Franchising has come a long way from the days when Ray Kroc sold his first McDonald’s restaurant and Col. Harland Sanders set out to share his “11 secret herbs and spices” with others — for a share of the profits, of course. Kroc is long gone, though McDonald’s Corp. has grown into a multinational powerhouse that’s all but synonymous with American fast food. And the Kentucky Fried Chicken chain founded by Col. Sanders, may he also rest in peace, is now in the hands of PepsiCo Inc., which also owns the mammoth Pizza Hut and Taco Bell chains.
For years, thanks largely to Kroc, Sanders, and other legends of the franchising industry, aspiring entrepreneurs by the hundreds of thousands came to see buying a proven brand name and a turnkey business operation as one of the shortest routes to realizing the American dream. Along the way, they created millions of jobs from coast to coast and enriched many of their parent franchisors by providing them with an ever-widening stream of royalties.
“Franchising,” an industry lobbyist once put it, “is the goose that laid the golden egg.”
As it has turned out, however, that claim — like so many others that the franchising industry has tendered over the years to its prospects, the public, and the press — is more fancy than fact. To be sure, franchising is still a very big business ($250 billion a year, not counting automobile dealers and gasoline stations) and a very big part of the nation’s economy (some 12.7 percent of all retail sales last year). But every week seems to bring reports of a new lawsuit by disgruntled franchisees, replete with allegations of inflated or broken promises, intimidation, or retaliation from corporate headquarters and discrimination of just about every imaginable variety.
Taking the gloves off
Fighting between franchisors and franchisees is nothing new, but both sides are now preparing for the biggest bout yet.
In one corner is Rep. John J. LaFalce (D-N.Y.), the no-nonsense chairman of the House Small Business Committee. LaFalce, who’s one of Capitol Hill’s cleverest and most tenacious tacticians, has been hammering away at alleged abuses in the franchising industry for several years now. This time he’s aiming to land the knockout punch: legislation that would, for the first time, subject the franchising industry to full-scale federal regulation. LaFalce’s self-proclaimed “holy crusade” to curb franchise abuses has drawn plenty of support from franchisees and, lately, from some important lawmakers in the House.
In the opposing corner is the International Franchise Association, the industry’s primary trade group, which represent roughly 700 of the nation’s 3,200 franchisors, including many of its corporate heavyweights. In an effort to stave off tighter regulation, the IFA has called its attack-dog lobbyists off LaFalce and thrown a few bones to franchisees.
In June, for example, the IFA voted to admit franchisees as members for the first time in its 33-year history, and it recently added two franchisees to its board of directors, which has never before had franchisees. (Last October, franchisees formed their own trade organization, the American Franchisee Association, which now counts more than 5,000 members.) But most tellingly, the IFA also established an advisory council of franchisees, adopted an Ethical Code of Conduct, and set up a National Franchise Mediation Program that’s run by the Center for Public Resources, a nonprofit alliance of more than 500 major corporations, law firms, academics, and public institutions.
Even the IFA’s incoming chairman, Jim Bugg Sr., the president of Bethesda, Md.-based Decorating Den Systems Inc., admits that the franchising community is finally waking up and smelling the coffee. Before LaFalce introduced legislation to regulate the industry, Bugg recently told a reporter, “I think the association just kind of took a blasé attitude.”
Too little, too late?
LaFalce has welcomed the franchising industry’s recent initiatives, but it may be a case of too little, too late.
“I have noticed a shift in the focus of public debate over franchising,” LaFalce said in April at one of his committee’s hearings, “from arguments of whether serious problems exist in franchise sales and relationships to discussion of appropriate methods for addressing any problems or abuses that may exist.”
By July, however, LaFalce’s words had a decidedly different ring.
“Given the best intentions, the ability to regulate internally is limited,” he said at another of his committee’s hearings on franchising. “The IFA should recognize the necessity of legislation for the benefit of franchising — it is in the best interest of franchisors. This problem is not going to go away. We have to emphasize the good and minimize the bad. I want to work with all associations, but this is difficult if they start with an attitude of obstinacy. “
Obstinacy, in LaFalce’s opinion, is the industry’s renewed counteroffensive against the legislation that he has introduced to strengthen federal franchise disclosure laws, establish minimum federal standards for franchisors, and provide for the collection of reliable data about the industry. The franchisors have vowed to spend whatever it takes to defeat LaFalce’s legislation, which virtually guarantees a bloody fight.
LaFalce introduced similar measures in 1992, following three years of hearings by his committee, but this year he’s been pushing much harder to line up new co-sponsors in the House and, particularly, on the Energy and Commerce Committee, which would have to approve major portions of the bills.
The triple threat
As franchisors see it, LaFalce’s package of legislation, unveiled in April, amounts to a triple threat:
♦ The Federal Franchise Disclosure and Consumer Protection Act — essentially a “truth-in-selling” measure — would beef up the requirements on franchisors to disclose detailed information about their business to prospective buyers. But perhaps even more important, the legislation would give franchisees the right to sue franchisors for violations of federal franchising laws.
Since 1979, the Federal Trade Commission has required franchisors to provide prospective franchisees with a presale disclosure document that includes audited financial statements, the management experience of the franchisor, any history of litigation or bankruptcies, estimates of the cost of starting and running the franchise, and substantiation of any revenue and earnings claims.
But because franchisees have no private right of action under the FTC’s franchise rule, in many cases their only recourse is to rely on common-law fraud claims, which generally carry a steep burden of proof. Proving that a franchisor deliberately set out to defraud a franchisee, according to lawyer W. Michael Garner, a franchise expert in the New York City office of Schnader, Harrison, Segal & Lewis, is “an almost impossible task in the absence of a real smoking gun.”
What’s more, the FTC hasn’t exactly been aggressive in enforcing its own rule. Through the first half of this year, the agency had brought legal action in eight franchising cases, compared with 12 in 1992 and five in 1991.
LaFalce’s bills would change all that by letting franchisees go to court to enforce the FTC’s rule, with a five-year statute of limitations.
♦ The Federal Fair Franchise Practices Act relies on a broad-brush definition of good-faith business conduct to promote fair dealing in the franchisor-franchisee relationship. In addition to guaranteeing franchisees freedom of association, it would prohibit such widespread industry practices as requiring franchisees to purchase equipment and supplies from franchisors or their subsidiaries, terminating franchises without good cause and forbidding franchisees from engaging in a similar business after the contract expires. It would also prohibit franchisors from using a variety of contractual and procedural roadblocks to prevent franchisees from seeking relief in court or through arbitration.
Most franchise contracts, for example, now require franchisees to bring any legal actions in the franchisor’s home court, which for many poses a financial and logistical hardship.
“A growing segment of the American population is routinely required to forgo basic legal rights just because they choose to become franchisees,” LaFalce says.
The Federal Franchise Data and Public Information Act would require the Commerce Department to collect and publish data from the annual disclosure documents that franchisors file, and would require the Census Bureau to gather and analyze statistical data on franchises as part of its five-year business survey.
Prospective franchisees and the public, not to mention federal and state regulatory authorities, now have no reliable source of information on which to base their decisions, particularly when it comes to the issue of termination and failure rates in franchising. In its promotional materials, the IFA trumpets the fact that fewer than 5 percent of franchises fail or close every year, even though it’s anything but a fact. The number is drawn from old Commerce Department reports that relied on surveys of franchisors. Most recent surveys of franchisees by independent researchers have generally pegged the industry’s annual failure rate in the range of 10 to 12 percent, although one independent study of terminations and failures, which covered roughly 5,000 franchisees in 15 business categories, put it at 34 percent.
“The most widespread myth is that franchises are a safe investment because they have a much lower failure rate than independent business,” Barry J. Cutler, the director of the FTC’s bureau of consumer protection, told members of LaFalce’s committee at a hearing in 1991. “In fact, there may be much less of a difference than is commonly thought.”
Officials of the IFA oppose even this, the least controversial of LaFalce’s trio of bills, saying only that “we are in favor of more studies. “
Upping the ante
After listening to a parade of witnesses criticize franchisors at a hearing of the House Small Business Committee a couple of months ago, Rep. Kweisi Mfume, a Democrat from Maryland who chairs the 40-member Congressional Black Caucus, said, “In many respects, it’s the old master-slave relationship all over again. “
Mfume’s remark may have been mostly hyperbole, but it clearly struck a raw nerve among franchisors, who already have a bad case of the jitters. And for good reason: LaFalce, for the first time, has managed to sign up more than a dozen co-sponsors for each of his three franchising bills, and more are on the way. They include Mfume, who may be able to round up the votes of many minority lawmakers; Rep. Ron Wyden, a Democrat from Oregon who sits on the Energy and Commerce Committee; and freshman Rep. Jay Dickey, a Republican from Arkansas who sits on the Small Business Committee.
Dickey, a lawyer by trade, knows what it’s like from the franchisee’s side of the fence: In addition to the two PepsiCo-franchised Taco Bell outlets that he now owns in Pine Bluff, he says that he’s owned franchises — some successes, some failures — under three other franchisors. LaFalce recently told The Wall Street Journal that having Dickey as a co-sponsor “gives great credibility” to the arguments for his franchising
legislation.
No kidding.
This column originally appeared in the September/October 1993 issue of D&B Reports.
Franchise Wars
Franchising has come a long way from the days when Ray Kroc sold his first McDonald’s restaurant and Col. Harland Sanders set out to share his “11 secret herbs and spices” with others — for a share of the profits, of course. Kroc is long gone, though McDonald’s Corp. has grown into a multinational powerhouse that’s all but synonymous with American fast food. And the Kentucky Fried Chicken chain founded by Col. Sanders, may he also rest in peace, is now in the hands of PepsiCo Inc., which also owns the mammoth Pizza Hut and Taco Bell chains.
For years, thanks largely to Kroc, Sanders, and other legends of the franchising industry, aspiring entrepreneurs by the hundreds of thousands came to see buying a proven brand name and a turnkey business operation as one of the shortest routes to realizing the American dream. Along the way, they created millions of jobs from coast to coast and enriched many of their parent franchisors by providing them with an ever-widening stream of royalties.
“Franchising,” an industry lobbyist once put it, “is the goose that laid the golden egg.”
As it has turned out, however, that claim — like so many others that the franchising industry has tendered over the years to its prospects, the public, and the press — is more fancy than fact. To be sure, franchising is still a very big business ($250 billion a year, not counting automobile dealers and gasoline stations) and a very big part of the nation’s economy (some 12.7 percent of all retail sales last year). But every week seems to bring reports of a new lawsuit by disgruntled franchisees, replete with allegations of inflated or broken promises, intimidation, or retaliation from corporate headquarters and discrimination of just about every imaginable variety.
Taking the gloves off
Fighting between franchisors and franchisees is nothing new, but both sides are now preparing for the biggest bout yet.
In one corner is Rep. John J. LaFalce (D-N.Y.), the no-nonsense chairman of the House Small Business Committee. LaFalce, who’s one of Capitol Hill’s cleverest and most tenacious tacticians, has been hammering away at alleged abuses in the franchising industry for several years now. This time he’s aiming to land the knockout punch: legislation that would, for the first time, subject the franchising industry to full-scale federal regulation. LaFalce’s self-proclaimed “holy crusade” to curb franchise abuses has drawn plenty of support from franchisees and, lately, from some important lawmakers in the House.
In the opposing corner is the International Franchise Association, the industry’s primary trade group, which represent roughly 700 of the nation’s 3,200 franchisors, including many of its corporate heavyweights. In an effort to stave off tighter regulation, the IFA has called its attack-dog lobbyists off LaFalce and thrown a few bones to franchisees.
In June, for example, the IFA voted to admit franchisees as members for the first time in its 33-year history, and it recently added two franchisees to its board of directors, which has never before had franchisees. (Last October, franchisees formed their own trade organization, the American Franchisee Association, which now counts more than 5,000 members.) But most tellingly, the IFA also established an advisory council of franchisees, adopted an Ethical Code of Conduct, and set up a National Franchise Mediation Program that’s run by the Center for Public Resources, a nonprofit alliance of more than 500 major corporations, law firms, academics, and public institutions.
Even the IFA’s incoming chairman, Jim Bugg Sr., the president of Bethesda, Md.-based Decorating Den Systems Inc., admits that the franchising community is finally waking up and smelling the coffee. Before LaFalce introduced legislation to regulate the industry, Bugg recently told a reporter, “I think the association just kind of took a blasé attitude.”
Too little, too late?
LaFalce has welcomed the franchising industry’s recent initiatives, but it may be a case of too little, too late.
“I have noticed a shift in the focus of public debate over franchising,” LaFalce said in April at one of his committee’s hearings, “from arguments of whether serious problems exist in franchise sales and relationships to discussion of appropriate methods for addressing any problems or abuses that may exist.”
By July, however, LaFalce’s words had a decidedly different ring.
“Given the best intentions, the ability to regulate internally is limited,” he said at another of his committee’s hearings on franchising. “The IFA should recognize the necessity of legislation for the benefit of franchising — it is in the best interest of franchisors. This problem is not going to go away. We have to emphasize the good and minimize the bad. I want to work with all associations, but this is difficult if they start with an attitude of obstinacy. “
Obstinacy, in LaFalce’s opinion, is the industry’s renewed counteroffensive against the legislation that he has introduced to strengthen federal franchise disclosure laws, establish minimum federal standards for franchisors, and provide for the collection of reliable data about the industry. The franchisors have vowed to spend whatever it takes to defeat LaFalce’s legislation, which virtually guarantees a bloody fight.
LaFalce introduced similar measures in 1992, following three years of hearings by his committee, but this year he’s been pushing much harder to line up new co-sponsors in the House and, particularly, on the Energy and Commerce Committee, which would have to approve major portions of the bills.
The triple threat
As franchisors see it, LaFalce’s package of legislation, unveiled in April, amounts to a triple threat:
♦ The Federal Franchise Disclosure and Consumer Protection Act — essentially a “truth-in-selling” measure — would beef up the requirements on franchisors to disclose detailed information about their business to prospective buyers. But perhaps even more important, the legislation would give franchisees the right to sue franchisors for violations of federal franchising laws.
Since 1979, the Federal Trade Commission has required franchisors to provide prospective franchisees with a presale disclosure document that includes audited financial statements, the management experience of the franchisor, any history of litigation or bankruptcies, estimates of the cost of starting and running the franchise, and substantiation of any revenue and earnings claims.
But because franchisees have no private right of action under the FTC’s franchise rule, in many cases their only recourse is to rely on common-law fraud claims, which generally carry a steep burden of proof. Proving that a franchisor deliberately set out to defraud a franchisee, according to lawyer W. Michael Garner, a franchise expert in the New York City office of Schnader, Harrison, Segal & Lewis, is “an almost impossible task in the absence of a real smoking gun.”
What’s more, the FTC hasn’t exactly been aggressive in enforcing its own rule. Through the first half of this year, the agency had brought legal action in eight franchising cases, compared with 12 in 1992 and five in 1991.
LaFalce’s bills would change all that by letting franchisees go to court to enforce the FTC’s rule, with a five-year statute of limitations.
♦ The Federal Fair Franchise Practices Act relies on a broad-brush definition of good-faith business conduct to promote fair dealing in the franchisor-franchisee relationship. In addition to guaranteeing franchisees freedom of association, it would prohibit such widespread industry practices as requiring franchisees to purchase equipment and supplies from franchisors or their subsidiaries, terminating franchises without good cause and forbidding franchisees from engaging in a similar business after the contract expires. It would also prohibit franchisors from using a variety of contractual and procedural roadblocks to prevent franchisees from seeking relief in court or through arbitration.
Most franchise contracts, for example, now require franchisees to bring any legal actions in the franchisor’s home court, which for many poses a financial and logistical hardship.
“A growing segment of the American population is routinely required to forgo basic legal rights just because they choose to become franchisees,” LaFalce says.
The Federal Franchise Data and Public Information Act would require the Commerce Department to collect and publish data from the annual disclosure documents that franchisors file, and would require the Census Bureau to gather and analyze statistical data on franchises as part of its five-year business survey.
Prospective franchisees and the public, not to mention federal and state regulatory authorities, now have no reliable source of information on which to base their decisions, particularly when it comes to the issue of termination and failure rates in franchising. In its promotional materials, the IFA trumpets the fact that fewer than 5 percent of franchises fail or close every year, even though it’s anything but a fact. The number is drawn from old Commerce Department reports that relied on surveys of franchisors. Most recent surveys of franchisees by independent researchers have generally pegged the industry’s annual failure rate in the range of 10 to 12 percent, although one independent study of terminations and failures, which covered roughly 5,000 franchisees in 15 business categories, put it at 34 percent.
“The most widespread myth is that franchises are a safe investment because they have a much lower failure rate than independent business,” Barry J. Cutler, the director of the FTC’s bureau of consumer protection, told members of LaFalce’s committee at a hearing in 1991. “In fact, there may be much less of a difference than is commonly thought.”
Officials of the IFA oppose even this, the least controversial of LaFalce’s trio of bills, saying only that “we are in favor of more studies. “
Upping the ante
After listening to a parade of witnesses criticize franchisors at a hearing of the House Small Business Committee a couple of months ago, Rep. Kweisi Mfume, a Democrat from Maryland who chairs the 40-member Congressional Black Caucus, said, “In many respects, it’s the old master-slave relationship all over again. “
Mfume’s remark may have been mostly hyperbole, but it clearly struck a raw nerve among franchisors, who already have a bad case of the jitters. And for good reason: LaFalce, for the first time, has managed to sign up more than a dozen co-sponsors for each of his three franchising bills, and more are on the way. They include Mfume, who may be able to round up the votes of many minority lawmakers; Rep. Ron Wyden, a Democrat from Oregon who sits on the Energy and Commerce Committee; and freshman Rep. Jay Dickey, a Republican from Arkansas who sits on the Small Business Committee.
Dickey, a lawyer by trade, knows what it’s like from the franchisee’s side of the fence: In addition to the two PepsiCo-franchised Taco Bell outlets that he now owns in Pine Bluff, he says that he’s owned franchises — some successes, some failures — under three other franchisors. LaFalce recently told The Wall Street Journal that having Dickey as a co-sponsor “gives great credibility” to the arguments for his franchising
legislation.
No kidding.
This column originally appeared in the September/October 1993 issue of D&B Reports.
D&B Reports Harland Sanders International Franchise Association John J. LaFalce Ray Kroc