Franchise Ownership: Caught In The Middle

Thursday, December 11th, 2014

Franchising puts small business owners squarely between hard-line corporate requirements and low-paid employees.  With a brighter financial history in mind, a husband and wife invested a half-million dollars in a sandwich chain franchise in the late 1990s. She quit her job to boost the hoped-for bottom line at a quicker rate. They began their careers as small-business restaurateurs trusting their parent corporation but wound up learning franchising, in many instances, is not the way to turn a fast profit, but instead a way to lose a lot of money.

Recent televisions news footage has shown well-attended rallies and protests by fast-food workers who are reasonably demanding higher pay. In their eyes the massive corporations for whom they toil can afford to pay them more. And they probably can. However, most of these hourly employees do not work for giant companies, they work for small business owners, franchisees, who themselves are being squeezed by elementary economics. The market power and economies of scale enjoyed by global fast-food businesses are not passed down to individual owners. Instead, they get a miniscule portion of the company’s big picture, and frustrating restrictions that keep them operating with slim profit margins and a better-than-average chance of failure.

The modern franchising model dates back to the middle 1800s with a pair of iconic American companies, the McCormick Harvesting Machine Company and the I.M. Singer Company. McCormick’s reapers and Singer’s sewing machines were not finding the wholesale market the companies had hoped for, so they built a network of agents, the first franchisees, with exclusive rights to sell and service the new products. Franchising solved distribution, distance and service concerns and in coming years would become the way most cars would be marketed to American consumers.

By the 20th Century, franchising was the norm in service industries. Howard Johnson hotels began franchising in the 1930s and, of course, McDonald’s franchises in the 1950s, 1960s and 1970s made Ray Kroc a rich man. The franchise plan today is responsible for the sale of the vast majority of fast food.  Today it is more the franchise owners that find themselves between the proverbial rock and hard place, even more so than their underpaid employees. The franchise system ensures that low-wage jobs are shoveled into smaller businesses, which do not offer much opportunity for advancement since the local workers do not actually get their checks from the company behind the food they serve.

Renovating the franchise model would not ideally mean just more money for employees, but more opportunity and more freedom for franchisees. The aforementioned sandwich company took the $500,000 from the husband and wife team and also took franchise fees from others in the same area, creating competition among their own investors. And when the couple complained to the company, their contract was terminated, meaning all their investment, equipment and fees were forfeited.

Still, the franchise model, called by some observers a current version of sharecropping, is attractive to hopeful business owners who see it as a way to ride the coattails of a major financial power to their own individual success. However, studies have shown that franchisees’ businesses fail more often than independent shops. Additionally, a perfectly managed franchise store could possibly generate a 10 percent profit margin, but single digit profits are the norm. All while parent companies are earning a 20 percent profit.

The more powerful companies set all the terms for their owners including the hours and days they must be open, how the actual restaurants must be designed and, more obviously, how the food is prepared. In addition, the big company has almost unlimited access to the financial records of the franchisee, in cases requiring two monthly reports, a profit and loss statement and a balance sheet each year.

Contracts generally force the franchisee to buy food and most other items from authorized vendors in order to maintain consistency at all locations. In many cases, though, vendors are selected because they offer rebates to the franchisor. Those rebates, often mean that besides contracted fees, a parent company could be earning through rebates that rightfully belong to its franchise owner. While smelling unethical, a company claiming rebates is not technically an illegal kickback if it is disclosed.

When a franchisee goes out of business, his financial life and career could wind up in shambles. Not usually so for the parent company which usually simply sells the franchise again. One San Diego chicken restaurant went through five owners in 11 years and still maintains the franchise.

As many small business owners likely already know, there are few laws protecting franchisees from their corporate owners and even ones enacted can be vague and hard to enforce. Many franchisees favor union-like associations to allow collective bargaining with franchisors.

The two groups most often at odds with each other, minimum-wage employees and franchisees looking for ways to cut expenses, are battling a common enemy, but are rarely in a situation of solidarity. Two things are becoming clearer as the franchise model gets, for lack of a better word, clunkier – boosting the minimum wage is necessary for better way of life of fast-food employees and an overhaul of franchise restrictions is just as necessary for individual owners.

The husband mentioned at the top of the story wound up committing suicide in the restroom of a sandwich shop. In the note he left he said his franchisor had all the rights of the contract between them, while all the duties fell to him. After his death a group of eight fellow franchisees of the same company posted the note online. Less than a week later, the company terminated the contracts of all eight.

KaleidoScoops offers you the chance to own your own business with the freedom you deserve without investing in a franchise. If you want to learn more about the cooperative business model and the KaleidoScoops brand, call us today at (877) 426-8488. You can also connect with us via email by clicking on Contact Us. Read more about us and Get The Scoop on becoming a KaleidoScoops co-op owner.