Franchise inquiries highlight necessary changes

As more tales of woe emerge in the ongoing banking and franchising inquiries, fundamental problems in retail franchising still need to be addressed.

The Federal Government was dragged kicking and screaming into a Banking Royal Commission and the Senate Inquiry into the operation of the Franchising Code of Conduct.

The government did not want to destabilise the economy in an investigation of banking practices and was not enthusiastic at revisiting the franchising sector after amending the code of conduct following the underpayment of wages scandals.

Believing they could satisfy a Royal Commission that they had identified and addressed their shortcomings, the banks advised the government they would not contest the establishment of the investigation.

The current Senate franchising inquiry became unavoidable after revelations of serious structural problems and unconscionable conduct emerged at Retail Food Group, a public company listed on the Australian Stock Exchange.

Problems across Retail Food Group’s various Australian food franchise brands added to the concerns about retail franchising, which had in the past two years swamped other franchise systems, including 7-Eleven, Domino’s Pizza, Pizza Hut, the Caltex fuel and convenience store network and Pie Face.

The parallel banking and franchising inquiries will inevitably change the franchise industry and its legal and financial constructs forever irrespective of the conclusions and recommendations of the Royal Commission and the Senate Parliamentary Joint Committee on Corporations and Financial Services.

The Royal Commission seems likely to have its timeframe extended and the Senate committee might also seek an extension to its current reporting date of September 30 after reportedly receiving around 400 submissions.

Submissions to the Senate committee formally closed on May 4 and the committee is currently conducting hearings around Australia.

Fundamental problems

The tales of woe in the franchising sector will continue this week in Melbourne and next week in Sydney.

Overwhelmingly, the submissions that identify problems in franchising have come from retail systems and that is unsurprising given the high costs associated with buying a franchise, fitout and ongoing operational costs and the significant trading hours commitment.

There is a fundamental problem in retail franchising which needs to be addressed more effectively and that is to recognise that the entrepreneur or corporation that is seeking to expand the business is using other people’s money to do so and is not always showing a duty of care to investors or financial and operational discipline.

In some cases, franchisors have expanded their store networks with a reckless abandon, providing limited retail support to franchisees, cannibalising sales of existing stores, selecting poor locations and not properly vetting applicants for franchises.

The banking and franchising inquiries actually intersect in the financing of applicants with some banks accrediting a franchise system and extending loans to applicants selected by the franchisor for a site.

If the applicant fails, the bank has been protected by the franchisee’s guarantees, generally tied to their homes, and then benefits from a new loan to a replacement investor.

The churn factor is often also a nice little earner for the franchise system and, of course, the franchisee was invariably the problem, not the location or the lack of retail support or franchisor decisions such as pricing directions or supply contracts.

Irrespective of the outcomes of the two inquiries, financing of franchises will be tighter in the future with banks taking a much greater interest in the health of the franchise system and the locations for which a loan is to be provided as much as for the applicant.

Retail franchise systems can expect much greater scrutiny from unions and a more unionised workforce as well as prospective changes to lease conditions from shopping centres.

There will be a greater level of scrutiny in respect of compliance with workplace laws, disclosure requirements to investors and other provisions of the franchising code of conduct.

There is a real possibility that a new regulatory regime might be created in view of what has been, to the detriment of the franchising sector, inadequate oversight by the Australian Competition and Consumer Commission.

The ACCC’s primary focus is on anti-competitive behaviours that adversely impact on consumers and it has failed to effectively address the power imbalance issues of the business to business relationship of the franchise model.

The resolution of disputes within franchise systems has not been adequately addressed with franchisees often claiming that the ACCC has shown little interest in their complaints and the state based Small Business Commissioners lacking the power to effectively intervene.

There is an existing Office of the Franchising Mediation Adviser, which is a Federal agency that offers mediation alternative to expensive legal action through the courts.

The office was established early in 2017 and has received around 400 requests for mediation of disputes.

The Senate inquiry could lead to a change in the regulation of the franchise sector bringing together the Office of the Franchising Mediation Advisor and a new agency for oversight of the Franchising Code of Conduct.

The inquiry has also been encouraged to consider a formal arbitration court to determine disputes between franchisors and franchisees.

Buyers beware

The inquiry and the adverse media headlines generated by Retail Food Group and the submissions to the Senate Committee will also impact of investor recruitment as lawyers and accountants caution their clients about buying franchises.

Most retail franchise systems have either flatlined or seen a decline in their store networks in recent years and investors would be expected to be more wary of opportunities whether or not disclosure requirements are further tightened.

The inquiry has already triggered a change of leadership in several retail franchises and there will be a sharper focus on site selection for new sites and, hopefully, enhanced retail support, training and education.

In its submission to the Senate Committee inquiry, the Franchise Council of Australia has acknowledged the importance of continuous education as well as regulatory and behavioural improvement.

The Franchise Council argues against more regulation or legislation, contending that the Federal Government should instead better enforce the compliance of existing regulation.

The Franchise Council’s submission supports improvement of the Franchising
Code of Conduct and more resources for the regulator (ACCC) to oversight the sector and ensure compliance with existing legislation and regulations.

It also supports better grievance handling and dispute resolution.

In its submission, the Franchise Council of Australia indicates it believes the ACCC is an effective and well resourced regulator with a good understanding of franchising  with expanded powers that allow it to issue fines and infringement notices, conduct random audits more frequently and pursue court undertakings.

However, it also supports increased resources, favouring the continued oversight of the franchising sector by the ACCC rather than the establishment of any new agency

The Franchise Council acknowledged in its submission that economic conditions in the past few years have “stagnated” while competition has become more intense and the costs of doing business have increased markedly.

The submission points to excessive rent increases in shopping centres as a key issue for retail franchises that have contributed to the failure of both franchised and independent businesses.

Although initially reluctant to entertain a further examination of the franchising sector, the Franchise Council of Australia recognises that changes are inevitable and, in some respects, necessary to ensure the health of the sector.