Next up in his series covering all aspects of franchising, Business Advice expert David Burton tells readers why, between franchisor and franchisee, it’s important to confirm a management fee structure from the outset.
You’d think that setting the correct management fee structure was a relatively simple process, but ensuring a correct rate is pivotal to both the franchisor’s and the franchisees’ success.
After the initial franchise investment fee, management service fees are typically collected on a monthly basis from each and every franchisee and are usually either a percentage of the franchisee’s turnover or a fixed monthly fee and in some cases a mixture of both.
Also known as royalties, management service fees, rates or franchise fees, this income is integral for the franchisor to support franchisees and to market, enhance and expand the brand.
The challenge for any new franchisor is setting the correct style and rate for its management fees. Setting management fees too high and there is little profit for franchisees and could be a turnoff for prospective investors. Too low, on the other hand, and the franchisor has insufficient funds to support its franchise network.
Whereas in a typical business, prices can be inflated or deflated if costs fluctuate, in franchising the franchise agreement generally stipulates the agreed rate at which the management service fees for the duration of the franchise license. Management service fees can be adjusted slightly for new or renewing franchisees but when they are set for the term, they are set.
A further challenge to the franchisor is that competitor analysis may show another franchisor has set their management fee structure at a much lower rate and how does one compete at that level? Looking at the level of support provided for the management fee may just provide a clue as to why a franchisor can set their rate so low.
Head of finance at ServiceMaster, Ray Apperley, said: “Management service fees are just one revenue source for a franchisor, but setting them at the correct level is essential.
“Consider the amount of support a new franchisee will require compared to an established franchisee who may be on the same rate of management fees. We find that many of our established franchisees, paying the same rate, actually require a different kind of support than our newer franchisees that receive more one-to-one marketing and operational support in the early days.
“It’s a balancing act getting the right fee structure in place but there are numerous variations and calculations to make and consider.”
A serious consideration is the level of support a franchisor will provide its franchise network. The franchisor’s role is to provide appropriate and sufficient guidance and support that its franchisees need to succeed and build a profitable enterprise and return on their investment, whilst ensuring the franchisor remains viable and effective too.
If one-to-one support isn’t affordable, develop a strategy and process to provide support in a more cost-effective way. Consider additional yet affordable charges that you can build into the franchise agreement, website management, social media and HR support can all be subscription based and afford the franchisor additional budget to provide these services.
A sliding scale management fee for example is a tried and tested tool for incentivising growth within the franchise network. For example, an initial rate of 10 per cent, sliding down to 6 or 7 per cent based on the franchisee reaching threshold points in increased turnover can be a fantastic motivation for a business to grow.
Care and attention are key when considering sliding scales as the same challenge arises, profitability for the franchisee and the viability of the franchisors business model is integral and whilst a sliding scale looks appealing to franchisees, the franchisor must ensure it is the right approach for the long term.
Finally, the franchisor must ensure that it is collecting all management service fees that it is owed which can provide another challenge. Investing in systems for franchisees to use to manage workloads enquiries, accounts and other operational tasks can support the franchisor in collecting the agreed management service fees and provide a seamless process for collating and invoicing the correct figures.
Whilst management service fees are a challenge to get right, this revenue stream is integral to the success and profitability of the franchisor. Research and due diligence is a must, as well as agreeing the balance of what level of support franchisees will receive and how much is too much.
Catch up with some of David’s previous articles from this franchising series:
- L is for Legal protection
- Keeping a relevant franchise
- Investment – Why franchising is the sound choice
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