A Government report titled “Fairness in Franchising” (the report) released on 14 March 2019 is essential reading for anybody who owns shares in companies that operate under a franchisor business model such as Retail Food Group Ltd (ASX: RFG) or Dominos’s Pizza Enterprises Ltd (ASX: DMP).

Franchising in Australia

Franchising is a big business in Australia and is estimated to have made up 9% of Australia’s GDP in 2016.

However, franchisees (the operators of the businesses) have often complained about the power imbalance between them and the franchisors (the brand owners).

Unfortunately, the report has similar findings to the Royal Commission into the banking and financial services industry stating, “disclosure alone is an insufficient regulatory response to power imbalances and exploitative behaviour by powerful corporations”.

Submissions

Over 400 submissions were made in response to the inquiry, with over 80% coming from franchisees. While the exact breakdown of franchisees mentioned is not available, over 40% related to RFG, Foodco and Domino’s. Others mentioned included 7-Eleven, whose franchise woes have been well documented, Pizza Hut and Caltex Australia Ltd (ASX: CTX).

Here’s Just Some Of The Issues

The report is a comprehensive 369-page document, so here are just some of the issues:

  • Wage theft (at times done for a franchisee to stay afloat financially)
  • Third line forcing of suppliers, when supplies could be sourced cheaper elsewhere
  • Supplier rebates (for the franchisor) in third line forcing, with the rebate amount hidden
  • Compulsory training for franchisees that is unaccredited to make money for franchisors
  • Intimidatory behaviour and misconduct by franchisors
  • Unfair contract terms, e.g. setting menu prices below cost
  • Franchisors refusing to engage in good faith in the mediation process, leaving court action as the only option for franchisees which they couldn’t afford
  • ‘Churning and Burning’ – where ‘churning’ is the repeated sale of a failed franchise at a single site to a new franchisee owner, and where ‘burning’ is to continually open new outlets (whether viable or not) to pocket upfront fees and ignore pressure placed upon existing outlets nearby.

Rask Perspective

It is a damning report which exposes the harsh reality of what some franchisees experience while the franchisor profits, often at the expense of the franchisee. A situation where the franchisor wins while the franchisee loses is not sustainable, as we have seen from RFG. The only way such a business model can survive is on a win-win basis.

Getting to the truth of franchise business models can be hard, as often those who have suffered will have signed non-disclosure agreements which prevent them from revealing details.

But I think it goes without saying that I am not a fan of franchisor business models because it is difficult to know whether it is a house of cards that could collapse at any moment.

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Disclaimer: Any information contained in this article is limited to general financial/investment advice only. The information has not taken into account your specific needs, goals or objectives, so please consider consulting a licenced and trusted adviser before acting on the information. Please read The Rask Group’s Financial Services Guide (FSG) for more information. This article is authorised by Owen Raszkiewicz of The Rask Group, which is a corporate authorised representative No. 1264179 of Strawman Pty Ltd (ACN: 610 908 211) (AFSL: 501 223).