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IF View - Issue No. 14

AUSTRALIAN
FRANCHISING - 
"TRAP FOR
THE
TRUSTING"

Issue No 14

Marketing Channel Strategy Consultants
USA - EUROPE - AUSTRALIA - BRAZIL - HONG KONG
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Many years ago, an American attorney, Harold Brown, wrote a book called “Franchising – Trap for the Trusting”.  We’ve borrowed Mr Brown’s title because it seems so relevant in Australia’ current franchising debate.

Those familiar with IF View know we rarely write about franchising since it is only one of many marketing channels for distributing goods and services.  However, bearing in mind the current debate on the status of the Franchising Code of Practice, it is appropriate for us to discuss the issue.

About three years ago, the Department of Trade and Industry, after consultation with many people involved in franchising, decided that franchising was best regulated through a Franchising Code of Conduct.  This Code of Conduct is strictly voluntary.  The average franchise buyer has no idea what compliance with the Code means.  More particularly, all that franchisors appear to be required to do is say that they are registered with the Code.

If franchisors breach the Code, they can be “drummed out of the corps” but as yet, none have.  The result is that franchise buyers buy franchises from those who purport to be abiding by the Code yet may, in fact, no be.  Another result is that franchising is given a legitimacy it does not deserve.  Today, most companies complying with the Code are major corporations who can’t afford not to comply.  That is, major corporations because of who they are, must behave ethically or the unethical people get fired.  Smaller companies usually can’t afford to comply because their balance sheets and operating statements are so bad that any franchise sale is nipped in the bud.

However, because the Code gives franchising some legitimacy, people still buy franchises from smaller, dishonest companies, and as a result, many franchisees lose their life savings.

The United States Federal Trade Commission has had full disclosure laws for 15 years.  These laws and the “Uniform Franchising Offering Circular” (UFOC) disclosure document, are supported by the International Franchise Association, the World’s major franchisors’ trade body.  Market research carried out in the US some years ago indicated that franchisors and potential franchisees favour franchise legislation using the UFOC.  

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Why can’t Australian franchising be legislated for and regulated as in the United States?  The UFOC is an inexpensive approach, it is effective because of the high fines levied on those who don’t comply and it keeps people from losing their assets to crooks or incompetents.  Since the introduction of the UFOC, American franchise fraud has fallen significantly and franchising’s image has improved to the extent that franchising now has a high level of respectability.

The argument put forth by those who favour the Franchising Code is that people will learn more about franchising through education.  We find this premise difficult to accept since, for example, police have difficulty in educating people not to drink and drive.

We can only protect people from themselves by giving them a legislative framework to provide information upon which they can base sound financial decisions.  As well, all franchise companies, large or small, must be forced to provide the same level of information.

Bearing in mind the cost of instituting the Federal Government’s Franchise Code, it would probable have been cheaper to send a group of Trade and Industry people to the United States to study the Federal Trade Commission’s UFOC and to institute it here, word for word.  The system works.  For those who question whether Australia should adopt American legislation, it is worth noting that much of our Trade Practices Act is based on the Robinson Patman and the Sherman Anti-Trust Acts of the US.

Some of the key areas covered by the Federal Trade Commission’s Uniform Franchising Offering Circular are detailed below:

The disclosure statement must be provided to the prospective franchisee at the earlier of either:

-          ten business days before money is paid, or

-          at the first personal meeting which occurs between the franchisor or the franchise broker and the prospective franchisee.

The failure of a Franchisor or Franchise Broker to comply with FTC Rule 436 could result in fines of up to $US10,000 per day.

The basic disclosure document consists of 20 categories of information.  The most relevant follow:

1.      Identifying information about the franchisor.

2.      Business experience of the franchisor and its directors and key executives.

3.      Description of the franchise.  

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4.      Money required to be paid by the franchisee to obtain or commence the franchise operation.

5.      Continuing expenses to the franchisee in operating the franchise business that are payable in whole or in part to the franchisor or to a person affiliated with the franchisor.

6.      Material sufficient to substantiate the accuracy of the claim must be in the franchisor’s possession at the time the claim is made.  A franchisor must possess the data upon which its earnings claim is based at the time the representation is made.  This data can consist of, for example, market studies, statistical analyses, franchisee profit and loss statements, as well as other types of information which customarily are relied upon by prudent persons in the course of making business decisions.  This material must be made available to prospective franchisees and to the Federal Trade Commission or its staff upon reasonable notice.  The franchisor must give notice of the availability of the substantiating material in conjunction with any representation made.  In order to protect franchisees from unwarranted disclosure of sensitive financial information the franchisors may delete any identifying information from which the identity of the franchisee can be obtained by the prospective franchisee.  This limitation, however, does not apply to disclosures made to the Commission.

7.      A list of persons who are either the franchisor or any of its affiliates, with whom the franchisee is required or advised to do business.

8.      Real estate, services, supplies, products, inventories, signs, fixtures or equipment which the franchisee is required to purchase, lease or rent and a list of any persons from whom such transactions must be made.

9.      Description of any franchisor assistance in financing the purchase of a franchise.

10.  Restrictions placed on a franchisee’s conduct of its business.

11.  Required personal participation by the franchisee.

12.  Franchisor’s right to select or approve a site for the franchise.

13.  Training programs for the franchisee.

Franchising in Australia can only become credible if franchisors are regulated and severely penalised if they break the law.

Self-regulation is a fairy tale.

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