Rod Sims, chairman of the competition watchdog, the Australian Competition and Consumer Commission, is itching for the government to reform the $170 billion franchising sector.

It follows a damning parliamentary report released last week that put the spotlight on the sector and found inherent conflicts of interest and an entrenched imbalance of power between franchisees and franchisors.

It found the current regulatory environment “manifestly failed to deter systemic poor conduct and exploitative behaviour and has entrenched the power imbalance” between franchisors and franchisees.

In other words, the model was not fit for purpose.

It also warned of the added complications when a franchise is listed on the Australian Securities Exchange or owned by private equity. “In short, there is a risk that listed or private equity may try to extract too much value from the franchise system, namely shifting profit from the franchisees to the shareholders,” the report says.

Listed franchises include Mortgage Choice, Domino’s, Retail Food Group and Collins Food. Private equity owns a series of franchises, including Pizza Hut.

When a sector accounts for almost 8.9 per cent of GDP and has been described in a joint parliamentary report as comparable to the financial services sector when it comes to poor corporate governance and cultural issues, it is time for the government to act.

The report recommends massive reform including stronger penalties and enforcement powers to the ACCC and changes to the Franchising Code of Conduct.

Key problems

“The best way to undermine governance is to have laws with low/no sanction for breaching them,” Sims told The Australian Financial Review.

He said a key problem with the franchising code was that too little information was needed to be provided to franchisees.

Sims said another problem was unfair contract terms between businesses wasn’t illegal. “This particularly matters when trying to deal with unfortunate contracts between franchisors and franchisees,” he said.

That the report and its recommendations are bipartisan at a time when politics has never been more polarised speaks volumes about the deep-seated problems and desperate need for reform.

The committee’s chairman was the Liberal Party’s Michael Sukkar, the deputy chair for most of the inquiry was Labor’s Deborah O’Neil. Also on the committee was Nationals senator John Williams, who triggered the inquiry, and Greens senator Peter Whish-Wilson. All four parties agreed on 71 proposals for reform.

For now, Labor and the Coalition are saying little, except that they are looking at the report and that the recommendations need to go through processes in terms of responding to it.

Small-business minister Michaelia Cash said, “The recommendations raise a wide variety of issues that impact multiple pieces of legislation beyond the Franchising Code of Conduct”.

Cash said the government would analyse the report and consider what improvements needed to be made before proceeding.

Labor is also looking at the report and the hope in some quarters is it will make an announcement in the next couple of weeks.

Both parties were quick to embrace the recommendations of the final report into the banking royal commission and the Morrison government accepted in principle the 22 recommendations outlined in the Allan Fels-led Migrant Workers Taskforce, released on March 6.

Those recommendations included criminal penalties for employers who deliberately and systemically underpay workers. Other recommendations included the introduction of a national registration scheme to track labour-hire firms, and banning employers from employing visa holders for a specified period if those employers had been convicted in court of underpaying visa holders.

The migrant workers report and the parliamentary report into franchising were sparked by a spate of scandals exposed by The Age and The Sydney Morning Herald featuring well-known franchise groups 7-Eleven, Domino’s Pizza, Caltex and Retail Food Group (whose brands include Michel’s Patisserie, Brumby’s, Gloria Jean’s, Donut King and Crust Pizza).

The media investigations found rampant underpayment of wages on the back of a brutal franchise model that pushed franchisees to cut corners, including ripping off workers, to stay afloat.

Franchising employs an estimated 500,000 workers and comprises more than 70,000 franchisees, many of them hard-working Australians who have used their retirement savings to buy a business in a box.

This is why it is likely to be taken up as an election issue. But the government also needs to look at the resourcing of the ACCC with a view to beefing it up.

The report recommends a new franchising taskforce comprised of Treasury, the ACCC and the Department of Jobs and Small Business, which would investigate key recommendations and draft proposals for legislative change. It makes it easy for both parties to make a quick decision on the report.

As Williams, who triggered the inquiry, says, “It is time for government to act now”.

The report recommends the proposed franchising taskforce examine unfair contract terms in franchise agreements with a view to making them illegal and introducing civil penalties. This is something ACCC’s Sims has identified as a problem that needs to be addressed.

It also calls on the taskforce to investigate the inherent conflicts of interest and a lack of regulatory controls for supplier rebates and third line forcing in franchising.

Significant rebates

In franchising, consistency of products and services across its network has allowed franchisors to use third-line forcing arrangements to require franchisees to use specific suppliers. These arrangements allow franchisors to use their size to bulk-buy and get discounts or supplier rebates. For example, Retail Food Group, which operates brands including Gloria Jean’s, Brumby’s, Donut King, Pizza Capers, Crust and Michel’s Patisserie, was speculated to have earned rebates of $40 billion in financial incentives from suppliers. The company never confirmed or denied these figures or whether any of the rebate was shared with franchisees.

RFG isn’t alone in taking rebates and not disclosing them. The parliamentary inquiry heard evidence from franchisees that they were forced to buy products including flour and milk at higher prices than available in the open market.

The parliamentary inquiry sought to address this by calling on the ACCC to collect data on these conflicts and the franchising taskforce to look at how to amend the Franchising Code of Conduct.

“The committee notes that in the financial advice and life insurance sectors, the regulator (ASIC) has investigated the nature and extent of conflicted remuneration and identified evidence of detriment. Such investigations have not been undertaken in franchising, and therefore the practical extent of the problem remains unquantified. The committee therefore considers that an important next step is for the franchising taskforce to conduct an investigation to examine conflicts of interest associated with supplier rebates and third line forcing,” the report says.

The inquiry, which attracted more than 400 submissions, said rebates and third-line forcing were the biggest issues raised by franchisees in confidential reports. Other issues included false and misleading disclosure, business models not viable, bullying threats and intimidation and ineffective dispute resolution.

The report says many submissions outlined “the significant and often life-changing detriment that many franchisees endured as a direct result of being exploited by franchisors”.

Franchise Redress’ Michael Fraser, who helped expose some serious scandals in the sector, said the report demonstrated that when people speak up and work together, great outcomes could be achieved. “Without these brave franchisees speaking up to the media, providing evidence to Parliament and the fine work of the committee, franchisees would continue to be exploited by unscrupulous franchisors for years to come.”

He is right. It is time for both sides of politics to step up and fix a sector that has been crying out for reform for decades.

Extracted from AFR