Branchising Australia - Changing the way we do things by Robert Toth of Marsh & Maher
Franchising has been operating in one form or another for the past 40 years in Australia. It became a regulated industry under the Franchise Code of Conduct in 1998.
The industry was regulated to protect individuals and small business operator (franchisees) by requiring mandatory disclosure of material information by franchisors to prospective franchisees at least 14 days before a Franchise Agreement is entered into.
The Code review
The industry as a whole has underdone major and rapid change over this period with a number of reviews of the Franchise Code by the Government over the years to address the imbalance of power and control between franchisors and franchisees. The most recent review with the appointment of Mr Alan Wein has just been completed. Mr Wein reviewed issues such as good faith in franchising, the rights of a franchisee at end of term including recognition for any contribution made to building the franchise and the operation of the provisions of the Competition and Consumer Act 2010 regarding enforcement of the Code.
The business format franchises and franchise models that currently exist are based on traditional franchise models whereby the franchisee operates under a brand, system and controls determined by the franchisor.
So what’s changed?
There have been major changes to business and the economic climate, as we are all well aware, over the past 4 to 5 years with the global financial crisis, increased competition in certain market segments and reduced margins on sale of goods services due to aggressive competition and marketing.
In addition to this there has been:
- changed expectations by franchisees as to the support, training and systems to be provided by a franchisor;
- the significant and rapid move from retail sales to online marketing;
- increased cost to franchisors in providing point of sale and software systems to support and monitor its franchisees;
- increased costs to franchisees by way of set up costs with labour and rental;
- rapid changes in social media leading to different avenues to market, to name a few;
- increased disconnect between franchisor and franchisee expectations;
- increased costs of regulatory compliance whether to do with the ATO , the Workplace Ombudsman, occupational health and safety issues.
In the midst of all of this change, the traditional franchise model by which franchisees pay a royalty and marketing fee based on percentage of their gross revenue or a fixed monthly franchise fee has not changed. Meanwhile, franchisees struggle to make ends meet and draw a reasonable salary for their effort and are unlikely to see a return on their investment.
This led me to think that with all of this change surely we must, as franchisors and franchisees engage differently and find a franchise model more suitable to current economic conditions and which addresses the “disconnect” that has become evident over the years between franchisors and franchisees. A model that is more transparent and which equitably shares the risks of doing business.
So what is “change”?
John F Kennedy said “change is the law of life and those who only look to the past or present are certain to miss the future”.
James Baldwin (an African American writer – 1924-1987) stated that not everything that is faced can be changed, but nothing can be changed until it is faced”.
What this says to me is that you can not expect to meet the challenges that confront business today using yesterday’s mindset and expect to be at the forefront of business tomorrow.
Branchising – A Whole New World?
I should first state that the term “branchising” is not new, and was a term coined by author David. D. Seltz in a text entitled “Branchising – Proven Techniques for Rapid Company Expansion and Market Dominance” first published in approximately 1960.
It is a term used to cover “business franchising” and traditionally referred to the conversion of existing company owned outlets, to franchised or licenced units. It includes establishing new units in conjunction with a franchisee in which both the franchisee and the franchisor each retain equity. The franchisor can sell the company owned outlet or a part of it recoup some capital for further growth while retaining some degree of control and ongoing profit from the franchised unit.
A Branchise is a franchise and will be governed by the Franchise Code with obligations of disclosure and subject to the mandatory obligations as contained in the Franchise Code of Conduct.
The resurrection of the concept of Branchising in Australia arose from my recent discussions with a number of consultants and due to the increased level on disputes and disentachment by franchisors and franchisees with the existing traditional franchise model.
I acknowledge the contribution of Glenys Crawford of Crawford Consulting in my developing what I now call “Branchising for Australia” as an alternate business franchise model.
So what is Branchising?
Is it just a fancy and clever name or does it truly reflect a different relationship between the franchisor and franchisee.
The traditional existing franchise relationship
The traditional franchise relationship tends to be a vertical relationship whereby the franchisee is under the control and power of the franchisor rather than truly working in partnership. The use of the term “franchise partner” by a franchisor does not change this feeling of control and power that a franchisee experiences.
The key features of the traditional vertical franchise relationship are;
- onerous obligations on the franchisee;
- little real obligation on the franchisor;
- all power and control vests in the franchisor;
- the good will and ownership of all intellectual property and good will developed over the franchise term remains vested in the franchisor.;
- the payment of franchise fees from gross revenue (not profit);
- no sharing of risk or profit;
- default provisions with threat of termination;
- all capital costs funded by the franchisee.
Branchising – a new business model
The Branchise model is a horizontal relationship representing a more equitable relationship whereby the franchisor and franchisee own the business together and work for mutual benefit. Each party has equity in the enterprise and therefore a vested interest in ensuring its success.
At the conclusion of the arrangement and/or sale of that business, the franchisee will recover (based on their equity) its share of good will and along the way a share of profit.
Advantages of Branchising
As a true partnering relationship it addresses the issues of the traditional franchise model in relation to the feeling of power and control held by the franchisor over the franchisee.
Each of the parties contribute financially and operationally to the business.
The franchisee continues the day to day management of the business with the support and of the franchisor who is likely to be more attentive as they have equity in the business.
The franchisor relies on the energy and enthusiasm of the franchisee.
A branchise outlet is not subject to unnecessary and undisclosed fees and costs. There is generally no marketing fund. The franchisor and franchisee work together and the franchisee directly accesses management financial support and systems.
The company becomes the franchisor upon each retail unit being sold to an independent operator, which then becomes a franchisee.
As each company unit is sold to a qualified franchisee the company recovers their cost for the fit out, inventory, equipment and good will in the form of a franchise fee.
The company can transfer the Lease to the newly appointed franchisee.
The owner/operator franchisee is generally a more self motivated individual than the salary manager.
It is a model that has been adapted in pharmacy where the older generation of pharmacists who may wish to take a step back or retire, can not readily sell their pharmacies as young pharmacists who may be working in the business do not have capital sufficient to purchase the pharmacy.
The parties enter into a partnership arrangement by which the young pharmacist as a manager builds up equity over time and acquires the older pharmacists interest. The older pharmacist may retain some limited equity and continues on as a mentor and an advisor.
In the US it has been found that Branchising results in a higher sale price per franchise unit than the traditional franchise unit.
The Branchising model already operates successfully in real estate and retail franchise models but is suitable for any market segment.
I am not saying that Branchising should take over the traditional franchise model. What it does provide is an alternate model to be considered.
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Robert Toth of Marsh & Maher
Robert Toth a Partner of Marsh & Maher Lawyers is a recognised leader in Franchise law in Australia and a Member of the Franchise Council of Australia (FCA) & the International Franchise Lawyers Association (IFLA).