Background to FranchiseED
FranchiseED Ltd is a not-for-profit and independent organisation which provides franchising education and research to the franchise sector. FranchiseED provides services to both franchisors and franchisees and generates income from a range of sources and therefore provides a balanced and independent view. This submission is written by Ms Kerry Miles, the founder and one of the Directors of FranchiseED.
Ms Miles has been involved in the franchise sector for over 15 years, with the last 10 years being the General and Business Manager at the Franchising Centre at Griffith University. This Centre was responsible for developing and managing the Franchisee Pre-entry Program which helps prospective franchisees with due diligence and is supported by the ACCC. Well over 10,000 people have completed this program since its launch in 2010. The Franchise Pre-entry program now sits within FranchiseED.
Through involvement with this program and upon speaking to many prospective franchisees over the past 8 years, it has been identified that the biggest problem is the lack of transparency when purchasing a franchise.With limited transparency and little consumer guideposts in franchising, the potential franchisee is left to their own skill set to uncover the viability of their investment. Unfortunately, many get it wrong.
The Major Issue
Purchasers of franchises are committing to a long-term relationship and financial obligations. The majority are doing so without the benefit of an independent valuation and an enforceable due diligence documentation.
The lack of transparency when purchasing a franchise and minimal consumer guideposts in franchising, the franchisee is left to their own skill set to uncover the viability of their investment. Unfortunately, many find out too late that the optimistic figures and sales brochures do not truly represent the marketplace.
Limited Transparency Leads to Market Failure
Franchising, although regulated, currently has limited transparency. With the advent of social media and ratings systems across the economy, transparency in many different industries is increasing. There are many instances across the economy, when consumers are unhappy, social media discussions become viral posts and issues filter out into the wider media. This doesn’t happen in franchising until major media organisations dig deep and people feel confident enough to speak out. This indicates that there is an element of fear by franchisees in speaking out.
In franchising, the ability to identify a strong or weak franchise system is very difficult.
The source of this lack of transparency is fourfold:
- The complexity of the disclosure document
- If there are problems within the franchise, franchisees can be intimidated not to speak out
- This is further exacerbated when a franchisee needs to exit the business, and therefore doesn’t want to tell the truth which can impede their ability to sell
- The potential franchisee gets caught in the dream and doesn’t dig deep to uncover the reality hence franchises still get sold in broken and unprofitable systems
This lack of transparency leads to market failure. That is, broken and unprofitable franchise systems with (previous) great brands, can still sell franchises as the perception by the less sophisticated investor is “well know brand means successful businesses”. Conversely, emerging or less high profile brands with strong systems (and in low profile industries), may not attract franchisees for the very same reason.
Furthermore, there is no simple way for the prospective franchisee to really compare one franchise system against another franchise system. There is no aggregated system, based on current and up-to-date information about the franchise, that helps the prospective franchisee make an informed decision. Prospective franchises are encouraged to do their due diligence but essentially only have their own skill set to draw on plus advisors such as lawyers and accountants. However, many lawyers and accountants don’t have the depth of experience and knowledge to provide solid advice in the franchising sphere. The cost of experienced franchised lawyers and business advisers may also impede advice from top level advisors.
Improved transparency will shine a light on weak franchise systems. Improved transparency won’t come from increased regulation, but rather addressing the market failure, and providing the tools and infrastructure for consumers (prospective franchisees) to make good decisions. This will address market failure and eventually weed out poor performing franchises.
Addressing Market Failure
A rating system is needed to provide objective information about the franchise. It needs to be totally independent of the franchisor and franchisor organisations, be highly reputable and robust. Franchisees need to have input into the ratings, and must be allowed to provide their input unencumbered. They must be allowed to be honest without fear of retribution from their franchisor. Such a system needs backing by a Government Agency to become established and assist in the framework of the ratings system.
Just like other ratings systems across the economy, increased transparency encourages companies to improve their performance. We now see very few cars rated at less than 5 star safety ratings and people make choices about where they put their Super based on ratings system. Clear consumer guideposts such as rating systems encourage the improvement of business performance as it provides a clear signal to consumers on things of value to them. For franchisees, this will include: return on investment, level of profitability, franchisor support, ongoing improvements and innovation in the franchise system, and franchisor’s response to grievances.
Once a credible and reputable rating system is in place, franchisors will take note! This is because declining ratings will inhibit their ability to sell future franchises and hence future royalty streams. The ratings will directly affect their future potential. A system such as a “Trip Advisor for franchises” is what the franchise sector needs.
If inherent failings within a franchise model are not addressed, a ratings system will provide the signal to potential franchisees that something is wrong within the model. It is expected that increased transparency will inhibit some of the mass failings we’ve witnessed over the past few years. Broken and unprofitable franchise systems will be signalled by a continual lowering of their ratings. Identifying incompetent and unscrupulous business practices will then be much easier to uncover for the potential franchisee.
Overtime, it is also expected that these rating systems be used as a key performance indicator of franchise management staff. This will provide a clear connection between franchise model performance, franchisee profitability, and by implication, the performance of the franchisor. Driven by the sense of wanting to be at the top of the ladder, franchisors will work much harder at ensuring franchisee profitability, satisfaction and model improvement.
A ratings system will also assist franchisees in the cases of the change of ownership of a franchise. There have been a number of high profile cases where the original founder and franchisor owner has sold the franchise to a venture capitalist or private equity firm, and then the system has declined and in some cases, completely failed. The VC trades on the brand equity and enjoys the locked in royalties due to franchise agreements and the franchisee has limited power to change their situation due to these agreements. However, they will have input into the ratings for that period, thus squarely reflecting back on the VC’s performance.
Some are saying that franchising is broken in Australia. Franchising is not broken. Everyday, just about every person in this country will be using the product or service of a franchise. Franchises often provide the first job for our kids and ongoing employment for hundreds of thousands of people.
But rather, the lack of transparency has enabled broken systems to continue and unethical, unconscionable business practices to go on unchecked. Franchisors are always going to have the upper-hand in terms of financial resources and contractual agreements weighted to their interests. Regulators do not have the power and resources to address all the issues. Furthermore, taking legal action, often the last resort of franchisees, is beyond the reach of most. The key to moving forward is to allow the market to determine which franchise system shines and which ones do not.
So rather than increased and more complex regulation (which can make it more onerous on franchisors and more complex to understand for prospective franchisees), what will tip these scales is two things:
- the ability of prospective franchisees to choose objectively and compare franchise systems based on data that is meaningful to them; and
- current franchisees’ ability to influence via their voice being heard through a publicly available ratings system.
Clear market forces via a ratings system will hit (or potentially enhance) franchisors in their long-term royalty pockets, and will improve the state of franchising so vital to the Australian economy. There’s only so far legislation can go in stopping unscrupulous business practices. But what can happen, is that increased transparency will weed out the weakest and encourage the strongest.
What do you think? Do you think a ratings system will help the franchise sector?