Why pay franchise royalties?

By Manuel V. Siggaoat Jr.

When I was first learning about franchising eight years ago, I came across the term "royalties". Knowing little about franchising at the time, I theorized that the business of franchising may have started with people of noble lineage - kings and queens, dukes and duchesses - or people with royal blood, hence the term "royalty"; I imagined that franchising probably started out in medieval times and royalties were homage or tributes paid to the king.

Soon after, I learned that business-format franchising started out long after after medieval times and that royalties were not tributes but regular payments made by franchisees to the companies who started out the brand or the business (recently, I came across a study claiming that some form of franchising may have been around during 12th century France; I was right, but that's another story).

Very often, royalties are paid to franchisors on a monthly basis and are percentages of sales made by the franchisee's store. For example, a franchisee may pay 5% of his P1M sales for the month of February or P50,000 to the franchisor within the first five days of the following month. Back then, I wondered why there was a need to pay the franchisor a monthly fee when a Franchise Fee was already paid at the start of the relationship for the rights to go into the business of the franchisor.

Royalties are different from Franchise Fees. Franchise Fees are paid in exchange for the franchisor's activities and expenses at the start of the franchise agreement. This includes site evaluation, training, background check, franchise sales & marketing, and of course, the rights to use the franchisor's trademark and business system.Royalties are paid to the franchisor for continuing activities in support of the franchisee and, to a lesser extent, for ongoing use of the name and system.

This suggests that the franchisee should be getting "continuing support" from the franchisor - regular visits, research & development, business consulting - in exchange for the royalties paid regularly. I've seen some cases where franchisors do not do anything for the franchisees after the initial training. In those cases, I don't see why the franchisor deserves to be paid royalties. In my experience, franchisees will happily and willingly pay royalties if he sees that the franchisor has been doing his part to help the business grow and prosper.

Sometimes, royalties are not collected by franchisors anymore. Instead, they require franchisees to purchase inventory and/or supplies from them. In lieu of royalties, the franchisors make money from the mark-up built-in to the transfer price of items sold to the franchisees. If you think about it, the concept is still similar to royalties, however, the mark-up is collected upfront whether the inventory is sold to the end customer or not. This scheme works out well especially for retail franchises where the main inventory being sold by the store bears the franchisor's brand and the franchisor is therefore the sole source of the item.

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