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by Simon Lord,
last updated 23/07/2009

in this article:

Some of the biggest brands in Australian franchising are being accused of churning in the latest attacks on the franchise sector there - and the Australian Competition & Consumer Commission (ACCC) is taking it seriously.

‘Churning' is the deliberate practice of selling a franchise location or territory that cannot be profitable then taking it back for a nominal sum when the unfortunate franchisee fails. The same location or territory can then be sold again to another franchisee until the same thing happens again - and again.

The Australian media, which always seem to take the opportunity to be aggressively anti-franchising, have given considerable publicity to claims of churning made by a group of 30 franchisees from some of Australia's largest franchisors, including Lenard's Chicken, Midas, Michel's Patisserie, Hungry Jacks, Bakers Delight and Howard's Storage World. The ACCC, which administers Australia's Franchising Code of Practice, has refused to confirm reports that it is close to bringing an action for churning against one franchisor. However, the chairman of the ACCC does say that churning is a problem that the ACCC is tackling.

The idea that any well-established franchisor - and particularly such respected brands - would deliberately engage in an activity that comes perilously close to fraud seems ridiculous. Apart from the damage to the franchisor's brand value and franchise relationships, a failing franchisee places a huge strain on a franchise system. There is the cost of additional support, additional resources, re-training and, ultimately, the potential legal costs of exiting or tidying up after a failure. A few years ago, consultant Greg Nathan calculated the cost to a franchisor of a failed franchisee at between AUS$70,000 and $200,000, depending on the nature of the franchise. There are few, if any, businesses that would clear that sort of profit on the re-sale of a failed franchise location or territory.

The Australian reports say that franchisors find it too easy to blame failure upon the franchisees themselves by citing poor management, ineptitude or a refusal to follow the franchisor's business model as reasons. They do not accept that there must be a reason why a system which has worked for other franchisees - many others, in the case of the big brands named - should not work in a few particular cases. And, as is often the case in the eyes of the media (and the occasional judge), the little guy must be blameless just because he is the little guy.

Twenty years ago, I worked for a franchisor in the UK. We had an outlet in one of England's largest cities which was never as successful as we felt it should have been. The field support person for that particular franchisee was constantly trying to get them to follow the systems and carry out the marketing plan, to no effect. Eventually, that franchisee was encouraged to move on and sell. The new franchisee, alas, performed no better. Now, you might reasonably question our skill at selecting franchisees, but at no time was there any intention to churn the site. The frustrated field support person was convinced that it was, in fact, a goldmine for anyone who could run it properly and when it came up for sale again he put his money where his mouth was and scraped together the funds to buy it himself. Within a couple of years, he was running round in a new Jaguar and he when he ultimately sold the business he had made over a million. Churning? No. All that was wrong was the failure by two consecutive franchisees to apply a proven system properly.

The ACCC's comments so far suggest that, whatever the truth of the claims made in the media reports, they believe there may indeed be some ‘rogue operators' within franchising who do deliberately churn sites. This may be true - but how have such well-respected brands as those named been dragged into the issue?

One suggested reason comes from Michael Sherlock, the former managing director of Brumby's Bakeries. Writing on the SmartCompany website, he suggests that a number of franchises have in recent years pursued a policy of ‘growth for growth's sake' that ignores basic business fundamentals, such as the fact that it is very difficult to find good quality franchisees and sites for any system beyond a certain level. At Brumby's, he points out, the most stores they were ever able to open in one year was 35. Franchises expanding, as some have, at 80 stores a year are suffering indigestion from biting off more than they can chew. The inference is that they have had to lower standards - of both franchisees and locations - to do so. Under those circumstances, a higher failure rate is likely - and allegations of churning are inevitable.

Here in New Zealand, although we may not have the churning issue to deal with, we do have other pressures. Low unemployment means a reduced pool of potential franchisees. Higher mall rents put a pressure on locations. And a limited market size means that all companies, franchised or not, reach market saturation sooner than might be the case in other countries.

The message for would-be franchisees is clear - does the industry you are considering entering still offer good growth opportunities? And franchisors would do well to re-evaluate their business model regularly. By increasing profitability for both franchisees and franchisor, you can still achieve good growth without generating - no matter how inadvertently - franchisee failures.

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