Local and national news was abuzz this past week over the protests and arrests made near McDonald’s Corp.’s headquarters. The protestors consisted of McDonald’s workers and labor activists demanding $15 per hour wages and the right to form a union. Similar demonstrations have occurred over the last few months at other fast food restaurant chains in both the United States and abroad. The protests of the well-known large franchisors generate great headlines, but the corresponding public debates about a “fair wage” largely miss the bigger picture: franchisees often have little real control over how much they can pay their workers. The reasons for this are several.
First, the manner in which courts interpret contract and antitrust law has greatly impacted the development of franchise law in the fast food industry. The franchise agreement governs all of the rights in a franchisor-franchisee relationship. Courts regularly strike down challenges by franchisees to provisions in those contracts using a contextual approach to contract interpretation. In short, if a provision is written into the agreement that is signed by the parties, courts will support the terms of such contract (even if they may be considered onerous). In this context, the franchisor-franchisee balance of power heavily favors franchisors. For example, most fast-food franchise agreements permit franchisees to purchase supplies from franchisor-approved vendors only. This creates a pricing monopoly for those goods. In effect, the contract prohibits franchisees to look to free market alternatives even if an approved vendor is selling inventory and supplies at prices greater than one finds at the local consumer wholesaler. Another example is how franchise agreements provide franchisors almost complete control over menu prices -- regardless of economic impact on the franchisee. Promotional items or special offers sometimes require the franchisee to sell at prices that are less than the costs of production. It does not matter if that $1 value meal item costs more than $1 to prepare; the franchisee has to sell it for $1.
Second, without substantial economies of scale, franchisee profit margins are often very thin – especially for those that do not have any economies of scale, multiple locations or private equity backing. After factoring in the cost of goods, annual inflation, royalty and advertising, capital expenditure requirements and other rents to the franchisor, franchisees often have little financial flexibility to implement wage increases.
Third, the "refranchising" trend in the fast food industry over the last decade has further skewed the economics in favor of the franchisors. “Refranchising” of a brand occurs where franchisors sell off company-owned stores to franchisees. This process generates cash for the franchisor while mitigating risk (or pushing such risk on to the franchisee) and can yield higher returns for the franchisor's stakeholders. However, this does not always have a positive impact on a franchisee’s bottom line. As a franchisor employs fewer actual restaurant workers, its business objectives tend to change. It relies more on the advertising and royalty payments instead of customer foot traffic. As a franchisor further removes itself from the day-to-day restaurant operations, it may be late in uncovering problems within the system or with a particular franchisee.
The “income inequality” debate will likely remain the cause du jour for some period. One can expect pundits, politicians and professionals to continue the debate on whether minimum wage increases will help resolve wage concerns within the fast food industry. It also remains to be seen whether the storming of the McDonald's headquarters will push state legislatures to pass state franchisee protection laws or promote the establishment of union-style independent franchisee associations. But as long as a franchise agreement governs the terms on which a franchisee can operate, the options for addressing wages will be effectively limited.