Could branchising be a viable alternative to the traditional franchise model? Robert Toth shares his personal view on this hybrid business structure.

Franchising has proved over decades to be a popular channel for individuals to achieve business ownership and success.

Yet over the years there have been regular attempts to fine-tune the franchise relationship to ensure the best outcomes for all. In fact the latest review has just taken place [you can read more about the Code recommendations here].

But what about a business structure that takes the best of franchising, and adds shared ownership? Enter branchising – an alternate business structure based on a horizontal relationship between franchisor and franchisee. Let’s take a look at the environment that this model fits in to. 

Franchising has been operating in one form or another for the past 40 years in Australia. It became a regulated industry under the Franchise Code of Conduct in 1998.

The business format franchises and franchise models that currently exist are based on traditional franchise models whereby the franchisee operates under a brand, system and controls determined by the franchisor.

So what has changed?

There have been major changes to business and the economic climate as we are all well aware over the past four to five years with the global financial crisis, increased competition in certain market segments and reduced margins on sale of goods services due to aggressive competition and marketing. 

In addition to this we have seen:

• Changed expectations by franchisees as to the support, training and systems to be provided by a franchisor;
• The significant and rapid move from retail sales to online marketing;
• Increased cost to franchisors in providing point of sale and software systems to support and monitor franchisees;
• Increased costs to franchisees – set up costs, labour and rental;
• Rapid changes in social media leading to different avenues to market;
• Increased disconnect between franchisor and franchisee expectations;
• Increased costs of regulatory compliance whether to do with the ATO, the Workplace Ombudsman, occupational health and safety issues

In the midst of all of this change, the traditional franchise model by which franchisees pay a royalty and marketing fee based on percentage of their gross revenue or a fixed monthly franchise fee has not changed.

Meanwhile, there are some franchisees who struggle to make ends meet and draw a reasonable salary for their efforts and these franchisees are unlikely to see a return on their investment. 

This led me to think that with all these changes surely we must, as franchisors and franchisees, engage differently and find a franchise model more suitable to current economic conditions; a model that is more transparent and which equitably shares the risks of doing business.

John F Kennedy said “change is the law of life and those who only look to the past or present are certain to miss the future.”

What this says to me is that you cannot expect to meet the challenges that confront business today using yesterday’s mindset and expect to be at the forefront of business tomorrow.

IS BRANCHISING A NEW IDEA?

The term branchising is not new, and was coined by author David. D. Seltz in a text entitled “Branchising – Proven Techniques for Rapid Company Expansion and Market Dominance” first published about 50 years ago.

It is a term used to cover business franchising and traditionally referred to the conversion of existing company owned outlets to franchised or licensed units.

It includes establishing new units in conjunction with a franchisee in which both the franchisee and the franchisor each retain equity.

The franchisor can sell the company owned outlet or a part of it and recoup some capital for further growth while retaining some degree of control and ongoing profit from the franchised unit. 

A branchise is a franchise and will be governed by the Franchising Code with obligations of disclosure and subject to the mandatory obligations.

The resurrection of the concept of branchising in Australia arose from my recent discussions with a number of consultants and due to the increased level of disputes and disenchantment by franchisors and franchisees with the existing traditional franchise model.

At this point I must acknowledge the contribution of Glenys Crawford of Crawford Kaye Ptd Ltd in my developing what I now call “Branchising for Australia” as an alternate business franchise model.  

WHAT EXACTLY IS BRANCHISING?

Is it just a fancy and clever name or does it truly reflect a different relationship between the franchisor and franchisee?

THE TRADITIONAL FORMAT

The traditional franchise relationship tends to be a vertical relationship whereby the franchisee is under the control and power of the franchisor rather than truly working in partnership.

The use of the term franchise partner by a franchisor does not change this feeling of top-down control and power that a franchisee experiences.

While not every franchise system shares the following features, in my view these are the key elements of the traditional vertical franchise relationship:

• Onerous obligations on the franchisee;
• Little real obligation on the franchisor;
• Power and control rests with the franchisor;
• The goodwill and ownership of all intellectual property and goodwill developed over the franchise term remains vested in the franchisor.;
• The payment of franchise fees from gross revenue (not profit);
• No sharing of risk or profit;
• Default provisions with threat of termination;
• All capital costs funded by the franchisee

THE BRANCHISE STRUCTURE

The branchise model is a horizontal relationship representing a more equitable relationship whereby the franchisor and franchisee own the business together and work for mutual benefit. Each party has equity in the enterprise and therefore a vested interest in ensuring its success. 

At the conclusion of the arrangement and/or sale of that business, the franchisee will recover (based on their equity) its share of good will and along the way a share of profit. 

As a true partnering relationship it addresses the issues of the traditional franchise model in relation to the feeling of power and control held by the franchisor over the franchisee.

Each of the parties contributes financially and operationally to the business. The franchisee continues the day-to-day management of the business with the support and of the franchisor who is likely to be more attentive as they have equity in the business. The franchisor relies on the energy and enthusiasm of the franchisee.

A branchise outlet is not subject to unnecessary and undisclosed fees and costs. There is generally no marketing fund. The franchisor and franchisee work together and the franchisee directly accesses management financial support and systems. 

The company becomes the franchisor upon each retail unit being sold to an independent operator, who then becomes a franchisee. 

As each company unit is sold to a qualified franchisee the company recovers their cost for the fit out, inventory, equipment and good will in the form of a franchise fee. The company can transfer the lease to the newly appointed franchisee.

As with a traditional franchisee, the owner/operator franchisee is generally a more self-motivated individual than the salary manager.

It is a model that has been adapted in the pharmacy sector where the older generation of pharmacists who may wish to take a step back or retire, cannot readily sell their pharmacies as young pharmacists who may be working in the business do not have capital sufficient to purchase the pharmacy.

The parties enter into a partnership arrangement: the young pharmacist as a manager builds up equity over time and acquires the older pharmacist’s interest. The older pharmacist may retain some limited equity and continues on as a mentor and an advisor.

SUMMING UP

In the US it has been found that branchising results in a higher sale price per franchise unit than the traditional franchise unit. The branchising model already operates successfully in real estate and retail franchise models but is suitable for any market segment.

Let’s be clear – I am not saying that branchising should take over the traditional franchise model. What it does provide though is an alternate model worth considering.