As the bricks and mortar retail sector continues to struggle with poor sales and falling profits, there’s growing concern about the health of the Australian franchising sector.

Shaky ground

As consumer and business confidence remains shaky and shopping centre rents remain high there’s a real danger that we will see more and more franchisors and franchisees being put into administration or liquidation.

With nightly news reports about major retailers struggling or going out of business, it’s inevitable that franchisors and franchisees will also struggle or go out of business. Not surprisingly, we are already seeing franchise systems where growing numbers of existing franchisees are trying to sell their businesses.

These are your mum and dad franchisees that have their life savings tied up in the franchised business. If they can’t find a buyer for their business or if their franchised business fails, then they lose everything.

There is no shortage of horror stories where the poor mum and dad franchisee have lost everything. Sometimes even the poor franchisor loses everything. Here the moral of the story is that franchised businesses fail just like any other business. And in the tough times we are currently facing it won’t be surprising to hear of more franchising failures.

Franchisors and franchisees should never fool themselves into thinking they can’t fail or are less likely to fail. While for many people franchising is seen as glamorous and rewarding, the reality is that sometimes franchising can become a nightmare.

Put simply, franchising is not for everyone. Some franchisors and franchisees should never have gotten into the franchising game. Sure, there are successes, but those successes are of little or no comfort to those franchisors or franchisees that have ended up losing everything.

Given the tough economic conditions it’s hardly surprising that some franchisors and franchisees are going to fail. That’s why anyone wanting to invest in franchising needs to do a great deal of homework. The days of a person going to a franchising expo and immediately signing up to become a franchisee should be long gone.

For the potential franchisor it’s obviously critical to be adequately funded. With the major banks pulling back from lending to businesses or inflating interest rates on business loans, potential franchisors need to be sure they can get access to affordable finance.

A lack of affordable finance is the kiss of the death for not only the potential franchisor but for all those existing franchisors out there struggling to refinance business loans with the major banks.

Not only are there growing numbers of franchisors who are feeling the credit squeeze by the major banks, but there are franchisors that don’t have the critical mass to self fund their expansion. That will inevitably put pressure on those particular franchisors and obviously potential franchisees should avoid those franchisors.

A lack of affordable finance is also hitting franchisees very hard. With many franchisees paying inflated retail rents in shopping centres that were set in the pre-GFC days, it’s clear that for a growing number of franchisees it’s even a struggle to fund their everyday business needs.

With the many pitfalls associated with franchising, it’s clear that those thinking of being franchisees should be careful to avoid franchisors that are not financially secure. A reasonably good indication of the franchisor’s financial viability is to look at how many franchised outlets with the franchisor’s name are on the market.

The more franchised outlets on the market as a result of existing franchisees trying to sell their business, the more alarm bells that should be ringing for the potential franchisee. The real danger here is that existing franchisees are rushing to get out before it’s too late.

We should never forget that generally few people rush to get out of something that’s making them lots of money. That’s why we need to ask lots of questions if there are lots of existing franchisees trying to get out. 

Any potential franchisee should go have a chat with lots of ex-franchisees. Obvious questions include why did the ex-franchisees leave the franchise? Would they buy back into the franchise? How supportive was the franchisor? Obvious alarm bells should be ringing where ex-franchisees can’t be located or whether they are too glowing in their feedback. If the franchise was that good why did they leave?

Inevitably, there are pitfalls in all franchises and it’s important to get the full picture regarding any problem areas so that any potential franchisee can make an informed decision. There’s no point buying a franchise if you end up with a dodgy franchisor.

Another danger area for both potential and existing franchisees is where the franchisor requires franchisees to buy goods or services from particular third parties especially if the third parties are related to the franchisor, or the third parties charge inflated prices for the goods or services. The real danger is that the inflated prices for the goods or services will, in turn, inflate the price of products sold by the franchisee. That makes the franchisee uncompetitive.

Just imagine being a franchisee who sells ice cream and the franchisee is required by the franchisor to buy ice cream ingredients from a third party that charges high prices for the ingredients. Of course, the franchisor will claim that the ingredients will be of “superior” quality but what if the franchisee’s ice creams are then significantly overpriced as compared to competitors?

What if you have McDonald’s franchisees selling ice creams at 50 cents each and the ice cream franchisee nearby sells them at $3 each. You guessed it. You might find many of those uncompetitive ice cream franchisees trying to sell their business or simply failing.

As with any business opportunity the level of investment in that opportunity depends on the level of confidence that investors have in the opportunity. With franchising there’s a very real danger that the tough economic conditions and the growing number of franchising failures will scare off potential franchisees.

In franchising there’s also the very real danger that potential investors lack confidence in the current regulatory environment. In fact, while there’s a Federal Franchising Code of Conduct that’s there to regulate the conduct of franchisors, the Federal Franchising Code is not backed by direct financial penalties for breaches of the Code.

Yes, that’s right. There’s a Federal Franchising Code that’s there to try and protect franchisees but the Federal Labor Government has repeatedly failed to back the Code with direct financial penalties where franchisors breach the Code.

We know there have been breaches of the Federal Franchising Code, but previous Federal Small Business Ministers like the singing Craig Emerson and the equally forgettable Nick Sherry have refused to reinforce the Franchising Code with direct financial penalties.

Let’s hope that the latest Federal Small Business Minister, Brendan O’Connor, follows the excellent lead of the South Australian Small Business Minister, Tom Koutsantonis, and moves quickly to impose direct financial penalties for breaches of codes of conduct such as the Federal Franchising Code.

Comments on this post close at 8pm AEST

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11 comments

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    • Mahhrat says:

      07:48am | 26/09/12

      I read this article, and I want to understand it, but all I can see is FRANCH.

      Franch franch franch franch franch.  Over 100 matches for franch exist on this page. 

      FFFFRRRRAAAANNNCCCCHHHHHHHHHHHH.

      I think you broke my brain, Franch - CRAP, Frank.  Sorry mate.

    • Testfest says:

      11:00am | 26/09/12

      Ha ha - I had the exact same reaction!

      I did a find word search for “franchis” and watched the screen just light up with yellow highlighting…

    • TrueOz says:

      08:43am | 26/09/12

      ...and right along with penalties for breaches of the Code by franchisors, there needs to be a proper regulatory framework (with penalties) put in place to deal with the flame fanning practices of the low-life, blood-sucking lawyers which tend to inhabit the franchise space. I’d guess that 80% plus of disputes between franchisors and franchisees would simply go away if these professional parasites were removed from the process. There is no reason why the Code could not mandate mediation and provide for enforceable undertakings by each party to a dispute. As it stands, the primary beneficiaries of the Franchising Code of Conduct are the parasitic lawyers, all of whom get paid regardless of the legal outcome, and without regard to the misery and havoc that they wreak in the lives of those that they are supposed to be representing. Until such time as the Code provides a compulsory way for franchisees and franchisors to resolve disputes outside of our adversarial court system, this problem will NEVER go away.

    • Bomb78 says:

      09:09am | 26/09/12

      I worked on the inside a a high profile, outwardly successful national franchisor for five years, leaving last year. Despite multiple listings in BRW and plenty of awards, the whole business was held together by sticky tape.
      The staff turnover in the national office was about 50% a year. About 1 in 6 of the franchisees were technically insolvent - they couldn’t pay their franchise fees, rent, supplier accounts on time or at all. As the Financial Controller I was not allowed too hard to get the money, as having franchisees goes bust looked really bad.  The CEO even balled me out in front of all the staff when I mentioned the oncoming global recession, later called the GFC, six months before there was a buzz word for it. We weren’t prepared for it, we didn’t counsel franchisees to hold off on major expansions of their business, and as a result franchisees suffered a lot of financial pain, and some major failures occurred.
      My tips if you are looking to invest in a fracnhise business: ask the franchisor to explain the strengths of their business without using the latest fad management speak. Find out the capitalisation of the franchisor; what percentage of turnover goes into support wages (not wages to the CEO, directors and their associates); if they pay large amounts to contractors or consultants, find out who they are and what they do; do your due diligence thoroughly, including the audits of their marketing or cooperative funds - franchisors aren’t required to release balance sheets for their marketing funds, but if they won’t show you an audited balance sheet, run for the hills. And if you can’t get your bank manager to finance it, don’t do it.

    • iansand says:

      09:52am | 26/09/12

      A lot of that stuff should (emphasise should) be contained in the disclosures required by the Franchise Code of Conduct.

      If it is not, or the material is incorrect, you should (emphasise should) be able to sue the franchisor for misleading and deceptive conduct.  Of course that would involve bloodsucking lawyers and more money than a broke franchisee probably has.

    • Bomb78 says:

      11:01am | 26/09/12

      iansand: you can try to sue a franchisor for misleading or deceptive conduct, but the burden of proof is too high a hurdle.
      The Code of Conduct needs more balls. Mandated disclosures, stricter penalties and a industry standard clearance on a prospectus, backed by a director’s guarantee, which covers all the information given by a Zor to prospective Zees. Any information provided outside of the investment prospectus should not be relied on by a Zee, nor can the Zor be sued for it.
      Something really specific: the exemptions in regards to third line forcing in the Trade Practices Act need refining - I’m not saying a Zor should not have the ability to define the products a Zee can use and sell, but there needs to be more transparency in regards to rebates and kickbacks that are built into the prices charged by approved suppliers. If you are looking to buy into a system, get clear information on what rebates are paid by suppliers back to the franchisor. Get it in writing, with an accountant, auditor or lawyer’s statement verify its accuracy. Again, if a franchisor won’t be open about the deals it has with suppliers, run away.
      The rlationship between a Zor and its Zees is symbiotic, but inherently balanced towards to Zor. Unless you have a relationship built on honesty, integrity and open communication from the very start, it will only end in tears I’m afraid.

    • iansand says:

      11:41am | 26/09/12

      Emphasis should.

    • Ziggy says:

      10:18am | 26/09/12

      I will give you a simple statistic from my business which includes Business Broking. 5 years ago potential buyers for small businesses were   overwhelmingly looking for a franchise. They saw them as “safe” Now less than 25% are seeking a franchise and most of those are astonished at how poorly most of them perform.The ultimate turn off is a franchise in a large Shopping Centre.
      Would I buy a franchise? No. But then I am very experienced at running a business.Most first time small business buyers are not.

    • esteban says:

      01:05pm | 26/09/12

      Ziggy. what you are saying is that the market is taking care of the problem.

      Because of the action of poor franchisors prospective franchisees are put off.

      Franchise has become a dirty word.

      Don’t get me wrong regulation has a role to play because so many franchisees are inexperienced and vunerable.

      Regulation only provides limited protection from poor or predatory franchisors.

      The real problem has been self regulation of franchisors by the FCA has been weak.

      Once again the market will eventually respond when good franchisors reailise that the poor ones need to be self regulated by having the FCA actually do something about poor franchisors.

      A franchise is not the panacea for a poor business model rather the reproduction of a proven business model.

    • lostinperth says:

      03:01pm | 26/09/12

      As an accountant I would estimate that around 75% of clients who go broke as a   business are involved in franchises. I recommend that people don’t buy them.

      I see many cases, particularly on the service franchises like lawn mowing, plumbing, electrical etc where one of the biggest if not the biggest expense is franchise fees.  It’s not uncommon that people pay more to the Franchisor then they get to keep themselves after doing all the work.

      Generally the only people who make money are those who sell the franchise and then take a cut of all sales.

    • AdamC says:

      03:31pm | 26/09/12

      Lostinperth, that does not surprise me. I find the move towards franchising particularly strange in the cafe and coffee shop market. Given that the typical net margin in those types of business is about 5%, if you’re lucky, once you deduct franchise fees from revenue and pay the in-all-likelihood inflated prices for supplies from your franchisor, you are probably barely breaking even.

      And why do you need a franchisor to sell coffee, cakes and sandwiches? What value can the franchisor be adding? Your West Australian Dome chain is a case in point. It seems to foist awful coffee, unimaginitive menu items and an outmoded look and layout onto its franchisees. It’s not as bad as the Coffee Club, though.

 

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