Could 2014 be the end of franchising as we know it? Looking at recent headlines, you’d have reason to think so. Following a year which many saw as franchising’s toughest yet, we look at the challenges facing the industry today and the lessons that franchisors must learn if franchising is to survive and thrive into the future.
Around the world, franchising has been getting a good walloping recently – with everybody from governments and e-commerce giants to franchisee associations getting into the act. Here’s a selection of headlines we saw in 2013.
The most talked-about news, in the United States anyway, was President Obama’s infamous healthcare programme which was quickly dubbed “Unaffordable Healthcare” by franchisees with larger workforces.
As you’d expect, Obama’s proposed 100% minimum wage hike, from around US$7 to US$15 per hour, caused virtually every franchise system based on low waged labour – of which there are a good many – to throw up their hands and predict the end of world as we know it. Notwithstanding the fact that there is as high a proportion of these kinds of franchises in New Zealand and Australia, whose minimum wages are already at that level, Obama relented and dropped the figure to US$10 per hour. This is not a done deal, however, as the Republicans are blocking the bill from going through.
This headline had commercial cleaning franchises across the United States shaking in their safety-issue workboots. In 2012, a Massachusetts court slapped a $3 million bill on the Coverall franchisor after deeming its franchisees to be employees and therefore entitled to employment benefits such as overtime, holiday pay and sick leave.
Other suits, brought by franchisees claiming to be employees who’ve had to pay fees for the right to have their jobs, have followed, even outside the janitorial industry in such major franchises as 7-Eleven. They could have expensive ramifications for other franchises around the world which exercise a high degree of control over their franchisees.
Among these ramifications could be franchisor liability for franchisees’ negligence, and even debts, if franchisees are reclassified as employees by the courts.
Subway founder Fred Deluca has waded into the fight, claiming “Subway would not exist” if he started his business today because of today’s “excessive” government regulations.
New Zealand wasn’t exempt from regulations with a potentially adverse effect on franchising, in the form of proposed changes to part 6A of the Employment Relations Act, which FANZ said would create a whole new legal relationship between franchisor and franchisee, and the Commerce (Cartels and Other Matters) Amendment Bill which could have potentially brought in hefty compliance costs for franchise systems.
In Auckland, the two Carl’s Jr master franchisees came under fire for locating their new burger restaurants in low socio-economic areas such as Avondale and Glen Innes. Restaurant Brands’ MD protested that these were the only locations available.
Australian franchising endured yet another Franchising Code of Conduct review, the fourth since 2006.
It’s clear that the “fair franchising” movement is gaining momentum in many parts of the United States, prompting the rise of more franchisee associations and franchisee protection bills in states such as California and Maine.
Multi-unit franchising has been behind the phenomenal growth of franchises such as Subway and Five Guys Burgers and Fries, but there are some pitfalls, as Ray Kroc found when he allowed one of his first franchisees to set up more than one hundred McDonald’s restaurants, allowing the franchisee to wield too much power in Kroc’s opinion. For franchising purists, multi-unit franchising seems to go against one of the most basic principles of franchising – that the best manager of a business is the owner of that business – a principle supported by research indicating that franchised business units will almost always outperform either multi-unit or company-owned business units.
The traditional advantage of franchising was expanding geographical coverage while spreading business cost and risk, but what now allows business expansion – even globally – with potentially even less cost and risk? E-commerce. It’s a massive strategic challenge for many traditional business models, including franchising.
Franchisors may claim that their franchise agreements must be tough in order to protect the brand from the actions of individual franchisees, but the reverse can be true. The oddly-named Chick-Fil-A franchise (pronounced “Chick Fill Eh”) faced a backlash from the gay community in the United States after media comments made by its controversial president Dan Cathy, which Business Insider magazine predicted would cause “permanent brand damage”.
Could all these challenges mean the end of franchising as we know it? We think so. But don't get us wrong. Almost every "traditional" business model out there today - and this includes franchising - is under threat from newer disruptive business models. Back in the day, franchising was a disruptive business model itself. The challenge now is for franchising to adapt and change in order to remain dynamic and vibrant in a brave new world. It's franchising, Jim, but not as we know it.
Lessons for franchisors and the franchising industry as a whole:
1. Franchisees must be truly independent business proprietors, not employees from whom franchisors can extract cash
It would have seemed a great idea for many franchisors – charging “franchisees” a fee for setting them up in what are basically jobs, then taking a cut out of everything they earn – but these franchisees and legislators are gradually catching on to the scam. Expect fallout in New Zealand as certain commercial cleaning and home services franchises find themselves under scrutiny. And don’t expect the fallout to be confined to those industries. The Chick-fil-A “franchise” mentioned earlier may be the second-largest fast-chicken chain in the United States and have people queuing to be “franchisees” (they accept 70 out of some 20,000 applications each year) but don’t apply if you don’t espouse Christian values, or if you do espouse Christian values and you’re single, or if you expect to build some ownership or equity. This is a classic case of buying a job, albeit a potentially high-paid one, rather than a franchise. Just watch out if the Maryland courts reclassify Chick-fil-A as employers and then start investigating their discriminatory hiring practices.
2. The days of “McJobs” are going
You could argue that franchising was built on a foundation of high-volume businesses using low-cost labour, but recent pressure around the world to provide a living wage – even in what have become known as “McJobs” – may change that. Franchisors are worried that increased labour costs will hurt their profitability or lead to higher prices, which will hurt demand and therefore their volume. Obama supporters argue that this hasn’t been the case in countries such as New Zealand and Australia where minimum wages are already higher than the United States’. But there’s no doubt that fast food and other low-margin, high-volume businesses will need to re-think their business models, and not just from a healthy eating perspective. They will need to do what their competitors have done – differentiate their product and add value in new ways rather than compete on cost.
3. The one-sided franchise agreement is on the way out
Believe it or not, there are still franchise agreements out there that give franchisors the right to terminate without cause. But the rise of multi-unit franchising and franchisee associations is putting pressure on legislators to introduce fairer franchising laws and the requirement to balance franchise agreements more evenly toward franchisees. Some franchisors such as Roger Bloss of Vantage Hospitality have embraced fair franchising and boosted their growth as a result (see our article “The franchisees strike back: The fair franchising movement – and why you absolutely need to know about it”).
4. Stop taking the easy way out and get back to franchising’s roots
It may sound contradictory that on the one hand we’re advocating change and on the other, cautioning against it when it comes to multi-unit franchising. Are we the only ones who have a problem with uncontrolled multi-unit franchising? Like frozen yoghurt franchises, it has become the flavour of the month – the movement now has its own associations, magazines and websites – but as we said above, we believe that in many ways it goes against the essential spirit of franchising and, by giving too many franchises to certain franchisees, may overstretch those franchisees while at the same time undermining the franchisors. Just sayin’.
5. Stop worrying about ecommerce and start embracing it
Internet and ecommerce franchises are now popping up everywhere, so it is possible for the two business models to work together. But there are more and more cases of franchisors keeping the two models quite separate from each other, and as we’ve noted in earlier articles, this could well be to the detriment of their franchisees, something the last Australian franchise code of conduct review took into account in its recommendation for franchisors to increase disclosure about online activities.
6. Don’t speak for your franchisees
Would you be happy if your franchisor took a public stance that took away one-tenth of your business? Whether you agreed with him or not? That’s the potential fallout from Chick-fil-A president Da Cathy’s anti-gay media comments, which have resulted in protests outside Chick-fil-A restaurants and boycotts by the gay community and their supporters.
7. Do we need a clearer definition of franchising?
Seems to us that the franchising model is becoming increasingly fuzzy and the lines blurred between what it is and what it isn’t. That’s OK, as long as franchisors and franchisees know where they stand. Google “franchising” and you’ll find as many definitions as there are search results. The USA’s FTC Franchise Rule defines a franchise as having three elements: the right to use franchisors’ trademarks, significant control of the franchisees’ method of operation by franchisors, and the requirement for franchisees to make payments to the franchisor before or within six months after opening for business. The problem is that there’s no mention of any of other rights of franchisees, or any limitations on the control exercised by the franchisor, which should have let Coverall off the hook instead of being reclassified as an employer rather than a franchisor in Massachusetts, but of course it didn’t because the fuzziness of the definition meant the state’s court had to make up its own mind about where the franchising relationship ended and the employment relationship began.
Franchisors are clearly confident that these lessons can be learned. Franchising confidence has rebounded in New Zealand this year, and last year in the United States the sector created an estimated 11,000 new establishments and 150,000-plus jobs, outpacing the overall economy in business formation and job growth.