Steady as he goes

It adds up: Income Tax Professionals chief executive John Bailey

John Bailey doesn’t fancy starting his company in today’s climate. The 66-year-old founder and chief executive of the country’s oldest accounting franchise, Income Tax Professionals (ITP), says the weight of competition in tax is immense.

“A kid goes to TAFE or does a few university subjects and comes out a registered tax agent,” he says. “They hang a shingle on a corner shop for three months during peak season, make their money and disappear.”

It’s a big statement from a man who started the country’s second franchise (after McDonald’s) in an era when franchising was spectacularly unpopular.

“Don’t look now that a huge per cent of Australian businesses are franchised,” Bailey says. “In 1974, when we signed our first three franchisees, there was terrible scepticism of the model, outrage that you were using other people’s capital to build your brand. We copped flack for years.”

Royalties then were 18 per cent, which seemed a lot for a business losing money the first year, breaking even the second and possibly turning a profit the third. Now royalties are closer to 10 per cent.

ITP enters its 40th year this July with an annual turnover of roughly $40 million. Last year was a good year, thanks to Kevin Rudd’s $900 cash handout. ITP typically grows 6 per cent a year but in the 12 months to June 30, 2009, it grew by 23 per cent because people had to have their tax return filings up to date to collect their $900. Growth for 2009-10 is up by 15 per cent, suggesting there’s been a residual benefit for ITP from the government’s stimulus measures.

It’s a long way from the early days when Bailey funded the expansion of the franchise network out of his own pocket and lived off his wife’s ballet income. The company’s growth hurdles are far from over. ITP has succeeded in maintaining a small number of loyal franchisees, with its 250 offices divided between 35 franchisees (fewer than 10 per cent are company owned).

“Franchisees hardly ever leave the network,” Bailey says. This provides tremendous stability but has put ITP in a bit of a pickle. Many of the original franchisees are on agreements drafted in 1971 terms. “At that stage we didn’t really know what we were doing,” admits Bailey. Instead of franchising out suburbs, ITP doled out entire areas.

The whole of Sydney, for example, is controlled by seven franchisees. In Queensland, the entire state (70 offices) is controlled by a single franchisee.

This means ITP’s growth is beholden to a franchisee’s capacity and willlingness to expand and develop its patch.

Bailey knows that some areas are under-utilised but opening them up means convincing franchisees to invest heavily in new shop fronts.

By comparison, rival H&R Block will open 10 offices in Sydney this tax season (July to October).

H&R Block regional director Frank Brass says the company has the same issues with franchisee complacency. It’s one of the reasons that most of the H&R Block offices (300 out of 380) are company owned. H&R Block appointed most of its 40 franchisees in regional areas, keeping the cities for itself.

This structural issue is certainly not isolated to ITP and has little to do with the actual number of franchisees, says Adrian McFedries, managing director of franchise consultancy DC Strategy.

McFedries says several brands have worked their way out of this predicament in recent years but it generally involves buying back franchises, splitting the territory and selling them off again.

Alternatively, ITP could strike a deal with franchisees to sell the rights to a suburb in their area in exchange for a percentage of profits.

It’s opportunistic, McFedries admits, but the alternative is a stalemate and inaction could destroy ITP’s market share if a more aggressive competitor moves in.

And competition is coming. This year, Perth accounting franchise Success Tax Professionals announced large-scale plans to expand to the east coast, starting with Melbourne and Brisbane.

Bailey is no stranger to competitive pressures. Four times over the past 40 years, he thought tax reform would annihilate ITP’s business – but it didn’t.

This has made him less edgy about the federal government’s recent announcement to offer standard deductions of $500 (increasing to $1000) for work-related expenses – as well as the fact that roughly 20 per cent of ITP’s business is now derived from small businesses rather than individuals.

In the end, rising rents have had the most drastic impact on ITP’s margins, eroding net profit from a franchised territory by 5 per cent over the years.

H&R Block sites similar issues. “Rent,” Brass says, “goes up by 4 to 5 per cent a year.”

BRW

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