Franchising. Why the Inquiry? | BTalk Australia

(14min 37) Franchising is the subject of a federal government inquiry due for completion this December. The focus is on unconscionable conduct in the sector.

Today on Btalk Australia Phil Dobbie talks to Adrian McFedries, the managing director of legal consultancy DC Strategy, about existing legislation in the franchising sector and what, if anything, needs to change.

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See also:
10 Things To Know Before Buying A Franchise

• Today’s Transcript

Phil Dobbie: Hello, I’m Phil Dobbie. Today on BTalk, franchising. It’s big business in Australia. In fact, it’s worth about a hundred and fifty billion dollars and employs 600,000 Australians. So is life all good and above board in the franchise world? In June this year, the parliamentary joint committee on corporations and financial services started an inquiry into the industry. It’s due to report on the first of December. For his views on that inquiry and the franchise sector in general, I’m joined by Adrian McFedries, the managing director of legal consultancy DC Strategy. Adrian, what’s the government’s concern here? Why have this inquiry? Are we seeing a rise in complaints from franchisees for example?

Adrian McFedries: I think we are seeing a rise in inquiry that’s prompting the number of federal inquiries, and state inquiries have originated with the franchisee. I think specifically, no different to anything in the past, it’s out of an acrimonious situation that these types of inquiries tend to rise. But that doesn’t necessarily mean that they’re statistically significant in the greater landscape of franchising in Australia.

Dobbie: Now the inquiry says it’s paying particular concern to section 51AC of the trade practices act, which is the bit that concerns itself with unconscionable conduct in business transactions. So they must have concerns about the way parts of the franchise industry operates.
McFedries: There is legitimately a concern and that’s the focus of the inquiry. I think what the question is specifically though is, what you talk unconscionable conduct, you talk act of good faith, what are we trying to achieve and what are the behaviours that are actually creating the concern and it’s a very simple relationship franchising. It’s contractual, it’s got two parties and the intentions of all regulation, which are well founded, are to ensure that the parties are entering into those contracts fully informed without misrepresentations and correctly assuming the appropriate business risks that come into it with the decision.

Dobbie: So do you believe that both sides of the party are well covered with existing legislation?

McFedries: Professionally, I think the answer is yes. I know that there will be listeners that completely disagree with that, but to put some perspective on it, Australia already is by far the most regulated franchise industry in the world and that in itself is not to say that we shouldn’t have more. Will there always be instances of poor behaviour? Absolutely. Can you regulate them completely out of the Australian landscape? You cannot. I think there are some changes that have been recommended which will probably come through but at the end of the day I don’t think it’s worth compromising the entire approach of franchising which is a very healthy sector in Australia for the sake of a few instances or even many instances of very, very small facts or situations that are actually driven more by the operators than they are by the industry as a whole.

Dobbie: Now this inquiry comes hot on the heels of the collapse of Kline’s, the jewellery chain who some have accused of selling franchises even when the company was clearly in financial difficulty. So is there a bit of a knee jerk reaction with this inquiry do you think?

McFedries: I think that adds to the wave of emotion that’s around the need for an inquiry. Is it a specific knee jerk reaction? Probably not. I think the wheels of motion were entrained before that occurred. But certainly there are people out there trying to join the dots between the two. I think that’s a long bow to draw. I personally don’t know much about the specifics of Kline’s but I do know as a professional advisor to retail, that business simply lost its way over a period of time with wrong merchandising. If I had to guess it would be more about increasing rental costs, reduced margins and simply not being relevant to the consumer anymore, whether it be company owned or franchise. So again, it’s like when you buy a white motor vehicle. You notice all the white motor vehicles on the road for a period of time so anything like that that gets some press at the moment is certainly going to be top of mind for people.

Dobbie: Yeah. Now what are the common concerns with franchisees? I should imagine, it’s paying the money and not getting the support you’re promised would be part of it or the support you’re expecting. Does that tend to be the main gripe between franchisees and franchisers?

McFedries: It is, I think it’s a matter of everybody delivering on what the expectations were and clearly there are two different stages when you buy a franchise and all the consideration that goes into that, it’s completely different when you’ve signed, starting to set up and then you really truly find out how good the individual operator is as a franchisee and also whether the franchiser is delivering on the aspects they said they would. I think in any situation though there is a tendency to, if it doesn’t work, human nature says we look to blame other people before we take responsibility ourselves. That in itself is I guess the acorn of the idea of why a lot of people are pointing to franchisers and saying the regulations are not satisfactory. But the gripes are fairly common around support and in fairness, there’s so much opportunity in Australia and absolutely brilliant regulation in the code at the moment that requires people to go and get independent advice prior to going into these franchise arrangements and you cannot, you simply cannot, have regulation diminish or remove business risk. There is always risk in setting up a business.

Dobbie: So is that part of the part of the problem unrealistic expectations?

McFedries: Yeah there is.

Dobbie: On the part of people taking these out?

McFedries: It is by both parties. I don’t doubt for one second that there are large pool of operators and you know, it’s a reasonable size of franchisers that simply get too caught up in trying to sell their franchise as distinct from focusing on building a quality business. Those people are still within the bounds of franchise regulation. Are they good business operators? Well you know, form your own view. But again, how do you regulate those people out of the marketplace? A franchisee just needs to ensure that they’re asking as many questions as they feel are appropriate and meet a number of franchise systems and get some gauge for the types of responses and the types of quality of operator they’re talking about. Don’t make the mistake of having too much emotional attachment early on and then trying to do the deal at all cost.

Dobbie: Now the dispute is mainly a one way street or do we find situations, have you seen situations, where the franchisee just isn’t meeting his or her obligations?

McFedries: There’s certainly a lot of that. It’s a two way street as it is in any situation. I mean, companies have dissatisfaction with employees, franchisers have dissatisfaction with franchisees. You don’t tend to see those reported on as much. Franchisers are not actively pursuing or suing franchisees in that regard. It’s more likely that they’ll be managed out of the network or encouraged to sell their business. But certainly there are franchisees that don’t deliver on their end of the bargain or perhaps have tried as a passive investment. I have one operator at the moment who’s had a franchiser bend over backwards more so that I’d perhaps ever seen before in terms of concessions of payments and various other things and the very simple reality is the franchisee put a couple hundred thousand dollars into the business, but after twelve months had the idea of they’d go back to their original job and just run it as a passive investment. So now that’s a delusion to think that franchising is a passive investment. It’s not. So again, it’s just about being realistic at the outset.

Dobbie: Yeah. So I mean, whether it’s passive or whether someone is actively trying to operate a franchise but is doing it badly, I mean poor management might be one aspect, deliberate scams are another. I mean, do we actually see many deliberate scams in Australia in this sector?

McFedries: Significantly less than before. I mean, pre the code’s introduction which it’s mandatory, its part of the Trade Practices Act that came into effect on October 1, 1998. That certainly tidied up the sector in a large way. And subsequent to that, obviously Australia’s had some very strong economic times. Franchising has really gone from strength to strength in this country. It is highly respected. Any franchise system out of Australia is highly respected around the world. So there is a good degree of depth in Australian franchising but, there are still unfortunately, people who try to make money out of selling franchises. You could call it pyramid selling schemes, you can call it what you like, but those people absolutely should not be in operation. Not only in franchising but in business full stop.

Dobbie: Not always easy to spot first hand, of course, or at the onset.

McFedries: Oh very hard. I mean it’s very difficult but you know, it’s like those property scams you see that happen on TV and you’re all sitting there wondering how on earth did they get conned by such and such and hindsight is a wonderful thing. Again all you can do is encourage franchisees to be as active in the due diligence and perhaps more so than they’d previously thought. A lot of people are ill-equipped to do a strong due diligence, but at the same time they make their decision, they don’t want to pay an accountant or an advisor a couple of thousand dollars to actually go and find some further information or perhaps dig a little deeper. So that couple of thousand dollars or it might be fifteen hundred, who knows what it is, is money well spent in my view if it saves you your house and a couple years time if that was the manifestation of any sort of scam.

Dobbie: Now one of the complaints that’s been reported from franchisees in the Kline’s chain was, it was difficult for them to leave, even when the chain was falling behind competitors. What rights do you have as a franchisee to switch to another franchise if things aren’t going well for the chain?

McFedries: Well the rights themselves are contained specifically within the contract. So anyone’s course of action, the starting point is the contract, which nine times out of ten will be an express contract. It’ll be signed. Scarily still in a number of cases you have implied contracts, where people have not actually gone and dotted the T’s and signed it. But ultimately the contract’s the starting point. Most franchisers logically are quite protective of people just pulling down the hording and starting to operate under another franchise and certainly contractually inducement from one franchiser for other franchisees to break their contract can come across is illegal. So it’s a hairy area, if I might describe it as that. A franchisee can leave their business at any point in time. The most common way to leave is to sell it.

Dobbie: What would you see as being the sensible middle ground between both parties in terms of terminations?

McFedries: Well it’s got to be based around a process of ultimately what’s called dispute resolution and because it is a source of dispute and the majority, the vast majority now are being resolved through mediation and sensible discussion rather than through litigation. I’d recommend anyone if they think they want to be out of the business, two scenarios. The business is performing OK but we’re not happy to be here anymore. The most logical exercise is to work with the franchiser to try and actively sell that business. The other is a distressed business and that’s a lot harder to deal with and they tend to be the situations where logically each party tends to be focusing on the other’s role but I would certainly encourage people to sit down and have a practical discussion. It is staggering how much money is spent in disputes. You’re talking sort of fifty/a hundred thousand dollars to see these disputes through to the end and often with no real gain.

Dobbie: So is it a fairly volatile sector generally? I mean you know, compared to outside the franchise world. Are we seeing a lot of disputes? Do we see heavy turnover of businesses?

McFedries: No.

Dobbie: It’s been, it’s the same?

McFedries: Quite the opposite. The average tenure of a franchisee in Australia now is about 7.3 years across all systems; average tenure of a full time employee in Australia is about 2.2 years. So that gives you some idea of volatility. It’s a very stable sector and the big difference, of course, is the people are in it to build an asset, whereas with a job you don’t have anything to sell at the end. So it’s a very stable sector and it is a very, very healthy sector in Australia. Yes, in any business, any industry, there are always instances of disappointing outcomes, particularly in markets that are having it a bit tougher like New South Wales and perhaps Victoria, but ultimately it’s a very strong sector. There are some very, very strong businesses and there are some really interesting businesses that have some serious international opportunity and they are really exploring that in major ways.

Dobbie: Now can you see any significant changes coming out of the government inquiry and do you think that inquiries like this do any damage to the industry? There’s been a few inquiries of late. I mean, is that going to put off potential franchisees from taking out a franchise?

McFedries: No, I don’t think it will. I think that people tend to dramatise inquiries. I don’t belittle the importance of them and I think that an objective view from time to time is good. Having said that you know, the latest federal inquiry that changes from all of that only got implemented in March, so we’re just coming off the back of the first real major overhaul since 1998. So I think that the real problem would be if we looked to over regulate a sector that is already performing very well. There are some checks and balances in there. I’ve always been a proponent of the view at the end of the day personal responsibility’s got to kick in at some point. You simply cannot become involved in any sort of business and expect that risk will be nothing. If people have lost properties and so forth, that is absolutely tragic, but there has to be a close look at the circumstances. Any other changes to come out of this regulation? I think the one that would be absolutely the worst possible outcome and crippling to be honest for Australian franchising would be if we went down to some sort of state by state regulation. Because the country simply does not have the economies of scale in each market. You cannot build a sustainable franchise just out of Victoria or just out of New South Wales. It’s simply not a viable prospect for a good quality franchiser. So if you just added a whole layer of crippling costs and needless regulation at a state level, on top of what’s sitting there federally, I think that would take franchising back a very, very long way.

Dobbie: Well this government came in talking about new federalism so let’s hope that’s not the case.

McFedries: Certainly hope so.

Dobbie: All right, thanks so very much for your time today.

McFedries: Thanks Phil.