Franchising

What’s going wrong with Australia’s franchises?

The Conversation /

Caltex service station

Source: AAP/Paul Miller

By Jenni Henderson, The Conversation

Two well-known franchise businesses in Australia are in trouble this week. At the time of year when businesses usually report their half-year financial results, petrol retailer Caltex announced it was stepping away from a franchise model just as a Fair Work Ombudsman report called its operating model “unsustainable”.

Retail Food Group, which owns a number of popular chains including Gloria Jeans and Donut King, blamed intense competition, landlord rents and labour costs for its lack lustre business results. But the group has also been plagued by allegations of exploitation and underpayment of workers in media investigations.

According to the Franchise Council of Australia, franchises like these employee a lot of people. Approximately 79,000 operating franchises in Australia employ 470,000 direct employees.

But over the past few years there have been a string of scandals engulfing franchises, including retailers 7-Eleven and Caltex, and takeaway food businesses Domino’s and Hungry Jacks.

So we’re answering your questions about the franchise model and why these problems keep coming up.

Is the franchise model itself bad?

Short answer: not necessarily, it depends on the franchise relationship.

A 2012 study from the US actually found that franchise businesses have better rates of compliance with industrial relations law than comparable independent small businesses.

Other research from France shows franchisees benefit from marketing, research and development and training offered by company owned stores.

Researchers Lorelle Frazer and Maurice Roussety argue that:

“Franchisees have been found to perform better than company-owned stores. Franchisees have skin in the game and are motivated by the bottom line of their stores.”

In fact a 2010 report from the Fair Work Ombudsman found franchisees that received industrial relations support from their franchisor were more likely to abide by the law than other employers.

But a group of researchers have pointed out that this support differs between large and small franchises. They say, as franchises mature, franchisor control over key processes in outlets tends to increase. But this doesn’t always extend to industrial relations.

How does a franchise agreement work?

Short answer: franchisees pay to become part of the franchise but they are often too optimistic about the financial risks involved.

A franchise agreement defines the rights and obligations of both parties. The franchisor usually charges the franchisee an upfront fee, an ongoing fee (such as a percentage of revenue), or a combination of the two.

Associate Professor Jenny Buchan describes it as a:

“…complex, expensive, purchase that will commit the franchisor and franchisee to a business relationship with each other for several years. The franchsior has usually sold many franchises, and signed many franchise agreements but buying a franchise is something a franchisee may do only once in their life.”

The law requires that franchisors provide a disclosure document complete with the information needed to make this decision. These laws assume franchisees will make a rational decision but research shows they are unrealistically optimistic about risks of setting up their business, even after those risks have been disclosed to them.

Who is accountable for what?

Short answer: franchisors are accountable to customers (and to shareholders), franchisees are accountable to employees (and the law).

If a customer is unhappy with what they’ve bought from any of the franchise outlets then they will take it out on the brand overall, by going to another business. So in that sense the franchisor is accountable to customers.

This means franchisor usually control anything related to their products, such as price, applying to suppliers and health regulations.

But researcher Jenny Buchan makes the point that venture capital firms buying up franchises means that franchisees now are seeing franchisors with less of a focus on quality goods and services:

A franchisee might buy their business from one franchisor, but, following sale of the network, have to deal with a new franchisor with different motivations. Venture capitalists and public companies have shareholders who prioritise dividends and capital gain ahead of ongoing success of franchisees’ businesses.

When it comes to the day-to-day operations with employees, this is the franchisee’s remit. It’s the franchisee who is legally accountable and is usually investigated and fined for any breaches.

This can sometimes leave franchisees in a tricky position of not being able to set the price or control quality. The franchisee may have to adjust their employees’ wages in order to make a profit or break even.

What happens when things go bad?

Short answer: the government passed a bill to make it clear that franchisors can now be punished as well as franchisees, but there are problems with the law.

In September 2017, a bill to amend the Fair Work Act passed parliament, designed to hold franchisors accountable and punishable for breaches of industrial law.

But as academic Louise Thornthwaite points out, workers may still face obstacles in successfully pursuing their entitlements:

“Many workers simply do not know their wage entitlements or how to identify them. Also, proceedings in the Fair Work Commission take time, and are costly, unless a worker belongs to a union or represents him or herself.

She also notes the evidence needed to make a case, such as records like payslips, are often missing in action or deliberately falsified.

There’s also an imbalance because franchisors are typically well-resourced and there are many big law firms whose names are on franchise agreements and who run law suits for franchisors.

But research from the CPA shows franchisees are more likely to seek advice, if at all, from suburban solicitors and accountants.

This article was originally published on The Conversation. Read the original article.

NOW READ: As Retail Food Group prepares to close hundreds of stores, is the reputation of franchising dead?

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  • John Hutchinson

    The problem is simply how they are Valued. The maximum anyone should have to pay for a franchise that is stuck in the middle of shopping centre is around $80,000.00. It erks me seeing the lady from Boost Juice telling us what a great business she has because unsuspecting Franchisees drop about 3 years worth of Salary into her purse every time they buy one and then wonder why they aren’t making any money.

    Just looking at the numbers quoted, suggests that each Franchise employs on average 6 employees. At an average of say $25000.00/employee/annum that is $150,000/year in Labor Costs without penalties etc. add $100,000/annum for Rent to keep Westfields happy add Franchise Marketing and Licencing costs, $30k – $80k/annum…that’s a lot of Cakes, Coffees and Juice to sell, just to meet “Sunk Costs” without buying inventory. This is excessive considering it is no more than a Small Business run by a Mum and a Dad. To get a 10% return on Capital, you would need to be having sales in the Millions to cover all that or 166,666 Cups of Coffee a year (@$6.00 a pop), 3205/week, or 460/day, just to cover overhead. They don’t add up.

    The only good thing about all this is that RFG are experiencing what most of their Franchisees experiencing and that is that their Business isn’t valued at the same price they paid for it.

    • Rohan Baker

      True, but when purchasing any business, whether it’s a franchise or not, you’d be a fool not to do due dilligence. Talking to other franchisees and letting an accountant look over the figures would be a good start.

      Yet I’ve seen that first hand with friends and associates who don’t do their homework first and then dive in with their life savings. In one case, a friend was were warned not to touch the existing franchise as the accountant said the numbers didn’t stack up. Not even close. But she ignored them and yes, went belly up within 1 year.

      No-one is coerced into buying any business and they see the franchise model as a sure bet and that it takes away a lot the planning/business model input required. But you can’t make that decision based on feelings of warmth and fuzzyness. You have to step back and look at it ruthlessly, then be prepared to walk away.

      • John Hutchinson

        I concur totally with you Rohan. I took all of 5 minutes to do those figures just off the top of my head and I cannot understand how people can fall into them…except that they are marketed directly at “Mums & Dads” and there must be a strong reliance on the “naivety” and inexperience of those people, to sell at such inflated prices.
        Glossy brochures and “100%” support promises make it just that much easier to suck people in. It wouldn’t be hard to see the line-up waiting at Boost Juice to think it’s a goldmine, but I reckon you would be lucky to clear .80c per cup, given that it seems to take about 6 minutes for them to prepare your drink.

        • Garry

          The sad reality is that mums & dads have to rely on their accountant for most of the due diligence and the fact is that the quality of public accountants is now so poor most don’t have a clue. Mums & Dads don’t have a hope when even their trusted advisor is a dope.

  • Tan

    Small business Franchise seems to work better in low cost countries such as USA, Singapore. Etc . Cost of business in Australia is simply getting to high and benefits tend to lean towards employees than small business. Consessions should be given to small businesses to reduce costs .

    • John Hutchinson

      I think that is an excellent observation Tan.