Introduction to franchising
Franchising is a business system where the franchisor (the business owner) licenses the right to operate a franchise to the franchisee. As the franchisor, you set the rules when it comes to the name, brand, business systems, marketing plan, trademarks, and methods for the franchisees, who buy the right to operate one or more franchises. The terms and conditions of your franchise arrangement are outlined in your franchise agreement, the most critical document defining your franchisor-franchisee relationship. In return for an upfront fee, ongoing fees, and other ongoing costs, the franchisee gains the right to operate a business in accordance with the franchise agreement.
Franchising is a proven business model if it’s planned and executed correctly. Franchising your business and becoming a franchisor can be a viable way to quickly scale up your business idea without high capital risk, by leveraging motivated owner-operators.
Franchising in Australia is regulated by certain laws, including the Franchising Code of Conduct (the Code) and the Australian Consumer Law. Note if a business agreement fulfils the definition of a franchise agreement as specified in the Code, it will fall under the Franchising Code of Conduct even if you as the franchisor don’t call it a franchise agreement.
Industries driven by franchise models
Franchising is a $140-billion industry in Australia, with over 1,000 business formats, tens of thousands of franchise businesses, and nearly half a million people employed.
Some of the leading industries for franchising include restaurants, bakeries, cafes, retail, salons, gyms, and fitness centres. Daycare and other home services, rentals, hotels, and inns are some of the other industries strongly driven by franchises.
Top-performing Australian franchises in these and other sectors are Ferguson Plarre Bakehouses (bakeries), Soul Origin (food court outlets), and Kwik Kopy (printing services). Snooze (bedding retailer), Total Tools (trade tools retailer), Top Juice (juice and salad bars), and The Shed (cafes and restaurants) are also examples of franchising success.
These particular franchise types and sectors thrive possibly due to access to a turnkey business model, marketing and business support, and the ongoing training the franchise system provides. They might be successful also due to strong market demand, moderate competition, and scalability of the franchise concept.
Advantages to franchising
Franchising offers multiple advantages for business owners – potential franchisors – who want to scale up their business concept. Similarly, franchisees enjoy a variety of advantages not associated with founding a business from scratch.
Advantages for franchisors include potentially rapid expansion coupled with low-risk financial gains:
- Quick expansion – With multiple franchisees buying into your franchise and providing capital, your business could experience easier and faster expansion, through a wide-ranging geographic area. Drawing on the manpower and financial resources of the franchisees, successful franchising models can be quickly replicated nationwide, which in turn heightens brand recognition and helps you attract franchisees and more customers. This is in contrast to you opening company-owned branches and outlets and managing your own staff and daily operations in these sites.
- Revenue streams – Depending on your franchise agreement, you could have the certainty of ongoing revenue streams in the form of fees like monthly royalties, which might be calculated as a percentage of sales.
- Economies of scale – Volume purchasing agreements could give you strong negotiating power with suppliers, which can lead to better pricing and economies of scale to benefit your franchise and franchisees.
- Expansion capital – The franchisees’ initial payments along with periodic royalty fees minimise the need for you to obtain financing from banks or invest your own capital to expand the business. As such, the financial/capital risk for you could be significantly lower.
- Transfer of risk – Financial and business failure risk could largely rest with the franchisees, which means you have a lower risk for each location opened. Similarly, fault for damage or losses experienced by customers could rest with franchisees (and their employees) and not you as the franchisor.
- Market feedback – You’ll benefit from feedback and regular reports from your franchisees, and with this you can track shifts in demand, consumer sentiment, and other trends to inform your strategic decisions and marketing campaigns.
- Reduced management – As a franchisor, you won’t need to deal with hiring and managing employees, who are the responsibility of the franchisee, and the same goes for day-to-day management. This leaves you free to focus on business development, franchise expansion, marketing, and other strategic objectives.
- Access talent – If you find the right franchisees, you’ll be working with business partners who are self-motivated, driven to succeed, and hard working. Franchising might enable you to access better talent who will work harder to build a successful operation than you would by hiring a manager. The success of their individual franchise operations enhances the overall brand and reputation of your franchise and supports your franchise success.
Advantages for franchisees
Understanding the advantages for franchisees will help you promote your franchise model to potential franchisees. Franchisees have access to an established business model, giving them more certainty and a higher success rate, along with removing the standard guesswork and barriers associated with new startups. This model has established ongoing marketing and business support, brand recognition, a loyal customer base, and tried-and-tested trade secrets or know-how.
Franchisees also receive ongoing training for running their business, which can help them avoid common startup mistakes. With a prominent brand, the franchisee could find it easier to obtain financing. They’ll have all the benefits of a comprehensive network of suppliers and other business partners.
Potential limitations of franchising
Franchising your business can be associated with potential limitations and risks. These could be mitigated with the right franchise agreement and terms and conditions.
- Initial capital outlay – As the franchisor, you’ll be taking on a level of risk with an initial investment to set up your franchising model and build it so it’s ready for franchisees. For example, you’ll need to design operational manuals, create a marketing strategy, and establish a franchise recruitment and training plan. You’ll also need to consult a lawyer and set up the right legal structure.
- Profit-sharing – You’ll receive a relatively small percentage of the turnover, typically in the form of a royalty fee. In contrast, with company-owned branches or outlets, you’ll reap 100% of the profits.
- Less dynamic – The franchise model could be associated with less dynamism and innovation as you could find it more challenging to implement changes across the whole network compared with company-owned sites. You might need to spend more time negotiating new standards with franchisees before retraining them and providing them with the right tools and processes for any major change.
- Trade secrets – Once a franchisee buys into your franchise, you’ll be sharing with him/her all the secrets of your business model. This includes systems, processes, intellectual property, product and service features, and other details relating to competitive advantage.
- Reduced control – The franchisees are independent business owners rather than branch managers. As a result, you’ll have less control over daily processes and operations. You’ll also have less visibility, which could raise the risk of franchisees acting in their own interest to the detriment of the franchise brand and goodwill. For example, franchisees taking shortcuts and failing to meet product or service standards can threaten the reputation of your franchise network, compromising your brand and destroying customer trust.
- Harder to build collaborative community – Similarly, while you can mandate hired store managers work collaboratively together, you could find franchisees harder to convince if you want them to cooperate as a community. Franchisees might view themselves as independent business owners and act in their own self-interest, and at times this could be detrimental to other franchisees.
- Compliance – Franchising is subject to specific regulation under laws like the Franchising Code of Conduct and Australian Consumer Law. Franchisors need to do due diligence and stay informed by working with experienced franchising lawyers to ensure the franchise set-up is fully compliant.
Potential drawbacks for franchisees
Awareness of the potential drawbacks for franchisees is important when negotiating with potential franchisees and refining your franchise agreement. Understand franchisees might find the initial set-up costs significant and unaffordable since they might need to lease premises and purchase equipment on top of paying the initial fee. They’ll also need to meet ongoing costs like royalty fees.
Some franchisees might find the franchise agreement too strict in its guidelines. For example, the franchisee might be limited in terms of customisation of his/her site, along with the freedom to apply site-specific marketing strategies. Similarly, the agreement might limit franchisees to approved lists of suppliers as well as require them to conform to specific processes for their daily operations. Finally, franchisees might be committed to the franchise for a given period and be unable to exit until they complete the contract period.
Legal considerations for franchisors
Again, as franchisor, you need to fulfil your obligations under the Franchising Code of Conduct. This covers disclosure requirements, a good faith obligation, observing a cooling-off period, and having procedures for ending a franchise agreement. You also have rights and/or obligations under Australian Consumer Law, the Competition and Consumer Act, the Australian Securities and Investments Act, tax laws, and state/territory licensing schemes.
In recent years, major brands like Subway, Caltex, and 7-Eleven have been penalised by the Fair Work Ombudsman for failing to comply with Australia’s fair work laws. These cases illustrate the importance of ensuring your franchise set-up is fully compliant with not only franchising and consumer laws but other applicable regulations like employment laws.
Note: the penalties were imposed on specific franchisees and not the network or franchisor. As such, you need to make franchisees aware of the fact they can be seen as operating their own business and managing their own employees even though the franchisor provides extensive support and an off-the-shelf business system.
Legal issues in the Subway, Caltex, and 7-Eleven cases
The Subway case saw the operators of two franchises penalised for underpaying a Chinese national worker who worked in both outlets. In addition, the court found the operators also underpaid a special clothing allowance. The operators also breached laws relating to record-keeping, payslips, and requirements on informing employees about their terms of engagement and classification.
In the Caltex case, the court found a Sydney franchisee who operated several outlets had falsified wage records for migrant workers. The false records made it impossible for inspectors to work out whether employees had been paid their lawful entitlements. The franchisee also breached laws relating to issuing timely and accurate payslips for employees.
As for the 7-Eleven case, the court found the two operators (companies with the same director) of several Brisbane stores had underpaid 21 employees. The employees were significantly underpaid for overtime rates, shift-work rates, and Saturday and public holiday penalty rates as outlined by the General Retail Industry Award 2010. In addition, several workers were paid under the wrong classification, and the operators had failed to meet record-keeping and payslip requirements, including records relating to cash payments.
Insights for franchisors
What insights do these cases offer for franchisors? First, review your franchise model and ensure it doesn’t encourage or motivate franchisees to lower pay for employees or limit rightful entitlements. For example, excessive limitations on franchisees’ discretion with business expenses could end up encouraging franchisees to underpay staff.
Also, the wording of your franchise agreement should make it explicit that underpaying is against the law. As a franchisor, you might need to take proactive measures to check franchisees are complying with the relevant laws, on a regular basis, as you may be deemed accessorily liable. Other laws and compliance issues you should train franchisees on include work health and safety, tax, insurance, fair work practices, and superannuation.
Assessing the viability of franchising your business
You might have received multiple enquiries about the possibility of franchising your business, but how do you know if your business is franchisable? Start by considering these four key issues.
1. Commercial profitability
Is your business profitable? For a successful franchise, your business should generate a marketable return on investment for prospective franchisees after royalties. Without a sufficient ROI, your business won’t be able to attract franchisees or keep them happy.
2. Long-term strategy
Are you ready to give your time and focus to make your franchise network a success? You should be committed to a well-defined long-term strategy that sees you investing in and growing your business.
3. Commercial viability
Have you considered whether the franchise model will be commercially viable for you? What should you expect to invest to support the growth of your franchise network, and can you afford it? Review the costs required to create your franchise model, including marketing costs. How much will your franchise network grow?
4. Professional qualities
Make sure you’re mentally ready to do and give what it will take to make your franchise network a success. You need to be strongly committed, meticulous, compliant, realistic, and patient.
If you’re satisfied you have the right qualities and long-term strategy and the model is viable, you can start looking into developing your franchise. This process involves four major steps, and ideally, you’ll be guided by franchising experts with legal expertise in the area at every step.
- Workshop – A strategic workshop guided by experts gathers information about your business, identifies your key objectives, and explores potential business models.
- Feasibility and Economic Development – Once you’re committed to the franchise development, you should develop short-term and long-term objectives to guide the expansion of your franchise model.
- Commercial Policy – The next step is to develop your commercial policy. This includes operation documentation and manuals as well as policy documentation outlining primary obligation roles and responsibilities for you, the franchisor, and your franchisees. These clarify who’s responsible for what and assists with quality control and maintaining high standards.
- Legal Documentation and Compliance – Based on your economic model, operations manuals, and commercial policy, you can then prepare all the legal documentation – including the all-important franchise agreement – you need to set up your business as a franchise.
Once you’ve worked your way through these four key steps, you might undergo a pilot-testing process with company-owned and operated outlets before taking on franchisees. A pilot run gives you an opportunity to refine your systems, procedures, operations manuals, and guidelines for franchisees and identify training requirements.
Franchising your business could see you rapidly scaling up and successfully expanding across geographical locations. Understanding the advantages and potential limitations of the franchise model not only enables you to sell your concept to potential franchisees; it gives you a sound understanding of the risks so you can address them.
A systematic approach from ideation to execution, guided by franchising experts with legal knowledge, empowers you with a solid foundation for success. Franchisors, franchisees, and franchise operations are subject to a broad range of regulations including specific franchising laws and employment regulations. The process of turning your business into a franchise should include drawing up well-drafted legal documentation so you can enforce your franchise model, protect your concept against risks like reputational damage, and ensure you’re compliant with the relevant laws.
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