photo from Harvey Norman's 2011 Annual Report

The Harvey Norman franchise in Australia is the largest retailer of its kind and mostly due to  its long history of constant marketing. Franchisor Gerry Harvey, one of Australia’s wealthiest men, must now review the franchisee financial model.

Macquarie Securities has declared Harvey Norman’s franchisee fee structure as “unsustainable” given the current retail market’s propensity towards discounting in low margin categories.  Current

The bank’s analysts have estimated that the cost of doing business (CODB) at Harvey Norman has risen to more than the gross margins charged at competitor JB Hi-Fi.

However, when examining the fees paid by franchisees to Harvey Norman in FY11, total fees paid equates to 19.47 per cent of franchisee total sales. This is before any labour costs, which are paid by the franchisees. Assuming these were around 3% of sales, a franchisee’s CODB would be 22.47 per cent — this is higher than the gross margins earned by competitor JB Hi-Fi.”

With the advent of low price, low margin online competition to the Harvey Norman range of products, we have seen all the bricks and mortar retailers in the sector lowering margins. That is simply another evolution of business as those retailers focus on their online business where traditional marketing has lost some impact.

A franchisor has the option to pass on the cost of competing to franchisees. But how long can that last before commercial reality demands a remodelling of the franchisee financial model to where the franchisor must absorb costs to ensure the viability of the franchisee network and investment worthiness of the franchise product?