I used the word "melee" in the title because it is one of the words I saw journalists use to describe the melee/brawl/shootout/riot/gunfight/gang war that occurred at the Twin Peaks restaurant on I-35 in Waco, Texas. (For those of you non-Texans, Waco is equidistant from Dallas and Austin on I-35.) According to reports, two motorcycle gangs, the Bandidos and the Cossacks, were having a "meeting" there when a fight in the bathroom and/or in the parking lot spread into the restaurant, the patio area, and the parking lot, resulting in the deaths of 9 people and in injuries to 18 more. (Some reports give an account of a coalition meeting with up to five gangs represented.) Around 170 bikers have been arrested. None of the diners, employees, bystanders or police officers were among the injured or killed. A lof ot folks on social media are talking about interesting civil rights and criminal aspects of the case, but there is also a fascinating corporate/contracts aspect to the case.
Twin Peaks is (according to Google maps) a "sports pub with scantily clad waitresses," but more important to this post, a franchise. (Apparently, after doing some research, I've discovered that the word for this type of establishment is "breastaurant." Nice.) According to Entrepreneur.com, in 2014 there were 34 TP restaurants, and 20 were company-owned. Franchises are not cheap ($50k/year) and require a substantial outlay and proof of liquidity ($1.5 million a store net worth and $500k liquidity), but TP franchises seem to have a good reputation online for being a good buy. Until possibly this week.
Last semester, Gordon and I (and Matt Jennejohn and Clark Asay) taught a colloquium on Law & Entrepreneurship. One of our fantastic students wrote her paper on the reputational hits a franchisee takes when a rogue franchisee damages the brand. Examples she gave were mostly of health, safety and labor problems, such as when the franchisee down the street gets bad publicity from having a horribly filthy restaurant. My read of the problem was that the franchisor, particularly when the franchisor owns many of the stores itself, has a strong incentive to monitor all franchisees and contract for control and/or damages to mitigate the possibility of brand-damage. I believe we are seeing this played out in the TP case.
Shortly after the shoot-out (a strangely mild phrase, evoking thoughts of a Six Flags theme park ride), TP revoked the franchise from the Waco establishment, widely publicizing the decision and distancing the brand from the actions of the Waco restaurant management. Why is any of this the fault of TP-Waco? According to Waco police, TP-Waco had been warned about hosting the biker "meetings" and encouraging well-known organized criminal gangs from hanging out there. I have not seen any identification of the owner(s) of TP-Waco and do not know if there are any familial or business connections between the owner(s) and a motorcycle gang, so the incentive of TP-Waco to encourage biker clientele is unclear. In fact, the Waco police contacted TP (national) and advised them of the situation, and TP (national) contacted TP-Waco. According to TP (national), it had no power to physically close TP-Waco on the day of the meeting, cancel the "patio reservation," or change any of its decisions. Its remedy was to revoke the franchise after the fact. Now, TP (national) says it is revising its franchise agreements to give it more power to act earlier -- I would love to see a copy of the new franchise agreement!
Anyway, our student's paper highlighted this very concern. Now, other TP franchisees surely will see lost business as patrons will associate the brand with violence or at least an unsavory biker culture. Not only did something awful happen there, but the management is being painted in the media as being an active participant. TP-Dallas has already sent out a press release trying to mitigate brand-damage, focusing on the fact that no patrons or bystanders were hurt. So, if TP-Dallas loses business, what can it do? I've looked everywhere to see if business interruption insurance covers this, and I can't find an insurance product for this type of loss. However, I have found evidence that franchisees often sue franchisors for a number of things, including "errors and omissions" in the franchise disclosure documents. The disclosure documents aren't public, but the TP website does stress that franchises are only given to a select few candidates who are very qualified. While criminal law types monitor the ongoing investigation, the boring corporate types will monitor the franchise situation!
I have been casting about for a new franchise to feature in my casebook, and with the help of a student, I was looking at Red Mango ...
After the junior high band concert, the whole family visited the local Red Mango franchise, and, of course, I had to ask: "what is authentic frozen yogurt?" The young woman behind the counter struggled with her response, but she finally managed to blurt out, "It's one of the five healthiest foods in the world."
As it turns out, the Red Mango website has a link to the source of this claim: Health.com. It lists "Yogurt (Greece)" on a page labelled "World's Healthiest Foods." (Can you guess the others?) If you follow the link on Health.com, it leads you to a brief story on yogurt, which begins like this:
Um ... maybe my case study can talk about fraud and consumer protection.
They are hitting the health angle hard. Here's more on "authentic frozen yogurt" ...
I love this bit of marketing. Red Mango ... natural goodness ... freshly delivered ... good health ... morning, day or night ... all-natural, nonfat, gluten-free ... wholesome ... healthy treat ... Fruity Pebbles and Cap'n Crunch!!!!
So you be the judge. Open the nutritional information below and tell me whether you would call this food "healthy." (Hint: look at the sugar content.)
UPDATE: See Larry Ribstein's post from January on Red Mango and other "Obama generation" stores.
McDonald's continues to supply interesting franchising disputes. The most recent revolves around the Dollar Menu: though the cost of food is rising, prices on the Dollar Menu remain fixed. McDonald's and its franchisees view this problem through different lenses.
McDonald's receives royalties based on sales and, thus, has an incentive to increase sales, even reduced-margin or, in some instances, negative-margin sales. On the other hand, franchisees profit only when revenues exceed expenses. The problem with the Dollar Menu is that franchisees don't make money selling a Double Cheeseburger for a dollar.
Franchisees can opt out of the Dollar Menu, but they still are required to pay into a collective advertising fund, so all of those ads promoting the Dollar Menu (reportedly $100 million of McDonald's $810 million measured media buy) are wasted on a non-participating franchisee. Or worse, if customers are upset about not being able to purchase food on the Dollar Menu.
McDonald's is experimenting with Double Cheeseburgers for $1.09 in Georgia and Mississippi, but that sort of blows away the notion of a Dollar Menu. For a brief report on the situation, see Marketplace.
This story reminded me of the old McDonald's television commercial stating that you could get a full meal (burger, fries, drink) and still get change back from your dollar. Gas was about $.25/gallon at the time, too. Anyway, I looked for that old ad on You Tube and couldn't find it, but I did stumble across this very early version of Ronald McDonald ... Yikes!
The WSJ had a story yesterday on a new movement: "Freedom Franchising." Apparently competition for good franchisees has become so intense in the past few years (with more than 900 franchise concepts rolled out since 2003) that some chains are taking a new tack: giving their franchisees more leeway to run their operations as they see fit. Great Harvest Bread Company, for instance, is allowing franchisees to decide what items to put on the menu and where to buy supplies, instead of restricting their menus or the suppliers they have to use. I'm going to assume, though, that all Great Harvest franchisees still have to sell bread. (Great Harvest has also, BTW, trademarked the term "Freedom Franchising").
I was intrigued by the article and premise, especially after teaching the Krispy Kreme case study from the Smith & Williams casebook, but I still wonder how a franchise can succeed if its stores aren't (pretty) uniform. The article also quotes the head of the Beef O'Brady chain of sports bars. The chain has been giving its franchisees freedom to set prices, but "[a]s we grow," he said, "we do feel that we need to be tighter and do more streamlining...to create a clear brand for our guests so that they know what to expect." Isn't a "clear brand" and uniformity the whole point of a franchise?
Krispy Kreme lost its CFO and Vice Chairman yesterday, and the stock is still in the toilet, where it has been wallowing for the past three years. (W$J) The company is trying to execute a turnaround, but it's slow going. Two weeks ago, the company held the first conference call with investors in years, and the mere occurrence of that event was heralded as a significant marker in the progress of the turnaround plan. Still, my sense is that the problems at Krispy Kreme transcend financial scandals. The more fundamental concern is that people don't really like Krispy Kreme doughnuts that much anymore. It was fun while it lasted, but we have moved on. And that whole wheat thing is not going to bring back the magic.
One of the testy and recurring issues in franchising has to do with how the franchisor uses the funds collected from the franchisees for marketing. Subway established a trust in 1990 to manage those funds, but the trust is now suing Subway's founder and Doctor's Associates Inc. (the franchisor) for changing the franchise agreement in a manner that disregards earlier commitments. I will try to track down the complaint and/or the franchise agreement here because the news stories are too sparse for much analysis, but this looks like it could be an interesting case.
Thanks to former student Juan Lozano for the tip.
I teach a short section on franchising in my law and entrepreneurship course, and that section begins next week. I have been a longtime reader of venture capital blogs, but I have never been a consumer of franchising blogs. The numbers are smaller, and the quality is mostly low, but I found two worth reading:
Wiggin & Dana's Franchise Law Blog: I wasn't looking for legal blogs, but as is often the case, lawyers lead the way. This blog is devoted to recent cases and news stories. The main negative is that they don't post enough.
Franchise Business Opportunities: This blog is part of Dane Carlson's excellent Business Opportunities Network. Lots of content, mostly focused on recent news stories about franchising.
The cover story in the December issue of Fortune ("Risk Reward") is on franchising. Here is the provocative theme: "The scant research that exists suggests that, as risky as starting an independent business is, buying a franchise is an even bigger roll of the dice." The article paints a pretty dreary picture for franchisees:
[B]uying a franchise too often ensnares would-be entrepreneurs in the worst of both worlds: You get all the financial exposure, headaches, and stress of business ownership—but someone else collects royalties on every nickel that comes through the door, not to mention fees for marketing, fees for this, fees for that, more fees for anything you can imagine (and some stuff you can't); and all the while, the franchisor dictates virtually every detail of what you can do, including what kinds of signs you can put up, how you price your wares, how much overtime you can pay your employees, and who'll be your suppliers. Violate the agreement, even in some tiny particular, and the franchisor can—and often will—snatch your franchise back.
I once taught a student who had been in franchising, at times as a franchisor and at times as a franchisee. After he graduated and formed his own law firm, I asked him, "If someone came to you with an idea for a franchise, how would you advise them to proceed?"
"Stop. Don't proceed. Find another idea."
To be fair, I have spoken with many franchisors and franchisees who love their businesses, and in certain industries (fast food being the prime example), franchising has made many people quite wealthy. Franchising may be more treacherous than starting an independent business, but I suspect that the reason failed franchisees are so outspoken is that they develop a sense of entitlement from the payment of the franchise fee.
The perception that a franchised business is a "sure thing" is enhanced by the disclosure that accompanies franchise sales. Although franchisors are every bit as vigilant at paying lip service to risks as sellers of stocks and bonds, the message does not always penetrate the eager franchisee's brain. Instead, they see projected earnings and imagine themselves as successful, independent entrepreneurs. The law reporters bear testimony of failed dreams. Franchise disputes are common, despite elaborate contracts. The bottom line is that franchising is a tough business, from both sides of the table.
Thanks to Marc Shuman for pointing me to the article.
Like Gordon, I generally try to eat at local places, rather than franchises, when I'm on the road. I find it amusing that both Gordon and I, despite our shared intellectual interest in franchising, stay away from the joints ourselves. In fact, Gordon and I may be acting irrationally, at least from a branding perspective.
Why do people tend to stop at McDonald's or Arby's on a road trip? Answer after the jump.
Branding, of course. The search costs are high for someone passing through on the interstate. Suppose you are trying to get in 500 miles one day and stop in a small town for lunch. You could go stop at a motel and ask for recommendations, then inspect the menu at a few different places, etc. But this is time-consuming, and since you may never come through the town again, you have no reason to invest in the research.
Instead, the rational consumer just looks for the golden arches. Fast food companies spend money creating and advertising the brand, and they enforce standards on franchisees to ensure some minimum level of quality. Most of the time, when you stop at McDonald's, you know what you'll get. It may not be gourmet quality, but it's not likely to give you food poisoning. When you stop at a local diner, you are rolling the dice. Worse yet, the diner's owner knows that many customers are just passing through, and so she has less incentive to produce a high quality product. Especially with difficult-to-observe things like kitchen cleanliness.
There are strategies to beat this lack-of-repeat-play problem. One basic strategy is to go to places that appear to be crowded with locals. Stay away from the empty places or places where the majority of license plates are out of state. Judge Michael taught me an even better trick: go where the cops go. Cops eat a lot of food in their car, and they tend to go to places where food is fast, cheap and pretty good. (Truckers seem indifferent to food quality, and instead look for product attributes like food quantity, big parking lots, roomy booths, and truck stop amenities like showers and table-side phones.)
Travel guidebooks (the kind that list B&B's) can also help. AAA guidebooks, back when they were in wider use, gave roadside diners an incentive to maintain high quality. I am hopeful that as mobile technology improves, it will be possible to type an exit number or intersection into your phone and instantly see reviews of local establishments. (Google Local, through SMS technology, can get you listings but not much in the way of reviews.)
Why go to all the trouble? Why not just stop at McDonalds? Well, sometimes I do, esp. when time is of the essence. But while I have nothing against franchised restaurants, I do prefer to support small business and entrepreneurship. I appreciate a diversity of eating options and want to do my part.
Also, and I suspect Gordon is with me here: It's just fun to try out new places. I'd rather risk the occasional disappointment than just have another bland and boring roadside experience.
Finally, there is my fondness for the open road. And when I think of roadside Americana, I think small town diner, not Travel Plaza McDonalds.
Did you know that Sears is a franchisor? I didn't before today, when I read about a lawsuit by Sears franchisees, who feel wronged in the wake of Kmart's takeover of Sears. You see, these little Sears stores (all located in rural areas and about one-fourth the size of urban Sears stores) are being forced to compete with Kmart stores that stock the same products, like Craftsman tools. The Sears franchisees negotiated exclusive territories, which they claim are being infringed.
These sorts of claims -- called "encroachment" claims -- are common among franchisors and franchisees. I would like to read the provision in the Sears Dealer Agreements, which I assume places some limits on Sears beyond the establishment of additional Sears-branded stores. In this case, Sears did not encroach by establishing new stores, but by distributing Sears products through Kmart stores, something that may not have been contemplated at the time of the agreement.
While driving "up north" in Wisconsin, we saw four or five dairy farms that had a sign that said "Land O'Lakes Member Farm." We were unfamiliar with these signs, and I assumed (wrongly) the evil Land O'Lakes conglomerate had gone and bought out mom-n-pop dairy farms or turned them into farmer-franchisees. Upon doing some research, I found out that Land O'Lakes, which is headquartered in Minnesota, is a cooperative and always has been.
Land O'Lakes is both a producer co-op (4000 members are dairy or agricultural producers who sell to the co-op) and a consumer co-op (1200 members are farms that buy feed from the co-op). Although the company is not publicly traded as a corporation, it does issue bonds. On it's balance sheet, I noticed that it does engage in hedging activities. The co-op is run by a board of directors, elected by the members. I would be interested to know if the member-owners feel more control than a shareholder-owner of a similarly large publicly-traded corporation.
I was looking through the March issue of Business 2.0 (subscription) and found a short article about Curves franchises and Gary Heavin, founder and CEO. (Two questions: (1) Why is it that the founder and CEO of a for-women-only fitness chain is a man? (2) Does any CEO have a more appropriate name for his company than "heavin" for an exercise chain?) One of the perpetual problems faced by franchisees is that they almost always are required to agree to pay the franchisor a percentage of revenues as a royalty. Since increasing revenues do not always result in increased profits, this royalty system creates a conflict between the franchisor and the franchisee. Heavin thought he had a better idea:
When I sold my first franchise in 1995, I learned that fast-food franchisees paid 6 percent of revenues each month, but that didn't make sense to me: Why should franchisees that make the most money have to pay me more? Instead, I charged $20,000 to open a club and a flat monthly fee of $395. Most of my franchisees were profitable in 90 days and were shouting from the rooftops about their quick success.
As his franchise has become more popular, he has raised the initial franchise fee to $30,000, and franchisees now pay 5 percent of revenues, but that payment is capped at $795. At some point, new store openings will slow and Heavin may find himself wanting a bigger piece of the pie, but this is a brilliant strategy for encouraging early success.
When I teach the segment of my Law & Entrepreneurship class on franchising, and I use Culver's as a case study, I inevitably draw a comment from a student who tells me that Kopp's Frozen Custard is better. Culver's is a franchise, and Kopp's remains a small family business with just three stores in and around Milwaukee. Tonight, for the first time, I had the opportunity to eat at Kopp's. The hamburger was outstanding -- one of the best I have ever eaten. The custard, on the other hand, was a bit too warm (soft) for my taste. I tried both vanilla and Rocky Road (which had those cheap, hard mini-marshmallows ... yuck), and although I am no custard connoisseur, I have a slight preference for Culver's.
You must remember all of the snide remarks about plaintiffs Ashley Pelman and Jazlen Bradley (and their lawyers) who were suing McDonald's claiming that the company's misrepresentations had led to a parade of horribles, including obesity, diabetes, heart disease, high blood pressure, and elevated cholesterol. That suit was dismissed in 2003 -- oddly, by a judge named "Sweet" -- but it is back again after the U.S. Court of Appeals for the Second Circuit (look under "Decisions=>Recent Decisions" for the text of the case) found that Judge Sweet erred in holding that a misrepresentation claim under the relevant New York statute required more evidence of causation.
When initially dismissing the suit, Judge Sweet wanted to know:
What else did the plaintiffs eat? How much did they exercise? Is there a family history of the diseases which are alleged to have been caused by McDonald’s products? Without this additional information, McDonald’s does not have sufficient information to determine if its foods are the cause of plaintiffs' obesity, or if instead McDonald’s foods are only a contributing factor.
According to the Second Circuit, Judge Sweet was too hasty: "This ... is the sort of information that is appropriately the subject of discovery, rather than what is required to satisfy the limited pleading requirements of Rule 8(a), Fed. R. Civ. P." So McDonald's was right in casting the decision as "procedural," but I cannot imagine that they are too happy to have the plaintiff's lawyers digging through their files.
Of course, this decision ties in nicely with Christine's post on the Academy Awards because the documentary "Super Size Me" was nominated for an an Oscar. When asked about the Second Circuit's decision, filmmaker Morgan Spurlock said, "For me it's a tremendous decision.I think we've reached a point where people and the judicial system are starting to realize that there is a separation between personal and corporate responsibility, that corporations do have a line they have to uphold when it comes down to what they present to people." Actually, the decision doesn't say anything about the merits of the case, so Spurlock is just blowing hot air. I suppose that's better than blowing his lunch.
While driving around my hometown of Lubbock, Texas this week, I wanted to show my kids the Baskin-Robbins ice cream store where I worked during high school. Not there! Notably, all of the Baskin-Robbins stores in Lubbock are now Kaleidoscoops ice cream stores. My dad mentioned to me that he had heard that the three Lubbock BR franchisees had had a falling out with BR and had terminated the franchise agreements. I was interested in the collective action of independent franchisees, so I looked on Google to find the story. The story is even more interesting than I imagined. Kaleidoscoops is a cooperative, started by 40 frustrated BR franchisees in Texas and Louisiana, and the Lubbock locations were some of the first to hang out the Kaleidoscoops brand. Power to the people!