February 28, 2018
Chanticleer AFR
Almost 50 years after franchising took hold in Australia through the expansion of the KFC, Pizza Hut and McDonalds fast-food chains there are serious doubts as to whether or not this popular business format remains fit for purpose.
The investigative journalism by my colleague Adele Ferguson exposed the obvious financial conflicts and governance flaws inherent in poorly-run franchise systems.
Her work found that in certain circumstances there was a power imbalance between franchisees and franchisors which was exploited to the detriment of franchisees and their workers.
This profit reporting season turned the spotlight on the weaknesses in the franchise systems used by Domino’s Pizza and Retail Food Group. Both companies are champions of the franchising industry.
They are often put forward as entrepreneurial success stories because of their rapid expansion domestically and willingness to take their franchise systems into overseas markets.
Results released by Domino’s in early February prompted investors to express caution about the health of the company’s franchise network in Australia.
Average earnings per store did not increase much, which raised concerns that Domino’s was taking too much profit out of the network at the expense of franchisees.
Lower profitability or slower growth in profitability in the Domino’s network could well be triggered by an ethical response to Ferguson’s investigation in 2016, which found evidence of wages fraud.
Franchisees feel squeeze
Some franchisees blamed underpayments on Domino’s franchise model, saying they couldn’t afford to pay staff correct wages. Paying appropriate wages would squeeze the profitability of franchisees.
Domino’s said last month that it was implementing new monitoring and investigative processes in relation to industrial relations.
It said these would “utilise sophisticated systems and methodologies developed in conjunction with Deloitte as a proactive strategy for the identification of undesirable activities” within its franchise network.
This process is expected to be in use by mid-March.
Separate to that Domino’s launched a program called Operations 360 to help franchisees maximise profit opportunities.
One of the lessons from the Domino’s experience was that it is best to treat franchisees well and not try to squeeze their profitability too hard.
Trading halted
Retail Food Group is another one of the poster children of franchising. Ferguson and Sarah Danckert found that it was squeezing its franchisees too hard.
RFG responded to these accusations by revealing it had been working with its franchisees to help improve the support it gives them.
“RFG remains a passionate proponent of the strength and vibrancy of the full format franchising model, and considers the benefits provided by an established brand, proven systems and ongoing support enhances the opportunity for small business owners to achieve success,” the company said.
But a recent profit downgrade made it clear that its efforts had not helped boost sales of new franchises.
On Wednesday RFG requested a trading halt in order to have more time to lodge half-yearly financial accounts. It was not clear from the announcement what was holding up the release of the accounts.
But reading between the lines it would appear the company’s auditor was not willing to sign off on the numbers without further work.
One concern for investors is that RFG’s balance sheet is already stretched because of the company’s aggressive expansion through acquisition.
If the company is forced to write down goodwill acquired through acquisitions it could put weaken its balance sheet.
Fortunately, the company extended its $150 million three year debt facilities in December. Managing director Andre Nell thanked National Australia Bank and Westpac Banking Corp for their continuing confidence and support.
Caltex another blow
The franchising system received another blow to its credibility this week when Caltex said it would convert all its franchised Caltex service stations to company-operated stores.
The company gave three reasons for this. One was the need to ensure the same level of quality of service across all outlets. The second was it needed to be able to move quickly to introduce a new retail format. Thirdly, it needs to simplify the supply chain.
The move by Caltex undermines all the arguments used by those who say the franchising system is perfectly suited to entrepreneurs seeking rapid growth. Caltex is sending a message that speed of change can be better managed through a single company ownership.
Caltex believes it has developed a “compelling and fair” offer to all franchisees. It said it “will sit down with every franchisee”, and will review and consider every circumstance in the case of those who are unhappy with their offer.
“Franchisees are under no obligation to accept the offer and can continue operating their site until their agreement expires,” the company said.
“Franchising has been an integral part of growing the retail business. Caltex appreciates that this is a significant decision and it will affect many of our franchisees. Caltex will work with our franchisees to manage the impact of this change, including by offering franchisees transition support and offering employment to all franchisee employees.”
The company will pay a minimum amount of $100,000 for those franchises with either a low initial franchise fee or a shorter term left on their agreement.
The franchise model has come under scrutiny in the car industry because of egregious actions by some overseas car companies. This issue was the subject of a review by the Australian Competition and Consumer Commission.
TONY BOYD
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