A few weeks ago I wrote about the Save Local Businesses Act (H.R. 3441), which has passed the U.S. House of Representatives and is currently sitting in the Senate. At the heart of that Act is defining the term “joint employer” for National Labor Relations Board purposes, an issue with tremendous potential implications for the franchising industry, among others. If passed, the Act would codify a long-standing interpretation of franchisees as being the sole employer of their local employees. For reasons I explain in the previous post, that would be a good thing for preserving and facilitating the benefits of franchising.
Franchising is an important business model in the U.S. Franchised local businesses represent the fastest growing segment for employment, and are expected to continue that trend. Franchising obviously offers benefits for both the franchisor and the franchisee.
In a forthcoming paper in Cornell Hospitality Quarterly, Matt Sveum and I find evidence for at least one of the major benefits of franchising. Namely, franchising helps to reduce agency costs and to improve performance incentives at the local establishment level. From the abstract:
A central theme in much of the franchising literature is that franchising mitigates the principle-agent problems between the owner of the franchise company and the operator of the local establishment by making the operator the owner-franchisee of the establishment. Despite the centrality of that assumption in the literature, there is little empirical evidence to support it. We use Census of Retail Trade data for essentially all full- and limited-service restaurants in the US to test whether franchisee ownership affects performance at the establishment level. We find a strong and robust franchise effect for full-service restaurants, but little effect among limited-service restaurants. We argue this difference is consistent with agency costs given differences in work processes and the importance of managerial discretion.
Full citation:
Sveum, Matthew and Sykuta, Michael E., “The Effect of Franchising on Establishment Performance in the U.S. Restaurant Industry,” forthcoming in Cornell Hospitality Quarterly; US Census Bureau Center for Economic Studies Paper No. CES-WP- 16-54. Available at SSRN: https://ssrn.com/abstract=2883267 or http://dx.doi.org/10.2139/ssrn.2883267
No, I’m not referring to the hit 1980s sitcom that launched Alyssa Milano’s career and took Tony Danza from a dimwitted, cab-driving boxer (in Taxi) to lovable hunky housekeeper. It’s a more important question than that.
Who’s the boss at a local business? Especially if that business has close relationships with another, larger company?
That’s the question at the heart of the Save Local Business Act (H.R. 3441) that is currently waiting action in the U.S. Senate. And how that question is answered could have big implications for hundreds of thousands of small business owners. For starters, and perhaps most specifically, for every locally owned franchised business in the United States. But that’s not all.
The issue stems from a 2014 National Labor Relations Board (NLRB) ruling in which the Board voted 3-2 to find that McDonald’s Corp. was a “joint employer” with all of their franchisees. In that case, labor union activists filed a complaint against McDonald’s directly rather than having to work against multiple individual franchisees, claiming that because McDonald’s Corp provides training and recommends employment standards and work policies for the local business owners that use the McDonald’s brand, the franchisor is effectively a joint-employer. And therefore, any labor violations that can be levied against one joint-employer apply to the local business as a whole. The NLRB agreed.
Prior to this ruling, the NLRB treated local franchisee owners as the sole employer of the local business. That meant that any labor complaints had to be filed against each individual franchisee. By expanding its definition of joint-employer, the NLRB made it easier for labor groups to a) file complaints against and b) potentially unionize an entire franchise network.
two or more entities are joint employers of a single workforce if (1) they are both employers within the meaning of the common law; and (2) they share or codetermine those matters governing the essential terms and conditions of employment.
This is not just an issue for franchises (indeed, Browing-Ferris was not about a franchise case). In fact, the above definition could be read to mean that any company that hires another company to provide services could be considered a joint employer of the contracted company’ employees, even if only on a temporary basis as part of their otherwise full-time job. That includes anything from temp agencies to security companies to housekeeping or maintenance contractors; even to agricultural producers.
For instance, many farmers raise chickens or hogs under contract with a meat processing company. Those companies may require the farmer and any farm employees to follow certain routines or practices to ensure the health and well-being of the animals being raised. Under Browning-Ferris, one could argue the processor is a joint-employer with the farmer, making the farmer subject to a host of employment laws that typically do not apply to small businesses.
Local business owners breaking ground for their new franchised store, the first Sonic restaurant in Rhode Island.
Likewise with franchisees, whether owners of restaurants, hotels, tax preparation companies, cleaning companies, home healthcare companies, or retail outlets. Most franchisees are small, local business owners that pay the franchisor for the rights to use the franchisor’s brand name and business format, to gain access to training resources, and perhaps to access inventories and supplies. Because the franchisor provides training resources and may recommend things like staffing levels, training processes, etc., as part of their business plan (which is one of the reasons to buy the franchise in the first place), most franchisors could be deemed joint employers with their local business owner franchisees.
That creates new risks for franchisors (since they have no direct control over local store operations) and exposes small business owners to regulations that only apply to larger businesses. Moreover, it puts any franchisee at even greater risk for the behavior of other franchisees and their employees. And that is a powerful disincentive for franchising. Since franchised businesses have been the fastest growing sector of the economy, such regulations could have far-reaching implications.
Joint employer status creates new risks for franchisors (since they have no direct control over local store operations) and exposes small business owners to regulations that only apply to larger businesses. And that is a powerful disincentive for franchising.
Fortunately for now, a new presidential administration in 2017 led to a change in the composition of the National Labor Relations Board. The new NLRB board voted 3-2 to overturn Browning-Ferris and restore its previous definition of joint employer.
And therein lies part of the problem. Change presidents, change NLRB composition, change the rules. That is what the Save Local Business Act is intended to fix. The Act provides a legislative solution to the problem of agency (NLRB)) discretion in defining what constitutes a joint employer. Can laws change? Yes. But that requires more than a change of one person (as in the case of the NLRB) to change the law.
So who’s the boss? For now, it’s the local business owner. It’s up to Congress to remove the uncertainty about how that question will be answered in years to come.
Much of the research on franchising as an organizational form relies on an agency theory explanation. In short, it assumes operators of local franchise establishments will have greater incentive to operate efficiently if they are owners of the establishment (i.e., franchisees) rather than managers employed by the franchisor-owner. However, there isn’t a lot of empirical research substantiating that assumption. Matt Sveum and my recent working paper finds that there does appear to be a franchise effect–but it depends on the nature of the business format. We use US Census data for essentially all limited- and full-service restaurants in the US and find franchising explains differences in establishment performance for full-service, but not for limited-service, restaurants. The abstract follows:
While there has been significant research on the reasons for franchising, little work has examined the effects of franchising on establishment performance. This paper attempts to fill that gap. We use restricted-access US Census Bureau microdata from the 2007 Census of Retail Trade to examine establishment-level productivity of franchisee- and franchisor-owned restaurants. We do this by employing a two-stage data envelopment analysis model where the first stage uses DEA to measure each establishment’s efficiency. The DEA efficiency score is then used as the second-stage dependent variable. The results show a strong and robust effect attributed to franchisee ownership for full service restaurants, but a smaller and insignificant difference for limited service restaurants. We believe the differences in task programmability between limited and full service restaurants results in a very different role for managers/franchisees and is the driving factor behind the different results.
The Missouri Auto Dealer Association (MADA) has been exercising its political muscle for at least a couple years to protect its antiquated state-supported cartel over new car sales. It seems they have finally succeeded in court where their lobbying efforts have failed. In an opinion last week by Cole County Circuit Judge Daniel Green, the court ruled that Missouri state statutes governing automobile distribution prohibit Tesla from operating its own retail stores in the state.
The case, which the MADA filed against the Missouri Department of Revenue, contested the State’s issuance of two franchise dealer licenses to Tesla for Tesla to open its own “franchise” retail stores. Basically, Missouri statutes have implemented a circular argument that prohibits auto manufacturers from owning new vehicle dealerships. § 301.550.3 RSMo specifically limits new car dealers to being franchises, statutorily side-stepping the possibility of a non-franchise new car dealer. The court essentially argued (perhaps rightly) that Tesla’s self-dealing of the franchise to itself was merely a rhetorical ploy to circumvent this failure of the statutes to allow for non-franchise dealers. However, even if that side-step were permissible, § 407.826.1 RSMo specifically prohibits auto industry franchisors from “owning or operating a new motor vehicle dealership in this state.”
Judge Green’s opinion basically means the laws of the state of Missouri preclude the possibility of any auto manufacturer selling its cars in Missouri directly to consumers. While Tesla can continue to operate its two service centers in the state, it cannot make car sales there. Instead, the company must continue to sell to Missourians over the internet with a point-of-sale in another state. (So much for more sales jobs.)
I and others have written previously (here, here, and here) why bans on Tesla’s direct-to-consumer sales model are bad for consumers and for society in general. This most recent ruling in Missouri just highlights how fundamentally flawed the regulation of commerce can be. Missouri’s laws, to the extent they ever made sense, are rooted in an antiquated industry and technological setting. Advancements in information technology alone have undercut many, if not all, of the economic justifications for an auto manufacturer to use a franchised distribution system. Laws that were written to protect franchisees in a 1950s-era distribution system do nothing now but raise consumers’ costs and thwart technological and organizational innovation that make everyone better off. Everyone, that is, except the franchised auto dealer cartel that sees all too clearly how little value it now adds in the sale and distribution of new cars.
Hopefully Missouri’s legislature will have the gumption to fix the flaws in its statutes that limit all new car retailers to “franchises” and instead let auto manufacturers (or any other manufacturer) choose the model they find best for themselves and their customers.
About a year ago I posted a couple of pieces (here and here) related to auto dealers’ attempts in various states to shut down Tesla’s direct-to-consumer distribution system. Dan Crane (Michigan Law) has a recent paper on the issue available at SSRN. Below is the abstract:
Tesla Motors is fighting the car dealers’ lobby, aided and abetted by the legacy Detroit manufacturers, on a state by state basis for the right to distribute its innovative electrical automobiles directly to consumers. The Tesla wars showcase the important relationship between product innovation and innovation in distribution methods. Incumbent technologies may block competition by new technologies by creating legal barriers to innovative distribution methods necessary to secure market acceptance of the new technologies. While judicial review of such special interest capture is generally weak in the post-Lochner era, the Tesla wars are creating new alliances in the political struggle against crony capitalism that could contribute to a significant re-telling of the conventional public choice story.
Roger Blair and Francine Lafontaine have a new paper out on “Formula Pricing and Profit Sharing in Inter-Firm Contracts” (here). They explore the use of profit-sharing contracts for vertical relationships, particularly the case of successive monopoly or the double-marginalization problem. Naturally, their focus is on franchise relations. The abstract follows:
Ronald Coase viewed transaction cost minimization as a central goal of contracting and organizational decisions. We discuss how a solution to the traditional successive monopoly problem that has not been discussed in the literature can economize on such costs. Specifically, we show that when we allow for profit sharing between upstream and downstream firms, a simple formula pricing contract can be used to generate the vertically integrated level of profits. This simple contract, empirically, would take the form of the standard linear wholesale price contracts that are ubiquitous in vertical contexts, even those where we might expect successive monopoly to be an issue. We discuss the advantages of the proposed contract from a transaction cost perspective. We also discuss some of its limitations, in particular the likelihood of misrepresentation of costs, and ways in which such misrepresentation might be addressed in the contract.
That’s the title of a new working paper with one of my former students, Michelle (Mullins) Santiago. You can access the full paper here. The abstract follows:
The wine industry in the United States has grown tremendously over the past few decades, from fewer than 1,000 wineries in 1980 to upwards of 7,700 today. The growth has occurred over a period that has seen substantial changes in the structure of the wine industry, the modes of distribution available to wineries, and the regulations governing them, perhaps most notably the advent of direct-to-consumer shipping of wine across state boundaries. Most economic research, however, has focused on supply relations between wineries and wine grape growers rather than between wineries and their downstream markets. In this paper we examine wineries’ contracting behavior with downstream distributors and the effects of industry structure, winery organizational structure, and state laws regarding direct shipment and distribution franchise laws.
o’s the boss at a local business? Especially if that business has close relationships with another, larger company?
whole. The NLRB agreed.