July 2015 • Stewart GermannCorporate Governance is Good for Franchising
Did you know that the turnover of the franchise sector in New Zealand exceeds $19 billion per year? This figure does not include the revenue generated through franchised hotels, petrol stations or car dealerships. There are over 400 franchise systems in New Zealand and over 22,000 individually owned franchised businesses. Franchised companies and franchised outlets employ about 100,000 people and 88% of New Zealand franchise systems are home grown which is very high compared to other countries.
Basically, franchising is a method of marketing goods and services and within New Zealand there are many well known brands including McDonald's, Armstrong Alarms, Bedpost, The Coffee Club, Paper Plus and Mexicali Fresh.
The strength of good franchising is to have a very sound system which requires strong procedures as far as the franchisor (the person who owns the system and the name) is concerned. Corporate governance which requires, in particular, proper procedures and high standards fits very well into the franchising arena. It follows that a franchising system which adopts good corporate governance practices will be far stronger than one which does not. But if corporate governance principles are not followed the system will be weaker.
The strength of a franchise system is having the detail of how to operate it and the secrets of the business written down in what are known as operating procedures manuals. These manuals form part of the intellectual property of the franchisor and they are an integral part of it, together with the name. The name plus good manuals means a strong system which means adherence to good corporate governance principles.
In New Zealand there is the Franchise Association of New Zealand Inc (www.franchiseassociation.org.nz) which was founded in 1996. The Rules of the Association make the Franchising Code of Practice and the Code of Ethics mandatory for all members of the Association. However, franchisors who do not belong to the Association do not have to comply with the Code of Practice.
Buying a franchise enables people to be selected, trained and supported on an ongoing basis. They receive an advertised brand and proven systems for marketing, production and management and they have the benefits of group research and buying. The failure rate for franchised units is under 5% over the first 3 years and this compares extremely well with independent, small businesses, which attract a 66% failure rate in the first 5 years.
While providing many strategic advantages, franchise systems also provide a layer of complexity to the governance and chain management role. The additional challenge is primarily due to the addition of franchisees which gives rise to two challenges. The first of these is attracting and retaining franchisees and the second relates to the ongoing management of the relationship with franchisees who take responsibility for employing and managing staff.
While having an interdependent relationship, franchisor and franchisee goals are never totally aligned. The franchisor is understandably interested in the development and protection of the brand and the system-wide sales. Conversely, the franchisee is driven by profitability and return on investment so franchisors are often challenged with managing compliance while franchisees focus on short-term profitability.
Governance is complicated by changes in the franchise relationship over time which require careful management. A franchisee's basic needs, attitudes and subsequent actions change as they gain knowledge, operating experience and confidence. Although franchising provides many unique challenges for directors and managers to learn about franchising, its structure and management will be well positioned to receive the benefits which franchising can provide. Good governance stems back to the decision to franchise the business and the Board and management must understand the rationale for their own franchising structure, how it differs from competitors and its relationship to best practice. The Board composition and allocation of duties should reflect the specific knowledge and requirements of managing a franchise system. The Board and management must at all times promote and practise ethical and responsible decision-making.
Choosing the right franchise system and brand is critical to success and if you are considering getting into a franchise you must do your due diligence which includes talking to existing franchisees and seeking advice from lawyers and accountants experienced in franchising. You should ensure that the franchisor is a member of the Franchise Association of New Zealand and brings together franchisors, franchisees and those with an interest in the franchise sector such as specialist lawyers, accountants and consultants to facilitate the process of learning and sharing information, and to encourage high standards of conduct which aligns itself to the principles of corporate governance. Through conferences, meetings, seminars, publications and other activities the Association seeks to help those considering buying a franchise. It also assists those who wish to franchise their own businesses to ensure that the correct procedures are put in place right from the start.
In my opinion, the principles of corporate governance as they apply to companies in New Zealand also relate to franchising. In the corporate area, the public and shareholders are demanding higher standards from directors and boards and there is no room for shortcuts. If directors on boards cannot keep up to speed and show professionalism then they must go. Franchising and corporate governance go hand in hand for without a robust franchise system which has been carefully planned and without a committed franchisor who strives to improve the system, the franchise will most likely fail.