What Is COGS
COGS (Cost of Goods Sold) represents the direct costs to produce or purchase inventory that your franchise sells. This includes raw materials, product purchases, packaging, and direct labor tied to production or fulfillment, but excludes overhead like rent, utilities, or administrative salaries.
COGS in Franchise Due Diligence
When evaluating a franchise opportunity, COGS is critical because it directly determines your gross margin and cash flow predictability. The Franchise Disclosure Document (FDD) Item 19 contains financial performance representations, and COGS figures are embedded in those projections. Many franchisors list average unit volumes (AUV) and estimated profitability, but the underlying COGS assumptions often receive less scrutiny than they deserve.
During your review, compare the franchisor's stated COGS percentages against your own research and industry benchmarks. For a QSR franchise, COGS typically runs 25-35% of revenue. For retail concepts, expect 40-60%. If the FDD shows 20% COGS in a food business, that's a red flag worth investigating through Item 20 (outlets that closed) or by contacting existing franchisees directly.
Franchisor Obligations and Supplies
Review whether the franchisor controls your supply chain through proprietary vendors. Many franchisors require you to purchase products exclusively from them or approved suppliers, which directly impacts your COGS. Item 6 of the FDD discloses required purchases. If the franchisor earns rebates or markups on mandatory supplies, that cost gets passed to you, inflating your actual COGS versus what corporate-owned stores experience.
Ask franchisees: "What percentage of your product purchases are mandatory through franchisor-approved suppliers?" and "Has the franchisor raised supplier prices in the past three years?" Territory rights and renewal terms (typically 5-10 years) also affect COGS strategy, since short renewal periods reduce your willingness to invest in efficiency improvements.
Calculating Your True COGS
- Request 24 months of P&L statements from 5-10 operating franchisees in different markets
- Calculate their COGS as a percentage of revenue to establish a realistic range
- Cross-check Item 19 projections against actual franchisee data to identify gaps
- Account for startup inefficiencies, first-year waste, and ramp-up periods when COGS typically runs higher
- Verify whether quoted COGS includes all mandatory purchases, packaging requirements, and delivery fees
Common Questions
How does COGS affect my franchise fee calculations?
Franchise fees are separate from COGS, but your ability to service the franchise fee and royalties depends on controlling COGS. If you're paying 35% COGS on $500K in annual revenue, you have $325K gross profit to cover a franchise fee, royalties (typically 5-7%), rent, labor, and all other operating costs. A high COGS percentage compresses your margin quickly.
Can I negotiate COGS through territory rights or renewal terms?
Not directly. However, if you secure exclusive territory rights or a longer renewal term (15+ years), you have more leverage to negotiate volume discounts with approved suppliers or request COGS relief during ramp-up. Most franchisors won't adjust their system, but larger multi-unit operators sometimes secure better terms.
What's the difference between COGS and royalties?
COGS is the direct cost to produce or buy products you sell. Royalties are ongoing fees paid to the franchisor, usually calculated as a percentage of revenue (not COGS). Both reduce profitability, but COGS varies with sales volume while royalties are fixed percentages.