How franchising works

The arrival of fast food giants KFC, Pizza Hutt and McDonald’s in the early 1970s saw franchising, as we know it, hit our shores. It has become a real New Zealand story, with more than 70 per cent of franchising brands now homegrown.

Franchising involves small and big business, with directors, entrepreneurs and managers exploring and implementing franchising across an ever-diverse range of sectors. Prominent industry groupings include general retail, food and beverage retail, accommodation, building and construction, business and home services, and trade services to mention a few.

Franchising is not an industry per se, but an organisational form established by conventional small business, large business (including private, public and SOE) and a number of co-operatives – the latter of whom often have members simultaneously owning a franchise unit as well as a stake in the overarching business.

Well-known homegrown brands include MTF (Motor Trade Finance), Columbus Coffee, Four Square, PAK’nSAVE and New World, Harcourts, Signature Homes, Green Acres, BurgerFuel, Laser Plumbing & Electrical, Stirling Sports and Mitre 10.

As quantified in a recent survey by Massey University, some 590 franchising brands and an estimated 32,000 franchisee- owned units in New Zealand now account for $36.8 billion in turnover (or $58.5 billion including motor vehicle sales and fuel retail).

Investment and incentives 

A wide range of entrepreneurs and companies continue to consider franchising their business, largely as a method of expansion and/or more efficient and productive remote unit establishment and management. Within this, key levers include franchisee investment in a local operation, meaning a franchisor can expand faster than they could otherwise while generating returns from the brand within the territory – assuming the franchise is well structured. For some large companies, franchising is also a way of reaching into smaller and remote territories that help build out national coverage – areas that are harder to reach or on a relative basis be smaller businesses.

But while franchisee capital is often considered an important advantage, it is most often the incentives for franchisees (when compared to salaried managers) that is most important. The incentives mean franchisees often establish and operate more efficiently and productively – more effectively organising local resources, be those premises, vehicles, and team development and rostering.

Down-stream they often provide better prospects for customers, convert sales, generate repeat custom, and manage local operational efficiencies. Indeed, for numerous companies and sectors, the concept of incentives from local ownership is of such importance many companies would not have expanded unless their units were franchised. Thus, franchising is sought to help drive a bigger and more sustainable business– and, of course, some franchisors strategically balance risk and reward by owning and operating a proportion of their networks themselves, while franchising others.

Motivations for buying a franchise

The recent Survey of New Zealand Prospective Franchisees, conducted by Franchize Consultants and Franchise New Zealand media in late 2022, explored the perspectives of 173 people looking to invest in franchising, with a proposed level of investment ranging from under $25,000 to over $500,000. Fifty-six per cent of those investing more than $300,000 were expecting total owner returns to be more than $150,000. A large number were looking to invest and operate the franchise with another party.

The key motivations for buying a franchise were greater income and wealth-building potential, better life balance, and more security and stability. Meanwhile, the main appeal of franchising, versus establishing an independent business, were a proven business system, established and recognised trade name of brand, and start-up and ongoing support and training.

For prospective franchisees, key reservations for investing at this stage included the cost of the initial investment and funding access, income levels and return-on-investment considerations, and current market conditions, such as dealing with a pandemic and staffing challenges (particularly finding reliable staff).

Trends impacting franchising

A Franchising Confidence Index survey of franchisors shows they rate their top five challenges to franchise system development in 2023 as access to finance (for their franchisees), finding franchisees, finding staff (for franchisees), rising operating costs and investor confidence. Top opportunities for 2023 were subdued, with references to better availability of sites on better terms, opportunities to reduce costs, new product development and multi-unit franchise owner development.

Franchisors also identified major trends most likely to impact on their business in the next 5-10 years. The future regulatory environment and changing customer expectations were identified as the top major trends. Other trends included changing community expectations, changing demographics and diversity, supply chain transparency, climate change, water and other resource management issues, and artificial intelligence.

New Zealand’s evolving regulatory landscape and resultant uncertainty on how it will be interpreted is of increasing concern for many franchisors, particularly in a country which is well-suited to franchising given the geographic dispersion of towns and cities, and the ease of doing business. Examples include Cartel Amendments to the Commerce Act, The Fair Trading Act’s “Unfair Contract Terms” regime, extended to many B2B contracts from 16 August 2022, and the Assisted Entry Work Visa, which features much more restrictive requirements for new franchisees compared to an independent business start-up.

Governance considerations 

Franchising has proven its resilience during tough times, including franchisors and franchisees trading, innovating and surviving through Covid-19, battling lockdowns and operating despite severe staff shortages. Notwithstanding the challenges, many continue to provide extensive support to franchisees, while juggling the need to research and adapt to wider trends.

The tough balance of managing the short, medium and longer term trends highlights the need for good franchise system governance, and a governing team that recognises the nature of franchisor- franchisee stakeholder relationships. That is because franchising involves a more complex relational and commercial situation, involving more invested and independent-thinking franchisees when compared to a company-owned chain with more compliant company-unit managers.

Any changes proposed, even if small, need to be well thought-out. There’s an adage in franchising that while you can ‘tell a manger’ of a change, you need naturally to ‘sell to a franchisee’ on any proposed changes, given their investment. While a company chain can just make systemwide changes, a franchise network must invariably bring franchisees on a highly considered change management journey.

Structures that help change

Many medium-to-large franchise companies will have a Franchise Advisory Council (FAC), a special group comprising both franchisee and franchisor representatives. FACs invariably have a core purpose involving advancing the mutual interests of both franchisees and franchisors in the long term. Aligned, they will often have objectives including discussing opportunities for improvement, considering proposed changes, better understanding one another’s perspective, and so on.

In the current environment, franchise company boards would do well to think strategically on how they consider the structure, operation and focus of the FAC. That is because the FAC can help a board (like its management) understand the franchisee perspective, including key issues, opportunities and insights. Accordingly, a board should naturally have an interest in the FAC’s focus and meeting outcomes – to the extent a board should be thinking strategically about FAC focus, at any point in time.

None of this is to suggest a FAC should be closely directed/managed by the board. On the contrary, a FAC’s success is often dependent on franchisees recognising the FAC as a structure that legitimately advances the interests of franchisees.

Nonetheless, the board should be interested in making sure such a potentially valuable group structure, for franchisees and franchisor alike, can maximise potential mutual advantages in the long term. In some cases that will mean short-term franchisee-interested issues might be prioritised, while in other cases more macro group-focused objectives (like changes to comply with recent legislation) will be forefront. 

Dr Callum Floyd is managing director of Franchize Consultants (NZ) Ltd and attended the IFA Franchising Convention in the US in February.