the pizza chain and at least one of the superannuation funds, First Super, has ask fund managers to examine the Domino’s Pizza business model. First Super has also initiated a discussion on the franchise model with 29 members of the Australian Council of Superannuation Funds, indicating underpayment of workers in the franchise sector could be widespread and franchisor oversight and controls might be lacking. First Super is concerned about ethical investment issues, but also the impact on a franchise system such as 7-Eleven or Domino’s of rectification of problems, including changes to business models to ensure their sustainability. As with the 7-Eleven convenience store chain, there has been systemic underpayment of workers by Domino’s Pizza franchisees, many of whom have struggled to deliver on the chain’s low cost pizza deals. The discounting strategies to boost market share and, for that matter, to recruit new investors as franchisees has cut profitability of many outlets thinner than the pizza crust they produce and have forced many franchisees to look for ways to cut corners. Rent, product ingredients, energy bills, regulatory charges and franchise levies are all non-negotiables, immovable costs, leaving only the wages costs for a franchisee to juggle. Arguably, the rorting at Domino’s Pizza is worse than 7-Eleven and certainly the pizza chain has more to lose in reputational damage as an ASX-listed company with store networks in overseas markets. The damage for 7-Eleven has largely been associated with compensation costs for underpaid employees, buyouts for some franchisees and the related cleanup expenses of the scandal. Despite the brand damage of the scandal, the convenience store chain probably hasn’t shed too many customers and Domino’s may well be fortunate to also retain its customer base, albeit higher product prices are inevitable going forward. Where Domino’s Pizza is more exposed than the privately owned 7-Eleven is with shareholders, who are already expecting operating costs to rise, growth to be impacted and profits to fall as the company addresses the wages issues and the viability of its business model and product pricing. The problem with franchises The Franchise Council of Australia has railed against new legislation in the Federal Parliament that would make franchisors responsible for breaches of workplace laws, including the rorting of student visas for overseas workers, sham contractor arrangements and underpayment of wages and entitlements under awards. The Council’s plea to drop the ‘joint employer’ provision and rely on workplace agreements and co-operative arrangements between franchisors and the Fair Work Ombudsman have not be assisted by the extraordinary circumstances revealed at Domino’s Pizza. Workplace laws and award requirements have been flouted in the past three years while the company was working with the Fair Work Ombudsman to address breaches that were identified in audits. Under the terms of the new deed, Domino’s will continue to ensure that it complies at all times and in all respects with relevant Commonwealth workplace laws. In the past three years, at least 2,400 workers in Domino’s outlets were underpaid an estimated $4.5 million. The underpayments were discovered in 102 audits of franchisee stores. That is a systemic problem, not an oversight, and for the problem to be so widespread, the franchisor has a case to answer on why their processes and retail support staff either failed to identify the underpayments or simply chose to ignore them until they attracted the interest of the Fair Work Ombudsman. What is most troubling about the revelations of such widespread breaches of workplace laws in the past three years is the fact Domino’s Pizza Enterprises has twice signed Proactive Compliance Deeds with the Fair Work Ombudsman in 2011 and 2014. In 2014, the company claimed it placed a “high priority on continuous improvement” and “welcomed the opportunity to continue to work closely with the Fair Work Ombudsman to ensure ongoing compliance with federal workplace laws”. As part of the compliance agreements, Domino’s Pizza Enterprises decided to self audit its franchisees and to provide “appropriate guidance and training to its franchisees to ensure they understand their workplace obligations and the importance of compliance”. The initial 2011 agreement followed the underpayment of 1,600 delivery drivers by more than $588,000. You would expect a greater level of vigilance by the company after signing the agreements and following the discovery that 1,600 employees had been shortchanged across a franchise system of around 500 stores at that time. “Employers who care about their reputation should be doing these sorts of things,” said Fair Work Ombudsman Natalie James. In the sordid tales of the Domino’s scandal, there are also allegations of visa rorting, intimidation of staff and claims that the franchisors head office staff fended off employee complaints. In at least one instance, it has been claimed head office staff told the employees not to bother taking their complaints to the Fair Work Ombudsman because it would only be referred back to the franchisor anyway. In the past three years, Domino’s has terminated a number of franchise agreements while other franchisees opted to quit the system. A total of 26 franchisees left the system as a result of adverse findings in the audits. In one further recent instance, a franchisee in Atherton Queensland has been terminated after he was caught allegedly trying to sell a visa sponsorship for up to $150,000. Domino’s Pizza expressed surprise at the behaviour, noting that the franchise was among the top five of profitable stores across its network. Behind the numbers While Domino’s Pizza Enterprises has reported a 17.2 per cent increase in revenue to $150.1 million for the Australia and New Zealand store network in the first half of the 2017 financial year, the health of the network is under scrutiny. Domino’s Pizza lifted underlying pre tax earnings by 23.9 per cent growth in the half with results boosted by 27 new stores, a menu upgrade and continuing innovation in customer interface with stores. However, the profitability of individual franchise outlets is reportedly not so robust and is the reason why many franchisees are apparently underpaying employee wages and entitlements or forcing staff to work unpaid hours. Domino’s has already been forced to put a Sunday surcharge on its pizzas to ensure franchisees do not lose money on Sunday and public holiday trading. In its release to the ASX, the company’s CEO and managing director, Don Meij, said a trial of the Sunday surcharge, which was to allow for higher wages for employees working on Sunday, had been positively received by customers with stable or increasing sales in test markets ahead of the national rollout. “It is refreshing our customers have given us credit for the surcharge as part of the introduction of these penalty rates as we continue the award modernisation process,” Meij said. Domino’s in review In a bid to stem the reputational damage and to address the continuing breaches of workplace laws by its franchisees, Domino’s Pizza Enterprises has now asked Deloitte to review its current processes. Ernst & Young was previously engaged on that task. With another 35 outlets to open in the current half, it would seem Domino’s Pizza Enterprises, like some other franchise systems, seems to have a strong franchisee recruitment team, but is under resourced in the retail support and system management teams that monitor franchisees. Meij has indicated the company has now commenced an audit of all 740 stores in Australia over the next eight to 12 weeks. Meij defends the sustainability of the system with stores profitable on sales of $20,000 a week or around $1.1 million a year. The company claims average sales for Australian outlets are around $1.4 million. Domino’s Pizza Enterprises is now providing bookkeeping services to around 60 per cent of its stores in a move that should tighten financial disciplines. Meij has pointed out that the stores that had left the system after being found underpaying staff were profitable outlets. At a conference in Sydney this month, Meij said the company will take action on any issues revealed in the current audit program to safeguard its reputation and to ensure Domino’s Pizza Enterprises meets all of its legal obligations. Meij said the company would take a “zero tolerance” approach to any franchisees that underpaid employees and, despite the revelations of such widespread breaches of workplace laws, he said Domino’s Pizza Enterprises believed its compliance program was “industry-leading”. He insisted the majority of franchisees were doing the right thing and the problems were not systemic but limited to a very small minority within the franchise network. Access exclusive analysis, locked news and reports with Inside Retail Weekly. Subscribe today and get our premium print publication delivered to your door every week.