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California's AB 2305 Shows How to Get Real Standards in Franchising

California lawmakers need to be aware of how much the Level Playing Field for Small Businesses Act, Assembly Bill 2305, will benefit the state’s consumers. The reason? The legal franchise model as it exists today allows franchisors loopholes to skirt their civic responsibilities. Central purchasing of chains from California’s farms and ranches, the wonder of the world, have been embroiled in spreading contaminated meat and lettuce to fast food restaurants throughout the country.

No doubt that these farms have a huge part to blame in this. But it should also be pointed out that this is a problem of a modern system that franchising chains have inadvertently helped exacerbate. It doesn’t need to be. California can help beef up sensitivity to the food supply from individual business owners.

Consumer standards, which protect the food supply chain, are too important to leave to the government alone to enforce.  What is needed is a better system in which the unintended good consequences of brands better maintain quality control and fund appropriate training and education.  

One problem is a lack of transparency for franchise owners. Franchising needs to return to its roots, in which the franchisor sets quality control standards for a reason and not just trap franchisees into paying high fees to mandated suppliers, who then kickback money to the franchisors.

California doesn’t need a kickback economy. That produces big problems.

Another problem is the imbalance to those who purchase franchised businesses when it comes to information. There is no legal counterweight to what a franchisor markets to franchised small business owners and what the franchisor is contractually obligated to perform.

Private Brand Standards and Public Safety

To understand the first benefit of Bill AB 2305, we have to return to 1950-1970, when McDonald's enforcement of private brand standards were of assistance to the public good and helped maintain a safe food supply chain.

The founder of McDonald’s, Ray Kroc, had a franchise model that was complete with Hamburger University and passing on volume price rebates to its operators. The growing chain had a quality control standard, which had a beneficial and unintended good consequence to consumers and restaurant owners. Kroc's enforcement of private standards produced a safer food supply chain for the public. Sadly, Kroc's vision is not upheld by many modern franchisors.

In the 1970's, Kroc and McDonald's set quality control standards and operating standards. But its franchised small business owners purchased their food from sources that they knew and touched.

Here is just one clever example of how the private brand's standards had a public benefit. Kroc shipped hamburger buns in package containing enough to make 100 hamburgers. The operating standard was that an operator should go through 100 patties for each package of buns. If the operator went through more, say 110 patties, then:

"Either his meat man was shorting him or someone else was stealing from him."

A meat man who would cheat on weights and measurements is a risk to public safety.  Kroc would have the meat man dead to rights, if he was found to be cheating.  

Today, we have more difficult contamination problems to detect and solve.

Worsening the problem is that brands set standards today for a different reason.  They require the operators to purchase from their preferred vendors. Many of these preferred vendors are simply competing on how much money they can rebate to the franchisor. There is no legal requirement for the vendors to compete on value and safety.

To understand why the modern franchise standards don't produce a public good, we have to understand how legal kickbacks work in the franchise industry.

Current Brands - The Kickback Problem

The franchisors you hear from today will tell you how strong their standards are. But, what they will not tell you is the reason for these strong standards.

Many franchisors have used the current legal model to primarily obtain kickbacks or commercial bribes from their suppliers. The franchisor mandates that the franchisees purchase supplies, at an artificially high price.  The supplier then splits all or some of this extra prices with the franchisor. This is perfectly legal as long as it is adequately disclosed.

The franchisor may elect, and many do, to report these kickbacks as essentially royalty income on their intellectual property and transfer the money out of state without paying California state income tax.

But, you will rightly feel uncomfortable with this arrangement, whether or not legal. Kroc was appalled by it.

A supplier who was being richly rewarded from his business relationship asked Kroc what he might like in return.

"Let's get this straight. I want nothing from you but a good [safe] product. Don't wine me. Don't dine me. If there are cost breaks, pass them on to the operators," declared Kroc.

Promises to the Small Business Operator and Consumer

The second benefit of Bill AB 2305 is to protect the consumer, the consumer of information who seeks to purchase a franchise. If the brand markets to prospective purchasers by making promises about volume rebates, quality standards, or continuous training, then their legal obligations in the franchise contract will have to match these promises.

Currently, most brands are only contractually required to provide sufficient training to open a location.

Further, the brands are only required to disclose somewhere in the fine print of a 500 page plus "Disclosure" document in legalese that the operator can only expect sufficient training to open a location and there are no price discounts.

But, of course these truths make hard marketing. Bill AB 2305 simply requires the brands to balance their marketing hype with what the franchise document delivers. It connects the brands to the responsibility of its marketing promises, which it currently can simply disclaim in the franchise agreement.

The Benefits of Balance

By California’s AB 2305 encouraging the return to a balance in which quality standards are used to strengthen a brand, and indirectly contributing to public safety, franchisors that live up to their marketing promises will protect the small business operator and consumer.  We can do no better to reflect upon Kroc's view of franchising.

"We are an organization of small business [operators].  As long as we give them a square deal and help them make money, we will be amply rewarded."

Assembly Bill 2305 provides that square deal for franchisees. And franchisors, consumers and the public will be amply rewarded by its passage.

Background: California's fair franchising bill heads to a second committee for approval tomorrow, Tuesday, April 24.  The Business, Professions and Consumer Protections Committee of six Democrats and three Republicans will panel a public hearing on several bills, including Assembly Bill 2305, the Level Playing Field for Small Business Act.

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About michael webster

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The International Association of Franchisees and Dealers was formed in January, 2010.  Currently, I am the Chair of the Strategic Committee which is overseeing the development of the IAFD and its business plan. The IAFD's goal is to empower franchisees.  We believe that independent franchisee associations are necessary to the health of a franchise system. The IAFD provides education, advocacy, member benefits and communication tools to independent franchisee associations, franchisees, franchisors and suppliers of services and goods to franchise systems.

Public posts are in the nature of further debate, and should not be taken as anything more than indications of IAFD policy. Candor and transperancy are important to the IAFD.  While BMM has allowed less than full registrations, my policy is not to answer even fascinating and interesting posts from guests.  I may respond to posts that a) there is not full registration, but b) are interesting.  You may always email for further private correspondence.  Like all policies, there will be exceptions.

Columns by Michael Webster are syndicated from the International Association of Franchisees and Dealers to Blue MauMau by permission of the author.