The franchise relationship that powers small business is fraying

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Franchisees and executives at burger chains, hotels and fruit-basket shops used to count on chummy relations to bolster their businesses. Those days are over.

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Stressed by the hit to business from the coronavirus pandemic, store owners and corporate bosses at Subway, Econo Lodge and other companies are bickering publicly as never before.

Companies are asking franchisees to buy equipment and adopt new safety protocols, moves they say are necessary to reassure customers during the pandemic and to grow thereafter. Franchisees are pushing back on store upgrades, promotional discounts and fees they say are excessive and undermine their profits. Some are agitating to replace executives or suing to change practices.

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"I get that franchising isn't a democracy, but at the same time, it's not a dictatorship," said Keith Miller, who was among Subway franchisees resisting when the company asked operators during the summer to offer two foot-long sandwiches for $10, a price they said was unprofitable.

Subway, incorporated as Doctor's Associates Inc., said it communicates with franchisees daily and has allowed them to defer or skip royalty payments during the pandemic. It ultimately reduced the foot-long-sub promotion to online only.

There has always been push and pull between franchisers — the corporations that own a brand, handle its strategy and set its standards — and the franchisees — those who own and operate the stores, hire the employees and deal with customers. An older approach that assumed both sides would pull in the same direction is giving way to a more combative model in which store owners increasingly fight corporate decisions they deem unfair.

A worker delivers food inside a McDonald’s in London, Britain on July 22, 2020. (Reuters)

Franchisees "feel they have no choice but to accept coercive contract terms and red tape," said Rohit Chopra, a member of the Federal Trade Commission, which recently held a hearing on the franchising business focused on what operators need to know when they're thinking about getting in. Executives overseeing brands said franchisees often have a more narrow and short-term perspective.

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Many of the franchisees' complaints are granular and might seem minor. Operators say they add up over time and can drag down profits, leaving franchisees feeling as though companies are trying to take advantage of them, which brands deny.

A group of Econo Lodge franchisees and operators of other lodging brands owned by Choice Hotels International Inc. said they were forced to pay $34.50 for 10 pounds of frozen sausage links that cost $22.37 elsewhere. In a lawsuit in federal court in the Eastern District of Pennsylvania, these franchisees allege this was part of a "pay-to-play" supplier program that requires vendors to make payments to Choice Hotels, the cost of which is passed on to franchisees.

Some U.S. Tim Hortons franchisees, meanwhile, said they were charged $104.08 more for a case of Applewood bacon than Wendy's Co. operators paid, and $11.92 extra for a case of plastic straws.

Some franchisees of McDonald's Corp. said that it didn't do as much to defer rent and make other concessions early in the pandemic as Dunkin' Brands Group Inc. did, and that McDonald's has taken too long to develop a new spicy chicken sandwich.

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Choice Hotels denied the allegations in Econo Lodge operators' suit and said it has worked closely with franchisees to provide aid during the pandemic. Tim Hortons parent Restaurant Brands International Inc. said it has made great strides in working with franchisees and called their allegations about costs unfounded. McDonald's said it has taken "unprecedented actions" to help franchisees, including spending $100 million on marketing.

In recent years, franchisees have formed their own organizations to more forcefully press their case with management teams, raising the possibility that issues that would have been ironed out privately in the past will spill into public view.

Rising tensions at franchised companies have implications for a part of the economy that has grown rapidly in recent years, generating jobs and investment in businesses ranging from hairstyling shops to tax-preparation outlets.

Franchisees run 55% of American hotels, according to industry tracker STR. They operated 84% of U.S. chain restaurants last year, according to data from restaurant strategy firm Aaron Allen & Associates. The roughly 774,000 franchised establishments in the U.S. employed about 8.4 million people last year, according to the International Franchise Association, a trade group.

A Dunkin’ worker hands a coffee out of a drive-thru window wearing gloves and a mask as the Coronavirus continues to spread on March 17, 2020 in Norwell, Massachusetts. (Staff Photo By Matt Stone/MediaNews Group/Boston Herald)

Interest in franchising has been rising and looks set to grow further as some of the people who have lost jobs in the pandemic strike out on their own. Inspire Brands Inc. said laid-off workers have been asking about starting outposts of its restaurants, which include Arby's and Jimmy John's Gourmet Sandwiches.

One franchise-led chain attributed the tensions partly to the pandemic, which has led to the temporary or permanent closing of about 33,000 franchise outlets, according to the trade association. "Franchisee relations are 100% correlated with how things are going," said Chief Executive Steve Joyce of Dine Brands Global Inc., owner of the Applebee's and IHOP restaurant brands.

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Many franchisees are small businesses and received government support during the pandemic. A May survey by the trade association found that 96% of 190 franchise owners polled had received federal aid under the Paycheck Protection Program passed by Congress.

Modern franchising dates back to the use of outside sellers in the late 19th century by the company then behind Singer sewing machines. The contemporary model — in which head offices grant the right to sell, using brand-specific methods, under a company name in exchange for royalties or other revenue — took off after World War II, said Marko Grünhagen, a professor of marketing at Eastern Illinois University in Charleston, Ill.

Franchisees pay brand owners tens of thousands of dollars, and spend significant additional amounts in some cases, for the right to open a franchised business. They sign multiyear contracts that spell out royalties or other money owed to the franchiser, such as a percentage of gross revenue, and agree to maintain the brand's standards. Franchisees also agree to pay various fees and typically contribute to marketing funds the brand uses to buy national ads.

In return, franchisees gain access to customers who trust the brand, plus training in how to operate profitably. The brand owner often sells the franchisees supplies and services at prices it sets. These sales and franchisers' fees have both become points of contention in some franchise deals.

Sam Meineke, the 89-year-old founder of his namesake car-repair chain, was part of a generation of entrepreneurs who helped transform the U.S. economy through legions of franchisees. He and peers such as Ray Kroc at McDonald's and Col. Harland Sanders at Kentucky Fried Chicken opened opportunities for middle-class shop owners, generating devotion.

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"If you don't successfully put him in business, such that he can make it, that's like stealing from him," Mr. Meineke said in a September interview, describing his approach to the franchisee.

Janet Cummings's family opened the first muffler shop Mr. Meineke franchised, in Houston in 1972. As her family's Meineke outlets grew, to a total of 18, so did her connection to the founder, who she said sent her a wedding gift and attended her parents' funerals.

"It was really like family," she said.

(Photo by Joe Raedle/Getty Images)

Mr. Meineke sold the business in 1983. A private-equity firm that became its owner stopped sending franchisees reminder notices when it was time to renew contracts, Ms. Cummings said. That was a disadvantage because renewing early allowed owners to roll over contracts, on terms that might be better than those available if they had to negotiate a fresh one. Operators pushed to get the reminders back.

"The further the owners are from the franchisees, the harder it is for them to understand what is good for the franchisee is good for the franchiser in the long run," Ms. Cummings said.

A different private-equity firm, Roark Capital Group, now controls Meineke, through a Roark-owned firm called Driven Brands. Ms. Cummings said she wasn't sent a renewal reminder for a long-held Meineke location.

In this case, she wasn't planning to renew anyway, because she is winding up her business after four decades. "If it was still more of a family thing, we might stick it out a little while longer," she said.

Neither Driven Brands nor Roark Capital responded to requests for comment.

Franchisees who have formed organizations in recent years to increase their leverage include lodging operators, owners of McDonald's restaurants, operators of Massage Envy studios and franchisees of Edible Arrangements LLC fruit-basket and flower shops.

Rich Gandhi's Quality Inn outlet in Middletown, N.J., owes franchiser Choice Hotels fees totaling 7.75% of gross revenue, according to a recent monthly billing statement. The statement also shows Mr. Gandhi owed Choice Hotels $92 for a fee tied to customers who book through outside sites, $63.98 for digital security and $586.44 for property-management technology. The total fee rate has roughly doubled in a decade, according to Mr. Gandhi.

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He is among the hotel franchisees suing Choice Hotels in federal court in Eastern Pennsylvania, partly over costs. The suit alleges Choice Hotels requires Quality Inn franchisees and operators of other brands to pay multiple fees for the same services and has assessed fees for products that are of inferior quality.

Besides calling the suit's allegations unfounded, Choice Hotels said it constantly reviews its fees and compares them to competitors, Tim Shuy, vice president of owner and portfolio strategy, denied that fees have roughly doubled over a decade but said some properties might see bigger increases over time as they first get established in the system. Fees added recently help operators run their businesses or attract customers, Mr. Shuy said.

"The vast majority of our franchisees are small-business owners who benefit from participating in programs that give them great purchasing power, that help them network and reduce costs," he said.

Some executives say franchisee complaints are shortsighted. Operators shouldn't expect business to improve just because they joined a franchised system, said Rajiv Trivedi, who in the early 2000s developed a franchising program for the La Quinta hotel brand, now part of Wyndham Hotels & Resorts Inc. "Many times, franchisees' expectations are unreasonable," Mr. Trivedi said.

Franchisees have helped to secure change at the top of a few companies. Yum Brands Inc. appointed an interim U.S. president at its Pizza Hut division in February after franchisees complained that company promotions had eroded profits.

"We have to build back our relationship with our franchisees, so we are partners in this," said the interim U.S. president, Kevin Hochman. A number of franchisees said they were happier under the new boss.

The biggest Pizza Hut franchisee in the U.S., NPC International Inc., filed for chapter 11 bankruptcy in July. Yum allowed NPC to close 300 restaurants.

Yum chief executive David Gibbs said the company communicates regularly with restaurant operators about their needs. "The well-capitalized are committed to the business and they are coming out of this stronger," he said.

Ben Hiner owns three Kentucky franchises of Edible Arrangements, the vendor of fruit baskets. There was a time when the parent company would fly franchisees to "fruit summits" at its then-headquarters in Connecticut, he recalled. Staff members distributed collared shirts for attendees to wear at summit events, in which people talked strategy and swapped operational tips.

"I left those meetings gung-ho and ready to go," Mr. Hiner said.

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Now he leads a franchisee association that recently sued Edible Arrangements. The suit alleged that an affiliate that handles online orders raised fees for operators to 10% per order from 2.5% last year and in 2018. Filed in Superior Court of Fulton County, Ga., the suit also alleged that franchisees were left with unexpected expenses when Edible Arrangements shipped them chocolates from a company where its founder, Tariq Farid, sat on the board.

A judge dismissed the case, pointing to a contract clause calling for arbitration. Plaintiffs will pursue their case in that avenue, said their attorney, Robert Zarco.

Mr. Farid said Edible Arrangements has shipped items to store operators to ensure consistent selection for customers. He said his relationship with the chocolate supplier didn't cross any lines.

He said the fee increases were contractually permitted and pay for e-commerce operations that have grown during the pandemic.

"We have to evolve. We've been around for 20 years," Mr. Farid said

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