In her lengthy expose in the Saturday Age 27th March 2021, investigative journalist Adele Ferguson cogently laid out the concerns currently being expressed by the franchisees of Laser Clinics Australia (LCA). LCA was purchased in August 2017 by the US private equity firm, KKR.
The LCA issue has arisen very soon after the announcement that the Retail Food Group (RFG), a publicly listed and high-profile franchisor, has been charged by the ACCC with unconscionable conduct.
It comes after Holden, while exiting Australia, treated its dealer franchisees and the Government in a manner which drew widespread condemnation. Last year, Honda unilaterally changed its business model reportedly leaving around thirty of its Australian franchisees without a business.
Unpleasant change is sometimes necessary, what matters is how it is managed, and the pain shared.
History is now littered with the train wrecks created by rogue franchisors.
Who can forget the 7-Eleven underpayment scandal and the Pizza Hut five-dollar pizza debacle? In the Pizza Hut case the franchisor insisted franchisees sell loss leader pizzas, below cost and against their wishes, many lost their businesses.
In 2018, on the back of non-stop scandals, there was yet another Parliamentary Joint Committee (PJC) Inquiry into Franchising. There have been seventeen previous Parliamentary Inquiries. This Inquiry received well over four hundred submissions mostly from franchisees and mostly in confidence.
The Inquiry 350-page report concluded that there was a massive and unacceptable power imbalance in the sector. The Inquiry reached its conclusions unanimously and it made more than 70 recommendations.
To this point the Federal government has done virtually nothing to address the primary and very serious power imbalance problem identified in the report. The Government approach has been to tweak the disclosure documentation franchisees receive before they sign up and significantly increase the potential penalties for breaches of the code.
The superficial changes announced by the Government will have little or no impact on the success of franchising as a business model.
This is because in the case of disclosure, Franchisors can and frequently do, unilaterally change the agreement by various means after it has been signed. So, the due diligence is consigned to the wastepaper basket.
In the case of higher penalties, they are of academic interest if you have already lost your business and, quite likely, your house. There is also a potentially perverse effect of a heavy fine in that it might undermine the viability of the franchisor and by extension the franchisees in that system
Franchisees have virtually no rights and they are incredibly reluctant to make a fuss. It only occurs out of utter desperation. The protections afforded to franchisees include the requirements that franchisors act in good faith, and not engage in unconscionable conduct. Under the heading of “good luck with that” these are ill defined ideas and must be established through litigation.
Franchisees are very rarely in a financial position to assert their rights through these mechanisms. Pizza Hut franchisees spent multiple millions pursuing their rights and found out the hard way.
How can franchising be fixed and why does it matter?
Firstly, Franchising is a massive sector, it represents nearly 10 percent of Australia’s GDP.
Where a business concept requires a wide geographic presence and serious investment, franchising is the obvious answer. Not only can new commercial ideas get access to capital provided by franchisees, in most cases franchisees also provide the bulk of the management workforce. Franchisees usually have their houses on the line, so they are remarkably self-motivated.
On the surface, it is a great model. Unfortunately, the devil is in the detail.
The sector is regulated by a Code of Conduct. The underlying assumption of the code is that it is governing a business-to-business relationship where one party is in the stronger position.
The underlying and indisputable reality is that a franchise enterprise is a single business with two stakeholders. Franchisors provide the business idea and the brand name and sometimes a worthwhile system.
Franchisees, on the other hand, provide the investment capital. Franchisees also provide their labour. They unarguably assume the vast bulk of the risk which is laid off to them from the franchisor.
They sign on to the lease obligations, they buy the necessary equipment, and they employ the staff. By comparison franchisors often have little capital invested, low overhead costs, and are able to largely insulate themselves from the risk.
It is not hard to argue that the franchisee contribution to the sector is way more important than the commercial ideas generated by potential franchisors, most of which are not rocket science.
The clue to fixing franchising lies in the simple recognition of the reality that franchising is a joint venture business model.
This proposition was recognized by the PJC Inquiry when it reported to Parliament in 2019. Along with the recommendation that, the capitalization contribution of franchisees, needed to be examined as a basis for redressing the disgraceful and unsustainable imbalance of power that now exists.
The ‘Code of Conduct’ is next to useless in protecting the interests of franchisees.
It needs to be replaced with legislation that treats franchisees with the respect they deserve, as the providers of well over eighty percent of the investment in the sector, and the bulk of the managerial oversight.
Such legislation would give franchisees the influence in the running of the business, that they need and deserve, to protect their interests. Franchisees need and deserve a say in the appointment and reappointment of Boards and CEOs.
They need a say in the transfer of the brand and system to a new owner, potentially, including a right of veto. They need a formal say in the competitive strategy especially how it supports their need to maintain profitability.
All of these rights exist for shareholders under the Corporations Act.
Franchisees should not accept anything less. It is not a simple fix, but it is critically important.
In the end a reformed franchising sector will root out the wrongdoers and benefit both parties to the franchising relationship, but also the financial institutions who are being asked to fund franchisees in a sector with known problems.
This is not to mention the employees of franchisees and the broader community. The laissez faire arguments of the franchisor lobby just doesn’t cut it.
As of this week, the sector has a new Minister in Stuart Robert.
We welcome his appointment. As the incoming Minister, he has the opportunity to make a real difference.
For everyone’s sake this scandal ridden sector needs a serious rethink. We look forward to working with the Minister to get the reform process back where the PJC Inquiry intended it to be.
Mike Sullivan
Chief Executive Officer
Australian Association of Franchisees