The most surprising bit of news this week was a ruling out from the National Labor Relations Board, saying that McDonald's Corp. functions as a joint employer with its franchisees and can therefore be held liable for their employment decisions. The immediate effect is to join McDonald's to a few dozen labor disputes at individual stores. But the goal is pretty clearly much larger: making it much easier to unionize McDonald's, by allowing unions to organize the whole company, rather than trying to eke out victories one store at a time. If this ruling stands, it will have seismic effects on the franchise model.
I’m not sure this ruling will stand, of course; it seems crazy to me. Corporations that work on the franchise model do exercise substantial control over the operations of their franchisees, but at the end of the day, the franchisees are legally separate companies -- and those companies are the ones that pay the paychecks, organize the schedules, hire, fire and so forth. This would hand McDonald's legal liability for something it has limited ability to control. Oh, sure, the franchise agreement can state that owners have to obey the labor law, but franchise owners are owners; McDonald's can’t just fire them for being jerks. It can terminate the franchise agreement, but that’s a lengthy procedure that frequently involves lawsuits. It’s not a very efficient way to enforce employment policy. This is the equivalent of saying that you can sue McDonald's because some jerk in Omaha violated the local health codes.
It seems likely to me that this would render most franchise agreements uneconomical, particularly if many of these operations ended up unionized. Suddenly, every franchise owner would be subject to labor agreements not negotiated by her, but by a distant union and an equally distant corporate labor department; most worker beefs would end up being multiparty negotiations, often with far-away national negotiators who don’t know much about your operation, and probably don’t care, either.
And so what, you might say. Wouldn’t it be better if these were national corporations offering good union jobs?
I could point out that franchises are often a gateway into prosperity for the kind of strivers who didn’t go to Harvard, or any college at all, including minorities and immigrants. I could point out that lots of ordinary Americans enjoy fast food, and that prices would go up a lot if those operations had to absorb the overhead of running a union shop -- not just the wages, but also the complexities of running a small business by the terms of a lengthy and complicated collective bargaining agreement.
But maybe the best question to ask is: Why do operations franchise? Some of the commentary I saw on social media this morning implied that it’s just a dodge to get around labor laws and prevent unionization.
Actually, franchising has lots of benefits. For example, it gives the parent company access to extra capital during the expansion phase, because it brings in new people with savings to invest, and the ability to access their own credit lines to build restaurants and buy equipment. But the most interesting reason was explained to me by James Schrager, who taught my New Venture Strategy class at the Booth School of Business.
Professor Schrager started off the class by asking us to answer a question: Why does McDonald's franchise? There are company-owned McDonald's. And McDonald's stores are, on average, quite profitable for fast-food operations. Why doesn’t the company buy up the franchises and keep all those profits for itself?
We came up with a lot of answers, though I don’t recall what they were. And one by one, he shot them down. When he had us totally stumped, and we sat defeated at our desks, he began to tell us an apparently unrelated story about his weekends at the lake, and the guy with the magnificent boat. Huge boat. Awesome boat. I don’t know anything about boats, so the details elude me. But the gist of it was that this was the kind of boat that people who like boats dream about, when they look at boat catalogs.
The guy with the boat, he said, owned a McDonald's franchise (I assume more than one, actually; they’re certainly profitable, but they’re not wealthy-beyond-dreams-of-avarice profitable.) That guy had a great boat. But he was never there to use his boat. He was back in whatever little Midwestern town he worked in, making sure that the toilets were clean.
And that, said Professor Schrager, is why big, successful outlets like McDonald's still franchise. You can’t buy that: the guy who has a giant boat, and probably an amazing lake house to go with it, and stays in town on the weekends to personally inspect the toilets every hour to make sure that they’re clean. And more than occasionally, to pick up a mop himself and clean up after the drunk, or the toddler, who just vomited in front of the soft-drink dispenser. You can hire a manager to run your stores, but that manager will almost never care as much as an owner whose personal net worth is riding on delivering a top-notch customer experience. A manager can always get a job doing something else. A franchise owner who loses his franchise is not just out of a job but also out of a six- or seven-figure asset. McDonald's franchises not because it needs access to the capital of its thousands of owners, but because those owners will deliver a better customer service experience than would a vast corporate bureaucracy.
(This can lead to problems if the brand starts to go downhill: your best franchisees leave, and the ones who are left don’t do such a good job, which degrades the brand even further, so that more of your best franchisees leave, and whee!, you’re suddenly in a tight downward spiral. Arguably this is what happened to Burger King a few decades back, and it almost killed the company.)
Is that something worth saving? We’re at the crest of a swelling wave of nostalgia for vast corporate bureaucracies, which are easier for vast government bureaucracies to heavily regulate without driving them out of business entirely. So I’m sure that a lot of people will say no, it’s not. Personally, I think that ownership, and small business, and individual operations, are valuable parts of a thriving society. I’d hate to see thousands, maybe millions, of them ruled out of existence because the NLRB would rather deal with a large corporate headquarters.
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