Exposing the franchising trap

Before exposing the franchising trap, it’s useful to set out what good franchising is all about. To begin with, good franchising can and does translate into good business practices where both the franchisor and franchisee cooperate for mutual success. A successful franchisor will give rise to successful franchisees in the same way that good franchisees help drive the franchisor’s success.

There are a number of key elements to good and successful franchising. To begin with, a good and successful franchisor is one with a proven business system and track record. A well financed, longstanding and experienced franchisor provides leadership and offers prospective franchisees an established way of doing business that allows the franchisee to succeed and prosper.

Clearly, not everyone will be a successful franchisor. Like anything, there are those who set themselves up as franchisors who are not cut out to be franchisors and are destined to fail. Let’s make no mistake – franchisors can and do fail. That leaves a financial mess and a trail of stress and misery for the franchisees that have invested in the franchisor’s “system.” Not only are there those who shouldn’t be franchisors, there are those franchisors who turn out to be just rogues. Those rogue franchisors simply take the franchisee’s money and offer little real support or undertake a pattern of conduct designed to “fleece” the franchisee.

The rip off by rogue franchisors can take many forms. For prospective franchisees loud alarm bells should start ringing if the franchisor requires the franchisee to buy products from the franchisor or a franchisor’s associate. The danger is that the products are sold with an inbuilt “cut” for the franchisor. Unfortunately, the “cut” or rebate to the franchisor may be exorbitant or unjustifiable. This, in turn, leads to the franchisee paying a much higher price than the franchisee may be able to get by independently sourcing the product.

The higher price paid by the franchisee to the franchisor or associate may simply make the franchisee uncompetitive in the market place.

Take for example ice cream retailing. If an ice cream retailer is selling an ice cream cone for $1 and a competing ice cream franchisee is selling the same sized cone at $2.50 because of the exorbitant price paid to the franchisor or associate for the cone and ice cream it doesn’t take too long for the franchisee to go out of business.

Obviously, franchisees need to steer well clear of franchisors who require the franchisee to buy products from the franchisor or associate. That is, unless the franchisor can demonstrate that the “buying power” of the franchisor means that the franchisee will get the products at a much lower price than if the franchisee independently sourced the products from another supplier. Therein lies one of the elements of good franchising.

A good franchisor will do everything it can to place franchisees in a strong competitive position. That includes assisting franchisees in getting a price advantage for products to be sold in the franchised business either through using the collective buying strength of the franchisees when negotiating prices with suppliers, or by the franchisor gaining efficiencies by making the product itself at a much lower price than other suppliers.

A good franchisor will also extract the best rental deal for franchisees. A good franchisor will use its expertise to go in strongly when negotiating rents with landlords, especially shopping centre landlords.

More alarm bells should ring for potential franchisees where the franchised business has been resold by the franchisor a number of times. This repeated “reselling” of a franchised business can indicate the business is inherently a dud or worse the franchisor is engaging in the practice of “churning.”

Churning arises where the franchisor sells a franchised business to franchisee A for, say $100,000, who subsequently fails or is driven out of business by the franchisor after which the franchisor buys the assets of the failed franchised business for say $20,000 and then “resells” the franchised business to franchisee B for say $100,000. You can see in this simple example that the franchisor is making up to $80,000 each time the business is “resold.”

It doesn’t take much to realise that rogue franchisors can make a lot of money from “churning” unsuspecting franchisees who can lose everything along the way.

So what can be done? First, we need the ACCC to get off its backside and weed out these rogue franchisors. The ACCC has power under the Trade Practices Act to shut these rogues down. Yes, the ACCC has fired the odd angry shot, but that’s just not good enough. The ACCC takes far too long to investigate franchising related cases and only rarely pursues rogue franchisors through the Courts. It’s a case of too little, too late by the ACCC in franchising matters.

Of course, the ACCC could always benefit from getting additional power to help weed out the rogues. In this regard, we can start by ensuring that there are financial penalties for breaches of the Franchising Code of Conduct under the Trade Practices Act.

The Franchising Code of Conduct sets out various standards of franchisor disclosure and conduct. In stark contrast to the competition and consumer law parts of the Trade Practices Act where there are serious financial penalties for breaches of those laws, there are currently no financial penalties for breaches of the Franchising Code even though the Code is supposed to be a mandatory code under the Trade Practices Act. Without financial penalties for breaches of the Franchising Code, rogue franchisors are easily tempted to cut corners and not fully comply with the Code.

A statutory duty of good faith would also set out clear ground rules by which all franchisors are expected to comply. Good faith represents good franchising. Good franchisors will act fairly, reasonably, honestly and cooperatively simply because that’s the essence of both good faith and good franchising.

A statutory duty of good faith needs to be backed by targeted additional disclosure that requires franchisors to disclosure the actual level of rebates they get from selling products to franchisees. Meaningful disclosure is also required to expose “churning.”

Through appropriate leadership by the Federal Government and Senator Nick Sherry, the new Federal Small Business Minister, we can protect the good name of franchising and stamp out the rogue franchisors. If Nick Sherry fails to act (much like his predecessor Craig Emerson) then the door will be wide open for the States to fill the vacuum with their own legislation and action.

The South Australian Labor Government is already showing the way and is to be applauded for standing up for franchisees and for a better franchising sector.