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Understanding the Australian Food Franchise Industry

November 19th, 2018

Food-Franchise-Industry

The idea of a food franchise business 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 businesses. Here, we look at the macro trends shaping the industry, examine the franchise business model and look at what’s really in it for aspiring franchisees.

The retail food industry in Australia

At a quick glance, the retail 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.

These trends suggest franchisees and other food retailers potentially need to take a more cautious approach than ever before.

For example, with the rise of eCommerce, fewer people are going into shopping centres, resulting in less guaranteed foot traffic for food retailers. Supermarkets are also becoming more powerful and selling more ready-made products like ready-to-heat meals.

In addition, food retailers are having to contend with cafes in the coffee segment, and bakers in the bread and other baked goods segment. And popular fast-food alternatives trends, like sushi chain stores add an additional layer of competition.

At the same time, 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.

In addition, staff wages are rising, especially for Sundays. For 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.

Added to all of this, with the housing and rental prices for consumers being as high in capital cities as they are, Aussies are cutting back on take-out foods and restaurants, and are spending more time cooking at home.

The 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.

A franchisee business model is one full of fees. Usually the franchisee pays to buy the business and continues paying the franchisor a share of takings and other additional charges.

In the typical 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. And 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 are people choosing to become a food franchisee?

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 a franchise 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. And 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.

What they may not know

Despite the appeal of the idea of owning and running your business, franchisees can find themselves working 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.

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.

Franchisees might also be aspiring entrepreneurs who opt for a franchise believing it will offer support, a proven business model, and lower risk. However, some commentators believe franchises are subject to an even higher failure rate than other types of businesses. With the low margins explained above, franchisees could end up stretching themselves thin in order to pay high rents and repay loans and avoid losing the house.

In fact, the franchise game is so challenging the teenagers in customer-service roles behind the counter could be the only ones earning less than the franchisee in the whole business.

So buying into a franchise could see the franchisee locked into a situation similar to what they’d been trying to get away from. He or she can’t afford to stop running the store, but the low margins means they’re only paying costs and not making meaningful profit.

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.

Franchisees get locked in

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 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.

Are you considering becoming a franchisee?

Becoming a retail-food-business franchise looks 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.

As a previous franchisee myself, I know first-hand the struggles and realities involved in becoming a franchisee in the Australian market. If you’re a franchisee and are struggling with business debts, my team and I can help – simply contact us on 1300 789 449.

If Your Business Finances Are Out Of Control, We Can Help.
Call us on 1300 905 107 or Click Here For More Information.

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David Hill
David has over 15 years in the insolvency industry – advising clients through restructuring of their business. His clear, “straight up” style provides clients with a strong direction of what they need to do, and how the process will work. As importantly, he brings empathy to the process – which is essential at a “high-stress” time for clients.

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