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The franchise model
The franchise business model
Franchising is an ongoing relationship between two separate commercial
parties, a franchisor and a franchisee. The franchising relationship is based
on a prescribed business model offered by the franchisor and carried out under
their guidance and oversight by franchise owners (franchisees). The Franchising
Code of Conduct (the Code) stipulates that, under a franchise agreement,
franchisees are granted the right to trade under the franchisor's brand and use
their system or marketing plan. This occurs on the basis of certain conditions,
- the franchisor retains control over the franchise system,
including the use of the franchise brand, marketing and advertising,
product/service quality and inputs;
- the franchisee's business is associated with the franchisor's
trademark, advertising or commercial symbol;
- the franchisee pays a fee in exchange for the use of the
franchisor's brand and systems. This can include initial one-off or continuing fees
for either or all of the following: starting capital investment, payments for
goods and services, royalties on profits and training.
There has been some debate about the breadth of the definition of a
franchise during the inquiry. This relates to the prospect of unintended regulatory
encroachment—or, in some cases, potential lack of appropriate regulatory
coverage— and is discussed further in Chapter 4, starting at paragraph 4.1.
For franchisees, the appeal of a franchise is the potential benefits of
being able to conduct a business under an established brand name using tested
operational systems. In turn, franchisors are able to grow their business by
allowing others to use the model they have developed, within an agreement that
allows them to retain substantial control over its use but without the
financial risks of significant capital expenditure.
Franchising has proved a very popular business model in Australia. According
to a Griffith University survey of franchising in Australia in 2008, there are now
approximately 1100 business format franchisors in Australia, compared with 960
in 2006 and 850 in 2004.
There were an estimated 71,400 franchised units in 2008 turning over $61
billion (in 2007) and employing over 400,000 people.
Businesses that have adopted the franchising model range widely in type;
examples include bakeries, mechanical services, travel agents, weight loss
programs, fast food outlets, gardening services, coffee shops and dog washing
They vary in size from multinational franchise systems with thousands of
franchisees, such as McDonald's, to emerging operations with just one or a
handful of units operating under the franchise system. Further statistical
information on franchising in Australia is contained in Chapter 3 starting at
Despite the popularity of franchising in Australia, variable contracts
underpinning the franchising relationship can impair the viability and success
of individual franchise agreements for the following reasons:
- differing expectations about the obligations of each party to the
- an asymmetric power dynamic within franchise agreements, with
potential to lead to abuse of power.
As with other contractual relationships, franchise agreements may take
the form of a written, oral and/or implied agreement.
The main difference from most other commercial relationships is that the nature
of franchising dictates that each party's contractual obligations are ongoing
and variable—forming a contract that is fundamentally based on an ongoing
relationship. These are not discrete, one-off exchanges between parties on
clearly defined terms that characterise ordinary contractual agreements.
The variable nature of the franchise agreement reflects the reality that
successfully managing a franchising relationship over time requires flexibility
of terms to adapt to constantly changing business conditions. Contracts between
franchisees and franchisors therefore need continuing cooperation and agreement
between the parties to ensure the arrangement provides benefit to them both. Dr Elizabeth
Spencer described the arrangement aptly:
Relational contracts are defined by features of incompleteness
and longevity. Relational contracts must be flexible, sometimes to the point of
being vague. There is often a high level of discretion accorded to the parties,
and such contracts therefore rely heavily on reciprocity and on trust that
develops over time between the contracting parties.
The real test of a franchise agreement comes after the contract has been
signed and the working relationship between franchisee and franchisor begins. Although
education, advice, disclosure and due diligence generate important information
about the potential for success, the true nature of franchising cannot be
appreciated until the relationship is under way.
Franchise contracts establish a broad, loosely defined set of
obligations for both parties. Franchisors are expected to offer an appropriate
level of support, guidance and advice to franchisees on using their business
model; maintain support through advertising and marketing; provide inputs and
equipment of an agreed standard; and update the model when business conditions
demand it. In return, franchisees are expected to pay agreed fees and royalties
and execute the business model as prescribed by the franchisor, to a standard
that maintains the reputation of the franchise network as a whole. The success
of a franchise model depends on the provision of a consistent, quality product
or service to consumers, who generally view the brand as a homogenous entity
and exercise their spending preferences accordingly.
While contractual flexibility is necessary in the franchising context, an
absence of clear and unambiguous responsibilities over the longer term provides
a potential source of dispute or tension between franchisors and franchisees. Although
the initial contract remains static, the terms of the contract are such that,
in practice, changes in fees, conditions and business systems can be imposed on
the franchisee by the franchisor through changes in the operations manual. Where
expectations about performance and/or conduct do not match that of the other
party, disagreements about how the franchise agreement is to be carried out can
occur and the relationship can break down.
For instance, a franchisee might be disgruntled with the franchisor's prescribed
model for offering a core product, based on direct customer feedback. The
franchisee may be dissatisfied with a perceived lack of responsiveness to evolving
consumer preferences and make minor changes independently to maximise store
sales. In such a case, the franchisee expects the franchisor to update the
business model to meet changing business conditions and may consider that these
expectations have not been met. Conversely, the franchisor expects that the
franchisee will strictly adhere to the model in order to maintain brand
integrity. In the hypothetical scenario presented above, their expectations
have also not been met—which precipitates a dispute between the parties over
who should be doing what and how. This example portrays a very basic version of
the genesis of disputes that occur in practice, but demonstrates the potential
for unmet expectations and consequential disputes within franchise agreements.
Compounding the 'expectation gap' problem for franchisees is the asymmetrical
distribution of power within the franchise agreement. The franchising model is necessarily
predicated on strict franchisor control over the use of their brand, allowing
them to impose strict terms and conditions on the way franchisees operate their
franchise business. Because the franchisor's model needs to be implemented
uniformly across the franchise network, franchise agreements are typically
underpinned by standard form contracts drafted by the franchisor. These are
presented to franchisees on a 'take it or leave it' basis: the franchisee can either
agree to establish a franchising relationship on the franchisor's terms or not
proceed at all.
In practice, franchisors are able to dictate business operations and
procedures to franchisees, and are able to change these at will. Standard form
contracts specify the beginning of a franchising relationship, but—as allowed for
in the contracts—the operations manual and other communications or directions
from the franchisor form the basis of daily operations. Franchisors can impose rigorous
obligations on the way the franchisee operates, which are subject to change at
the discretion of the franchisor. These obligations may be strictly enforced: failure
by the franchisee to meet their obligations, as interpreted by the franchisor,
can trigger termination of the contract.
This control allows franchisors to prevent franchisees from exploiting their
intellectual property to the detriment of the overall franchise network but can
also lead to the potential for abuse of power.
On the other hand, standard form contracts provide little or no scope
for franchisees to impose stringent obligations on franchisors or apply their
own discretion to open-ended terms of the agreement.
Despite their investment in the business and their dependence on the use of the
franchise model to derive returns from this investment, franchisees can exert
little or no leverage when seeking to impose their interpretation of the
franchisor's obligations on the agreement.
Franchisors are therefore in a position to exercise far greater power
than franchisees when enforcing the terms of open-ended, variable agreements. From
the franchisee's position of relative weakness, they must hope that the
franchisor will not exercise their discretion opportunistically. In good
franchising relationships the franchisor nurtures and assists franchisees to
maximise profit royalties and achieve growth of their brand. Such is the cooperative
and interdependent way the majority of franchising relationships are conducted.
However, the imbalance of power within the relationship means that scope exists
for rogue franchisors to use their control opportunistically for financial gain
at the expense of franchisees.
Franchising regulations need to operate in a way that seeks to prevent these
instances from occurring. This is the focus of the committee's inquiry.
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