Retail Food Group "damaged the reputation of franchising" slams parliamentary report

Written on the 14 March 2019 by David Simmons

Retail Food Group "damaged the reputation of franchising" slams parliamentary report

The parent company behind Brumby's, Donut King, and Michel's Patisserie has been slammed by a parliamentary inquiry into Australian franchisors.

The committee devoted a chapter in their Fairness in Franchising report released today to Retail Food Group (ASX:RFG) as an example of a franchisor who is taking advantage of an insufficient regulatory framework the report recommended serious consequences for RFG.

The inquiry recommended that the Australian Competition and Consumer Commission (ACCC), the Australian Securities and Investments Commission and the Australian Tax Office, conduct investigations into the operations and dealings of Retail Food Group, its former and current directors and senior executives and companies and trusts they own, direct, manage or hold a beneficial interest in.

The committee has directed the watchdogs to to investigate breaches of the Australian Consumer Law, the Franchising Code of Conduct, insider trading, short selling, market disclosure obligations (including related party obligations), compliance with directors' duties, audit quality, valuation of assets (including goodwill), and tax avoidance.

The committee said that RFG has "damaged the reputation of franchising" in Australia, and said that the franchisor took advantage of the power imbalance implicit in the franchisor-franchisee relationship.

"When outfits such as RFG acquire already-existing franchise systems, the franchisees in those systems are suddenly exposed to strategic risk and may be exploited in a system where they currently have little chance of either redress or escape," says the committee.

Of particular note was what the committee calls "churning and burning"; the systematic opening and subsequent closing of underperforming franchises. During 2011/12-2017/18 oer 1000 new outlets were opened under RFG and over 1100 were closed.

"With a peak outlet population of around 2500 outlets in 2015-16, the closure of 1100 outlets raises questions about the viability of the business model," says the committee.

RFG refused to provide data relating to potential churning and burning which the committee has criticised.

"It seems reasonable to the committee to draw one of two conclusions from the refusal. One possibility is that RFG is seeking to avoid providing data that would in fact substantiate the allegation that RFG churned sites across its networks. If this is the case, then RFG may not only have engaged in unethical business practices, but may also have misled Parliament."

"The other possibility is that RFG, its board and management were incompetent."

Because of RFG's practice of churning and burning the committee has recommended that the ACCC be given expanded powers to intervene and prevent the marketing and sale of franchises where a franchisor shows a track record of churning and/or burning.

RFG was also slammed for its interactions with the regulators. In particular the committee points out how it took RFG 18 months and action from the ACCC to prompt the franchisor to address unfair contract terms in their franchise agreements. RFG eventually provided the ACCC with new terms in May 2018, but this was a process that should have been completed by November 2016.

The committee also refused to allow the current tough retail environment to be an excuse for RFG's behaviour.

"Several major franchisors have spoken of the harsh realities of the current retail environment, and the particular difficulties involved in operating shopping centres," says the committee.

"Nevertheless, it appeas that RFG has operated a particularly unjust business model in which shareholders and senior executives have profited at the expense of franchisees."

RFG responded to the report this afternoon, with executive chairman Peter George supporting changes which will be of benefit to the franchising industry.

"The current management team and board completely understand that RFG's future success is directly linked to the profitability of its franchisees. We have instituted a comprehensive program of investment and improvement to materially help existing and new franchisees grow and prosper," says George.

More broadly the inquiry uncovered a number of major issues with the current framework of franchising in Australia.

"The current inquiry has identified something much worse: systematic exploitation of some franchisees by a subset of franchisors and a regulatory framework that does not provide adequate protection against such practices," says the committee.

The committee has proposed substantial changes to the Franchising Code of Conduct and to the responsibilities and powers of the ACCC.

These change address disclosure, franchise registration, supplier rebates, whistle-blower protections, unfair contract terms, cooling off periods, exit rights, collective action, dispute resolution, binding commercial arbitration, alignment of industry codes, churning, education, and leasing arrangements.

The recommendations are designed to lift standards and conduct across the industry and to rebuild confidence in franchising in Australia.

The embattled franchisor denied speculations earlier this week that administrators could be called in as soon as next week.

The operator reported a loss of $111 million for the first half of FY19 with 93 store closures during the period.

Turnaround efforts have barely cut down RFG's debt which at the end of the first half was at almost $259 million, and shares have fallen by almost a third since the announcement to $0.20 - a level that is around 17 per cent of what it was this time last year.

The group has been on the receiving end of negative media coverage over the past 12 months with claims of financial ruin amongst its franchisees, many of whom have taken up class actions against RFG.

The allegations from disgruntled franchisees include claims that RFG charges excessively high fees along with marketing and food costs. It has also been accused of operating questionable business practices, including its level of disclosure to new franchisees.

Major events in RFG's history

2000
Tony Alford becomes CEO and managing director of RFG

Jun 2006
RFG listed on the ASX

Jul 2007
Brumby's Bakery acquired

Oct 2007
Michel's Patisserie acquired

Jan 2010
DCM Donuts and Big Dad's Pies acquired

Feb 2011
Esquires Coffee Houses acquired, Pizza Capers acquired

Oct 2012
Crust Gourmet Pizzas acquired

Nov 2012
The Coffee Guy acquired, La Porchetta acquisition terminated

Dec 2014 
Gloria Jean's acquired

Jun 2015
Andre Nell succeeds Alford as CEO

Jul 2016
Nell succeeds Mr Alford as managing director

Dec 2017
Media articles on RFG franchise issues 

Dec 2017
RFG share price collapses

Jan 2018 
Richard Hinson joins RFG as chief executive Australia, then promoted to RFG group CEO in May 2018

Nov 2018
Peter George succeeds Colin Archer as chairman

Dec 2018
Richard Hinson resigns as CEO, executive chair George takes over

March 2019
RFG reveales a loss of $111 million and report it has closed 93 of its stores in the first half of the financial year and plans to shutter more.

At around midday (AEDT) RFG shares were trading at 20 cents, down from a four-year peak of $7.28 in September 2016.

Read more here:

Retail Food Group "damaged the reputation of franchising" slams parliamentary report
Retail Food Group denies administration rumours
Retail Food Group shutting stores and slashing costs on heavy losses
Retail Food Group restructure drives out CEO
Retail Food Group chairman flags asset sales, imminent "major restructuring"
Former RFG CEO accused of using franchisee to hide lossmaking stores
Alford ramps up his exit of RFG shares
Alford quits as RFG boss at top of his game

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Author: David Simmons

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