Franchising model’s uncertain future
The franchising sector has been on the receiving end of a lot of negative political and media attention over the past two years.
The industry response has largely been to pop in earplugs and cover its eyes with blindfolds and just wait till all the problems go away.
The Franchising Council of Australia continues to roll out media releases of self-congratulations for the industry, announcing award winners for franchising excellence and forums to showcase investment opportunities.
The Council has protested the timing, intent and conclusions of inquiries into the sector claiming it is in robust health, despite the falls from grace of some of the most celebrated franchise systems.
A little bit like the alcoholic who can’t rehabilitate without first acknowledging they have a problem, the franchise sector is certain to be plagued with serious problems well into the future, unless it recognises the limitations of the franchising business model.
Franchising has been around for a long time and does undoubtedly have its success stories but it is uncertain that retail franchising systems can survive in their current form.
At the very least, retail franchising systems are likely to become much less lucrative for franchisors who are unlikely in future to be able to obtain the level of franchise levies, marketing fees and even product supply charges that they have received in the past.
Franchisors are also facing the prospect of higher operating costs associated with a tightening of regulations and legislative provisions to ensure the appropriate governance and accountability of their systems and enhance operational support for their franchisees.
The franchise business model arguably works for service businesses, which in many cases have low ingoing costs and often provide a customer referral facility, which provides a clear and direct value for the fees.
Retail franchises are an entirely different matter as they involve high entry costs for the franchise rights, store fit out costs, rent and occupancy charges for tenancies, inventory carrying costs and hefty wages bills resulting from extended hours trading in most locations.
Franchisees have much longer hours to spend managing a retail business than investors in other types of franchises and, at the end of the day, many are effectively working for nothing after coughing up their various dues to franchisors.
The scandals and increased level of disputation involving retail franchise systems should not be surprising, given that the entire retail industry is under pressure with major local chains closing stores and others failing financially and international retailers such as The Gap and Esprit abandoning the Australian market.
The seasonality and vagaries of fashion has meant there have been few apparel franchise systems.
General merchandise chains like Beacon Lighting and The Good Guys bought back their franchises while the struggling Godfreys cleaning appliance chain has waxed and waned on its franchising program.
Yum Restaurants Australia, which built its business around a pure franchise model has also been buying back KFC franchises, a move that led to a dispute with another franchise company, Jack Cowin’s Competitive foods, which triggered a parliamentary inquiry that led to the adoption of ‘good faith’ clauses in franchising legislation.
Faced with a debilitating level of disputes with franchisees and the reputational brand damage of breaches of employment laws and underpayment of wages, Caltex, the fuel giant has also decided to exit franchising and to buyout its current franchisees.
Among other casualties, the Angus & Robertson chain was one of many retail franchise chains to collapse, along with other systems such as the Allied Brands portfolio, Eagle Boys Pizza, Pie Face, Kleins and Kleenmaid.
Most of the successful retail franchises in Australia have been food chains but food franchise systems are starting to struggle as evidenced by the problems at Domino’s Pizza, Pizza Hut, Retail Food Group and Craveable Brands.
The wages scandals at 7-Eleven and Domino’s Pizza have forced both companies to change their profit sharing ratios to ensure their franchises are viable, after franchisees pleaded that their shortcuts on employee wages and entitlements had been their only hope of economic survival.
Most food franchise systems in Australia are declining in numbers of outlets and have been for several years.
The brands that are still growing are generally those that are expanding into overseas markets, usually under master license agreements, and advantaged by lower operating costs, especially in labour costs.
While both the Queensland-based franchise systems, Domino’s Pizza and Retail Food Group, are facing challenges in the domestic market, including franchisee disputes, both are continuing to enjoy relative success with their overseas businesses.
Interestingly, Domino’s Pizza and Retail Food Group are both listed on the Australian Stock Exchange with the pizza chain regarded as one of the best performers in terms of growth and shareholder investment returns.
Craveable Brands, the owner of the Red Rooster, Oporto and Chicken Treat brands attempted to float on the Australian Stock Exchange last year in a transaction that would have valued the business at up to $400 million.
Institutional investors had little appetite for the deal pitched by Archer Capital for the Sydney-based fast food company that was formerly known as Quick Service Restaurants.
The float idea was abandoned in July 2017 and there has been no trade buyer interest in an acquisition of Craveable Brands because of doubts about the franchise systems and scepticism about bullish prospectus forecasts.
Archer Capital had planned to expand overseas in New Zealand, China, the United States and the United Kingdom but the global push has not reached expectations and the store numbers for both the Red Rooster and Chicken Treat chains have fallen in the past six years.
Those doubts that have been given further credence by a submission from a group of Craveable Brands franchisees to the current Senate Inquiry into the Franchising Code of Conduct.
Michael Sherlock, the former Brumby’s Bakeries CEO, argues the franchising sector is at a crisis point because of a lack of leadership by the Franchising Council of Australia which he claims has been “taken over” by lawyers and consultants.
Sherlock believes the Franchise Council of Australia has failed to properly address issues in the industry and that its board should be overhauled with only current franchisors and franchisees as directors.
The board currently does not include any franchisees.
Sherlock argues directors on the board should have a minimum of five years trading experience with a proven ethical performance and a minimum of 30 franchise outlets.
Under Sherlock’s proposal, current chairman and former Federal Minister for Small Business, Bruce Billson would be forced to step down along with former chairman and legal advisor, Stephen Giles.
Sherlock sold Brumby’s to Retail Food Group in 2007 when the chain had 321 outlets.
The chain currently has around 240 stores and its decline and the relationship between the franchisor and franchisees was one of the reasons the Australian Senate established an inquiry into the effectiveness of the Franchising Code of Conduct.
Sherlock has been surprised at the Franchising Council of Australia’s denial of any problems in the franchising sector despite the scandals and disputes of the past two years.
He argues franchisors should be more transparent with fees and charges, including supplier rebates and the application of marketing levies.
Sherlock also believes franchise deeds should be registered in a similar manner to commercial leases.
Submissions to the Joint Committee on Corporations and Financial Services inquiry into the Franchising Code of Conduct closed last week and a report to the Federal Parliament is expected in June.