Why franchising doesn’t add up

The real problem in the franchising sector is not that there have been some snake-oil salesmen in the industry over the years, it’s that retail franchise systems didn’t keep up with the maths.

Franchising has a long history and in early times, it was a good way to expand a successful business concept, with a franchisee stumping up the capital cost of establishing a business in return for a proven brand concept, buying power and operational support.

The package, arguably, did meet the franchise industry’s claim that investors in franchise systems were less likely to fail than someone establishing a business from scratch by themselves.

The franchisor achieved operational scale and greater brand awareness, income from the sale of franchises, ongoing marketing and franchise levies and, in many cases, a slice off the top of supplier contracts.

All is good while the going is good, provided you weren’t seduced by flawed franchise systems like the Quiznos venture launched by Wendy’s, Kleenmaid or Pie Face.

The problem is the maths, which are usually more favourable to the franchisor. He has the sale price for the franchise rights upfront, regular franchise and marketing income, a share of the resale of a franchise or more if the site has been surrendered, while the franchisee is still liable for costs until a new investor signs up.

The franchisee, however, has to meet all of those obligations to the franchisor as well as rent and occupancy costs, staff wages and oncosts, products, energy bills, ingredients and services from franchisor-nominated suppliers and, in many cases, the finance costs associated with loans to fit out the store.

Then there is the maths of falling footfall and in-store sales and the increasing level of online transactions, new competitors and new customer engagement, such as UberEats and Deliveroo in the food categories.

Most franchisors of retail concepts did not set out to burn investors in their systems but they have failed to recognise that retail economics have changed markedly and margins and earnings are tight.

Many franchisors have failed to innovate or adapt their business models to meet the more challenging retail market conditions that in many cases have seen franchisees hand over what would have been their net profit from the business to pay the franchisor’s fees.

The result of the failure of retail franchisors to recognise the evident and increasing problems in their systems and to effect changes to ensure the viability of their franchisees – including not just cost profiles but also customer expectations – has resulted in damning reports by two Senate committees.

The Franchise Council of Australia has publicly welcomed the Senate report on the underpayment of wages and entitlements and the abuse of student work visas. This has already generated legislative changes and, should a Shorten Labor government be elected, will see wage theft laws introduced.

The FCA also publicly welcomed the Senate report tabled last week on the inquiry into franchising, while also trying to suggest that the sector’s problems were only related to a small number of systems – albeit some of the most feted in terms of industry awards.

The Senate committee noted that there were successful and profitable franchise systems that treated their investors fairly but it also found that some franchisors had systematically exploited franchisees.

The Senate committee found the existing regulatory framework and the Franchising Code of Conduct had not provided the assumed protection of franchisees operating small businesses against the abuse of contractual power by some franchisees.

This was a significant inquiry delivering around 70 recommendations with “substantial changes” to the Franchising Code of Conduct and the responsibilities and powers of the Australian Competition and Consumer Commission.

Recommendations addressed issues such as disclosure, franchise registration, supplier rebates, whistleblower protections, unfair contract terms, cooling-off periods, exit rights, collective action, dispute resolution, binding commercial arbitration, alignment of industry codes, churning, education and leasing arrangements.

If adopted in legislation, the recommendations will force significant changes in the franchise sector and increase costs to franchisors, likely resulting in some closing their systems.

But never mind the regulatory framework and enforcement, the real challenge for franchisors is to tackle the maths.

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