Commentary
The promise of franchise businesses is that any schmuck with the money to buy one, the grit to do it, and the extraordinary work ethic required to run a business can be successful—and even become wealthy beyond their wildest dreams. No highfalutin Ivy League college degree (let alone an MBA!) to succeed in business; not even a high school diploma. All you need is a license from a franchisor and an operating manual.
And for generations of would-be entrepreneurs, that was the case. And the model made hundreds of thousands of them multimillionaires. A few have even become billionaires!
A One-Sided ‘Partnership’
But the franchise model has always favored the franchisor over the franchisee. The franchisee makes the investment, does all the work, takes nearly all of the risk, and pays the franchise fee—typically a percentage of the gross receipts—always. No matter what. As one franchisor’s executive told Time Magazine in 1973, “We’re just like the Mafia; we skim it right off the top.”The franchisee also surrenders the rights to their own innovative genius. McDonald’s has earned billions of dollars from the Egg McMuffin, Filet-o-Fish, and Big Mac sandwiches, all of which were first created by franchisees, sometimes to the less-than-tepid reception of the franchisor. Ray Kroc, the entrepreneur who built McDonald’s into a global empire, is said to have told Lou Groen, the inventor of the Filet-o-Fish, “You’re always coming up here with a bunch of crap! I don’t want my stores stunk up with the smell of fish!” Today, some 300 million Filet-o-Fish sandwiches are sold annually, adding some $2 billion in sales per year to McDonald’s registers.
If Groen was treated like the franchisee innovators who gave McDonald’s the Egg McMuffin or the Big Mac—Herb Peterson and Jim Delligatti, respectively—he received nothing more than an acknowledgment for the billions of dollars those innovations brought to the chain’s cash registers. Kroc called Peterson’s egg sandwich a “crazy idea” and Delligatti had to fight for his triple-decker sandwich and even violate corporate directives to use a sesame seed bun from a local baker. Even the name “Big Mac” was dreamt up by a lowly secretary, despite McDonald’s being staffed by a whole platoon of marketers.
One doesn’t have to be a lawyer to see the franchisor–franchisee arrangement is a one-sided deal.
One former franchisee in the ice cream business said the following:
“Once I heard them call (franchisees - Ed.) suckers and not one of the key corp leaders owned a store. Corporate’s attitude was allow the franchise to make as little money as possible and take as many ”rebates“ as possible from the vendors. They considered the franchisee as workers.”
Enter the FTC
Roughly three months ago, the Federal Trade Commission (FTC) issued a Request for Information (RFI) expressing its interest “in learning more about the means by which franchisors exert control over franchisees and their workers. Specifically, the FTC is interested in how franchisors disclose certain aspects and contractual provisions of the franchise relationship. (but also) about the scope, application, and effect of certain contractual provisions and aspects of the franchise relationship.”In announcing the RFI, the FTC seemed to be referencing another aspect of some popular franchises.
“Amidst growing concern around unfair and deceptive practices in the franchise industry, the FTC hopes to hear from a broad range of stakeholders about how the franchise relationship is working, and how it is not,“ officials said. ”It’s clear that, at least in some instances, the promise of franchise agreements as engines of economic mobility and gainful employment is not being fully realized.” (Emphasis is mine.)
The RFI came about 18 months after the nation’s largest restaurant franchisor, McDonald’s, settled a lawsuit by the nation’s largest black McDonald’s franchisee, who had alleged “red-lining” of restaurants, the practice of keeping black-owned franchises in mostly black neighborhoods, where revenues tend to be less and expenses for things like insurance and security are higher. Over 50 other black plaintiffs who had made similar allegations had their suits dismissed. But just a week before the chain settled with the largest black franchisee, it had announced a $250,000,000 program to provide alternatives to traditional financing, to help prospective franchisees “who may face socio-economic barriers,” as McDonald’s described them.
It’s an open question as to how the FTC’s enhanced interest in franchised businesses will play out, and particularly how it will play out among minority franchisees and incumbent franchisees who may find their franchise renewals jeopardized by franchisors who are trying to increase emphasis on DEI (Diversity, Equity, Inclusion). Wall Street hedge funds have emphasized “social credit” among their investment criteria and franchisors have obliged. Several incumbent McDonald’s franchisees, for example, have expressed fear of losing their franchises.
Already, franchised businesses seem to be discriminating in favor of targeted minorities by offering them an array of financial incentives to sign agreements. Ben & Jerry’s Ice Cream, for example, reportedly waives the franchise fee and rebates the first year of franchise fees for prospective minority franchisees. It also waives the transferor fee of incumbent franchisees if they sell to minorities. Other franchised businesses offer benefits to additional categories of preferred minorities, including women, veterans, and even members of the LGBT community who are not available to other prospective operators.
Summary
The franchisor has always had the upper hand over the franchisee in franchise negotiations, so I welcome reasonable FTC efforts to “level the playing field” in negotiations beyond “take it or leave it.” Any exploitation of franchisees should be prohibited by the FTC to advance the “fair trade” the agency promotes. I also welcome efforts to set guardrails against onerous and unilateral obligations placed on the franchisee without the franchisee’s input. Finally, franchisees like the late Jim Delligatti, who engage in the kind of “shop floor“ innovation that gave us the McDonald’s Big Mac, but who must first obtain the franchisor’s approval in order to sell their innovation, should have FTC protections. They should be able to protect their innovation and negotiate just compensation for themselves and not simply have to surrender rights to the franchisor. (And, yes, as someone whose innovation as an employee once reduced process time from several skilled man-weeks to a few unskilled man-hours, I feel the same about innovations created by employees.)Finally, I would welcome closer scrutiny by the FTC, the Department of Labor, and the Justice Department Civil Rights Division of all these efforts that purport to enhance “diversity” among franchisees. Some of them reek of the kind of discrimination that is clearly illegal under federal employment law. While there is certainly an argument to be made that a franchisee is “not really” an employee, franchisors hold out their licenses to all comers and then select among those best qualified by their financial means and skills. But weighing opportunity for, perhaps, millions of dollars in income, more heavily for (or against) a franchise applicant’s immutable characteristics seems overtly unfair and un-American. A Supreme Court decision pertaining to race-based admissions, Students for Fair Admissions Inc. v. President & Fellows of Harvard College, that is expected to be rendered this month or next should shed light on the legality of such preferences.
