Bhupinder “Bob” Baber bought two Quiznos franchises in Long Beach, California, in 1998 and 1999. His investment totaled $500,000, and Baber’s wife, Ratty, quit her job to work at the restaurants for no pay. The Babers did this because, as Bob would later recall, he “trusted in Quiznos.” But, as he soon found out, being a franchisee can be a very swift and painful way to lose a lot of money.
Over the past year, thousands of fast-food workers have staged protests and rallies for a higher hourly wage. As they see it, big corporations like McDonald’s and Domino’s can well afford to pay workers more. But the vast majority of these workers don’t work for these giants. They work for people like Bob Baber. Franchisees don’t enjoy the market powers and economies of scale of their parent companies. Rather, they run small businesses with narrow profit margins, high failure rates, and plenty of anti-corporate grievances of their own. Anyone who wants to help immiserated fast-food workers, in other words, also needs to spare a few thoughts for their immiserated bosses. That means reforming the deeply troublesome franchise system.
Franchising as we know it is an American invention, and it dates back to the mid-19th century. The McCormick Harvesting Machine Company, which made reapers, and the I. M. Singer Company, which made sewing machines, found that wholesalers didn’t want to carry or distribute these expensive and novel machines, nor did they want to offer parts and repair. So McCormick and Singer came up with an innovative solution: They built a network of independent agents. In return for carrying the product, the agents received a sizable cut of revenues from sales and repair, and exclusive rights to sell the machines in a certain area. In a vast country, franchising solved a lot of problems related to distribution, distance, and repairs. In subsequent decades, franchising also became the model for selling automobiles.
For a fast-food franchisee, a profit margin in the single digits is common. By contrast, at the corporate level, McDonald’s enjoys a profit margin around 20 percent.
In the 20th century, businesses began to see the value of franchising in the service sector. Howard Johnson used franchising in the 1930s, and Ray Kroc built an empire on McDonald’s franchises in the 1950s, ’60s, and ’70s. Today, fast food is sold almost entirely through franchises. Worldwide, franchises represent about 80 percent of McDonald’s restaurants, 95 percent of Burger King restaurants, and 100 percent of Subway restaurants. (The rest are usually company-owned flagship restaurants in high-profile locations or restaurants relinquished by one franchisee and not yet assigned to another.)
The positioning of franchisees between fast-food workers and large fast-food companies is part of a larger trend within the economy that might be termed (with apologies to Karl Marx and Friedrich Engels) “the devolution of the proletariat.” As the Boston College law professor Kent Greenfield observes, corporations and even the federal government have learned to use “suppliers, subsidiaries, franchisees, contractors, to avoid responsibility” for the welfare of those at the bottom of what business schools call the “value chain.” The low- wage jobs are offloaded onto smaller entities. Making things worse for workers is a lack of opportunities to move up the corporate ladder, since a burger-flipper doesn’t actually work for the company whose logo decorates his uniform.
It’s not just the workers who get a lousy deal. Over the years, Bob Baber, the Quiznos franchisee, became increasingly frustrated by the terms of his contract. One of the issues that galled him the most was that Quiznos was allowed to (and did) place additional sub shops in his franchise area, creating what he felt was direct competition that cut into his profits. Baber formed the Quiznos Subs Franchise Association, a sort of franchisees’ union, through which he hoped to leverage better terms. A month later, the Denver-based company terminated Baber’s franchise, claiming his restaurants were not being maintained properly, and other contractual defaults. When a franchise agreement is terminated, all investment by the franchisee—including acquisition cost, equipment, and fees—is effectively flushed away. Baber and Quiznos became enmeshed in a protracted legal struggle, with Baber refinancing his house and spending nearly $100,000. (A public relations spokeswoman representing Quiznos told us it is the company’s position to not comment on any litigation past or present.)
Despite such stories, people still buy into the franchise dream. For many Americans, owning a franchise seems like a starter kit for being your own boss as a small-business owner. You have the benefit of riding on a well-established national brand, and all you have to do is manage the shop. But a 1997 study by Timothy Bates, an economist at Wayne State University, concluded that “entering self-employment by purchasing an ongoing franchise operation is riskier than alternative routes.” A 2007 study commissioned by franchisors found that franchisees had higher failure rates on Small Business Administration loans than non-franchisees. If everything goes right for a fast-food franchisee, he might enjoy a profit margin of about 10 to 12 percent, but a profit margin in the single digits is far more common. By contrast, at the corporate level, McDonald’s enjoys a profit margin around 20 percent.
Well-known fast-food companies have so much clout that franchisors get to set the terms, and franchisees can take them or leave them. A 2013 McDonald’s franchise agreement stipulates not only how the restaurant shall be designed and the food prepared, but also how many days a week it shall be open (seven) and during what hours (7 a.m. to 11 p.m. or “such other hours as may from time to time be prescribed by McDonald’s”). In order to ensure clean finances among those with whom it partners, McDonald’s requires the franchisee to submit two financial reports monthly, plus a profit and loss statement and balance sheet once a year, and McDonald’s is free to examine at any time all franchisee financial records.
The more successful the brand, the tighter the leash. “Thirty years ago,” says Rick Swisher, who opened Los Angeles County’s first Domino’s in 1981, “we ran our own business with guidelines from the franchisors as to how the product was to look.” But by the time he closed his 11 Domino’s franchises in 2012, he says, franchise reps were so concerned with corporate imaging that they were telling employees, “You’re not answering the phone correctly.”
Franchise agreements usually require the franchisee to purchase food and other items only from authorized vendors. This helps to maintain consistency in quality. But, as Robert Zarco, a Miami-based franchisee attorney, points out, there’s more to it than that. Vendors can get picked because they offer a rebate to the franchiser. So if you’re a franchisee of, say, a pizza chain, you might find yourself overpaying for tomato sauce, only to see your overpayment make its way into the pocket of your corporate overseer. Yet as long as the rebate is disclosed, it is not, in the eyes of the law, an illegal kickback. More than one observer has likened contemporary franchising to sharecropping.
If a franchisee folds, moreover, the corporation may not suffer much. So long as willing buyers keep lining up, a restaurant can churn through successive franchisees. Robert Purvin, in his book The Franchise Fraud, cites a Popeye’s franchise in San Diego County that had five different owners in just 11 years. “Five businesses have gone under,” he writes, “but the ‘franchise’ still exists!”
At some point, however, squeezing franchisees becomes bad business. If too many restaurants go belly up, so could the franchisor. (Quiznos, for instance, has struggled financially in recent years. In 2010, the company settled, without admitting liability, a multimillion dollar class-action lawsuit brought by franchisees. New executives have spoken publicly about taking measures to improve the company’s franchisee relationships.)
Franchisees enjoy few regulatory protections at the federal level, and even at the state level, statutes intended to prevent exploitative franchising arrangements can be vague. New Jersey’s Franchise Practices Act, for instance, outlaws the imposition of “unreasonable standards of performance upon a franchisee” but doesn’t define what these are. Some people might argue that federal and state governments have no business imposing specific limits on private contracts between consenting parties. But governments already do that through minimum wage and maximum hour laws. There’s no logical barrier to regulating franchise agreements in a similar way.
The approach favored by Purvin, who is chairman of the American Association of Franchisees and Dealers, is to strengthen franchisees’ ability to create franchisee associations to engage in something like collective bargaining. (Some franchisors actually require franchisees contractually not to join franchisee groups.) Granted, enshrining such rights of association wouldn’t necessarily prevent companies from finding ways to retaliate (just as detailed labor laws don’t prevent companies from finding ways to fire union supporters), and enabling franchise owners to earn larger profits wouldn’t guarantee that they’d treat workers better (that’s why fast food workers must themselves unionize). But it would at least make better treatment more possible.
So, while fast-food strikers and franchisees have little love for each other—low-wage labor and cash-strapped management tend to regard each other with the opposite of solidarity—the two groups have more in common than they think. Both are being squeezed by the same absentee overlords. Increasing the minimum wage is necessary to improve the station of fast-food workers, but so too is loosening the franchising straitjacket.
In November 2006, Bob Baber walked into the bathroom of a Quiznos, pulled out a gun, and shot himself three times in the chest. He wrote a suicide note for his wife, and one for the media. A portion of the latter read: “In this franchise system the Franchisor has all the rights and no duties or obligations, whereas it is just the opposite for the Franchisee.” After Baber’s death, the Toasted Subs Franchisee Association, a group of Quiznos franchisees, posted his suicide note online. Six days later, eight board members of the association received notices from Quiznos: Their contracts had been terminated.