Chapter 2 F ranchisees Risks and Resp onsibilities

Chapter 2

Franchisees’ Risks and Resp onsibilities

Dr Sudha Mani | Senior Lecturer Monas h Un ivers it y

About the Author

Dr Sudha Mani is a Senior Lecturer at Monash University. Her expertise is in the area of governance of franchisor-franchisee relations and their performance implications. Dr Mani applies advanced econometric methods to work with big data. Her research has appeared in highly prestigious Financial Times top 50 journals. She has contributed to the Australian Parliamentary Inquiry Committee’s report on the Franchising Code of Conduct and was a keynote speaker at the National Franchise Convention 2019.

According to the Australian Bureau of Statistics, there are 2.1 million small businesses in Australia. There are about 150,000 franchisee-owned businesses. Franchise Australia 2016 reports retail trade, accommodation and food services, and administration and support services as three the dominant industries in franchising and constitute about 60 per cent of all franchised businesses.

Entrepreneurs can start their independent business or become a franchisee.

Starting an independent business is both exciting and challenging. There are various decisions entrepreneurs have to make. They have to decide on the nature of the business. They should set financial and non-financial goals and develop a plan to achieve them. They should consider the cost of setting up the business and the time and resources needed to manage suppliers and employees. Entrepreneurs should carefully consider how they would attract customers and build the brand. An independent entrepreneur may not have the time and the full range of expertise needed to set up a successful business.

When the business risks of going alone are high, then joining a franchise becomes a viable option on the table.

Entrepreneurs often look to franchising as a viable alternative to managing an independent business. Entrepreneurs considering franchising can rely on a tried and tested business model. They can depend on the brand to bring in customers. The franchisors can also help manage the leases, suppliers, and employees. Franchisors can provide the necessary training to get things rolling and provide continued support.

So, the first question is, should you go it alone as an independent business or be a franchisee?

Personal Goals - As an entrepreneur, start by identifying your personal goals. This would include both financial and non-financial SMART goals. The financial goals can be on sales, profits, growth, or customer satisfaction. The goals should also include personal goals, such as sending kids to college or retirement planning.

Write down the goals and then carefully consider whether going independently or working with a franchisor will help you achieve these goals. Don’t forget to include information on how long you are willing to wait to achieve those goals. Investment Budget: Entrepreneurs should plan the budget needed to invest in the business. How much can you afford to invest in the business? How will you pay your personal and business bills while the business takes off? Thinking about the financial implications of the business decision will help you take a medium-term perspective on the decision. Do you have the investment capital (yours or borrowed) to invest in the business? What’s the extent of risk you are willing to take?

It’s a business, and there is no guarantee of success. Have you considered the downside risk of your investment? Should you budget for both time and money to do the necessary due diligence on more than one franchise brand?

Working with franchisors: Entrepreneurs considering franchising should consider whether they are willing to work within the ‘rules’ of the franchise. Franchisees get the advantages of the brand, but they also cede control over some of the business decisions. Are you ready to work with the rules of the franchise system and be a team player? Do you trust the franchisor to cede control of the business?

Once you decide that franchising is right for you then finding the right franchisor is critical.

Entrepreneurs can potentially reduce the business risk of managing an independent business by working with a franchisor, for example, better access to the market (consumers) and business processes. However, they are introducing franchise risk. Franchise risk is the risk of working with a franchisor.

The Australian Parliamentary Committee in 2019 completed a review of franchising in Australia (see Fairness in Franchising report https://www.aph.gov.au/Parliamentary_ Business/Committees/Joint/Corporations_and_Financial_Services/Franchising/ Report). One of the most critical lessons from the inquiry is that not all franchises are the same. Prospective franchisees should invest the time and resources to identify the right franchisor.

What should you look for to reduce franchise risk?

Talk to a handful of franchise brands to understand the business model and to understand your own priorities. How does the franchisor select new franchisees? Fit with franchisor: Do you think you can work with the people involved with the franchise brand? What are the franchisors’ priorities? Can you achieve your personal and financial goals working with the franchisor? Is there goal alignment between your priorities and that of the franchisor? Company-owned outlets: Does the franchise brand have company-owned outlets to show their skin in the game? What proportion of their store are company-owned outlets? What is the franchisors’ growth strategy? How are they planning to grow both locally and nationally? What’s the general growth trend in the last few years? Are they relying on company-owned or franchisee-owned outlets for growth? How often and how many company-owned outlets have changed to franchisee-owned outlets and viceversa in the last three years? Royalty rate and other fees: The royalty is the amount you are going to be paying the franchisor on a weekly/monthly basis for the brand and other services of the franchisor. Do you know the royalty rate? Is it due on a monthly or weekly basis? Is it a per cent of sales or a fixed amount? What kind of accounting practices are in place for the royalty payments? What are other fees associated with the franchise? Typically, how long does it take for the franchisee to break-even? What kind of costs would you include to consider break-even?

Bankruptcies and insolvencies: Has the franchisor, directors, or if any of the franchisees filed for either bankruptcy or insolvency? In my research published in a Financial Times ranked marketing journal, my co-authors and I find that failure of

franchisors and franchisees have a significant impact on the chances of other franchisees going bust. Franchisee association: once you start the business, it is crucial to be aware of how you’ll manage the business on an ongoing basis. Is there a franchisee association? Can you talk to other franchisees and share ideas and learn about best practices? Incentives: If the franchise is a success, then do you have an option to grow with the brand? Incentives such as the preference to open new outlets in the area or lower fees to open additional outlets have shown to reduce the risk of franchisee insolvency. These incentives are rewards for successful franchisees with an ambition to grow. Even if you are not planning to add additional outlets, knowing that the franchisor supports existing franchisees is essential.

Training: Does the franchisor provide adequate training? Who handles the training? Who pays for the training? Where and when is the training delivered? What kind of ongoing support does the franchisor provide? Are you comfortable with the level of support? Franchise system changes: Any franchise system will require changes. How does the system handle changes? Who bears the cost of the changes? Does the franchisee or a franchisee committee have a say on the viability of changes? Exit and transition arrangements: How long is the contract between you and the franchisee? What happens at the end of the contract? What are your options if things go south?

Seek expert advice

Last but not least, once you’ve talked to a few franchisors, it is time to start a more formal process. Do get expert legal and financial advice. The franchisor is required to provide disclosure documents to prospective franchisees. These are complex documents and need the experts to scrutinize them. Trying to save some money now could cost you significantly more later on. A franchise business is not free from risk. But, can you find the right franchisor to reduce the franchise risk?

Ask questions and then vet the franchise disclosure documents. Getting the answers from the franchisor and then vetting the franchise system using legal and accounting experts is a way to reduce the franchise risk associated with the business.

Dr Sudha Mani

Sudha.mani@monash.edu https://research.monash.edu/en/persons/sudha-mani https://www.linkedin.com/in/sudha-mani-2648666