So, the due diligence is consigned to the waste paper basket. In the case of higher penalties, they are of academic interest if you have already lost your business and, quite likely, your house.
There is also a potentially perverse effect of a heavy fine in that it might undermine the viability of the franchisor and by extension the franchisees in that system. Franchisees have virtually no rights and they are incredibly reluctant to make a fuss.
It only occurs out of utter desperation. The protections afforded to franchisees include the requirements that franchisors act in good faith, and not engage in unconscionable conduct. Under the heading of, good luck with that, these are ill- defined ideas and must be established through litigation.
Franchisees are very rarely in a financial position to assert their rights through these mechanisms. Pizza Hut franchisees spent multiple millions pursuing their rights and found out the hard way.
Too much at stake
So, how can franchising be fixed and why does it matter? Firstly, franchising is a massive sector, it represents nearly 10 percent of Australia’s GDP.
Where a business concept requires a wide geographic presence and serious investment, franchising is the obvious answer. Not only can new commercial ideas get access to capital provided by franchisees, in most cases franchisees also provide the bulk of the management workforce. Franchisees usually have their houses on the line so they are remarkably self-motivated.
On the surface, it is a great model. Unfortunately, the devil is in the detail.
The sector is regulated by a code of conduct. The underlying assumption of the code is that it is governing a business-to-business relationship where one party is in the stronger position. The underlying and indisputable reality is that a franchise enterprise is a single business with two stakeholders. Franchisors provide the business idea and the brand name and sometimes a worthwhile system.
Franchisees, on the other hand, provide the investment capital and they also provide their labour. They unarguably assume the vast bulk of the risk, which is laid off to them from the franchisor. They sign on to the lease obligations, they buy the necessary equipment, and they employ the staff.
By comparison, franchisors often have little capital invested, low overhead costs and are able to largely insulate themselves from the risk.
It is not hard to argue that the franchisee contribution to the sector is way more important than the commercial ideas generated by potential franchisors, most of which are not rocket science.
So, the clue to fixing franchising lies in the simple recognition of the reality that franchising is a joint venture business model.
This proposition was recognised by the PJC Inquiry when it reported to Parliament in 2019, along with the recommendation that the capitalisation contribution of franchisees needed to be examined as a basis for redressing the disgraceful and unsustainable imbalance of power that now exists.
The code of conduct is next to useless in protecting the interests of franchisees. It needs to be replaced with legislation that treats franchisees with the respect they deserve, as the providers of well over eighty percent of the investment in the sector, and the bulk of the managerial oversight.
Such legislation would give franchisees the influence in the running of the business that they need and deserve to protect their interests. Franchisees need and deserve a say in the appointment and reappointment of boards and CEOs. They need a say in the transfer of the brand and system to a new owner, potentially including a right of veto. They need a formal say in the competitive strategy especially how it supports their need to maintain profitability.
All of these rights exist for shareholders under the Corporations Act. Franchisees should not accept anything less.
It is not a simple fix, but it is critically important. In the end a reformed franchising sector will root out the wrongdoers and benefit not only both parties to the franchising relationship but also the financial institutions who are being asked to fund franchisees, in a sector with known problems.
This is not to mention the employees of franchisees and the broader community. The laissez faire arguments of the franchisor lobby just doesn’t cut it.
As of this week, the sector has a new minister in Stuart Robert. We welcome his appointment. As the incoming Minister, he has the opportunity to make a real difference. For everyone’s sake this scandal ridden sector needs a serious rethink. We look forward to working with the minister to get the reform process back where the PJC Inquiry intended it to be.
Mike Sullivan is chief executive officer of Australian Association of Franchisees.