Why Buying a Franchise is a Costly Business?

Investing in a franchise can be an attractive proposition given the security it offers. Running a franchise involves a lot of recurring expenses besides one-time initial set-up costs such as licensing fees, market differentiation, and operational costs. For example, to open a McDonald's franchise, the QSR chain charges a service fee of 4% of all monthly sales from franchisees.

Another important consideration is the alignment between your interests and the business concept. It is also a long-term commitment. As a franchisee you must be prepared and aware that while you would make profits, the upkeep of a franchise business is costly. That is even more true in a highly competitive market.

So let's understand why taking a franchise of your favorite fast-food restaurant requires you to maintain a healthy bank balance and enough working capital.

What does it take to run a franchise business successfully?

For a franchise business, paying a one-time franchise fee is not enough. The cost to start a franchise business can range drastically, from a few thousand dollars to millions. Usually, the average cost is listed by the franchisors on their website. There are several other fees and expenses you will need to pay to the parent company. Let's take a look at some of them.

Royalty fees

Franchise royalties are the fee a franchisor collects from the franchisee every month. It is a percentage of revenue generated by a franchisee and can range from 4% to 12%, or sometimes higher, depending on the franchise business and the terms of the Franchise Disclosure Document (FDD).

For example, when you purchase a franchise of Kentucky Fried Chicken (KFC), you pay an initial franchise fee of around $45,000. In addition, you pay 4 to 5% of your monthly gross sales to the franchisor as a royalty fee.

Marketing expenses

When you own a franchise, one of the things you can capitalize on is the brand identity. Franchisors spend large sums to market and advertise their brand. As a franchisee, you are required to do your bit too, by paying a certain amount as a monthly marketing fee based on your revenue. For instance, if you generate an average monthly revenue of $25,000 and the franchisor requires 2% of monthly revenue for marketing, you pay $500 every month for national or local marketing. McDonald's charges 4% of gross sales from franchisees for advertising and other promotional activities.

Training expenses

When you own a franchise, the franchisor generally provides training to your employees to ensure consistency in operations and processes. To avoid complications, you along with at least one other employee are required to attend and complete the training program. While you pay the franchise fee to the franchisor, you are also responsible for travel, living, and other expenses involved in the training program for yourself and the employees who undergo training.

Local area fees and taxes

Whenever you start a business, the local or state government typically charges a certain amount as fees and taxes for using the public right-of-way. This fee covers charges a business owner pays for establishing a business, acquiring building permits, and getting approvals from the municipalities, local government, or state government.

Inflation

Rising inflation has impacted almost every industry, and franchising is no exception. According to the International Franchise Association, an estimated 90% of franchisees have experienced a moderate to substantial impact of inflation on their business. From increasing the cost of goods and services to lowering sales, inflation has made it more difficult for franchise owners to run their businesses.

Why do franchisees today need more money?

The business landscape today is very different from what it was a decade ago. The internet, the evolution of technology, social media, and the pandemic have transformed the business ecosystem. The challenges entrepreneurs face today are different from what their predecessors faced. Despite the easy availability of bank loans and credit, franchisees today require more money to run the show than franchisees in the 70s or 80s did. What are these challenges? Let's find out.

Employee attrition is high

In recent years, job churn in the United States, voluntary or involuntary, has seen a significant spike. High employee turnover means recurring hiring costs, training costs, and engagement costs. It is a vicious cycle. This was less of a problem in the 70s and the 80s. People did leave jobs back then, but attrition rates were not as high as they are now. Attrition is also a major driving force behind franchise businesses investing in technology and automation.

Automation and technology require investment

Running a successful franchise requires consistency across locations, streamlined operations, and automating repetitive tasks. Software and technology have become an important part of any successful franchise brand, which was not necessarily the case in earlier times. As a result, franchisees today have to bear an additional expense in the form of technology fees.

Subway charges each outlet a monthly technology fee from franchisees to cover the cost of digital technology such as mobile applications and online ordering. The company also states in the FDD that this fee can be increased at its discretion. Franchisees today have to factor in additional costs to afford and upgrade technology when required.

High marketing costs

Traditional offline marketing is no longer enough. Businesses today need a strong online brand presence as well. With many options available in the market, franchisees have to spend more money creating brand visibility at a local level to attract, engage, and retain customers. While the franchisor charges a percentage of your sales for marketing and advertising, it is equally important for you as a franchisee to allocate a budget to market your business locally.

Summing it up

The modern business ecosystem is very different from what it was a few decades ago. The franchising business model has undergone a massive change from its beginnings in the 1900s. Today, the stakes are much higher, and the investment one needs to run and own a franchise is remarkably different from what it was a few decades ago.