What is Royalty?

Royalties are payments made by one party (the licensee or the franchisee) to the other party who owns a particular asset (the licensor or the franchisor) for the right to use that asset permanently. Royalties are usually negotiated as a percentage of the gross or net income from the use of the asset or at a fixed price per unit sold, but there are other forms and compensation rates. Royalties are entitled to aggregate future royalty payments.

The license agreement defines the terms under which resources or property are licensed by one party to the other, either without limitation or for a limited duration, business or geographic area, product type, etc. License agreements can be regulated, especially if the Resource is owned by the government, or they can be private contracts that follow a general structure. However, some types of franchise agreements have comparable terms.

Gross sales

This is the most common type of royalty structure. In this royalty setting, franchisors charge a certain percentage of the franchisee's gross sales. The main advantage of this structure is that it gives the franchisor an incentive to participate proportionally in the growth of the franchisee. There are usually three types of gross sales:

Fixed Royalty

This is the most common permanent franchise contract. Under this royalty structure, the franchisee will be required to pay a fixed percentage of the sales to the franchisor, regardless of the franchisee's sales or income. It is the simplest fee structure for administering royalties.

Increasing Percentage

Under this type of contract, as a percentage of gross sales, franchisors charge a premium to franchisees who want to open a head office. Location is one of the most important factors that influence the success or failure of a franchise. Some marketplaces are more likely to generate more sales than others.

Decrease Percentage

Under the percentage reduction model, the franchisee pays a smaller percentage of gross sales as total gross sales increases. This model is beneficial to both the franchisee and the franchisor. Because it provides additional rewards for increased performance and encourages franchisees to grow and be more profitable, which is a good result for franchisors as well.

Percentage per transaction

In this type of royalties, franchisors charge a fee based on each product sold or transaction made. This type of royalty structure is widely used in some industries, such as the hospitality industry or the automotive industry. Franchisees who collect this type of royalties often use point-of-sale systems that do the calculations automatically.

Split Profit

In a copyright-shared profit structure, the franchisee's total profit divided between the franchisor and the franchisee by agreement, such as 40/60. Although distributed rewards are not common, they are less supported by franchisees.

No Royalty

Franchisees will not charge any franchise fees under this agreement. The franchisor only generates revenue from the sale of products to franchisees. It generates income from a manufacturer or supplier who has established a franchise channel as a retail chain selling their products. Recently, Amul granted its retailers a franchise without any consideration.