Who’s to Blame: Franchise Inquiry to Separate Fact from Fiction
Tens of thousands of SMEs enter the marketplace each year, and tens of thousands exit, which means the Australian business environment, spread across all sectors of the economy, is ever-changing. This landscape is dotted by enthusiastic start-ups that may fail dismally or end up a roaring success; thirty-year-old businesses that have occupied the same premises for decades only to find they’re no longer relevant; or solo operations starting up that may go on to have 20 staff.
And there’ll be franchises – some will be highly-profitable, successful businesses for years to come, others not so – but all of them in the mix nonetheless.
The number of entries and exits remains steady across all models of business however, simply because not everyone is cut out for it! Running a business takes discipline, hard work and good decision-making. Starting one also requires extensive research and due diligence, along with independent professional advice.
Despite the exit rate remaining steady across different business models, the franchising industry has attracted a hefty level of criticism of late following wage scandals among several high-profile chains.
In some of these cases such as 7-Eleven, the Fair Work Ombudsman (FWO) found there was systematic, intentional exploitation of vulnerable workers by some franchisees. Some franchisees have been out in force in the media, blaming (fairly or unfairly) their franchisor for pushing them to the brink financially by making their businesses unprofitable through unfair contact terms, misleading negotiations before signing up, hefty fee structures or forcing them to use non-competitive running costs.
But the veracity of such claims often plays second fiddle when an attention-grabbing headline is at stake.
In reality, when business practices are put under the microscope, such instances are rare indeed in a system that’s been working extremely well for hundreds of thousands of businesses, for more than half a century. These very public cases however, have created a perfect storm of purported non-compliance within the franchising regulatory framework by both franchisors and franchisees.
Caltex for example, was also sanctioned after the regulator found some level of non-compliance in 76 per cent of audited franchises. The petrol giant has stressed on several occasions that there was no correlation between each site’s profitability and its associated underpayment of workers, but the company has stumped up the money to make sure affected staff are compensated for their franchisees’ non-compliance with a $20 million fund to rectify the underpayments. Since the FWO’s findings, Caltex has started auditing its entire store network, and as of May, had terminated 19 franchisee agreements for underpayment of workers or other cases of non-compliance, and it is well within its rights to do so, as these are contract terms that are set out clearly in each franchise agreement, which have allegedly been broken by the franchisee.
So who is actually at fault in this, and other cases?
Some argue franchisors are to blame for not devoting enough time and resources toward regularly auditing its franchisees for compliance or for including allegedly unfair contract terms.
Others say it’s the franchisees’ faults for failing to do their own due diligence, mismanaging their own businesses or thinking it’s acceptable to make up their shortfalls through underpaying their employees’ wages and entitlements.
The Federal Government’s Vulnerable Workers Act, which was introduced into Parliament in a hurried manner in September 2016, was an attempt to try and repair or further regulate a system that in reality, was operating quite successfully.
According to the Australian Small Business and Family Enterprise Ombudsman, in 2016, there were 2,066,523 small businesses; 50,995 medium businesses; and 3,717 large businesses in Australia – totaling 2,121,235 in total.
The Franchise Council of Australia estimated in 2014, there were an estimated 79,000 franchise units (operating under 1160 business format franchisors), with a collective sales turnover of an estimated $144 billion.
In the twelve months prior to when these figures were collated, just 1.5 per cent of franchisees had been involved in a substantial dispute with a franchisor. While the jury’s still out on whether or not the Vulnerable Workers Act will actually have any effect on cases of intentional underpayment of workers, what is has done is add more costs for those doing the right thing.
The Federal Government’s recent Parliamentary Franchising Inquiry – the findings of which are due at the end of September – is a further attempt to establish the fact among the fiction. We know that franchisees operating under unscrupulous franchisors are effectively powerless when it comes to franchisor abuse, and will suffer tremendous financial losses as a result.
This is something that is never acceptable and must be rooted out – which the Inquiry certainly aims to do, as it investigates areas like how the Code is being operated and its effectiveness, dispute resolution, termination rights, unfair contract terms, reporting obligations and disclosure of information.
The same goes for franchisors with unscrupulous franchisees in their network who think they’re above the law when it comes to paying their staff the correct wages and entitlements – and in these cases, the franchisor’s reputation is always going to end up suffering the most damage.
What has emerged while trying to weed out the unscrupulous, is that in many instances there has simply been a great deal of business mismanagement – on both sides of the fence. Put simply, not all franchisors are perfect, and not all franchisees are perfect, and poor decisions are almost certain to lead to financial pain.
For franchisors, there have been cases of:
- Borrowing too much;
- Overspending;
- Expanding too quickly;
- Failing to invest in the internal systems needed to maintain a growing network of stores;
- Allowing people who were totally unsuited to running a business to buy a franchise (many of whom have disregarded instructions to engage independent professional legal and financial advice);
- Having inconsistent franchise agreements between franchisees;
- Failing to keep a close enough eye on ‘red flag’ behaviour;
- Inadequate back-end support for those who needed it;
- Disadvantageous contract terms that don’t support competitive sourcing practices
For franchisees, common mistakes have included:
- Inadequate due diligence when buying the franchise through independent, professional legal and financial advice;
- Inadequate prior research;
- Not obtaining professional advice when negotiating lease agreements;
- Poor stock control systems and practices;
- Expensive and inappropriate rostering due to a lack of understanding about award rates and applications;
- Poor staff management in general;
- Borrowing excessively and spending on areas with a poor ROI;
- Overspending in general;
- Extremely poor customer service
On the opening day of the Parliamentary Inquiry hearings, HWL Ebsworth special counsel Derek Sutherland said that government could not legislate to protect people from their own poor conduct when they signed up to be franchisees.
“They’re not taking enough interest at the time when it matters, to really get some advice and make an informed decision,” he said at the time.
Mr. Sutherland went on to tell the Inquiry that while franchise agreements clearly state that small business owners should get financial and legal advice before entering an agreement, in practice, many didn’t, because they didn’t want to spend the money.
Issues like supply contracts where franchisees must buy ingredients from the franchisors, (which can lead to business owners paying an unfairly high price on goods, which can shift profit margins from their business back to head office for example); or problems surrounding dispute resolution in some franchise agreements, have been discussed during the hearings.
But these and many other problems raised could have been picked up very early in the negotiations by a qualified, independent legal and financial professional, and could have easily have been negotiated prior to finalising contracts.
So, while we wait for the results of the Inquiry, there’s one clear takeout – when franchisors and franchisees both do their homework, a franchise model can be incredibly rewarding.
DOMINIQUE LAMB is the CEO of the National Retail Association and Director of NRA Legal, who has extensive experience providing industrial relations and employment law advice to a range of small, medium and large businesses across a range of industries. Dominique brings a level passion and motivation to her role which is hard to find. In 2011, she was awarded the Australian Institute of Management’s Young Gun of the Year Award and in 2016 Dominique was a finalist in the Brisbane Women in Business Awards.
For more information contact the National Retail Association at:
1800 738 245