Royalty fee

Royalty Fee is a mandatory fee paid by the franchisee to the franchisor. The basic fee is paid for connecting an existing point to the franchisor's network. In connection with current operations, the franchisee pays current fees. These are parts of the profit shared with the franchiser. In addition, additional fees are paid.

Franchise costs

Franchise costs depend to a large extent on the type of franchise and may vary from less than a thousand to even several hundred thousand Euros and more. It depends on the industry, brand and income of the franchiser. The cost of a franchise depends on the industry in which it operates. The most expensive franchises include franchises from the catering, clothing and gas stations industries. The cheapest franchises are, for example, those from the education, finance and banking or tourism sectors (without hotels).

When analyzing the amount of the franchise fee, the following issues should be taken into account:

• The numer of initial franchise costs, i.e. the costs of entering a given franchise system,
• Sources of initial franchise costs,
• The amount of franchisee's investment costs (e.g. renting and furnishing of premises, purchase of goods, acquisition of rights, licenses, etc.)
• The number of commission expenses that the franchisee will be obliged to incur for the benefit of the franchiser during the course of its business.

As regards the costs that the franchisee will have to bear, note the following types of costs related to the franchise:

• Initial franchise fee
• Current franchise fee
• Contribution to the common marketing fund

Initial Royalty Fee

The initial royalty fee is a fee that a franchisee pays once by joining a given franchise system. It should cover the franchiser's costs related to the creation and sale of the franchise package.

By paying the initial royalty fee, the franchisee finances its right to use the business idea created by the franchiser. The initial franchise fee is determined by each franchiser individually, however, there are several factors that will affect its amount.

The factors influencing the amount of the initial franchise fee are as follows:

• preliminary and current services provided by the franchiser - usually the greater the scope of franchiser's assistance in opening a new outlet, the higher the initial franchise fee,
• size of the area in which the franchisee will operate - the larger the geographical area, the higher the fee for joining the franchise system,
• period for which the franchise agreement is concluded - the longer the period, the higher the fees.

Initial royalty fees imposed by the competition - the so-called "invisible hand of the market" operates here - if the franchiser has a lot of competition (e.g. in the food industry, where there is a lot of franchise), it will have to look at the competition and adjust its requirements regarding franchise fees to it. If it requires a much higher initial fee than its competitors, it will not attract potential franchisees.

In the case of distribution franchising, franchisers often include franchise fees in the price of goods delivered to franchisees. Thanks to this solution it is possible to join a distribution franchise without having a large share of capital to start with.

Current royalty fee

A current royalty fee is a fee that the franchisee will pay regularly (usually once a month). It is intended to cover the license to use the trademark right and the support provided by the franchisor. The current royalty fee may be a fixed amount or an amount charged as a fixed percentage of income, sales value or turnover. The amount and nature of the current fee are determined in the franchise agreement. Before the franchisee commences franchising, he or she should know exactly all the franchise costs he or she will be obliged to bear.

Payment to the common marketing fund

The success of a franchisee, a franchiser, and the entire franchise system depends on the recognition and positive brand image. Therefore, it is common practice for a franchiser to create a special fund from which money is allocated exclusively for the promotion, marketing and PR of a franchise brand. Thanks to this fund, the franchiser has the necessary resources to promote the brand in national and local media, to conduct marketing campaigns or to produce advertising materials for the entire chain. The amount of contribution to the marketing fund depends on the estimated costs and scope of the company's promotion. Usually, it is a fixed amount, which is paid monthly. If a franchise fee is not included in the franchise agreement, the franchisee is not obliged to pay it. Contractual penalties cannot be imposed for failure to pay such fees on time (although it is logical that in order for the cooperation with a franchiser to be maintained at a good level, such fees must be paid on time). During the first months of the franchise unit's operation (during the "start-up"), the franchisor often does not collect monthly fees and marketing fund contributions in order not to charge the outlet which has not yet reached the break-even point, i.e. has not started earning for its current needs.

Examples of Royalty fee

• Percentage of Revenue: In this type of royalty fee arrangement, the franchisee pays the franchisor a percentage of the revenue generated by their business. The percentage is usually determined by the franchisor and will vary depending on the type of business and the agreement between the two parties.
• Flat Fee: A flat fee is a one-time fee that the franchisee pays the franchisor for being part of the franchise network. This fee is usually a fixed amount and is not based on the performance of the franchisee's business.
• Advertising/Marketing Fees: This type of fee is usually used to cover the cost of advertising and marketing campaigns that the franchisor has implemented. The franchisee is responsible for paying the fees to the franchisor in order to be a part of the marketing efforts.

Advantages of Royalty fee

Royalty fees are an important component of franchising, providing a steady stream of income for the franchisor and giving franchisees an opportunity to build their own business. The advantages of paying a royalty fee include:

• A steady source of income for the franchisor: The royalty fee is a fixed sum paid by the franchisee to the franchisor on a regular basis, usually as a percentage of monthly sales. This guarantees a steady income stream for the franchisor even when sales slow down.
• Lower upfront costs for the franchisee: By paying a royalty fee instead of an upfront franchise fee, the franchisee is able to invest more in their business and focus on growth. This can lead to more success and profitability for the franchisee.
• Established branding and market recognition for the franchisee: By joining a franchisor’s network, the franchisee is able to benefit from the franchisor’s established brand and market recognition. This can help the franchisee build a successful business faster than if they had to start from scratch.
• Potentially higher profits for the franchisee: With the help of the franchisor, the franchisee can improve their marketing and operations, leading to higher profits. The success of the franchisee can in turn benefit the franchisor, since a higher profitability means a higher royalty fee.

Limitations of Royalty fee

Royalty fees can be a great source of income for franchisors, but there are some limitations to consider. Here are some of the main limitations of royalty fees:

• Royalty fees are typically a fixed percentage of the franchisee’s gross revenue, which means that if their sales are down, so is the franchisor’s income.
• Royalty fees can be expensive for franchisees, which can make it difficult to attract new franchisees.
• The franchisor may have to spend additional money in order to support the franchisee, and these costs may not be covered by the royalty fees.
• The franchisor may not be able to collect the royalty fees if the franchisee is not making enough money.
• Royalty fees are not always easy to track, and franchisors may not always receive the payments on time.

Other approaches related to Royalty fee

Royalty Fee is a mandatory fee paid by the franchisee to the franchisor in order to gain access to the franchise network. Other approaches related to Royalty Fee include:

• Fixed Royalty Fee: This involves charging the franchisee a fixed amount per month or year, regardless of the franchisee's profits or losses.
• Variable Royalty Fee: This involves charging the franchisee a percentage of gross sales or profits. This model works best in cases where the franchisee is expected to make a certain level of sales or profits.
• Hybrid Royalty Fee: This involves charging the franchisee both a fixed fee and a percentage of gross sales or profits.

In conclusion, Royalty Fee is a mandatory fee paid by the franchisee to the franchisor in order to gain access to the franchise network. Other approaches related to Royalty Fee include Fixed Royalty Fee, Variable Royalty Fee and Hybrid Royalty Fee.

Footnotes

Royalty fee — recommended articles

Franchise fee — Placement fee — Residual payment — Discriminatory pricing — Sole distributor — Depreciation vs. amortization — Strategic assets — Phoenix company — Aggregator model

References

• Fosfuri A. (2004), Optimal licensing Strategy: Royalty or fixed fee?, RePEc
• Kabiraj T. (2017), Fee vs. Royalty Licensing and Consumers’ Welfare, "Journal of quantitative economics: journal of the Indian Econometric Society" 16(3)
• Landers A. (2012), Understanding Patent Law, LexisNexis
• Lutz N. A., Gallini N. (1992), Dual Distribution and Royalty Fees in Franchising, "Journal of Law Economics and Organization" 8(3)
• Maruyama M., Yamashita Y. (2011), Franchise Fees and Royalties: Theory and Empirical Results, "Review of Industrial Organization" 40(3)
• Nwogugu M. C. I. (2005), On Franchise Royalty Rates, Franchise Fees and Incentive Effects, SSRN Electronic Journal

Author: Agnieszka Krztoń