Westpac - What Are You Paying For?

One of the common questions people ask about franchising is ‘Why should I pay all that money for a business when I could do it myself?' It's a reasonable question, but it's one that suggests the questioner doesn't actually understand how franchising works. Let me ask another question, this time from a banker's perspective. If franchising weren't such a successful business model, why would banks bother to have specialist franchise teams? After all, we love customers who have healthy growing businesses - and franchising represents a significant part of the small business sector now.

Much of the uncertainty about the value of a franchise comes from confusion about the various different costs involved - both initial and ongoing costs. Once you understand the costs, it's much easier to understand the value of the franchise and how you might fund your investment. In this article, I will cover both aspects.

Initial Costs

Initial costs are those one-off payments you make when you first set up your new franchised business. These are generally divided into two types: payments you make to the franchisor, and payments made to third parties such as equipment suppliers.

Franchisor Payments

In exchange for obtaining the right to use the franchisor's name and assistance, you may pay some or all of the following fees.

You can expect to pay an initial franchise fee to the franchisor. This is an upfront fee which will give you the right to use the franchisor's name, brand, operating system and other intellectual property for a certain term. This fee covers the development cost of the franchise system for the franchisor and sometimes includes an element for training or other initial services (these fees may also be charged separately - there are sometimes tax benefits in separating them out). The franchise fee can range from $10,000 to $100,000 and may be a great investment or may be too much. If the franchise system is strong and offers a lot of benefits, a higher fee can be well worth paying. If the system is a poor one, even a small amount may be too much.

The most successful and profitable franchise systems tend to share a number of characteristics. These include: good management information systems and benchmarking processes; a proven product or service; a strong brand or accepted trade name; a tried, tested and documented way of doing business; a record of ongoing development of the product or concept; initial and ongoing training and support; good purchasing power; co-ordinated marketing and advertising. A franchise with these advantages can command a higher initial fee.

Third Party Payments

These are the costs anyone has in starting up a business, franchised or not, and can far exceed the cost of the franchise fee, especially where fit-out, equipment and stock are concerned. Some items (equipment, vehicles, premises) may be leased or rented, thereby reducing initial funding requirements.

This is an area where buying a franchise can be very beneficial, as the franchisor will be experienced in determining exactly what you need. They will normally have negotiated better prices and sourced different components from the best suppliers, and can usually give an accurate breakdown of the expected set-up cost so you know exactly what funding you need.

Ongoing Costs

The ongoing costs of running your franchise can be divided the same way.

Franchisor Payments

The payment that you will often hear most about is the ongoing franchise fee or royalty. This is a fee paid for support services and the ongoing development of the franchise - product and system development and so on. It also includes a profit element for the franchisor.

The royalty is usually payable as a percentage of turnover (sales) or as a flat fee in, for example, service franchises. It may also be included in a mark-up on product supplied by the franchisor. The level of fee varies but is commonly 3-10%, although it could be much higher if the franchisor provides an exceptional level of service. Once again, whether or not it is worth it depends on what you get for your money - if the support services are good they are usually worth every cent; on the other hand, you could find yourself paying for services you do not receive for the term of the franchise agreement. Find out what other franchisees think before committing yourself.

There may also be a number of other ongoing fees required. It is common to have a national marketing fund, to which contributions are compulsory, and you may also be required to spend a certain amount on local marketing. Some systems also charge separately for, eg. software licences, conference contributions; accounting or credit control services and so on.

Third Party Payments

Payments to third parties such as suppliers are usually a matter between you and those suppliers. Where a supplier is common across the franchise, the franchisor should have negotiated favourable terms (both price and payment deals) on the basis of bulk purchasing power. Even where a supplier is unique to you, if they are significant enough (such as a landlord) the franchisor may have specialist knowledge or personnel who can help you negotiate the best possible arrangement.

Value For Money?

If the franchise you are interested in shares the characteristics of a good franchise system, you may pay more in dollars to be part of the system, but get such good value that it is really a bargain. You are lowering your risk and increasing the chances of getting a profitable business with a sustainable model well into the future.

If your bank is a franchise specialist, they will put a significant value on the benefits offered by and the proven track record of a good franchise system. This will make getting business finance much easier, and may also give you access to better transactional packages. When buying a franchise, you still need to do a proper assessment with the help of legal and financial professionals, but all these factors add up. Choose the right franchise and you will find it well worth the apparent extra money you pay.

This article is taken from Franchise New Zealand magazine Volume 16 Issue 3

Contact details for Westpac

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