The U.S. Federal Trade Commission last year published more than 2,200 comments about franchising, more than half of which came from franchisees. Late last week, as it made illegal undisclosed fees and retaliation against operators who complain to the government, the agency also reopened those comments.
In the process, the commission also listed a dozen concerns that franchisees raised about the industry and some practices by franchisors. Here are those concerns and why they matter.
Unilateral changes to operating manuals: Some franchisees argue that franchisors will unilaterally change operating manuals, adding requirements to operators that they didn’t expect when they signed onto the brand. For instance, they may change operating hours or restrict the vendors they can use. Franchisees have little choice but to follow these rules.
Others argue that such changes are necessary to keep up with changing consumer pressures and government regulations. Indeed, many franchisees count on their franchisor to keep up with competition and keep operating manuals up to date. This may be one area where communication with franchisee groups was key. One franchisor told the FTC that changes made with consultation with franchisees were less likely to be concerning to operators.
Misrepresentations at the sale process. Franchisors that misstate the startup cost of a business during the sale process, or the potential profit margin, can create “dire consequences” for operators.
“Dickey’s will tell franchisees the costs will be $400k and it will cost sometimes double that but you don’t know until you are already heavily invested,” Brandon Gerrick, a franchisee of Dickey’s Barbecue, said in a comment.
Franchisees that invest into these businesses based on those representations can be saddled with a higher-than-expected level of debt and thinner profits can result in severe financial hardship. If they take out SBA loans, franchisees can often lose their homes if their business fails.
Fees and royalties. Franchisees complained that fees for operating their brand, particularly for technology or credit-card processing. The complaints were strong enough that the FTC effectively banned any fees charged to franchisees.
Some fees are important, especially as new technology becomes paramount in the franchising space. And some said that fee changes outside of inflation clauses or reserve disclaimers were uncommon in most franchise agreements.
Vendor kickbacks. This is a major problem for a number of brands. Many franchisors control their supply chain. They will take incentives from vendors for the right to sell food and paper to franchisees. But those incentives typically drive up the cost of operating a franchise, sometimes to the point where the franchisee can’t make money.
Franchises need to oversee a supply chain to ensure consistency and have a right to make a profit from that. And franchise rules require that franchises disclose how much they make from these relationships. But it can create serious headaches for many systems. In the case of the sandwich chain Quiznos, high food costs were a big contributor to its ultimate downfall.
Retaliation. One of the biggest criticisms of the FTC’s comments were the frequency of anonymous posting. A quarter of franchisee comments were anonymous, with many citing the potential for retaliation.
Non-disparagement clauses, common in franchise agreements, exacerbate these fears and “effectively silence franchisees.” It was enough that the FTC told brands they cannot retaliate against franchisees for reporting to the government.
Non-compete clauses. Franchisees argue that these clauses can be confusing and can limit their ability to find other work once they leave a system. Franchisors argue that they’re necessary to ensure that a franchisee doesn’t share trade secrets.
The FTC recently banned these agreements between businesses and their workers, but not among franchisees. Still, the agreements fall under an assortment of state laws, including some outright bans.
Renewal problems. Franchisees say that a franchisor has too much power over whether an agreement should be renewed. Franchisees sometimes have to accept changes they disagree with or risk losing their business.
Franchisors argue that they need to be able to make these changes to keep up with changes in the marketplace or demands for new technology. Still, the issue was a big complaint for Subway franchisees:
Those who renew their franchise agreement either must pay a higher royalty (10% of sales) or accept conditions many operators believe to be onerous.
Contract negotiations. Franchise agreements are typically take-it-or-leave-it contracts, which sometimes give the franchisor power to make unilateral changes. Franchisors, on the other hand, argue that a single agreement ensures everybody is on the same type of contract. Allowing for negotiation would open up a big can of worms.
Disclosure issues. A lot of franchisees complained about disclosure issues, over issues such as profitability, fees or buildout costs. Rules for the franchise disclosure document, required of all franchises, appear ripe for updating to make them easy to peruse or standardize some of the information in them, such as financial data.
Private-equity takeovers. The influx of private-equity groups into franchising in recent years has itself elicited concern, given the groups’ penchant for short-term investments and often-aggressive financial moves.
The investment groups rely heavily on debt and mandate aggressive growth while often cutting back on services or increasing fees. The groups’ short-term focus is often at odds with the long-term goals of franchisees.
Marketing fund transparency. Franchisors pool money from franchisees to use for brand marketing, which can be beneficial for franchisees. But it can also be a source of tension as operators sometimes do not know how those funds are used.
Some franchisees argue that the funds are used to market corporate stores or to sell franchises. They argue that more disclosure is needed on the use of such funds.
Liquidated damages. This is one of the more controversial issues in franchising, as a lot of franchises will require operators pay fees if they close early, potentially including unpaid royalties. Franchisees potentially face a tough choice to keep open a money losing store or face the prospect of a heavy payout.
Franchisors, on the other hand, have argued that such clauses can add predictability and can promote a settlement when a franchisee wants out of the system.
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