Entry No.07i

IT Writers Awards

Dozens of new Internet service providers are finding franchising models to be an easy way to establish an ISP presence with minimal technical expertise. Yet while the model has been getting a warm reception in regional areas, the going has been somewhat harder for some metropolitan franchisees – particularly those of HotKey Internet Services, which last month was sued by two dozen franchisees claiming it has helped parent company Primus Telecommunications cut into their exclusive turfs.

HotKey, one of Australia’s first franchised ISPs, currently has more than 50 licensees around the country, having bought early franchisor Starway in 1997 and built a successful enough business that it was purchased by expanding telco-cum-ISP Primus Internet. But in the past eighteen months, several new entrants have emerged to challenge HotKey’s one-time dominance in franchising -- in which franchisors set up local points of presence (POPs) using the investment of local business owners, but let those owners handle the day-to-day running of the business.

It costs a lot to build an ISP network, which is why small and expanding ISPs have seen franchising as such a promising opportunity to achieve the growth and geographical reach that have long been the domain of cash-rich companies like Telstra Big Pond, OzEmail, Optus Internet and TPG Internet – which each invests tens of millions of dollars annually to support over 100,000 subscribers nationwide.

Franchisors play on customers’ dislike of large, impersonal ISPs by promising a personal touch and fast response that only smaller, regional players can offer. Many customers still see value in this personal service -- particularly in regional areas, where the majors have less of a presence.

Brad Francis, chief executive officer with Brisbane-based WebExpress.net.au, believes franchising has given the company an opportunity to build brand equity across a broad region with a far lower investment than if the company was trying to do it alone.

"We decided to make the jump into franchising because being an ISP is a full-on business where you’re working 16 hours a day, and you either have a bucketload of money and employ a lot of people to get bigger, or look at different models," he explains. "We didn’t want to get impersonal like bigger ISPs, and have 1800 numbers where customers wait an hour for support, so we decided a franchise was better. Our savings is that we don’t have to manage a large infrastructure of people; a one or two-man business can support around 50 to 1000 customers, and we get one call per 200 customers per day, which is very low."

WebExpress partners invest around $35,000 to get into a franchise, which gets them an exclusive territory, a 2Mbps leased line or 45Mbps satellite Internet link, all associated POP equipment, 24-by-7 technical support and an automated billing system managed by WebExpress. In return for setting up and maintaining the POP, WebExpress takes a 25 percent commission.

Since it began wooing franchisees last year, WebExpress has already commissioned four new POPs around Brisbane, has another about to go live and hopes to secure several more deals with franchisees in several rural Queensland areas. Subscriber numbers have risen from around 3500 last year to over 5000 this year, and should grow further after a recent deal in which WebExpress will lease dial-in ports at 30 other ISPs’ POPs nationwide.

But just what makes a franchisee, who usually has no formal experience with Internet technologies, invest tens of thousands of dollars in something they know so little about? Quick time to market is a popular motivator for franchisees, who can leverage the franchisor’s experience in developing infrastructure and focus on building their local market by rubbing their proverbial elbows with the locals.

"It’s a lot better than doing it myself," says Philip Mack, a chemist by training who, along with pharmacologist wife Gladys, invested $75,000 into an ISP franchise from multinational operation Quik and is now operating as Quik Internet of Melbourne.
"It was only a hobby before, but we thought at the turn of the millennium that we should do something new," he continues. "Franchising was the way to get started, because to start it myself I would have to learn so much technology, and wouldn’t have the confidence and support. Quik is a very good brand – we are at worst comparable to Telstra and OzEmail – and we have the support from the master franchisor. The profit margins are very thin, and we realise that but the fact that we get support, and don’t have to do everything ourselves, is a very big help."

Similar reasons drove garden supply store owner Keith Williams and his wife Jeannette -- previously a network controller with Shell Australia – to invest $20,000 into a franchise of Starway, which was later purchased by Hotkey. Founded in 1996 and now run out of a shop in the Mornington Peninsula centre of Somerville, their franchise – Hotkey Peninsula – has won a strong regional following that now numbers over 1100 subscribers.
"We’re not the cheapest and never tried to be," says Jeannette. "But our point of view is that if someone rings the office, they expect the phone to be picked up by people that work there, and expect calls to be answered promptly. There’s none of this putting people on hold or making them call Sydney; we don’t charge to fix Internet problems. We employ local people, have probably provided five jobs -- apart from our own – over a period of years in the Peninsula, where employment is pretty scarce."

But franchising is not without its share of risk, particularly in terms of finding the right type of people to set up an operation. Quik Australia managing director Allan Phyland, who brought the US-based Quik franchise to Australia and operates Quik Internet of Northern NSW from the rural town of Alstonville, warns that despite the Net’s technical nature, technical people are the least suited to running a successful franchise.
"It’s definitely a sales and marketing business," Phyland explains. "Quik has taken the technical side out of it, and if anyone is going to struggle it’s because they’re too technical. We have been really particular in who we take on; the ones that battled in the US were the real techy, geeky types and that’s now what we want. It’s just so important to get the right people, and half the battle is won."

Quik has added ten franchises over the last twelve months, and is growing its customer base at around 32 percent per month, according to Phyland, who plans to add another ten franchisees this year and eventually top out at around 50.

Although franchise operations have been particularly popular in rural areas – where the personal touch they provide is particularly well received – they face heavy competition in metropolitan areas, where major carriers and ISPs are focusing their efforts in order to tap into the far larger customer base. But as an ongoing lawsuit against HotKey and Primus suggests, those ISPs can get too close for comfort when aggressive marketing campaigns bring them into direct competition with their franchisees.

In mid-June, HotKey Brighton owner Seaplane Pty Limited headed a group of 24 outraged NSW and Victorian Hotkey franchisees to file a claim against HotKey, Primus, HotKey chief operating officer Campbell Sallabank and Primus director Ravi Bhatia.

A copy of the 35-page Statement of Claim obtained by The Age alleges violations of the Commonwealth Trade Practices Act 1974 sections 51AA, 51AB, 51AC, 80, 82 and 87, including misleading and deceptive conduct; breach of contract; inducing breach of contract; unconscionable conduct, and aiding and abetting.

The problem, according to the Statement of Claim, was that HotKey promised its franchisees that Primus’ takeover of the business would result in a substantial funding injection for further developing the HotKey franchise across the country. HotKey also agreed to channel any subscribers it won through its own marketing to the franchisee covering each new subscriber’s territory.

But things began going downhill from September 1997, when the claimants say Hotkey’s technical support started dropping off. From March 1998, the claim says Hotkey began closing its own POPs and transferring its franchisees’ customers to Primus’ POPs. Hotkey also, the franchisees claim, began directing the subscribers it was picking up directly to Primus Internet – and not to its franchisees, as previously agreed.

By March 1998, Primus was assimilating administrative, accounting, technical and marketing staff into its own office, and by January 1999 Hotkey’s technical support had been incorporated into Primus’ own support service. Hotkey had effectively disappeared as a separate entity, the claimants allege, and was simply being used by Primus as a way to build its own subscriber base at the expense of Hotkey’s franchisees.

The application seeks not only compensatory damages, but an injunction barring HotKey from marketing its services within its franchisees’ territories; supplying dial-up access to customers in those territories; sharing information about franchisees’ customers or confidential details about franchisees’ new business opportunities with Primus; promoting Primus’ Internet services to customers of HotKey franchisees; and sharing directors, infrastructure, marketing services, branding or otherwise marketing itself as a subsidiary of Primus

Primus declined to comment on the case, which is currently being heard before the Federal Court of Australia. But Tristan Newton, operations manager with ISP DIALix – originally a Western Australian ISP that dabbled in franchising before being recently acquired by JustNet -- believes increasing competition in ISP services will threaten traditional franchising models in metropolitan areas and push ISPs towards co-location agreements where they expand into new areas by renting space on each others’ POPs.
"It’s not worth it to have an office set up somewhere else," Newton explains. "Having an office with a few lines into it is cheaper than having a manned office; the industry is too chocked, too competitive. It worked in early days, but margins aren’t as high as people make out: these days, it’s easier to have a computer there and buy [bandwidth] through a third party."

However the case against Hotkey and Primus is ultimately resolved, it will stand as an example of the potential dangers when the ultra-competitive Internet industry starts treading on its own toes.

"The idea was great, and worked well," said one of the claimants, who asked to remain anonymous, "but one of the things that has hurt the franchising system is that the big guys have gotten in and there are some people selling at pretty stupid prices. To sell unlimited access for $19.95 a month when a Telstra phone line costs $20.95 a month is pretty goddamned stupid to me. I still believe in the franchise system, but perhaps not in the way it’s being run."

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