Owning a franchised business is completely different from owning an independent business. So for entrepreneurs who want to start a franchised business, we will outline the costs associated with operating a franchise.
- The franchise owners must pay Royalty and Ad/Marketing Fee to the franchisor every month.
- The franchisor calculates royalties according to gross sales that franchised location makes, so more revenue = more $$ to a franchisor’s bank account.
- The expense associated with hiring and paying employees will take approximately 30% of the gross income, so this is one of the highest operating costs of a franchise.
- The rent for the retail space of the franchise can go from $0 to a few thousand dollars per month, so this cost will depend on which type of franchise investor chooses to start.
Main Costs Associated With Operating Franchise
Franchise Royalty Fee
The main difference between the operating costs of an independent business and franchised one is that the franchise owner will be obligated to pay a certain royalty fee to the franchisor(owner of the Trademarks).
This fee franchising company calculates according to the gross sales that franchised location makes per month, which means that it will fluctuate according to the revenue.
The exact percentage of this fee depends on the franchisor, but usually, it is 4+% of the gross sales.
Ad/Marketing Fund Fee
One of the better-known operating costs associated with operating a franchise is an ongoing Ad/Marketing Fee that the franchisor charges its franchisees every month.
When the franchisee signs an agreement with the franchisor, this automatic obligates him to pay for the marketing campaigns that the owner of the trademarks run on the national and local level. So every aspiring franchise owner must know that this fee will take a certain percentage of his business profit margin.
Usually, this fee is 2% of the gross sales that franchised locations make per month, so this cost is not small as it seems at first.
However, if they are run properly, marketing campaigns should have more brand awareness for results, which will bring more revenue for the franchisee in the long run. So this can be a win-win situation for both parties involved in this type of business.
By signing a franchise agreement, the franchisee(the buyer of the franchise) agrees to pay a so-called ”Initial Fee”. By paying this fee, the new owner gets the right to use the franchisor trademark, so sometimes this fee is also called and ”Licensing Fee.”
Aspiring franchise owners must be aware that Initial Fee can be a very costly expense. For example, McDonald’s as a franchising company charges its franchisees $45,000 for the Initial Fee, so we must put this fee on the list when we talk about costs associated with operating a franchise.
Also, investors must know that the rights to use franchisor trademarks end when the franchise agreement expires. On average, these contracts last ten years, and after that franchisor and franchisee must sign a new deal.
Franchise Agreement Renewal Fee
After the first franchise agreement term expires, if the franchisee and franchisor decide that they want to continue to be business partners, in that case, they must renew their contracts.
A franchise agreement renewal fee usually costs 50% off the initial fee. If the initial is $40,000, the renewal fee will be $20,000.
As we mentioned before, these agreements usually last for ten years, so every potential franchise owner must be aware that the expiration of this contract will mean more outlay for the investor.
Cost of Raw Materials
One of the biggest operating expenses of most businesses is the cost of raw materials. The franchised locations, for example, in the restaurant sector, spend approximately 30% of the gross sales on paying for raw materials necessary to prepare food for the customers.
The peculiarity of the owning franchise is that franchisee must buy work materials directly from suppliers approved by the franchisor.
Some franchisors charge a higher price for raw materials than one on the open market, so it is important to find a franchisor that is not misusing its franchisees!
So when we talk about costs associated with operating a franchise, we must mention that franchisees must work according to the franchisor’s rules. So it is important to choose the franchisor that will not make a profit by charging franchisees more for raw materials and other supplies necessary for work.
As mentioned above buyer of the franchisee is obligated to run a business according to the franchisor’s rules. It means if the trademark owner decides that it is necessary to make changes in the exterior or interior of the franchised location, the franchisee will need to pay for it.
Remodeling can be very expensive, so franchisees must count on the cost associated with improving/remodeling their franchise.
Real Estate Improvement Cost
The highest cost of buying a franchise is associated with the improving real estate in which the business will run its operations. For example, suppose the investor decides to start a franchised restaurant that will operate its business in a standalone facility with a drive-thru. In that case, the costs of the improvements can be a few million dollars.
However, if the investor opts for starting a service franchise, that will be much cheaper than starting a franchise in the food sector.
For example, cleaning franchises don’t have an expense associated with real estate costs. Most of the cleaning work is happening at clients’ places, so investors who want to start a business without rent outlay can opt for starting this type of franchised business.
In the U.S, leasing the retail space will cost franchise owners between $11 to $23 per square foot. So future franchisees must calculate the costs of the leasing space because this is one of the biggest expenses associated with operating a franchise.
For the employees’ wages, benefits, and other expenses related to labor costs, the franchise owner can expect to pay 30% of all gross sales amount. So if the franchise location makes $500,000 in revenue per year, it is expected that $150,000 from it will go to workers’ salaries.
Work Permits, Tax, and Accounting Fees
The franchised businesses must operate under the law of the state in which they operate, which means that the franchise owner must count at the cost associated with all kinds of work permits and licenses that are must-have to operate a business legally.
Tax and certain fees that charge accountants are also cost associated with the operating franchise, so every aspiring owner must count that these expenses will occur monthly.
We have outlined what are the main costs associated with operating a franchise. Aspiring franchise owners must be aware that paying franchisor royalties will take some percentage from the profit margin; however, that doesn’t mean that franchised businesses are not good investments.