Author
Grahame WardDirector & ASIC Registered Liquidator
The idea of a food franchise in Australia might have you seeing dollar signs, but take a closer look. The numerous media reports about wage fraud and staff underpayment have highlighted the risks and challenges of buying into a franchise business. Here, we look at the macro trends shaping the industry, examine the franchise business model and unpack what’s really in it for aspiring franchisees.
The retail food industry in Australia
At first glance, the fast food industry in Australia seems to be thriving, especially with large franchises like Subway, McDonald’s and KFC maintaining a strong presence in our cities. However, a closer look at the macro trends of this industry brings to mind some major challenges.
- Declining foot traffic – The rise of eCommerce has led to fewer people visiting shopping centres, impacting customer numbers for food franchises in Australia.
- Supermarket competition – Supermarkets are expanding their ready-made meal offerings, increasing pressure on takeaway and fast food businesses.
- Shopping centre competition - Food retailers are also having to contend with cafes in the coffee segment, bakers in the bread and other baked goods segment, and popular fast-food alternatives like sushi chain stores. Rising lease prices - rent for food retailers (and other retail operations) are still going up by at minimum the Consumer Price Index each year – and often more in high density areas.
- Higher labour costs -staff wages are rising, especially for Sundays. For food retailers in shopping centres, this adds to the already-high labour costs because they’re required to open on Sundays and observe other extended-hours-trading practices.
- Changing consumer habits - with greater cost-of-living pressures, Aussies are cutting back on take-out foods and restaurants, and are spending more time cooking at home.
These trends suggest that food franchises in Australia potentially need to take a more cautious approach than ever before.
The fast food franchise business model
Seeing how busy and popular food franchises like Red Roosters and Oporto can get in shopping centres could give a false impression of the viability of food franchise business models.
In reality, food franchises operate on razor-thin margins and the maximum profit you might expect is probably around 10% of revenue.
What is a fast food franchise?
A franchisee business model is one full of fees. Usually, the franchisee pays to operate under a larger brandand continues paying the franchisor a share of takings and other additional charges.
In the typical fast food franchise operation,
- 10% to 20% of revenue is directed into rent,
- 30% goes into cost of goods sold,
- 25% to 30% are spent in staff wages,
- 6% to 10% are committed to royalties, including marketing
- 5% covers the phone, internet, power, and other utilities
This leaves a franchise around 10% of their incomings to profit. Plus, if he or she borrowed money to start the franchise, loan repayments will be coming out of this 10%, further eroding their net earnings.
Food franchise business models really only work when franchisees are doing big volumes. However, as noted above, the macro trends aren’t supporting large volumes for individual franchisees; instead, they’re adding to the cost pressure, increasing competition and reducing foot traffic.
Why do people buy food franchises in Australia?
So given the weaknesses of the franchise business model, why are people still choosing to become food franchisees?
It could be the appeal of becoming your own boss.
The flexibility and freedom, and the idea of buying yourself a job could be more appealing to people looking to escape the rat race and own their own business. In addition, buying into an established Australian food company means you have a level of support as well as a ready-made business model, so you’re not starting from scratch.
Most food franchises might cost around $300,000 to buy into, which could be more affordable than other types of businesses, especially if you obtain a loan. In my experience, it’s common for franchisees to take out a loan secured against their own property, such as the family home, which might have equity they’ve built up during years of regular employment.
The hidden challenges of owning a food franchise
Despite the appeal of the idea of owning and running your business, franchisees can find themselves facing unexpected difficulties, such as:
- Long hours and high stress: owners often get stuck in a groundhog-day-like routine, working a high number of hours each week in order to cut staffing needs and lower high labour costs.
- Lack of financial planning: Franchisees might fail to do enough homework – like consulting accountants and lawyers – before they buy into the business, and get locked into something less profitable than they thought.
- Low profitability –With the low margins explained above, franchisees could end up stretching themselves thin in order to pay high rents, repay loans and avoid losing the house.In fact, the franchise game is so challenging that the teenagers in customer-service roles behind the counter could be the only ones earning less than the franchisee in the whole business.Franchisor-driven competition –Since the franchisors get royalties on turnover and not profit, the franchisors aren’t necessarily motivated to set up a situation supporting maximum profits. And with each successful franchise location, nothing stops the franchisor from putting up an extra franchise around the corner, to the detriment of the franchisees but to their own benefit.
Financial Risks: Loans, Debt & Bankruptcy
One of the biggest risks in the Australian food franchise sector is financial strain. Franchisees could find themselves locked into a personal guarantee due to the loan funding their franchise, and they could be locked into contracts with landlords, suppliers and other parties in relation to their business. Profits might not increase, even as rents and the cost of goods supplied continue to rise each year.
Ultimately, the average franchisee could end up losing their house or other property that was used to secure their original business loan.
Many franchisees end up going bankrupt or fighting their franchisor in court, and disputes are so common the ACCC has a dedicated information page on the franchise code of conduct.
The potential for an imbalanced relationship can also result from the fact that franchisors tend to be well-resourced, with the means to hire big law firms. In contrast, franchisees tend to seek advice from suburban accounting and law firms in the event of a dispute.
Illegal wages and unpaid staff
A possible symptom of how challenging the franchise business model can be are the widely reported stories about underpaying wages to staff in major franchise brands operating in Australia.
Even established franchises like Caltex have experienced wage fraud scandals, and are now shifting away from the franchise model.
The systemic underpayment of staff is unsurprising as franchisees are usually trying to cut costs through any means available, and staff wages are often the easiest, ‘path of least resistance’ option for the short term.
Other franchises might use the ATO as a bank by not paying taxes when due. Avoiding tax payments for as long as possible could help them cover other urgent costs like invoices from landlord and suppliers. Yet this could result in costly legal action by the ATO against the franchisee.
Considering becoming a food franchisee? Do your homework first
Buying into a food franchise in Australia can seem like an ideal way to get started as an entrepreneur. In reality, franchises in the retail food industry offer low margins, possibly higher risk, and the potential for an unbalanced franchisor-franchisee relationship.
The wage-fraud and underpayment controversies highlight the risks of this business model. And at the same time, the macro trends in the retail food sector could further raise the pressure on franchises.
Franchisees need to do their due diligence and make sure they understand the risks before buying into this type of business.
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