earnings on franchises
Why do business owners “rent out” a brand and what do they get out of it? What happens after purchasing a franchise and how can a franchisor avoid risks? I'll tell you about the most successful business model of a Russian entrepreneur
Main sources of income for franchisors
Initial payment
The initial or lump sum fee is a fixed cost of the franchise. By purchasing it, the user gets the right to work under the name of the franchisor for the duration of the agreement (5-10 years). The lump sum fee is taxable.
The main factors influencing the size of the lump sum payment:
business model,
brand popularity,
region,
franchise terms.
The lump sum payment can reach several million, or it may be absent – it depends on the business model of the franchisor. The absence or low threshold of the lump sum payment indicates that the franchisor will receive the main profit from royalties or, for example, from sales of equipment to the franchisee. Some franchisors provide a system of discounts, installments and deferments for a large initial payment. However, the more famous the brand, the less chances to come to an agreement. The cost of the payment will also depend on the region chosen by the franchisee. For example, opening an Invitro medical office in Moscow costs 700,000 rubles, in the region – from 200,000 to 500,000 rubles.
Franchise terms typically include:
state registration of the DCC,
trademark,
service mark,
know-how,
personnel management and training system,
sales techniques,
accounting and reporting forms,
consulting on commercial and management issues,
quality control,
additional services (legal support, accounting, etc.).
Royalty
Royalty is a regular payment. It can be fixed or a percentage of turnover or profit. Sometimes it is subject to special conditions specified in the contract. For example, a fixed fee in the first year and a percentage of profit in subsequent years. The frequency of payments is also individual: once a month/quarter/half-year/year/etc. Royalty holidays are an exemption from payments for several months after the launch of the business.
Royalty is like a subscription, a fee for using the services provided by the franchisor. These services may include: access to a CRM system, provision of equipment, selection and training of employees, an advertising campaign.
There is no law establishing the rules for calculating royalties, as well as the lump sum payment. The amount of payments will depend on the popularity of the brand, region, expected income, and average business rates.
Royalties are also taxable.
Marketing fee
Marketing fee is a regular payment for an advertising campaign and other marketing activities. It comes in three forms:
In cases where the marketing contribution is included in the royalty, the franchisor does not take into account the individual characteristics of the franchisee's business in its advertising campaign.
It involves the payment of a fixed amount. The franchisor can change the concept at the request of the franchisee. But most often such a contribution is divided into two parts, one of which is paid to the franchisor, and the second is spent by the franchisee on conducting their own advertising campaigns.
It is a cumulative system that gives the franchisee the greatest possible freedom. The size of the fund depends on the volume of purchases or sales of goods. The franchisor provides a choice of services or materials for a certain amount earned by the franchisee. An additional motivation for timely marketing promotion is the risk of burning up accumulated funds.
The marketing fee covers part of the ongoing costs aimed at strengthening and promoting the brand. The franchisor invests the collected funds according to the development strategy chosen by him. If at the moment it is a sale of a franchise, then he will pay for native and contextual advertising, advertising in social networks, SEO, development of a corporate website, publications and mentions in the media, participation in ratings, development through exhibitions and catalogs or a personal blog.
Sale of goods and equipment
To maintain the brand's uniformity and image, franchisees purchase branded goods from the franchisor. These include stationery, leaflets, tableware, packaging, plastic cards, consumables, stands, racks, employee uniforms, etc. Such sales bring good income to the company and allow it to exist stably.
Franchisors can make money by selling consumables to franchisees or third parties. For example, sushi companies are the largest suppliers of rice in Russia.
Purchase of equipment at the initial and subsequent stages is also often carried out through the franchisor or certain suppliers. This is necessary to comply with the established standards and requirements of the company. However, if the franchise does not have a lump sum or royalty, then the franchisor receives these payments in a hidden form: earns money on the sale of equipment with a huge markup. This is called anti-franchise.
Additional sources of income
Training and support
The training and support fee is included in the cost of royalties and/or a lump sum payment. Let us remember that for a lump sum payment the franchisor is obliged to provide the franchisee with know-how, which includes knowledge, practical experience of technical, commercial, managerial, financial and other nature. The franchisor is also obliged to instruct the user and its employees on issues related to the implementation of know-how rights; provide the franchisee with ongoing technical and advisory assistance in training and improving the skills of employees. However, with a low lump sum payment, the service package may consist, for example, only of production technologies and work standards. Then the franchise package, the cost of which will already be included in the royalties, may include items on training and support for the franchisee.
Types of support and training:
step-by-step launch algorithm,
help from a business mentor,
training program for franchisees,
instructions for selecting premises,
selection, training and accreditation of employees,
marketing plan and provision of materials,
access to the CRM system,
consulting on commercial and management issues,
assistance with legal, accounting issues, design, SMM.
License fee
A license fee is a fee for using a trademark, technology or certain know-how. It may be included in royalties or the cost of the product purchased from the franchisor. It may also be:
a fixed amount that is paid once, for example, every 5 years;
interest paid monthly.
The license fee covers the franchisor's costs associated with using its patent or technology.
Subfranchising
Subfranchising is the franchisee's right to act as a franchisor in relation to third parties. The purpose of such a business model is expansion in a certain territory. The franchisee has much more freedom and opportunities for real development, which has a positive effect on the company's income. Income, in turn, is distributed proportionally to the contributions of the franchisor and subfranchisee. This system of doing business carries risks, such as a serious threat to reputation, so it is typical for stable networks.
Subfranchising has several varieties, the classification of which depends on the volume of rights received by the franchisee. For example, a subfranchisor can not only sell a franchise, but also represent the interests of the general director.
Advantages of subfranchising:
a regional subfranchisor better adapts the franchise to local conditions,
The franchisee will receive feedback much faster.
As an example of the successful implementation of the sub-franchising model, in addition to the well-known McDonald's and KFC, we can recall Anytime Fitness. The startup became famous due to the round-the-clock operation of fitness centers and their low cost with high quality of services. Having reached a critical point of development in its segment in 2004, the fitness club began to work on a franchise basis. As of 2024, there are more than 5,000 points in 50 countries around the world.
Advantages and Disadvantages for Franchisors
Advantages of franchising for the franchisor
Franchising is an effective way to expand a business. Through franchisees, company branches appear in other cities and countries, work on brand recognition, increase customer loyalty, and interact with potential and real partners. At the same time, the franchisor shares risks and costs with its franchisees. Sometimes, such expansion results in unexpected collaborations and new milestones in brand development.
Some types of businesses reach a critical point in their development, and franchising becomes the only way out. Bright examples are McDonald's, Starbucks, Invitro. For others, franchising is just one of the possible development paths.
Disadvantages and risks
Damage to brand reputation.
Often this happens due to loss of control. The franchisor may rush to delegate decision-making powers that the franchisee is not ready for.
Risk mitigation: establish a clear contract, provide training and support, and monitor compliance.
Decrease in profits.
Revenue declines are often due to competition from franchisees or third parties.
Risk reduction: careful selection of franchisees, realistic financial terms, implementation of effective planning and trade management strategies.
Dependence on the franchisee.
The success of a business largely depends on the ability to negotiate. The franchisee should share the goals and views of the franchisor, and the latter should take into account the requests and wishes of the franchisee. If this does not happen, conflicts reduce the effectiveness of the business for both parties.
Risk reduction: developing a culture of cooperation and trust, building and maintaining strong relationships, effective communication, feedback.
Wrong choice of franchisee.
For mutually beneficial cooperation, the franchisor needs to find a person with similar views on business and the way of doing things. Otherwise, reputation and finances may be damaged.
Risk reduction: careful selection and screening of franchisees.
Expansion too fast or too slow.
In this matter, the franchisor should stick to the golden mean, because too rapid expansion is a risk of losing control over quality, franchisees and the business as a whole. The result is a tarnished reputation and decreased customer loyalty. Slowness threatens the loss of opportunities and competitiveness.
Risk mitigation: timely implementation of effective planning and management strategies.
Failure to protect your intellectual property.
Intellectual property includes your brand name, logo, slogan, products, services, processes and systems. Allowing your IP to be used illegally is voluntarily handing over your business to a third party.
Risk mitigation: preliminary work with documents and laws, monitoring and preventing any unauthorized use, violation or imitation of IP.
Neglect of core business.
Franchising is a way to expand your business, but don’t forget about developing your core business. Growth comes from innovation; adapting to market changes and needs, trends and technologies. It’s worth thinking about developing new markets and partnerships.
Risk reduction: continuous development and expansion, search for partners.
Real examples of successful franchisors
“1C” is Boris Nuraliyev's IT company, which has existed for over 30 years. Its branches are located in 25 countries and more than 600 cities. “1C” has concluded more than 10,000 franchise agreements. What allowed Nuraliyev to achieve such results? To emerge from the crisis of the 90s and all subsequent ones with minimal losses?
Boris Nuraliyev's company specializes in automating business processes. In 1991, Nuraliyev wrote a program for a teletype, and then began selling it. By the end of the year, sales were 6,000 units. It was an amazing and unexpected result. At that moment, Boris developed a rule that became key for many years: “build a business through partners.” He gave 55% of the cost of a product or service to distributors, and later made them his partners. Western vendors such as SAP or Oracle worked with end customers of their programs. Nuraliyev delegated this to partners.
While expanding and distributing his product, Boris did not forget about developing his core business. An accounting program appeared that could automate simple processes. The demand for 1C was confirmed by a large number of pirated versions. After the release of a draconian anti-piracy article in the Criminal Code in 1997, the problem of IP protection was solved.
Nuraliyev did not strive for enrichment, he built the largest partner network and constantly worked on the development of his product. It was the partners and the unconditional value of “1C” that allowed the company to avoid economic crises.
Boris becomes a partner of Yuri Miroshnikov, the head of the gaming software department. Together they launched the game “IL-2. Sturmovik”, which entered the top 25 games of all time and nations.
In 2010, the number of 1C franchisees reached 6,000. No one else in the world had such a developed network.
Market development led to the strengthening of competitors: ERP and SAP. The director of 1C realized the need to expand the company and, having found an investor in the person of Baring Vostok, began to buy up other market participants. He also accelerated the creation of joint ventures with partner companies; bought assets that increased the prestige and level of the company in the eyes of investors; invested in the development of computer games; bought up “cloud” companies and developments of this technology. And in 2012, he released new programs with the implementation of “cloud” technologies.
It is easy to see that Nuraliyev's main secret is constant forward movement. He alternates expansion and development of the core business. Establishes strong partnerships. Listens to market changes and customer needs. Introduces technologies. Masters new market segments.
Conclusion
The success of a franchisor depends on many external and internal factors, but income can always be calculated. Attention to legal and market aspects, to partners, franchisees and clients will help to notice opportunities or risks of unexpected situations in time, analyze and respond to them appropriately.
Results and conclusions
The lump sum fee, royalties and marketing fees provide the main income for the franchisor.
Hidden income is a legal, integral part of the franchisor's income.
Subfranchising is an aggressive business model that brings maximum possible profit and risk to the franchisor.
The risks and disadvantages of franchising are minimized by implementing effective, balanced and realistic business models.
