How do franchisors make their money?

People often see franchising as a win-win relationship. Franchisees gain access to a proven business model and franchisors earn income by supporting and expanding their network.

But exactly how do franchisors make money from their franchisees? Here, legal and franchising experts share their insights into:

● the main income streams

● the importance of transparency

● how franchisors can profit sustainably

What are the main sources of franchisor income?

Franchisors earn money from several different sources, typically beginning with an upfront payment and continuing through regular ongoing fees.

As Brian Duckett explains, “Other than the income that the franchisor may receive from running their own business outlets, the majority of a franchisor’s income usually comes from the various payments made to them by their franchisees.”

Initial franchise fee

The initial franchise fee, sometimes referred to as an upfront or turnkey fee, gives the franchisee the right to use the franchisor’s name, system and training.

This fee can vary significantly depending on what the franchisor includes – from basic rights and support to a complete business setup.

Should franchisors make a profit from the initial fee?

While the initial fee provides a valuable source of income, it’s not meant to be a major profit driver. As Pratt explains, the purpose of the initial fee is to reimburse the franchisor for the substantial cost of:

• recruiting and training franchisees
• providing the initial obligations to enable a franchisee to set up in business
• their involvement in a franchisee’s business at the beginning of the relationship

If the fee includes a large profit element, John Pratt, senior partner at Hamilton Pratt, warns, “there is a danger the franchisor will want to take on franchisees whether or not it believes they are capable of operating successfully, simply in order to receive the initial fee containing the upfront profit element.”

Management service fee

Once a franchisee begins trading, the ongoing management service fee (MSF) becomes the key income stream. As Pratt notes, this fee is calculated as a percentage of a franchisee’s turnover. In the UK, it’s approximately eight per cent.

According to Vicky Wilkes, head of legal at Aston Villa Football Club, this ongoing payment is in exchange for “the continued use of the franchisor’s trade marks, know-how, goodwill and operational methodology. It also covers any ongoing assistance provided by the franchisor.”

This fee is reinvested back into the franchisor’s business and may be used in part to develop the continued growth of the franchise network.

For a franchisor, then, income is not just about profitability – it’s about sustainability and long-term success. As Pratt neatly sums up, “Franchisors make money by having successful franchisees.”

Advertising levy

Some franchisors also introduce an advertising levy, usually around 2%, to fund brand-wide marketing and promotions.

“The marketing levy should only be spent on marketing activities and should not contain any profit element for the franchisor,” Pratt adds. He notes, however, that it’s “quite proper for a franchisor to recharge its internal marketing costs to the marketing fund.”

Product supply

Brian Duckett, former chairman of The Franchising Centre, adds that franchisors may also make a profit on the supply of products, depending on the nature of the business.

“Franchisees need products to sell, or to use in the operation of their business,” he says. “In many cases, the franchisor will supply these and make a profit on them. Alternatively, they may appoint approved suppliers from whom they receive a percentage commission.”

Shelley Nadler, legal director at Bird & Bird, notes that “if you have to buy all or some of your products from the franchisor, you need to enquire whether the franchisor will make a profit on this transaction.”

In certain cases, she adds, “the franchise agreement will not provide for the payment of a separate management services fee or other continuing fee. This is because the mark-up on the sale of goods will instead be the source of profit for the franchisor.”

Transparency is key, Pratt stresses. “Franchisors should not make hidden profits – every income stream for a franchisor must be transparent.”

He acknowledges that franchisors “can charge a mark-up and/or receive commissions or discounts from suppliers […] provided the franchisor is entirely up front about it.”

Property

There are also property-based revenue opportunities: “The franchisor may decide that where it takes a lease of premises and sub-lets to its franchisees, it charges a higher rent to the franchisee. This means they earn a profit rental for themselves,” says Nadler.

“Some franchisors add on a fixed sum or certain percentage of the annual rent payable to cover their costs in administering the sub-leases.”

In summary

Franchisors earn income from a mix of upfront fees, ongoing royalties, marketing levies and, sometimes, mark-ups on goods or property rentals.

The most successful and reputable franchisors keep these income streams transparent, use them to fund genuine support for their franchisees and reinvest in growing a healthy, sustainable network.