Franchise Fracas

When Curtis B. Bean of Marshfield Hills, Mass., bought a dozen franchises in Car Checkers of America Inc. two years ago, he thought it was an ideal investment. If anybody should know, he figured, he should. Bean had spent more than 20 years in the franchise business, including four years as CEO of Howard Johnsons Franchise Systems Inc. Besides, he had heard glowing reports about New Jersey-based Car Checkers from franchisees. Bean especially liked the franchise because its mobile auto-inspection services were intended to prevent used-car buyers from getting ripped off.

As it turns out, Bean and 15 other franchisees charge in a lawsuit, they were the ones getting fleeced. The "franchisees" they spoke to had never owned franchises, and the profits they had been promised never materialized, the suit claims. Meanwhile, the Federal Trade Commission charges in a civil complaint that Car Checkers' officers, Wendy Mandell Geller and her husband, Lee Geller, misrepresented advertising costs and falsely claimed that no prior experience was needed to perform the inspections. By the time Bean went out of business, he had lost more than $200,000--his life savings. "If I can fall for it, anyone can," says Bean. Lee Geller calls the allegations against the two "unfounded."

Charges of broken promises and hidden costs are just some of the numerous problems plaguing franchising today. Throughout the $246 billion industry--defined in its purest form as excluding auto dealers and gas stations--franchisees are battling franchisors for more control over their businesses. The franchisors are fighting back vigorously to preserve their profits. And now Congress is poised to introduce legislation that could regulate the entire industry. At stake is the future of a large chunk of the U.S. economy: Franchised businesses account for some 12.7% of retail sales. Anything these days can be--and is--a franchise, from steel bungee-jumping towers (Air Boingo) to gun shops (Strictly Shooting). For small-business owners, franchising offers an alternative way of raising capital that speeds growth. For more laid-off managers and early retirees, it's a way to pursue the American dream of owning a business.

Yet for more franchisees today, the dream is just that. Not that owning a franchise was ever a guarantee of success. Bad management and poor location have done in any number of franchises in past years. But the recession, oversaturation in many markets, and huge debt loads from leveraged buyouts are putting new pressures on franchisors to squeeze franchisees. As franchisors burrow into new markets, they're also increasingly vying for the franchisees' customers. These new pressures are coming on top of an already unequal power structure in an industry with inconsistent laws and lax enforcement.

TERMINATED. Franchisors and franchisees aren't supposed to be adversaries, but they're becoming so. At Little Caesars Enterprises Inc., for example, franchisees say they're forced to buy ingredients and paper from a company-owned distributor, paying up to 15% more than rivals for identical items. Franchisees at other systems say that when they complain, they're terminated or sued.

Franchisors have their own set of complaints. To PepsiCo Inc., owner of KFC, Pizza Hut, and Taco Bell, some franchisees are resisting the changes needed to keep the systems competitive. As for Little Caesars, it says franchisees have no reason to gripe because they're free to purchase ingredients, except for two trade-secret items, from sources that the company approves. Other franchisors say franchisees don't do their homework and expect too much. "My big challenge? A person buys the franchise and expects to be rich and not work," says James S. Bugg, CEO of Decorating Den Systems Inc.

Franchisors also claim that franchisees are demanding more because they're more powerful. Years ago, most franchisees were mom and pop operators with a few stores, says IFA President William B. Cherkasky. Now, many franchisees own multiple units. With more economic clout, franchisees are organizing, then hiring lobbyists and lawyers to press their cause. "We're the victims of our own success," he says.

Whatever the reason, the fireworks have lawmakers' attention. After years of inaction, Congress is about to reintroduce legislation boosting franchisees' rights. The current law focuses only on disclosure and, in general, has been loosely enforced. Under pressure from Congress, the FTC is stepping up enforcement. The states are jumping in, too. Iowa recently passed the harshest franchise law to date, forcing franchisors to follow strict rules for franchise terminations, renewals, and transfers. "A growing segment of the American population is routinely required to forgo basic legal rights just because they choose to become franchisees," says Representative John J. LaFalce (D-N.Y.), who is sponsoring the bills.

Franchisors are vowing to spend whatever it takes to defeat legislation. The battle will be bloody because so much is at stake. Maintaining the status quo could scare away prospective franchisees and slow the industry's growth. Yet overburdening franchisors with regulations--and the lawsuits that follow--could mean higher costs for consumers and lost jobs. "Here we are taking something so wonderful and cramping it with the prospect of new laws," says Bret Lowell, a franchisor-lawyer.

Just how wonderful? There are no independent data on franchising. The IFA claims in its promotional materials that fewer than 5% of franchises fail or close annually. In comparison, the U.S. Small Business Administration says that 63% of new businesses fail after six years. Most experts would agree that more franchises survive than other new businesses. Even so, the 5% figure comes from old Commerce Dept. reports that relied on surveys of franchisors. Recent surveys of franchisees by consultants and academics put the annual failure rate between 10% and 12%. "This is an industry that controls the image of itself," says Dean Sager, a LaFalce aide.

HOME COURT. Franchising today is a far cry from the days of Colonel Sanders, the founder of Kentucky Fried Chicken Corp. In the 1960s, franchisors and franchisees considered themselves partners. Contracts, franchisees say, were often just scribbles on a napkin. Franchises such as Sonic Corp., a drive-in burger chain, are trying to retain such open relationships, while others such as Blimpie are working to regain them (box).

But those franchises are becoming the exceptions. As a result of corporate takeovers and swelling bureaucracies, franchisors today are more autocratic. Franchise contracts are often upwards of 50 pages--and heavily weighted toward the franchisors. For example, franchisors, as a rule, require franchisees anywhere in the U.S. to fight all legal disputes in the franchisors' hometown.

Intensifying competitive pressures, meantime, are driving some franchisors to oversell themselves. Other franchisors are withholding information that might scare away prospective investors. Last August, for instance, the FTC sued the now closed WhiteHead Ltd., a Stamford (Conn.) furniture franchisor, and its key officers, Walter J. Wright and Richard J. Wall. The suit alleges that the company did not disclose a $10 million fraud judgment against the two men over a prior franchise. Wright declined to comment. Wall's lawyer, Sarah Brown, says he's preparing to fight it.

In the restaurant industry, the tougher competitive environment is prompting lots of griping by franchisees, says William G. Hall, president of the Texas Dairy Queen Operator's Council. He says franchisees are being forced to absorb price hikes from all sorts of suppliers but are constrained in passing the increases on to customers. Despite the tougher times, Hall, a former independent restaurant owner, is a devoted franchisee: "I firmly believe in the benefits of being part of a larger group."

Still, many fast-food franchisees say that they can't make it because their key competitor is their own product. In general, franchisors can decide how many units can be opened in any one area. PepsiCo in particular has franchisees running scared. In its 1991 annual report--featuring rabbits on the cover--Chairman D.Wayne Calloway wrote that PepsiCo was "redefining" its business from "quick service restaurants" to "quick service food distribution." Pizza Hut pizza, he said, would now be sold in airports, malls, and so on. The same would be true for KFC and Taco Bell, whose "self-contained kiosks are starting to multiply like...well, like rabbits."

The shift toward company-owned "distribution points" has been good for PepsiCo's bottom line: Domestic profits in 1992 for the three food businesses were up 17%. But PepsiCo's franchisees claim that the new strategy has been bad for them. At KFC and Taco Bell, franchisees charge that the multiplying outlets are encroaching on their markets. And Pizza Hut franchisees claim that the company is expanding, in part, by buying up the best restaurants itself. A Pizza Hut spokesman says the charges are untrue. At KFC, Vice-President Gregg M. Reynolds says that it's not its policy to encroach upon franchisees' territories. As for Taco Bell, a spokesman says that new stores have impacted less than 1% of all restaurants nationally.

Even so, some Texas legislators are pushing a bill aimed at Taco Bell that, among other things, would protect franchisees from competition with company-owned restaurants, prevent franchise terminations without good cause, and bar reprisals against franchisees trying to organize themselves.

NO-GO ZONES. Ever since Iowa passed its tough law last July, franchisors have voted with their feet: At least 22 companies have said they will quit franchising in the state until the law changes. And McDonald's Corp. is suing over the law's retroactivity. Franchisors say that the law takes away their right to run their systems as they see fit. Anti-encroachment provisions, for example, bar food franchisors from opening new stores within a three-mile radius of existing franchises or where the population is less than 30,000. Franchisors also fear that the law gives far franchisees in contract disputes. For years, courts ruled that since franchisees signed the contracts, they were stuck with the terms of the deal--no matter how one-sided--and threw out the suits. But in a recent case against Burger King Corp., a Florida federal court said that it will let a jury decide whether the company encroached on a franchisee's territory. Burger King "disagrees with the decision" and will take steps to address it if they have to, says General Counsel Roger Thomson. For now, Burger King and its franchisee association are trying to hammer out an encroachment policy that will free the fast-food operator to expand but won't hurt existing franchisees, says Jerry Ruenheck, the association's president.

Other franchisors are also taking the offensive. On Feb. 11, 11 top franchisors launched a mediation program to avoid litigation. Earlier, the IFA announced a new Franchisee Council and an expanded ethics code. And the IFA's new chairman is promising an era of conciliation and self-regulation. "We're going to be inclusive," says Chairman Steve Lynn. "We're going to focus on what's right."

Can the industry be trusted to regulate itself? Congressman LaFalce doesn't think so. He's introducing legislation that would require more disclosure, set uniform minimum standards for franchise relationships, and give franchisees the right to sue franchisors for violations of the federal franchis-ing law.

Franchisees and regulators say the proposed legislation would help readjust the balance of power and make franchising more fair. But franchisors say that there are plenty of laws on the books already. To some extent, that's true. Some 15 states have disclosure laws regulating the sale of franchises, and the other states must abide by the federal franchising law. Meanwhile, 13 states--not necessarily the same ones--have so-called relationship laws governing what franchisors and franchisees do.

But critics says this patchwork of rules still leaves most franchisees unprotected and allows franchisors to unfairly maneuver the system. Franchisors say that it also makes compliance more costly and cumbersome. State securities regulators are beginning to address these concerns by making their disclosure documents more consistent and easier to use. By setting uniform minimum standards, the proposed federal legislation could also help ease the tensions inherent in the industry. If so, franchising will continue to be a bright spot in the economy instead of a battlefield for disgruntled franchisors and franchisees.

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