Pizza Hut was once a
symbol of the rapid rise of fast food in Australia. But now it's a company at
war with the very people who've helped make the chain a household name, its
franchisees.
Dozens of Angry
Pizza Hut franchisees have launched legal action against their parent company,
the US fast food giant Yum!
Brands, after a price war with
rival Domino's forced them to slash the price of pizzas, sending many out of
business.
A class action to be heard
in the Australian Federal Court this week alleges Pizza Hut parent company
breached its duties to it’s franchisees by denying them the chance to make a
profit. The franchisees are seeking damages to cover the losses they have
incurred.
Kentucky-based Yum!
Brands is the world's second biggest fast food company, worth $51 billion.
Breaching The Franchise Agreement
The franchisees are
reportedly attempting to find out if Yum! breached its franchise agreements
with its stores and engaged in unconscionable conduct by lowering prices.
Jason Gehrke, director of
the Franchise Advisory Council, said, “It is not unheard of for groups of
franchisees to band together to challenge their franchisor.”
In this case, Gehrke says
it appears Pizza Hut is playing “catch-up” to rival Domino’s, which recently
introduced $4.95 pizzas on weekdays. Pizza Hut has responded by matching the
offer.
“Pizza Hut is introducing
the strategy in response to a move by a competitor,” says Gehrke. “Domino’s
fired the first shot and they would not have done that without a rationale and
a belief they can sustain it.”
“But by playing catch-up
and wanting to move very quickly, Pizza Hut probably hasn’t brought their
franchisees along the same journey and that might explain their course of
action. Some might have felt it was too much too soon.”
Gehrke says the link
between sales volume and profitability may not always be apparent to a
franchisee, who “might feel that a drop in price will cut their profits but
doesn’t guarantee an increase in volumes.”
“Any executive that is
advocating a price reduction strategy would want to have some science to back
up the hope that volumes will increase,” he says. Gehrke says the “pizza wars”
in the US are well-documented. “And in a price war, the race to the bottom
means that only those with the deepest pockets survive.”
“The real winners out of this will be those pizza brands that aren’t
trying to be the cheapest, the ones that position on quality,” he says.
Gehrke says while this is
not the first time a group of franchisees have banded together to launch a
class action against a franchisor, “this is probably the first time in recent
memory a class action has been unleashed over a pricing issue”.
He says the case
“illustrates the danger of a discounting strategy” and given the directions
hearing will not take place until early October, “it’s a long time to wait for
franchisees who are hurting already.”
Gehrke says it is highly
unlikely Yum’s agreements with its franchisees would contain a duty of care for
the franchisees to be profitable, which is essentially what the class action
will rest on.
“There is usually nothing
in a franchise agreement about profitability,” he says. “There is no legal
obligation.”
Yum! Brands takes a six
per cent cut of all sales at Pizza Hut stores in Australia, regardless if the franchisees
are running at a loss. Yum! Brands is making money even if the franchisees are
not.
Legal Obligation
The franchisees said the discounting
strategy would amount to a breach of the implied duties of Yum contained in its
franchise agreements, including a duty to cooperate with franchisees to achieve
the objects of the agreement, a duty to act “reasonably and/or honestly in the
performance of duties and exercise of any rights, powers or discretions under
the franchise agreement”, and a duty to act in good faith towards the
franchisees.
The disgruntled group also
said the strategy would constitute unconscionable conduct by Yum in
contravention of Australian Consumer Law.
Solicitor for the
franchisees Jim Kartounis, who is also the president of the Australasian Pizza
Association, said the class action represented 288 of the chain's 298 stores
nationwide.
He said many franchisees
had been forced to give up their businesses because of the price war, which
Pizza Hut had anticipated "because the strategy did not allow for
franchisees to sustain their businesses".
It is believed 32
franchisees have lost their businesses since the introduction of the pricing
strategy.
Award-Winning Store Closed
Lyn and Fred Bayakly had a
thriving store in Perth's northern suburbs before the price war began. The
store was one of the highest trading stores in Western Australia, had won
several national awards and was used to train new franchisees.
"We had 40 staff and
we continued to dominate in terms of operational excellence, sales growth and
compliance," Ms Bayakly said.
She said Western Australia
franchisees agreed to a three-month trial period of selling pizzas for $8, on
the condition that it would be stopped if it proved unsuccessful. Gourmet
pizzas previously selling for $14.95 were included in the trial, despite
assurances from Pizza Hut that this would not be the case, and free deliveries
were also introduced at different times.
Her store lost $9,000 a
month during the trial period but Pizza Hut refused to stop the trial, despite
Ms Bayakly providing financial data to management soon after it started showing
the scale of the loses being incurred.
"They said the
marketing has all been done, it's too late to stop the trial," Ms Bayakly
said.
Following the trial, the
company decided to implement a nationwide policy of selling pizzas for $4.95
from July 1 last year. At this point, Ms Bayakly said the losses incurred by
the business increased to $5,000 per week.
"It sent us spiralling
further into debt, but the company didn't want to know," she said. "Their
conduct has been bullying, unconscionable, deceptive and intimidatory
throughout.”
Eventually, in November
2014, Pizza Hut terminated the franchise agreement and closed the store,
leaving the Bayaklys hundreds of thousands of dollars in debt.
Unable to service the
debts, the couple face losing their home. They have a fleet of delivery
vehicles they have been unable to sell, and have had to borrow money from
family members to make ends meet.
Significant Investment
The franchises are not an
insignificant investment. According to the Pizza Hut website, franchisees are
required to invest as much as $300,000 to open a new store, plus a start-up
fee.
Franchisees are also
required to pay a monthly royalty, advertising contribution and purchasing
contribution to Yum!, which are based on a percentage of a store's sales.
It's not the first time a
major fast food company has found itself in a battle with its own franchisees
over pricing strategies. This
class action has been likened to a case in the United States where hundreds of
Burger King franchisees took legal issue with the franchisor in towing the line
to sell a cheeseburger for $1.
Information
About Class Actions
In this case the class
action, which has been launched in the Federal Court, is an opt-out. This means
that many more Pizza Hut franchisees, on a national scale, could be included in
the action. To begin a class action a franchisee must satisfy three
requirements:
There must be seven or more people claiming against
the same defendant;
Your claim must arise from related circumstances; and
You need to have a substantial common issue or law or
fact.
Class actions can be
worthwhile in lowering the costs of litigation.
In Summary
Franchising presents both opportunities and risks. A franchise should provide a
comprehensive and virtually foolproof business model - however, problems can
arise when the financial modelling
underpinning the system is flawed.
Franchise
relationships are unbalanced. As a potential franchisee, the key to avoiding a
costly mistake is due diligence. Generally speaking, the more mature the
franchise system, the lower the risk, but due diligence is still critical to
making the right decision.
If you are
considering becoming a franchisee, you should read and understand the
franchisor's disclosure document, test the financial model, speak to other
franchisees and ensure that the franchise agreement goes no further than
necessary to protect the integrity of the franchise system. In other words,
professional advice is absolutely indispensable.
I hope this helps you and your business to be outstanding.
That is all -
David
