Unlike the man in Woody Allen’s Annie Hall who famously forgot his mantra, the Republican Party drones on about small businesses being the engine of growth with no hint that they will ever forget their lines and go off message. The interests of small businessmen form a kind of unified theory of Republican economic policy. Small businesses create most of the jobs in this country. Small businesses struggle to meet regulatory obligations. Small businesses won’t be able to survive let alone expand if they have to pay more in labor costs. If the government would just get off the backs of small businessmen, an economic miracle would bloom.
I don’t have numbers to prove it, but I believe all of this pandering is successful in winning the GOP the support of a large plurality of small business owners, even if there is polling data that suggests that they don’t agree with the Republicans on everything.
Members of one breed of small business owner might want to reconsider their political affiliation. I’m talking about franchisees. As Josh Freedman lays out in the March/April/May issue of the Washington Monthly, a combination of recent legal decisions and new economic practices by franchisors, is putting the screws to franchisees.
To understand what is happening, you first need to understand the typical franchisor/franchisee relationship.
Franchisees…pay for the entire cost of constructing and equipping the restaurant, which in the case of a new McDonald’s requires an investment of $1 million to $2 million. Franchisees then pay a fixed percentage of their revenues every month in royalty and advertising fees, while also often having to buy most of their supplies through the franchisor.
Done correctly, franchising can work well for everyone. Franchisees, many of whom are first-time entrepreneurs, benefit from the tested products and strategies of a large chain. They can also realize some economies of scale by purchasing supplies in bulk and spreading the costs of shared expenses, such as advertising.
The problem is that the old relationship has been changing, much to the disadvantage of franchisees. To begin with, franchisees have limited flexibility to control costs. They may get a bulk discount on their supplies, but as a result of a 1997 court ruling in Queen City Pizza v. Domino’s Pizza, they generally can’t shop for cheaper suppliers. They also have little to no control over what they can charge for their food. In 2009, a group of McDonald’s franchisees lost a court case they brought to protest a corporate policy that compelled them to sell double cheeseburgers for a dollar. At the time, it cost them more than a dollar to make a double cheeseburger. In another case cited by Freedman, a Colorado family went to court when they were ordered to offer a $4 value meal at their two Steak ’n Shake restaurants. They lost the case and both franchises. And, if you think about it, if you sink $1-2 million into building a McDonalds, you’re stuck with being a McDonalds. You can’t turn it into something else, or find a buyer who plans on being anything other than a McDonalds franchisee.
With all their other options for creating liquidity removed, the only thing left is the cost of labor. But franchisees don’t really control that, either.
While franchisors don’t set wages directly, the fact that they set almost every other input and control the levels of fees paid to them means that they effectively determine what franchisees can afford to pay their workers. “The corporations set wages by setting everything but wages,” notes Jack Temple, a policy analyst with the National Employment Law Project. Individual franchisees cannot shift money from other costs to pay for higher wages because they do not control what is left.
Here we have a strange confluence of interests. Fast food workers have difficulty getting better pay for a variety of reasons, including the difficulty of forming a union of workers from tens of thousands of (technically unaffiliated) small businesses. Likewise, franchisees have trouble banding together to petition their corporate overlords.
Currently, franchisors are free to ignore or undermine franchisee associations. As franchise attorney Erik Wulff wrote in the Franchise Law Journal, “A franchisor, unlike an employer under the National Labor Relations Act, is under no legal compulsion to meet, recognize, bargain with or do anything else with any group of franchisees that purports to be a franchisee association. In fact, franchisors are within their legal rights to ignore franchisee associations completely.”
Looks to me like the fast food workers would benefit if their bosses could form a union, and the bosses would benefit if the whole industry (including themselves) were unionized.
It makes sense for these fast-food franchisees to unionize because they have become prey to firms like Bain Capital.
More than seventy chain restaurant brands are now owned by private equity firms. One of the main investment strategies utilized by private equity firms is called “refranchising,” which refers to selling off company-owned stores to franchisees in order to maximize cash and shift risk away from the company.
Burger King, while under the control of a series of private equity players—including Bain Capital and more recently a complicated investment vehicle called a special-purchase acquisition company, or SPAC—has sold off well over 1,000 of its restaurants since 2009. This has reduced Burger King’s revenues but raised its net earnings. DineEquity, which owns Applebee’s and IHOP, sold more than 150 restaurants to franchisees in 2012 and now retains ownership of only about 1 percent of the restaurants in the two chains. “There has been a massive sell-off of company-owned stores at franchises over the last few years, and, more broadly, over the last decade,” says Jack Temple. Rather than face the risks of owning restaurants that are barely profitable or may lose money, investors would rather sell these units to franchisees who will pay them royalties and other fees as well. Like other forms of corporate “de-risking,” however, this process does not eliminate risk—it simply pushes it onto franchisees while shielding the company and its investors from harm.
With the chains primarily focused on financial engineering and no longer in the business of running their own stores, the interests of the franchisor and franchisee quickly diverge in ways that hurt everyone in the industry except those at the very top. As a former Burger King supplier noted in an interview with the popular franchisee blog BlueMauMau, “The cost of goods … and what the specs are get to be less important if you don’t have a dog in the operational part. And so the store’s bottom line is not important to them at all. They don’t understand it.” In this model, the role of big business is not to create a symbiotic relationship with franchisees and their employees, but rather to extract as many economic rents, or unearned gains, as possible.
Whether they realize it or not, these Republican-leaning small businesspeople are now in roughly the same position as sharecroppers or serfs. And that’s if they are lucky. The unlucky ones are in a situation more akin to owing money to the mafia.
With franchisees in such a precarious position, raising the minimum wage alone may not be an effective way to lift fast-food workers out of poverty. The New York Times’ Editorial Board cited Freedman’s piece today in support of their argument in favor of a higher minimum wage, but they seem to have largely missed the point of his argument. So, let me reiterate his point:
Until the growing imbalance of power between franchisors and franchisees is corrected, there is little chance that wages for fast-food workers can be substantially improved. For workers to get a raise, we need to reform the franchised fast-food industry from top to bottom.
Maybe if franchisees stopped embracing the maker/taker rhetoric of Mitt Romney and Paul Ryan and made common purpose with their employees, they’d discover that collective bargaining is the solution to their problems. Sooner or later, they’ll realize that the Republican Party is doing them no favors.