Franchising is a common form of contractual relationship. Australia has the highest per capita number of franchise outlets and it is the fastest growing form of retail in the land. Recent data indicates that Australia has 1160 franchising networks, accounting for 79,000 outlets which employ around 500,000 people. In spite of the popularity of US chains such as McDonalds, Hungry Jack’s and KFC, 86 percent of franchise networks in operation are home-grown.
If you’ve purchased any fast food from a chain store, the chances are that it was from a franchise. Although we often associate franchising with retail and services, especially fast food, notable examples can be found across different sectors, including:
- Food Retail: Baker’s Delight, Brumby’s Bakery
- Cafés and Fast-food: Boost Juice, Domino’s Pizza, Donut King, Fergusson-Plarre Bakery & Cafe, Gloria Jeans, Grill’d, La Porchetta, Michel’s Patisserie, Mr Whippy, Muffin Break, Oporto, Pizza-Hut, Red Rooster, Subway, Tasty Trucks, Urban Burger
- Convenience Stores: 7-Eleven, Ezi-Mart
- Financial Services: Aussie Home Loans, Choice Home Loans, Mortgage Choice
- Home and Do-It-Yourself (DIY): Clark’s Rubber
- Personal Services and Home-based Services: Care-care, Chem Dry (carpet care), Home Fresh (produce delivery service), Jim’s Mowing, Kumon Schools & Tutoring, Poolwerx, Tint-a-Car, VIP Home Services
- Retail: Beds for Backs, Bedshed, Bevmarks, Snooze,
In theory, franchising should benefit both parties. The franchisee benefits from a tried and tested business model while the franchisor gains access broad markets without significant capital outlay and obtains the required revenue to provide services to the network. Ideally, franchising should be a ‘win-win.’ However, recent revelations suggest that, at least in some sectors, franchising has become a win-lose, where the loser is the franchisee.
Critical success factors for a franchise network include:
(a) Sufficient income for franchisees to achieve a reasonable return on their investment
(b) Sufficient return for the franchisor to retain their interest in managing the franchise
(c) Sufficient revenue for the franchisor to fund the support services offered to franchisees (e.g. R & D, new product development, marketing and promotion, administration, IT support, supply chain management, training)
In practice, a variety of franchising models operate. Under one arrangement, franchisees pay a royalty fee (typically a % of sales) to the franchisor. A different model occurs when franchisees pay no fees, but the franchisor collects a rebate from suppliers who provide goods to outlets in the network. Under this approach, franchisors may need to carry out checks to ensure that franchisees are obtaining all their supplies through the approved channels. In yet another model, the franchisee pays a fee based on services provided. Yet another approach is to use a combination of all three methods. For example, McDonalds sub-leases properties to franchisees, takes a royalty on sales and charges outlets for the supply of approved foodstuffs.
A Senate Inquiry into the Operation of the Franchising, currently hearing evidence and due to report later this year, is shining a spotlight on a ‘greedy corporate culture’ that all too often fails franchisees by subjecting them to a ‘brutal business model’ with high fees, unrealistic sales targets and severe penalties for franchisees wanting to exit the network. This combined with deficient and ineffective regulation has left many franchisees vulnerable. In extreme cases, some franchisees have lost their businesses or left bankrupted.
The sheer volume of scandals surrounding franchising has left number of commentators questioning whether franchising in Australia is at a ‘turning point’. Some of the allegations that have been levelled against franchise networks include:
Systemic underpayment of wages and exploitation of migrant workers
A team of journalists from the ABC TV’s Four Corners and Fairfax Media first broke the story of Australia’s largest convenience chain store, 7-Eleven, and its systemic underpayment of wages in 2015. Critics have pointed out that 7 -Eleven’s business model which requires franchisees to pay 57 percent of its profits to Head Office (well above industry averages) is not sustainable. Of the 43 percent profit retained, the franchisee is obliged to pay for wages, superannuation, Work Cover, overheads, cleaning, store supplies, merchandise including stock losses, business licenses, taxes, loan repayments and “miscellaneous expenses”. In effect, the business model is flawed and forces franchisees to cut corners and underpay wages simply to stay afloat.
Many 7-Eleven employees were foreign students, living and working on student visas. If they complained about wage underpayment, they were often threatened with deportation. The investigation also revealed that 7-Eleven was doctoring timesheets, rosters, company financial statements and compliance documents.
Separate investigations, also carried out by the Fairfax media team revealed similar issues in other franchise networks. These stories have triggered a Fair Work Ombudsman’s investigation into wage fraud and ultimately led to the Senate Inquiry into franchising.
Prohibitive terms of trade
Another problem highlighted by the Senate Inquiry is that franchisees are locked into purchase agreements, often at prices that are well above market rates. For example, tobacco franchisees have complained that they are paying prices $30 -40 per carton above those paid by major grocery stores such as Coles, which means that they are uncompetitive and lose customers. Such arrangements contribute to channel conflict. Other franchisees point out that even when the franchise network changes suppliers leading to inferior quality products, they remain locked into prior agreements. Certain Michel’s Patisserie franchisees complained when Head Office shifted to providing frozen goods, often of poor quality which was contributing to customer complaints and a loss of patronage.
Failure to deliver promised support services
Franchisees report a litany of issues – complaining about the franchise network’s failure to deliver promised services such as reduced support from head office, too little product innovation, too little advertising. Furthermore, operators who have been trading at a loss, or have been bankrupted, report that they face punitive exit clauses.
In light of the public scrutiny and the negative publicity surrounding franchising, some operators have decided to get out of this mode of operation. For example, Caltex has announced that it plans to fade out all its petrol station franchises within two years.
Read the following article and consider the discussion topics below:
Dancker, S., Latimer, C and Hatch, P., “They live like kings, we work like slaves': Is franchising at a turning point?” The Age, 3 March, 2018 (also published in the Sydney Morning Herald)
- Have you patronized a franchised outlet recently? Did you know that the outlet was part of a franchise at the time of making a purchase? If yes, did this knowledge influence your purchase decision. Describe your experience as a patron of a franchised outlet.
- Discuss the advantages and disadvantages, to the franchisee, of being a member of a franchise network.
- If you were given the opportunity, would you be prepared to enter into a franchise agreement? Why/ Why not?
- What advice would you give to a friend who is considering entering into a franchise agreement?
- Comment on the claim that franchising is at a turning point.
Further reading and useful links
Adele Ferguson and Mario Christodoulou, “The Domino’s Effect,” Sydney Morning Herald, 2017 (For interested readers, this article provides a detailed description of the fees franchisees pay to the franchisor)
“7-Eleven Revealed” Sydney Morning Herald Interactive, [a series of short videos and background notes on the joint investigation by Four Corners and Fairfax Media into systemic underpayment of employees and exploitation of migrant workers; the 2015 story that first highlighted serious problems within the franchising industry and prompted the Senate Enquiry]
The Franchise Council of Australia (FCA) – peak professional association
“Franchising Trends”, The Franchise Show, [Short Video Segment, outlining the principal growth areas in franchising]