Too much friction in franchising action

Australia is the most franchised nation in the world but there is continual unrest within the relationships. As franchising expands dramatically, the danger is fewer people will look before they leap.

It’s a sector that will generate a massive $10.8 billion in profits and pay out more than $21 billion in wages. According to IBISWorld, franchise industry sales are expected to increase 5.7 per cent to $180 billion over 2012-13, about 14 per cent of GDP.

Sounds good? How do you explain that one in five in the industry says it doesn’t work? Some even say it’s a scam where franchisors are churning, that is to say, selling franchises destined to fail and then reselling them to others. Welcome to the world of franchising, a sector built around ambition, symbiotic relationships and people looking to buy themselves a job when they’re under-prepared, under-capitalised, unsuited temperamentally or have unrealistic expectations of what running a business is really like. Claims about scams are par for the course in franchising.

For example, the Australian Competition and Consumer Commission nearly five years ago rejected allegations that Bakers’ Delight engaged in misleading, deceptive and unconscionable conduct. Still, that hasn’t stopped anti Bakers’ Delight web sites popping up. Regulators be damned, they’re still fighting the battle. That’s the world of franchising.

The relationship between franchisees and franchisors has been compared to a marriage. And just like what happens when some marriages bust up, things can get ugly. Particularly in the franchise sector which is growing in inverse proportion to the wave of downsizings sweeping through the country.

This is why the ACCC is now reporting a big increase in complaints within the franchising sector. From July to December 2012, the ACCC received 454 complaints. That was up significantly from the 271 complaints registered in the January to June 2012 period. These complaints were primarily focused on unconscionable conduct and misleading or false conduct.

Timing is everything. Just as the small business minister Brendan O’Connor announced an inquiry into the Franchising Code of Conduct in early January, three Pie Face franchisees started preparing to sue the company for millions of dollars. They’ve alleged there have been undisclosed costs – like accounting, staff entitlements and IT expenses – and that the franchisor is hell-bent on opening new franchises within a three minute walk of their premises.

Again, this is all part of the franchise universe. According to the latest research, many franchisees are dissatisfied with their franchisor. Some, like the Pie Face franchisees will be seeking legal action.

And disputes in the industry are common. Last year, for example, there was the case of South Australian restaurant chain Billy Baxter which was put into liquidation over fears that directors were stripping the company of assets to avoid paying a $1.3 million damages suit brought by franchisees who claimed they were misled by representations of revenue and profit that could be made in the first year.

Whether the code, established by the Howard government in 1998 to reduce the incidence of franchisors misleading potential franchisees, needs fixing is another question.

Australia already has a reputation as one of the most heavily regulated franchise markets in the world and the code is one of the most rigorous around.

Under the code, for example, franchisors have to give prospective franchisees information before they make a financial commitment. Franchisors are required to follow set procedures when dealing with franchisees. The ACCC administers the code which has the force of law.

The Franchise Council of Australia claims that the level of disputes in the franchise industry is no more than 1 or 2 per cent but that’s telling only half the story. After all, when does a disagreement become a dispute?

Psychologist Greg Nathan, who founded the Franchise Relationship Institute, says his research shows that at any one time, 18 per cent of franchisees would be aggrieved. Of that 18 per cent, 3 to 4 per cent would be talking to their lawyers. Nathan says it’s just symptomatic of what happens when people are running businesses built around symbiotic relationships.

The reality is most disagreements don’t get to court. Nobody can afford it least of all the franchisees. Most are resolved through mediation and compromise. In other cases, the franchisees just live with it in a state of permanent dissatisfaction, much like some marriages.

Toughening up the code will not stop disputes in franchising. As Nathan’s research suggests, it’s just the nature of the beast.

Despite these grievances, Australia remains the most franchised nation in the world. We have three times as many franchises per capita compared with the United States. And industry revenue has risen by a steady 3.5 per cent per annum over the past five years, and that’s during the financial crisis.

The growth drivers: more real household disposable income, an increase in the number of women returning to the workforce, leisure time availability, and more people taking out packages and seeking the flexibility of being their own boss.

Franchising has enormous opportunities for growth. IBISWorld forecasts that industry revenue will grow from $188.1 billion in 2013-14 with growth of 4.5 per cent to $214.6 billion in 2017-18.

And it will change too, creating new opportunities for aspiring business owners. While retail trade operators have continued to dominate the franchising market over the past decade, the big growth will be in services over the next 10 years. The service sector has been growing strongly. Personal services, like pet care, auto repairs and servicing, and IT services have been making big inroads over the last five years.

Here is the exciting part – there’ll be new forms of franchise businesses within the next 10 years. With an ageing population, we can expect new franchises springing up. There will be franchise pharmacies, aged-care facilities and medical practices as health care providers outsource more of their services. Teaching and entertaining children franchises will grow. And advances in technology will create more home-based franchises. Watch this space.

The reality is the industry has much bigger challenges than grievances and complaints. Consider for example how online sales will create significant issues for retail franchises.

Furthermore, IBIS predicts that fluctuations in consumer spending will lead to the eventual demise of smaller franchised chains. Anything less than 20 to 30 outlets will struggle to stay afloat. The ones that will suffer the most will be in the bulky good segment selling furniture, electrical goods, home improvements and bedding. The ones coming under the most pressure will be franchises selling juice and coffee.

The other big challenge for franchises is Gen Y which, over the next five years, will make up 40 per cent of the Australian workforce. It’s not exactly a generation flush with funds and given that it can cost anywhere up to around $500,000 to take out a franchise, that could create an issue for franchisors who might be forced to come up with radical new finance structures. They might also have to give Gen Y shorter franchise periods which now run five to 10 years.

Despite these challenges, Australia’s franchise industry will continue to evolve. More will become franchisees as companies reduce numbers, outsource and new customers and niche markets emerge.

Ten years from now, franchising will be a completely different proposition, with new players serving new markets and industries.

Still, the pattern of continual unrest in franchising is a warning. Prospective franchisees should do the due diligence, talk to other franchisees and get good legal and accounting advice, to ensure they are not in the 18 per cent.