By Dr Ashlea Kellner, Adjunct
Franchising can appear a far lower risk option compared to independent small business ownership. You can ‘be your own boss’, but with the support of a mentor, a brand, and the systems of a large and well-resourced franchisor. The main benefit of buying into a franchise system is the power of brand recognition and an established reputation. Advertising and marketing strategy is managed by professionals in corporate office (the ‘franchisor), and paid for by franchisees (store owners). Initial site selection, store fit-out, training, product development, supply relationships (and potential group discounts), product pricing strategy – all are services typically provided by the franchisor. In return the franchisee pays royalties (typically 4-10%) and fees for other services to the franchisor, which differ by industry and system. Assuming the franchisor is operating with the franchisees’ best interests in mind, this arrangement offers the franchisee savings through economies of scale, and reduces risks compared to independent business ownership.
If the individual chooses to go into business alone, they must not only get the word out that the store exists, but convince the public it is reputable and worth visiting. They are not just a business owner, but now a specialist in commercial site selection and lease negotiation, store design and styling, marketing, advertising, product development, logistics, accounting and sales, to name a few. For an experienced business person, this may be manageable, but for an inexperienced entrepreneur, it may be overwhelming. Although on the upside, the independent owner makes all their own decisions, and keeps all the profits.
The fees and royalties may seem a small price to pay to receive the membership benefits of a franchise system. Although, with this level of franchisor support and involvement also comes a high degree of franchisor control, which can in fact put franchisees in a more vulnerable position than independent business owners. What if the site where you open your Gloria Jeans franchise store, for instance, is just around the corner from The Coffee Club and Starbucks? What if the franchisor opens another Gloria Jeans kiosk in the same shopping centre and your sales plummet? What if the store you just purchased was previously owned by a franchisee that went bankrupt trying to keep it afloat, but you were never provided their actual financial data? These are examples of unscrupulous franchisor conduct relating just to the control of site selection, some taken straight from the Fairness in Franchising Report released by the Senate earlier this year.
The risk of franchising, for the franchisee, is due to the power imbalance inherent in the Franchise Agreement, and the Franchise Code of Conduct, which the Senate Report agrees is weighted heavily in the franchisor’s favour. A franchisor can indulge in behaviours that clearly disadvantage franchisees, however franchisees have very little power or voice to respond. The franchisor has almost total control over fixed costs of a franchise store – rents, product, royalties, fees, advertising. The domain of franchisee control is limited.
Franchisees can influence – to a degree – the presentation of the store in terms of cleanliness and order. They can determine who they hire, how employees are managed on a day-to-day basis, practical training and hence, potentially – the quality of customer service. And finally, franchisees can control wages paid to their employees. This factor is important as it can comprise a high proportion of total expenses. It is not surprising then, that many franchisees have working long hours for free in their stores (to reduce wage expenses), and their inability to pay fair and legal wages to employees. Franchisees can be successful when they ‘have a committed franchisor, a proven and evolving brand, and franchisees that are well supported’. In light of the Senate Report, however, would-be business owners ought to diligently research the risks of the franchise option. A media release by the commission conducting the inquiry reported that the findings suggested ‘systematic exploitation of some franchisees by a subset of franchisors and a regulatory framework that does not provide adequate protection against such practices’. While independent business owners certainly take on a great deal of risk, this comes with complete control – over expenses, systems, strategy, and business decisions such as whether they will stay or leave their business. Although the probability of failure is arguably much higher for independent owners compared to franchisees, failure will be due to their own behaviour or volition, not that of a larger and more powerful entity operating in shareholder interests – rather than the interests of franchisees.