Nine-Fairfax deal
ACCC chair Rod Sims.

Franchising has been a terrific playground for people with no morals.

If you were willing to destroy the lives of lots of hopeful people by selling them a dream, you would find such people were abundant and so, so full of optimism. You could relax by your pool. Have someone bring you a drink. Fear not. The rules couldn’t touch you.

Until now.

Today, perhaps, that poolside drink tastes bitter. The Australian Competition and Consumer Commission is taking mega franchisor Retail Food Group to court in a seismic moment for the sector. The ASX-listed company is the company behind several well known brands including Donut King, Michel’s Patisserie, Brumby’s Bakery and Gloria Jean’s Coffee.

“We allege that Retail Food Group withheld critical profit and loss information about these corporate stores from incoming franchisees and falsely represented that these loss-making stores were viable or profitable,” ACCC boss Rod Sims said on Tuesday.

This is long overdue. Franchising is an enormous part of the Australian economy. Just like the banking and finance sector, although there are many, many good operators, the sector is big enough that a small share of bad apples can do enormous damage.

Let me tell you a story

My franchise fascination dates back to 2013.

Pie Face outlets were popping up all over central Melbourne — 24-hour meat pie shops seemed to be on every corner but with almost no customers. On a quiet January day with no other news around I started ringing franchises at random to find out how business was.After a few dead ends I will always remember when one franchisee said: “Is this about the Queensland thing?”

I thanked him and started ringing pie shops with an 07 prefix. It wasn’t long before I was talking to a circle of angry franchisees at various points on the road to business collapse, personal bankruptcy and divorce.

Australians weren’t really keen on 24-hour pies. As the pie franchisees were losing their livelihoods, the franchise itself was deep in the red.

Fawning PR had been piling up for the investment banker behind Pie Face, but his company was headed for bankruptcy. The founder was forced off the board and pursued by the Australian Tax Office. He faced no criminal charges. Creditors eventually got 19 cents in the dollar.

Some Pie Face outlets are still around. After a messy process, administrators turned around a smaller version and sold it to a petrol station company.

Each time I see one I remember the pie franchisees. They had a dream, but their life savings disappeared. Their families were strained past breaking point.

And I remember the slick guy who sold them the franchises. According to his smiling LinkedIn profile, he is an investment banker again, in New York.

I blame McDonald’s

The golden arches cast a glow over the whole franchise sector, but the lesser lights of franchising are more in the shadows. The simplest problem with franchising is that a lot of businesses are destined to fail. This isn’t a surprise — small business attrition rates are huge, as the next chart shows.

Rather than concluding this makes franchising a good idea, perhaps we should consider that it makes it dangerous. Would we let a financial company market a product that hurt customers so often?

There’s a huge difference between starting your own business and buying one. Turning it into a commercial relationship ought to put a huge burden on the seller to guarantee it is safe. Much like food safety laws. The reason we are super vigilant on commercial kitchens but let you eat mouldy cheese at home is that the intercession of a profit motive makes the risk to the unaware systemic.

We don’t demand people do due diligence before eating at a restaurant. We make sure the buffet is safe.

But it works better than starting your own business!

Yes, franchises fail less often than your own business, but they usually cost more to get into and make people much more unhappy.

A 2012 survey found 70% of failed franchise buyers described it as “the worst thing I ever did” compared with 30% of failed independent businesses. That’s an insight into how traumatic it can be to be trapped in a failing business and have no power to change it.

I see franchising as a business that sells a financial service — for a hefty upfront fee it promises an income stream. But it is not regulated the way a financial service is.

The upside largely goes to the franchisor. If the business is profitable, that money flows back to the franchising company in multiple ways: high regular fees and profits on the supplies it compulsorily sells to franchisees.

What’s more, if your franchise does really well, the franchisor has full visibility of your accounts and will often open a competing franchise across the road. Your upside is limited.

The downside is less limited. It rests with the poor person — often a recent migrant — who cobbled together tens of thousands of dollars, or a few hundred thousand, to buy a muffin shop, computer repair service, or whatever.

If the business starts going badly they often have to work 80-hour weeks without paying themselves. Supposedly it is their business, but there’s little room for initiative. They can be in big trouble if they vary the business model, leaving them feeling trapped as costs outstrip revenues.

What can franchisees do? They underpay workers as much as their consciences will permit (sometimes this is a lot). They do shifts themselves. They eat the losses for a while. But if things go badly enough they bow out. The franchisor happily takes back the business (at times they do help franchisees on-sell it, leaving the owner with trading losses but no capital loss) and sell it again to the next sucker.

Because each outlet can be sold, there’s not always motivation for the franchise system to optimise each one. But in coffee shops and pie outlets, little things like the way your sign faces in a shopping centre can be the difference between life and death. The brand itself is not enough to guarantee success. Neither is the hard work of the owner.

Inside each franchise system, some outlets are doomed. The next sucker doesn’t know if the specific business they are buying is a dud.

ACCC on the case

Selling dud outlets is what the ACCC is after Retail Food Group for.

“The ACCC alleges that Retail Food Group acted unconscionably and engaged in false, misleading and deceptive conduct when it sold or licensed 42 loss-making corporate stores to incoming franchisees between 2015 and 2019,” Sims said.

“The prospective franchisees simply had no way of knowing the true financial performance of the stores, and we allege that Retail Food Group took advantage of this when selling or licensing the stores.”

I was leaked a list of Pie Face store results in 2013 and while the Sydney airport store was making terrific profits, plenty were making losses. When a franchising company rolls out its smiling franchisee representative to tout the benefits of buying into the system, you can bet it’s one of the lucky few.

George Mihailides bought into Boost Juice a couple of decades ago. The store was thriving, but changes in the complex where it was located meant patronage slumped. He started doing long shifts himself but eventually handed back the store to the franchisor. He lost his house and was homeless for six months.

“I think personally there should be some skin in the game with the franchisor so if there is a loss that goes on at the store level, they have to bear part of it,” he said. “If it’s a true partnership they should bear part of it.”

One sign the franchise sector is terribly broken is the trail of reviews. The sector is in a state of perpetual reform. A major Senate inquiry reported in 2019. Consultation just closed on the government response to that review. It is proposing a few more tweaks to the model to improve disclosure.

Will it be enough? I doubt it. About the only thing you can guarantee is another review in a few years.