Franchising: Is Your Franchise Fee Too Low?

Do You Know Your Cost Per New Franchisee?

A number that you absolutely must know to effectively run a franchise company is “cost per new franchisee” for each new unit sold.

To calculate “cost per new franchisee” divide the total annual cost of your franchise development department including labor, expenses, marketing, advertising, contact management, and other costs by the number of new franchises sold that year.

Cost per New Franchisee Analysis

Total Annual Franchise Development Dept Expense / # of new franchisees sold per year = Cost per New Franchisee

To illustrate, if you spend $200,000 per year and recruit ten new franchisees, your cost per new franchisee would be $20,000. If your current franchise fee is $15,000 and your cost per new franchisee is $20,000, you would be going backwards in cash flow $5,000 every time a new owner joins the team.

The negative cash flow of $5,000 doesn’t include any financing you might provide, broker fees, initial training costs or support costs to launch the new franchisee. In this scenario these additional costs would significantly increase your negative cash flow. So the more locations you sell, the faster you go broke!

As this illustrates, an incorrectly computed franchise fee could have a significant negative impact on your company’s cash flow. An experienced franchise consultant who sets up your franchise business should model these costs when setting your initial franchise fee. If your cost per new franchisee is too high in relation to a reasonable, competitive franchise fee, you must re- evaluate your costs or have adequate cash reserves to offset the negative cash flow.

Too many companies establish their initial fees based solely upon their competitors’ or other franchise companies’ fees and not based on their own costs and needs. Don’t be afraid to make adjustments to your initial franchise fee when needed. Before adjusting your fees consult with your legal counsel about the impact this change will have on your FDD. Adjusting your franchise fee is considered a “material change” to your FDD that requires you to update your state registrations and re-disclose any potential franchise candidates you are currently working with.

A Seasoned Set of Eyes

I had a discussion with Fred DeLuca, the Co- Founder of SUBWAY® Restaurants concerning emerging franchise companies. He indicated that after startup it took him nine years to figure out the sandwich business and another nine years to figure out the franchise business. If you do the math, it took him 18 years to figure out the business.

Unfortunately, when Fred created SUBWAY® Restaurants in 1965 there weren’t many of the resources available for franchising that there are today. Back then new franchisors had to learn by bloodying their knees. Fred’s suggestion for all franchisors today is to take advantage of the resources and get expert help and advice!

With so many moving pieces during this crazy emerging phase of your company, it is strongly recommended to have an experienced C-Level franchise executive spend some time assessing your system. Choose someone who has dealt with these issues first-hand (I.E. “Me”), because they will have the experience to spot any looming problems and advise you on best options for continued growth.

As the old saying goes, “You don’t know what you don’t know!” Don’t let that get in your way of being a franchise Mega-Brand.

The above is an excerpt from my book Five Pennies: Ten Rules to Successfully Building a Franchise Mega-Brand and Maximizing System Profits.

Have a question or two on managing your franchise brand? Give me a shout for a free consultation.     

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