Franchising’s growth riddle

It seems almost everyone in the franchising sector has growth on their minds.

Well established franchisors such as US pizza giant Pizza Hut and ice cream business Ben & Jerry’s, Clarke Rubber and Battery World are all embarking on franchise recruitment drives.

On top of this, six new businesses – including Las Olas Fresh Mex Grill, Malaysian food chain Secret Recipe, Ozzy Klean and Eureka Multimedia – have announced plans to start franchising in the last two months.

But there’s a big problem – franchise recruitment is as tough as it has been in decades.

With consumers still cautious and the high Australian dollar coaxing consumers to spend their hard-earned dollars online, some say the country’s $130 billion franchise sector needs some new strategies to keep growing.

Norton Rose Partner Stephen Giles says franchising in Australia has reached a level of maturity and new expansion strategies are needed.

He says franchisors would need to look at converting single franchisees into multi-unit entrepreneurs and tips private equity to play a role in driving consolidation.

Jason Gehrke, director of the Franchise Advisory Centre, tips an increase in franchise exporting, while veteran industry adviser Rod Young says franchisors will need to freshen their offerings to win both cautious consumers and new franchisees.

But competition expert and franchisee advocate Frank Zumbo believes the sector still has a credibility problem and franchisors need to restore confidence after episodes such as the collapse of the Angus & Robertson book chain.

A group of breakaway A&R franchisees sought to terminate their franchise agreement with REDgroup Retail earlier in March, saying they no longer received the benefits of belonging to the company, and the actions of administrator Ferrier Hodgson had damaged their individual business.

The groups reached a ceasefire last month, although the breakaway party maintained a preference for trading as independent stores even after the truce was announced.

Zumbo says the incident should be seen as a “wake-up call” for a sector which, to some degree, has a credibility problem.

“The collapse has made people think twice,” Zumbo, who specialises in competition and consumer law at the University of New South Wales, says.

“The word is spreading that some franchisors are high-handed, dictatorial,” he tells SmartCompany.

“And word-of-mouth can be very negative for a franchise system.”

But Giles is cautious about the long-term impacts of the RQuestioned on whether the spat between the administrators of collapsed book business REDgroup Retail and dozens of Angus & Robertson stores.

He says while the dispute might make franchisees consider the possibility of the franchisor going bust, the reality is that franchisees generally choose to not include a termination clause in their contract.

“What franchisees have purchased – the right to use the brand and system – typically remains in place notwithstanding the insolvency,” Giles tells SmartCompany.

“Termination would rarely be of assistance when a franchisor goes into administration, and is therefore not highly sought by franchisees when contracts are being written.”

“And the rejection of a request for such an amendment by a franchisor is not unreasonable – it could, for example, substantially affect the decision of a bank to lend to a franchisee, a landlord to make premises available or the value and strength of the franchisors business,” he says.

Doing more with less

One area where Zumbo and Giles agree is on what’s next for the franchise sector in terms of growth strategy – a drive to build scale.

Giles believes the next path to growth will be focusing on existing relationships with franchisees rather than targeting new recruits, and encouraging franchisees to take on more stores, with the multi-unit model still undeveloped here compared with the United States.

Another method for growth, Giles says, is encouraging a franchisee to take on more stores.

“We’re also seeing growth through private equity funding, and capital markets to fund growth,” Giles says.

Zumbo change is necessary to combat still-tight financing conditions, high rents, and poor retail conditions.

“There are too many small, undercapitalised franchises, so we will see more rationalisations or failures; consolidation, mergers, joint-ventures, multi-franchising, people trying to build on each other’s critical mass.

“There needs to be consolidation. If they don’t consolidate, more will fail.”

Zumbo says franchisors should be sitting down with franchisees to discuss issues such as rents, retail sales, and the way the business is run.

“If you want people to invest in the sector, you need to give them confidence, and sadly where there are franchisor collapses that doesn’t go well for confidence.”

Services to grow

Lorelle Frazer, director of the Asia-Pacific Centre for Franchising Excellence at Griffith University, says while franchises are not immune to troubles, they remain an attractive option during difficult times, and bargains are possible now before prices lift alongside an improving economy.

Frazer expects a resurgence in service-sector franchises, with business and personal services such as cleaning, accounting and administration tipped to grow.

“Once people feel confident and have money behind them again, they’ll opt to use services like cleaning, car detailing, household services, because they’re time-poor,” Frazer says.

Frazer also believes Australia’s ageing population will deliver opportunities.

“We’ll need to service that sector, and I’m not just talking hospitals and nursing homes,” Frazer says.

“They’re a quite wealthy sector, so there’ll be demand for services like travel to leisure to holidays to vehicles. That’s a market that potential franchisors ought to be sussing out.”

She also notes a continuing trend towards allied-health franchises, with dentists and physiotherapists, for example, attracted by the idea of delivering their services with branding behind them.

“They are specialists but not necessarily good business people or people who want to spend their time on running a business, so a franchise allows them to deliver their services but have the branding behind them,” she says.

Food, which has fared reasonably well during the GFC, could also continue to provide growth for franchisees, she says, with consumers perhaps reticent to splash out on an expensive meal but willing to allow themselves a treat now and then.

Franchise exports

Jason Gehrke, director of the Franchise Advisory Centre, says while low unemployment numbers and capital constraints are undoubtedly putting a dampener on franchisee interest, the sector will continue to evolve.

“There will constantly be newcomers to the franchise sector, and there will always be new business models which may lend themselves to franchises, so while the sector might be mature, that doesn’t prevent the entry of new players,” Gehrke says.

He says for franchisors approaching relative saturation, future growth opportunities lie in improving store-on-store sales or looking at franchise export.

Gehrke cites Boost Juice, Cash Converters and Gloria Jean’s as businesses which have successfully pursued overseas growth, but notes a continued strong Australian dollar could curb some enthusiasm.

For those looking to take on additional franchises, Gehrke cautions franchisees to ensure they’re equipped to take on the extra responsibility.

“It can be a good growth path for a franchisee, providing the right checks and balances are in place,” he says, adding this path is more suited to proven franchisees.

On the prospect of greater private-equity investment in the sector, Gehrke says while private equity has shown more interest, it has yet to deliver the results, and its short- to medium-term profit aspirations stand at odds with franchisors’ goals.

Unique slant means good growth

Rod Young, founder and executive director of franchising specialist firm DC Strategy, says services and retailers with a “unique slant” will continue to grow.

Young says the Hairhouse Warehouse franchise – which aims to be a “one-stop shop” by offering hair and beauty services in its shops – and kitchenware and cookware specialist Matchbox – which has offered cooking demonstrations at the back of its stores – as businesses thriving in competitive fields.

“The market is segmenting into those businesses that hope the GFC will recover and they can continue doing businesses, and those franchise models that are starting to emerge now, or are offering new, unique or different propositions,” Young says.

And he has a view on how long it will take for consumer confidence, and therefore spending, to pick up. Young says it could be as early as November, if not by the start of next year.

“Over the next six to eight months we’re going to see consumers bring back their debt levels to where they’re comfortable,” Young says.

“I expect next Christmas [2011] will see excellent sales,” Young says. “In winter, there’ll still be conservatism. But moving into the southern summer, we’ll see the consumer start to realise the sky hasn’t fallen in.”

So while the good times might start rolling again for retailers by the year’s end, Young says one lasting effect of the GFC is the focus on value.

He points to the $3 million in sales recorded by Zara’s Sydney store in its first week as evidence that consumer behaviour has not been permanently muted by the global downturn. It’s a cliché because it’s true – value is the new black.

Young points to Cartridge World, which recycles and refills cartridges, as another business offering a unique point of difference. He says not only is this business “riding the environmental wave”, it’s also surfing the “value wave” because it’s 70% cheaper than buying a new cartridge.

Young says people shouldn’t be scared of starting something new, despite the challenges.

“It’s always a good time to go into business. Every business is a risk. But it doesn’t change the fact that the franchise model is a very attractive model.”