Franchise Alliance and converting a licensing business to a franchise

Converting a licensing business to a franchise can be fraught with difficulties, but in many cases it is also necessary to comply with the Trade Practices Act. Franchise consultancy Franchise Alliance principal, Phil Blain, explains the process and its pitfalls.

As a franchise consultant to the industry for many years it has never ceased to astonish me the lengths some organisations go to in order to avoid being labelled a franchise. Firstly, I will examine some possible reasons for this having occurred and secondly, look at some of the expected outcomes of a managed change from a licensing structure to a franchise structure.

The situation is all the more surprising given that the Franchising Code of Conduct contains absolutely nothing that any morally sound, best practice business would not wish to adhere to. It is, rather, wrapped around a practical common sense commercial approach to doing business.

Robert Gardini was the solicitor charged by the government with investigating the introduction of a legislated version of the FAANZ voluntary code and in the late 90s he consulted Bill Borowski (my late and sorely missed business partner) and myself, advising that we were among the minority of advocates for the Code’s introduction. We thought it wasn’t actually tough enough, and I still hold that view.

But if the Code is relatively tame, why then is my practice involved with so many companies, large and small, public and private, that declare: “We are not a franchise?”

In the majority of cases the key reasons for trying to avoid the Code are:

• Historical – trying to avoid the hassles: In 1998, or just prior to the introduction of the new legislation, a client sought franchise advice from a franchise consultant about the potential impact of the Code on its business. I will be decidedly unpopular for this next statement, but I believe many lawyers at the time were scare mongering and saw the new Code as a chance to drum up business. Resistance to change and fear of the unknown were influencing factors also. As a consequence, some fairly complex and sometimes unnecessary restructuring took place. These structures have in later years served to hold back the company’s growth, rather than enhance it. The cooperative structures that remain, for example, are cumbersome dinosaurs with so many heads they self-mutilate to destruction.

• Monetary – trying to avoid the costs: There was a genuine – and somewhat justified – fear that the creation of all the necessary documentation and reporting procedures would place a heavy burden on existing franchisors. There was indeed some investment required at the time, but the resultant business analysis and benefits and efficiencies that emerged as a result far outweighed any costs incurred.

• Entrepreneur versus unscrupulous operators – trying to skirt the law: There was also a fear that the establishment expenses would prevent entrepreneurial entry to the franchise market, making new franchises too expensive to establish. What we have seen happen is that the true entrepreneur continues to find the way to market, but the ‘make a quick buck and run’ guys have been excluded from the franchise community.

Due largely to the efforts of the FCA , ACCC and other franchise consultants, franchising is definitely not tarred with the same brush it was 10 years ago. It is no longer a stigma to be labelled as a franchise – on the contrary, statistics now confirm the success of the model, and to be a franchise is clearly perceived as an advantage if the business is under scrutiny.

Given this, there are many companies that no longer fear being labelled a franchise, and upon examination (often by in-house franchise advice) come to the realisation that under the Code they are, in truth, deemed a franchise, and as such need to make some changes in order to comply.

As is widely known, failing to comply with the Franchising Code of Conduct can be a breach of the Trade Practices Act, and the fines are horrendous.

The definition of franchising is broad yet concise. Specifically, a business model is a franchise if:

1. There is a written, oral or implied agreement between parties.

2. Goods and/or services are supplied under a system or single marketing plan.

3. Businesses are substantially associated with a trademark, advertising or commercial symbol.

4. Associated parties pay a fee, directly or indirectly.

So, you bite the bullet, decide to comply with the Code and thereby avoid the potential wrath of the ACCC – but then what do you need to do, and what will be the likely outcomes?

First up, get good accounting, legal and commercial advice. Big companies frequently outsource to a franchise consultancy for necessary franchise advice but smaller operations sometimes struggle to see the value in a franchise consultant, preferring the do-it-yourself approach. In the long run, this can actually become a more expensive option as the time needed to discuss franchise advice and implement change is generally grossly underestimated. Also, lack of experience leads to tasks having to be constantly redefined and repeated. There is no substitute for specialist franchise advice from an experienced franchise consultancy.

Allow me to paint a common picture: you have 50 licensees who some years ago signed a fairly innocuous agreement and life has been ticking along fairly amicably ever since. The licensees haven’t given you much grief; but their businesses haven’t performed spectacularly well because they are all so diverse and different. Especially the guys in Queensland and WA, “because it’s different here and you don’t understand”.

You now declare that they will be furnished with a new agreement – 10 times longer, far more complex, and everyone is going to have to adhere to the system. What’s more, the business will become a franchise.

Fear of the unknown kicks in and the rumour grapevine rapidly grows, fuelled by speculation. The unfortunate bottom line is that no matter how well prepared you are, no matter what little actual commercial changes will really occur, no matter how well you explain all the benefits, there will still be attrition. Indeed, if allowed to run out of control, you run a risk of complete mutiny and eventual system meltdown.

Be prepared to conduct a road-train education program emphasising the advantages of the new structure. Top executives, not just the franchise support manager, must personally visit each state and present a logical case as to why the switch is necessary and the benefits it will deliver – particularly to existing licensees.

Although they should in theory care about the finances of the franchisor, in practice they rarely do.

It is vital to impart the message that as a licensor, the company has taken franchise advice to the effect that it is, in fact, structured as a franchise, and as such formal conversion to a franchise is necessary to comply with the law. The presentation is then best followed up in the next few days with face-to-face personal meetings to allay any remaining fears and explain misunderstandings.

However, despite these (frequently costly) efforts, our experience at Franchise Alliance is that there will still be somewhere between a 10 and 20 percent licensee attrition rate. If a licensee wants out, our franchise advice as a franchise consultancy is to let them go as quickly and inexpensively as possible.

Restrictive covenants may exist in written agreements, but they are hard to enforce and trying to enforce them will only deflect your attention from the main game plan.

Of course, it is not necessarily all one-way traffic, and as a franchisor you may choose to not offer a franchise to certain individuals whose profile does not suit the new growth strategy. However, if these individuals insist on remaining with the business in their existing capacity, the onus is on the franchisor to continue the relationship without disadvantaging licensees against new franchisees. This is admittedly a difficult situation that may take years to work through until the license agreements expire. The creation of a franchise advice council to work with influential licensees may help in this respect.

Whichever way you look at it, converting from licensing to franchising is fraught with difficulties. It can be a time-consuming and frustrating period, but it is also an excellent opportunity to rebrand and reinvigorate a stale system. The future is franchising.

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