Profit opportunities for franchise systems arising from changes to competition laws
When your franchise system was established, considerable thought was given to the profit centres it would create and achieving from them a return satisfactory to the system and/or its shareholders, which at the same time provided an acceptable income to your franchisees to justify their investment and personal involvement. You wanted to offer them a business model that met all investment expectations and would grow and prosper to the benefit of all concerned.
You calculated set up costs at both ends, administration and other running costs, acceptable margins, and assessed supply chains and a myriad of other factors.
Typically you as the franchisor determined an upfront cost the franchisee would pay for the opportunity, an acceptable ongoing royalty/licence fee, marketing contributions, IT systems and software costs as well as ongoing support including transactional matters such as renewals and sales by franchisees.
The franchisee and its advisors ran a ruler over your system and made a conscious decision to join based on expected benefits and future growth.
Where you chose to deliver goods and services to your franchisees you were able to develop appropriate margins and secure in some cases rebates from third parties. If you set up a related body corporate specifically to carry out some of this servicing you were also within the parameters of the law (particularly, the Competition and Consumer Act 2010 – “the Act”).
Therefore your franchise system and your opportunities for more profit were dependent on controlling margins, looking for efficiencies and of course growing the franchise system to produce enhanced revenue flows.
What you couldn’t do – and still can’t for the moment
What the Act didn’t allow you to do (amongst other things like setting minimum prices) was to contractually require your franchisee to acquire goods and services from unrelated third parties prescribed by the franchise system. In other words, aside from supply yourself or by a related body corporate (what is known as first line forcing) the most control you could exert was to go through a process of vetting and approving suppliers who met your franchise system’s standards and franchisees were free to nominate third parties to be so approved.
The prohibition against your nominating third parties as suppliers is known as third line forcing and is enshrined in Section 47 of the Act.
The prohibition can only be overcome by applying to the ACCC (which administers the Act) for an authorisation or notification whereby you have to satisfy the regulator that the benefits of your third line forcing conduct would outweigh any adverse effect on competition. Many franchisors did not wish to incur the expense of having their lawyers prepare and submit these filings.
What you couldn’t achieve as a result of this prohibition
Consider your franchise system.
Are there specific or generic goods and services supplied by others where they make a margin and you may not even be able to secure a rebate?
What would show on your bottom line if your franchise agreement allowed you to direct your franchisee to set suppliers with whom you could negotiate bulk purchasing benefits for your franchisees and at the same time receive rebates and other benefits?
Let’s say you could achieve large volume orders through your system and offer them on an exclusive or semi-exclusive basis to a third party supplier. Wouldn’t they be interested and wouldn’t they talk up a deal to benefit you and your franchisees?
Stepping back from basic product/service supply what about the following:
- One broker or insurance company supplying all franchisee insurances;
- One shop-fitter attending to all stores;
- One IT and computer supplier and support entity;
- etc.
Can this be done?
Changes to the Act to benefit franchise systems
On 18 October 2017, the Federal Parliament passed laws that will amend the prohibition against third line forcing by early 2018. The exact commencement date will be the sooner of the Governor’s proclamation or 6 months from 18 October 2017.
The amendment substantially assists those who would like to be prescriptive about suppliers to their franchise systems, and would like to improve their bottom line.
Under the amended law third line forcing will only be prohibited it if the relevant conduct has the effect or likely effect or purpose of “substantially lessening competition in the relevant market as a whole”. The ACCC cannot oppose the behaviour unless the conduct is shown to be substantial in an identified market.
The ACCC is presently engaging in public consultation on guidelines that will assist businesses in assessing their position however we expect these to follow a number of existing criteria in identifying what is a relevant market (it may be a State/Territory or part of it or indeed the national market), substitutability (whether products of a party can readily be replaced by others), whether barriers to entry have been created and other subtle matters.
The above matters are of course not exhaustive however they do set the scene for an examination of your franchise system by us if management is of the view that the relaxation of the prohibition is a matter your system may benefit from.
What to do next
If our commentary is of interest to you we suggest:
- You discuss the same with your management to determine if this is an opportunity worth investigating for your franchise system;
- You consider amending your current franchise agreement template for future grants and renewals to provide that if the Act permits you can direct the purchase of goods and services from suppliers you nominate; and
- Contact our award-winning franchise team!