Franchise sector falls under regulatory scrutiny

Donut-King-OutletIt has been a trying month for Australia’s franchise sector, which has been hampered by a string of scandals and is now staring down the barrel of a Senate inquiry.

A spokesperson for Senator John Williams has confirmed that he intends to move a referral to hold a parliamentary inquiry into the franchise sector by 20 March, and that he is confident he has the numbers to move ahead with proceedings.

Attention from Canberra will shine further light over the industry, after a particularly rough few weeks and opens the door to the introduction of new regulations to curb what some say is widespread exploitation of franchisees and employees within some of Australia’s largest networks.

Retail Food Group (RFG), owner of Donut King, Gloria Jeans and Crust Pizza, has shed more than 40 per cent of its market value in the last fortnight, after announcing that it would close up to 200 stores and incur a $138 million impairment amid worsening trading conditions.

For the embattled franchisor, investor backlash, which could see it served with a class action lawsuit and parliamentary oversight, are just the latest battlefields, following a series of allegations of franchisee exploitation and employee underpayment within its network in recent months.

This follows wage underpayment allegations relating to 7-Eleven, Domino’s and most recently Caltex, which was the subject of a Fair Work Ombudsman finding last week that an “unsustainable operating model” was underpinning a non-compliance rate of 76 per cent within its network.

The petrol giant has decided to move away from franchising all together, announcing a plan to spend $120 million over the next few years transitioning to a company-owned service station model by buying out its 433 franchisees.

Meanwhile, dozens of franchisees within the Aussie Farmers Direct network have been left hanging after the business fell into administration last week, with reports that an over-eager expansion strategy put undue pressure on partners.

But the bite of consolidation may be the least of the franchise industry’s concerns, as the possible senate inquiry would examine whether the issues that have led to the woes of RFG and other franchisors are structural across the sector, and if further regulation is required to address the problems.

Franchising issues structural?

Brumby’s bakery joint-founder and industry veteran Michael Sherlock is still a believer in the franchise model, but says recent events have shown that many of the problems facing the sector – namely a lack of transparency and a power imbalance between franchisees and franchisors – extend beyond individual cases.

“The headlines in the last week were pretty grim,” Sherlock tells IRW. “I’m hearing reports that people trying to sell franchise businesses are being told by brokers not to bother – that’s appalling.”

Maddison Johnstone, a franchisee advocate who co-founded Franchise Redress and has most recently been investigating claims of exploitation within RFG’s network, says the issues facing the Australian franchise sector are varied, but are in many ways structural.

“There seems to be a focus on aggressive growth,” Johnstone says.

According to Johnstone, many franchisors have pursued growth at the expense of franchisees by flooding the market with stores and putting pressure on margins.

“It’s growth at all costs – that’s the kind of mentality these franchisors have, particularly if they’re publicly-listed.”

Franchise lawyer Jenny Buchan of the UNSW Business School points out that the type of growth franchisors pursue is also important, differentiating between revenue generated from the ongoing operation of franchisees (royalties) versus selling more outlets.

“You ought to be able to run head office operations from royalties. There should be some sweet spot you reach as a franchisor where you don’t have to continue to sell new opportunities,” she said, citing a reliance on new outlets as a trap that some major networks have fallen into.

Buchan, also a member of the ACCC’s small business and franchise consultative committee, adds that in the case of publicly-listed networks such as RFG, a conflict of interest exists between shareholders and network partners that’s driven an unsustainable model.

“The main danger is there are too many people trying to clip the ticket,” she explains. “[Franchisors] are trying to satisfy too many people…they have to satisfy franchisees, but they’re the easiest ones to run rough-shot over because the contracts are so onerous.”

The terms of reference for the possible parliamentary inquiry include assessing whether franchisees interests are adequately protected by franchise agreements and the franchise code of conduct, which the ACCC regulates.

RFG maintains that franchisees and shareholders are both “key stakeholders”, and does not see a conflict of interest, telling IRW in a statement that the performance of its network is intrinsic to its success.

“The performance of our franchise network is intrinsically linked to RFG’s success, and as such, is a priority for the business,” an RFG spokesperson said.

RFG has been undertaking consultation with its franchisee network to address questions about the long-term sustainability within its network and is finalising a review conducted by Deloitte into its business model.

“What we identified during this process is the need to improve partner support and simplify our business model,” a spokesperson said.

“We believe our partners have responded favourably to recent communications and efforts regarding cutting costs and increasing on-the-ground support, and we will continue to work closely with them to reduce pressure where we can.”

Getting to the bottom of wage scandals

Wage underpayment scandals, which have been a problem in recent years and have already been the target of new regulation, will also likely come up in the Senate’s inquiry.

But there are those who argue that wage underpayment scandals are squarely on the shoulders of franchisees.

Bob Beaumont, executive chairman of Beaumont Tiles, who has backed the model and will increase the number of partners in his own network in the coming years, says the primary issue facing the sector are “unscrupulous franchisees”.

“Some unscrupulous franchisees bleed about being forced into [underpayment] – no-one is forced into it…[they] can’t go and blame anybody but themselves because they made that decision,” he says.

Beaumont says that legislation passed in the wake of underpayment scandals to make franchisors more accountable for underpayment within their networks is unfair and impractical.

“It’s going to be a real challenge for the franchise industry to be the policemen for the government,” he says.

But Buchan argues that the story of franchisees who have underpaid employees runs deeper, and that the legislation is being worked around by franchisors.

“There was only going to be underpayment if the franchisees can’t afford to pay properly,” she says.

“There are franchisors that have been trying to get their franchisees to sign what really amounts to waivers, saying they will take full responsibility for any underpayment.”

Complex contracts lead to unfavourable outcomes

According to Buchan and Johnstone, a significant problem currently facing the sector are franchise agreements themselves and a general lack of transparency from franchisors. It’s led to franchisees getting in over their heads, spurring underpayment and defaults.

“Franchisees are signing into agreements they don’t understand,” Johnstone says. “Some have sought legal and financial advice and have been told not to do it but do so anyway.”

“It’s a big problem…there’s ruthless recruitment of franchisees – lots of brands will say that it doesn’t matter if you have no experience.”

Buchan concurs, saying that a lack of franchise lawyers in Australia has left buyers unable to conduct “proper due diligence” on purchases, and that the complex nature of agreements.

“We need to have a look at the way franchising is regulated, the [code of conduct] in its current form doesn’t hit the mark. It gives the franchisor too little responsibility,” Buchan argues.

Buchan believes legislative change is ultimately needed to increase transparency and franchisee protections under the code.

“Franchise agreements and disclosure documents should be on the public record,” she says.

Sherlock also believes changes to the code – which the proposed inquiry would examine – are necessary. Franchise buyers aren’t able to adequately access information related to how franchisors spend marketing budgets or what fees, renewals and sales expectations are.

“Franchisees need to be registered like commercial leases or there need to be disclosure documents to [ensure] transparency,” he says.

Franchise Council of Australia (FCA) executive chairman Bruce Billson says the franchise code of conduct is “comprehensive” but believes it could be strengthened to more strongly encourage franchisees to obtain legal advice before entering into an agreement.

“If you feel you can’t afford to get specialist advice about such an important decision, you can’t afford to invest in a franchise business,” Billson tells IRW.

“The FCA sees merit in examining whether this encouragement should be beefed up to be more insistent or perhaps for first-time franchisees, an obligation to ensure that every franchisee who buys a franchise business does so with their eyes wide open and is fully cognisant of the risks and rewards involved.”

But Sherlock has also called out the FCA, arguing that it has provided inadequate leadership amid scandals within the sector.

“Eighty per cent of the franchisors are doing the right thing but the FCA isn’t speaking up for that. They’re trying to speak up for everyone,” he says.

Sherlock has called on the FCA to overhaul its board and membership policies to ensure that only established franchisors and franchisees can serve on the board.

“If the FCA says, ‘Well, we’re doing a great job look at the health of franchising in Australia’, they can’t say that – it’s time for reform,” Sherlock contends. “You go to any of their meetings and they were dominated by lawyers, accountants and consultants.”

Responding to Sherlock’s criticism, Billson said that the FCA regularly consults its members on appointment processes, and as recently as last December approved a series of initiatives addressing franchisee, franchisor and supplier engagement, alongside member standards and system accreditation.

“FCA membership opens up a range of different ways of engaging with peers and the broader franchise community and these are being constantly enhanced,” Billson said.

“Currently, the board is elected by the membership and with the exception of me who has been appointed as an independent director and the executive chair with a clear mandate to implement change and reform.”

 

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