FRANdata’s Response to the FTC’s Request for Information on Franchise Agreements and Franchise Business Practices

June 8, 2023

Federal Trade Commission

Attn: Lina Khan, Chairperson

600 Pennsylvania Avenue NW, Suite CC–5610 (Annex C)

Washington, D.C. 20580

RE:  Solicitation for Public Comments on Provisions of Franchise Agreements and Franchisor Business Practices (FTC Docket No.-2023-0026) (March 10, 2023)

Dear Ms. Khan,

FRANdata is grateful for the chance to present its perspective (referred to as the “Comment”) to the Federal Trade Commission (FTC or Commission) concerning the Commission’s solicitation for information pertaining to the “methods through which franchisors exercise influence over their franchisees and employees.”

The objective of this response is to present a thorough and well-informed analysis regarding the diversity of businesses and franchisees utilizing franchising as a growth strategy. It aims to offer valuable insights into the existing information available to franchisees, enabling them to make informed decisions. Additionally, it will explore the intersection of supply chain management with franchise relationships and business operations. Emphasis will be placed on the crucial role played by a centralized supply chain function within franchise systems, and the potential adverse consequences for franchisees and consumers in the absence of such centralization.

About FRANdata

FRANdata is uniquely positioned as an expert in franchising with the largest database of franchise information, the largest library of franchise documents, and the largest research team in the world exclusively dedicated to researching the franchise business model. FRANdata possesses over 30 years of business experience in franchise analysis and is generally considered by the entire franchise community as well as state and Federal institutions, as the most objective source of information about franchising.

FRANdata’s History

FRANdata started out as a franchise regulatory document collection company in 1989. With that foundation, it added other types of data sources relevant to franchising and became an information and research company. FRANdata launched the Franchise Registry and worked with the Small Business Administration (SBA) in 1998 to assist in their affiliation assessment which vetted franchise agreements for potential control issues defined by the SBA of which 98% of franchise brands were able to overcome and then further developed a franchise credit risk rating to help standardize the risk assessment for lenders financing franchisees from publicly available sources.

FRANdata’s Capabilities

FRANdata has an extensive database of 60,000 franchise documents, and more than 10,000 franchisor and supplier clients. The franchise community has embraced the company’s robust analysis and advice developed through years of experience and extensive sources of information. This has allowed FRANdata to evolve into the central authoritative source of such services with analysts and consultants capable of objectively addressing franchise business model performance.

Along the way, FRANdata developed analytical tools to correctly measure performance outcomes and determine the factors that lead to improved performance. FRANdata serves a leading role in developing industry standards of performance for areas of the franchise model and establishing benchmarks based on those standards.  Some of these standards have found their way into common usage, such as franchised unit continuity rates, true franchised unit failure rates, and franchisee time to breakeven, which much of the lending community relies upon through FUND^TM Score, FUND^TM Reports which in turns has had a positive impact on improving franchise performance for the industry writ large.

U.S. Franchise Market

The projections for the US franchise market in 2023, as outlined in the 2023 Franchising Economic Outlook, indicate a positive and steady growth trajectory. The number of franchise establishments is expected to reach 805,000, showing a growth rate of 1.9%. This expansion is expected to create around 254,000 new jobs, resulting in a total franchise employment of 8.7 million and a growth rate of 3.0%. Moreover, the franchise sector is predicted to experience a 4.2% increase in economic output, with total franchise output rising from $825.4 billion in 2022 to $860.1 billion in 2023. Additionally, the franchise market’s share of the overall economy, as measured by its contribution to GDP, is projected to remain stable at 3%.

These growth indicators in the US franchise market demonstrate the resilience and effectiveness of the franchise business model. Despite facing macroeconomic challenges, franchising continues to drive economic growth by providing employment opportunities across the economic spectrum and fostering entrepreneurship. Franchisees can benefit from established brands, proven systems, economies of scale, and support from both fellow franchisees and franchisors. On the other hand, franchisors reap benefits such as growth capital from new franchise units, accelerated system-wide growth, geographic expansion, and motivated franchisees who have a vested interest in the success of their businesses and often operate as owner-operators.

Overall, the US franchise market showcases the mutually beneficial relationship between franchisees and franchisors, contributing to overall economic prosperity by promoting job creation, business development, and entrepreneurial success.

DIVERSE FRANCHISING LANDSCAPE:

Franchising is vast and encompasses 300+ business format categories, catering to brands of varying sizes. The graph below illustrates the distribution of brands based on the total number of franchised units they own.

Approximately 54% of the franchised units in the U.S. are owned by multi-unit operators, while remainder are owned by single-unit business operators.  However, this percentage can range greatly depending on the industry with the travel industry at the lowest consisting of 3.44% multi-unit ownership and the QSR industry at the high-end with over 80% multi-unit operators.

Franchising offers vastly different investment opportunities from start-up costs as low as $20,000 in the Decorating and Home Design industry to as high as $429 million in the hotel industry.

Information Availability

From time to time, people push for greater disclosure of franchise information.  More information is always helpful. However, as in SEC requirements for publicly traded companies, most of the time publicly accessible information is available to make an informed decision about whether to invest in a business. This information necessarily includes regulatory documents but also in the internet era, many other sources of information. Burgerim is a franchise brand that is often referenced as an example of what can go wrong with the franchise business model. It clearly performed badly and many small business owners lost their entire investments in the business. The question is whether there was adequate information with which to observe such behavior. When an emerging brand signs its first franchisee, there is no franchise business experience with which to evaluate performance. Early franchisees in a brand are taking more risk and should do more diligence. Yet In 2018, after Burgerim only had been franchising for a relatively short time and the better part of a year before scathing news articles surfaced, FRANdata prepared a report for lender clients on the credit risk associated with this brand.  The report was initially prepared by a junior analyst, which is noted because of the relative ease with which an inexperienced analyst identified serious issues. The only tools used to create this assessment were web searching and the brand’s FDD. The report provided a scathing view of the founder, the prospects for the business and the implications for lenders financing franchisees associated with this brand.

All this information was available to prospective franchisees.  When a business intends to mislead and allegedly conduct fraudulent activities, no amount of additional disclosure is likely to dissuade them.  We would note that one area that would improve a prospect’s ability to assess a franchise opportunity is additional disclosure around the number of units sold under development agreements.  That way, franchisees could see how much a franchisor is focused on selling units and can compare that disclosure to actual openings.

Importance of Supply Chain Function

Franchisors provide valuable support and assistance to franchisees to optimize their operations. One essential aspect of this support is the provision of supply chain services, which can range from being the primary supplier and distributor of proprietary products, to vetting, negotiating, monitoring, and auditing preferred suppliers, to guidance on selecting suppliers.

To support these functions, franchisors usually establish a team of professionals. The size of the team can vary greatly depending on the size of franchise system and the industry.  For instance, the role of the supply chain function in the lodging and food service industries is significant due to the complexities of the businesses which include the amount of inventory, inventory management, assets including furniture fixture and equipment, and risks to the consumer.  The role of the supply chain function in service businesses such as a maid service business or a painting business will be less significant.   These businesses are less complex with fewer assets and products. In addition, the supply chain function varies by industry because in many cases the team is as large as nearly 2,000 people involved in manufacturing and distributing the products and 50 executives with educational backgrounds and professional experience in managing the supply chain. The range of estimated cost to perform these functions can also vary from a few hundred thousand dollars in the health and fitness industry to more than two hundred million dollars in the food industry. Franchisors frequently receive remuneration from franchisees for managing the supply chain functions of the franchise system. The sources of income are:

• Mark-ups on franchisor-supplied products: These mark-ups cover the cost of sourcing and distribution.
• Supplier Fees and Exclusivity Fees: In the franchise system, suppliers may opt to provide a lump-sum payment to franchisors in exchange for an exclusive contract. Franchisors utilize these fees to assess the level of dedication and seriousness of suppliers towards serving the franchise system.
• Vendor Rebates: the supplier commits to making ongoing rebate payments to the franchisor, which are determined by the franchise system’s purchasing from the vendor. These rebates may be associated with the number of franchisees purchasing from the vendor or the overall volume of purchases made by the franchise system. Many franchisors pass on the rebates to franchisees to support their growth in the system.

Following are the types of supplies and services franchisors either manufacture and distribute themselves, mandate specific suppliers or set of suppliers to provide and distribute or may recommend suppliers to their franchisees:

• Product suppliers
• Equipment suppliers
• Technology suppliers
• Maintenance and repair suppliers

The supply chain function plays a crucial role in franchised businesses for several reasons:

• Consistency and Brand Integrity: Franchised businesses’ promise to the customer is that the consumer will receive consistent product quality, service standards, and brand image across multiple locations. A well-managed supply chain ensures the timely and consistent delivery of goods, materials, and services, supporting brand integrity and customer satisfaction.
• Quality Control and Product Safety: Maintaining consistent quality and ensuring product safety are vital aspects of franchised businesses. An effective supply chain includes robust quality control measures, including rigorous supplier selection, product and service testing, ongoing product or service oversight, and adherence to regulatory standards. By enforcing strict quality control protocols, franchisors can protect their brand reputation, protect the equity of each franchisee’s business and ensure customer safety and satisfaction.
• Environmental Social and Governance (ESG) & Corporate Social Responsibility (CSR) & Animal Welfare Accountability: Consumers demand that the businesses they visit develop policies that they not only hold themselves accountable to but also their supply chain. An effective supply chain has the capacity and wherewithal to vet suppliers and hold them accountable to ESG, CSR and Animal Welfare standards. Merely establishing the policies will not be helpful. Business needs to ensure that there are policies and procedures such as auditing suppliers to confirm that they meet the standards they claim. Failure to comply with these policies can result in claims of customer fraud and litigations.
• Cost Efficiency: An efficient supply chain helps optimize procurement, inventory management, and distribution processes, leading to cost savings for both franchisors and franchisees. Effective supply chain management can minimize waste, streamline operations, negotiate favorable pricing with suppliers, improve overall financial performance, and offer consumers a better value than they can otherwise obtain from an independent business.
• Scale and Growth: Franchise businesses thrive on scalability and expansion. A well-designed and agile supply chain allows for seamless replication of operations across multiple franchise locations. It facilitates the ability to scale up production, accommodate growth, and enter new markets more efficiently, thereby enhancing the franchisee’s potential for success.
• Supplier Relationships: Franchise systems often rely on strategic partnerships with suppliers. Strong supplier relationships and negotiations can result in favorable terms, volume discounts, exclusive deals, and reliable access to quality products or services. A well-managed supply chain fosters collaboration and mutually beneficial partnerships, ensuring a steady supply of goods or services to meet franchisee demand.
• Adaptability and Innovation: The evolving business landscape and customer preferences require franchise systems to stay agile and embrace innovation. A flexible supply chain allows for the integration of new technologies, product variations, and market trends. It enables franchisors and franchisees to respond quickly to changing consumer demands, adopt new processes, and introduce innovative products or services, fostering competitive advantage and long-term success.
• Vetting of Suppliers: Franchisors need to ensure that their supplier partners have the capability and financial wherewithal to serve their franchisees. This ensures that they avoid a scenario where a key distributor enters bankruptcy or liquidation proceedings with little or no warning, disrupting the entire supply chain. Franchisors also ensure that their partners have ethical business practices, follow rules and regulations, and source their raw materials responsibly.

 

The supply chain services performed by franchisors provide benefit that goes beyond the lowest price. By effectively managing the supply chain, franchisors and franchisees can enhance operational performance, maintain brand integrity, and drive sustainable growth in a competitive economy. Managing the supply chain functions of a brand encompasses more than just price negotiations. It involves ensuring that franchisees receive comprehensive support in handling their day-to-day business operations while benefiting from the expertise of the franchise system. Franchisors derive the greatest benefit when franchisees perform well and generate the highest possible revenues.

 

Role of Franchisees in Centralized Supply Chain Management

Franchisors play a crucial role in operating the supply chain functions within their franchise system; however, some franchise systems have a cooperative that handles the centralized supply chain function demonstrating that this function needs to be centralized regardless of who is performing the function. In a cooperative model, franchisees own the purchasing cooperative and hire experienced supply chain executives to perform strategic supply chain management.  Franchisees are the shareholders.  The purchasing cooperative holds valuable knowledge that can greatly assist the franchisor. For instance, when the franchisor is planning a time-limited promotion requiring all units to stock a specific product, the cooperative needs to be informed well in advance to secure the best pricing and terms for the necessary products to support the promotion effectively. Furthermore, if the cooperative identifies that a slight modification to a product’s specifications can result in substantial cost savings, sharing this information with the franchisor at an early stage proves beneficial. It allows the franchisor to explore alternative products, propose lower prices, and potentially increase sales volume as a result. Many franchisors realize the value of Purchasing Cooperative (owned by franchisees) and the value it brings to the system. Brands such as Subway, Dunkin’, Arby’s, Burger King, Dine Brands, and Yum! Brands use purchasing cooperative to manage supply chain functions. The purchasing cooperative provides numerous support including and beyond price negotiation. For example, Restaurant Service, Inc., the independent supply chain and distribution cooperative for Burger King, provides numerous support functions including business analysis, promotion planning, commodity analysis, technology integration and analytics, and supplier selection.

Most franchisors establish Franchise Advisory Councils, which serve as a platform for franchisees to collaborate with the corporate team.  One aspect that franchisees provide feedback on is various aspects of the supply chain, including sourcing, logistics, and inventory management. By incorporating the input and ideas from franchisees, franchisors can enhance the efficiency and effectiveness of their supply chain operations, leading to improved product quality, streamlined processes, and ultimately, greater success for the franchise system.

 

Negotiated and Non-negotiated Provisions in Supply Chain

Negotiated provisions in supply chain management typically include products and services that are not critical to the brand such as office supplies, insurance, etc. Non-negotiated provisions, on the other hand, includes approved suppliers or vendors, product lists that are core to the brand, branding and packaging requirements, minimum quality standards, and adherence to specific supply chain protocols or systems. These provisions are designed to ensure consistency, brand integrity, and operational efficiency throughout the franchise network.

It’s important to note that the specific negotiated and non-negotiated provisions in the supply chain can vary depending on the franchise system and industry. Franchisors report in Franchise Disclosure Documents (FDDs) the percentage of purchases that are made by a franchisee by designated or approved suppliers in opening and operating their business. This percentage varies greatly by business and by industry.  For instance, in service business, it can be 15% whereas in food service it may be greater than 90%.

In addition, most franchisors have provisions to evaluate new suppliers if a franchisee recommends them to the system.

Challenges to a Non-centralized Supply Chain Function

Standardization and Consistency

Maintaining consistency across multiple franchise locations can be challenging, especially when dealing with different suppliers, regional variations, and local regulations. Ensuring adherence to brand standards and product quality requires effective coordination and monitoring.

Supplier Relationships and Negotiations

Establishing and managing relationships with suppliers can be complex, especially when dealing with a large network of franchisees. Negotiating favorable terms, delivery timelines, managing contracts which include service level agreements and support services to the franchise system, and resolving disputes require careful attention and effective communication.  This, in turn, has a direct impact on the customer experience, thereby influencing the overall sales performance of franchise businesses.  When a franchise system partners with suppliers, suppliers provide additional resources and expertise to improve the overall operations of the business.  As an example, an insurance supplier shared a story of how workers at a fast food restaurant had unusually high levels of worker’s compensation claims.  The supplier analyzed the operation of the fast-food restaurant and provided operational suggestions which lowered worker injuries.

Inventory Management

Balancing inventory levels without incurring excess costs or stockouts is a constant challenge. Accurate demand forecasting, efficient replenishment processes, and ensuring that there is an availability of supply in major catastrophic event such as COVID-19 pandemic in 2020, Russia-Ukraine war in 2022, etc.

Operational Efficiency

Streamlining supply chain operations and minimizing waste is crucial to optimize costs and improve overall efficiency. Identifying and addressing bottlenecks, implementing lean practices, and leveraging technology solutions can enhance operational performance.

 Compliance and Regulatory Requirements

Franchise businesses must navigate various regulatory requirements related to product safety, labeling, and quality standards. Ensuring compliance across the supply chain, including suppliers and franchisees, requires robust monitoring, training, and auditing processes. For a brand in food industry, food safety is the biggest concern. Brands need to ensure that the food served in their restaurants is contamination free, safe to consume, and meet stringent policies regarding dietary restrictions. Similarly, a brand in healthcare industry need to ensure that their equipment is regulatory approved. A brand in child-related industry would need to understand various nuances related to child safety and ensure that their business provides best consumer experience when it comes to child safety.

Supply chain functions vary differently across industries. The regulatory landscape is vastly different, and the consequences of non-compliance vary across industries.

Other Value Adds When Franchisors Handle Supply Chain Aspects

Product and Technology Innovation: To actively engage customers, franchisors must continually innovate their products and services. For instance, the implementation of loyalty apps that offer rewards for repeat purchases becomes feasible when there is a unified technology partner serving all franchisees in the system. Likewise, product innovation relies on the assurance that the necessary raw materials will be readily available for manufacturing or production. Without a focus on innovation, customers are more likely to shift their loyalty to competitors who are constantly introducing new ideas, leading to a decline in sales for the entire franchise system. Therefore, it is crucial for franchisors to prioritize innovation to retain customers and sustain business growth.

 

Ability to keep prices low to serve regions and areas with low median household income: By leveraging their scale, franchise systems can effectively maintain low product costs. This benefit extends to franchisees operating in rural regions or areas characterized by a low median household income, allowing them to offer affordable prices to customers. As a result, essential services like home healthcare, medical services, and more remain accessible to customers at affordable prices.

Marketing and sales campaigns such as “Limited Time Offers” that boost sales at local franchisee stores: The ability of franchisors to design marketing and sales campaigns that effectively enhance sales at their stores relies heavily on the visibility of supply chain and inventory levels across franchisees. Without this crucial information, the franchisors’ capacity to create campaigns that align with both customers and franchisees would be significantly hindered.

Economic Impact in Absence of Centralized Supply Chain

Increase the cost of each franchisee by 30-50%: By pooling the purchasing power of multiple franchise locations, franchisors can often negotiate the cost of goods at discounted price, ranging from 30% to 50% compared to individual negotiations by each franchisee. This cost-saving benefit translates into improved profitability for franchisees and strengthens the overall competitiveness of the franchise system as a whole.

Increase in cost related to auditing: If each franchisee were to individually manage their own suppliers and vendors, the cost of auditing franchisees by the franchisors would escalate significantly. With decentralized supplier relationships, the franchisors would need to allocate additional resources to conduct separate audits across multiple locations. These increased auditing costs would ultimately be borne by the franchisees themselves, leading to higher operational expenses for running and operating their businesses.

Higher cost to consumer: In case the cost to operate a franchise business goes up, the franchisees would mark up the price to customers to recover additional cost. This is especially a big problem for essential services/products in regions with low median household income.

Indirect Effects on Franchise Businesses in Absence of Centralized

Supply Chain

The role of a centralized supply chain extends beyond securing supplies at competitive prices for franchisees. It encompasses delivering value and comprehensive support that transcends mere cost considerations. Leveraging a centralized supply chain brings several advantages, including ensuring brand consistency, maintaining quality assurance, complying with regulations, fostering product innovation, implementing commodity planning and hedging strategies, facilitating business planning, and efficient inventory management. By establishing a robust supply chain management system, businesses can open in a timely manner with minimal obstacles while safeguarding the equity of franchisees.

• Delay in opening of new units: If every franchisee were to independently negotiate and onboard their own suppliers, it would result in a significant increase in the average time required to open a new unit. The process of identifying, evaluating, and establishing relationships with suppliers can be time-consuming and resource-intensive for individual franchisees. Moreover, the need for separate negotiations and contracts at each location would further elongate the timeline for launching a new unit.
• Negative impact on good franchisees: If a single franchisee compromises product quality, it can undermine the overall brand image and customer experience, affecting not only their own unit but also the reputation of other franchisees. This scenario can lead to customer dissatisfaction, loss of trust, and business decline for the entire franchise system. As an example, Chipotle, is a well-known brand, that used local suppliers in their chain restaurants.   In 2016, they experienced outbreaks of food-borne illnesses that resulted in their hiring experts to overhaul its food safety regime so that all of the food was being clean and packaged in a central location.  This was after the company experienced a 14.6% sales decline and 44% decline in profits.  The typical timeline for sales recovery from a food safety issue is 1.5 years provided there is substantial focus and marketing behind the recovery.  Imagine the negative impact to the equity in an entire system’s franchisee base if one franchisee has a food safety issue.

Franchisors Mitigate Challenges through a Centralized Supply Chain

Franchisors commonly engage in negotiations with vendors who offer national accounts, aiming to ensure consistent and standardized product quality across all their franchise stores. By doing so, franchisors take proactive measures to maintain and uphold product quality standards. This meticulous attention to quality control serves to provide customers with positive experiences and ultimately enhances customer retention. For instance, in the food category, the success of any brand heavily relies on the assurance that their food will consistently exhibit a similar taste across different franchise locations. However, if individual franchisees were to select their own suppliers for raw materials, it could result in significant variations in taste and quality. Consequently, customers of the brand may become uncertain about the ability of a franchised location to meet their expectations and preferences, potentially leading to reluctance in visiting the store. Ultimately, such circumstances can adversely impact the overall sales performance of the entire franchise system.

Product servicing: Suppose a customer purchases a product from one location but encounters an issue due to the utilization of subpar components. If the brand offers free replacement or servicing of the product at any franchise location, franchisees at different locations may hesitate to undertake the servicing task, as it may result in financial losses for them.

Leverage scale: This advantage became particularly evident during recent supply constraints experienced during the pandemic and in 2022. Due to their larger size and collective strength, franchised businesses often received priority from suppliers. This preferential treatment towards franchisees is a direct result of the scale and size of the franchise system. Individual franchisees stand to benefit significantly from this scale and magnitude, which would not be achievable if each franchisee were to negotiate contracts independently.

Streamline supply chain operations: By maintaining a comprehensive overview of their entire franchise system, the system is able to streamline their supply chain operations and enhance overall efficiency by facilitating the exchange of best practices, identifying bottlenecks, and promptly addressing any issues that arise. For instance, in the event of a natural calamity such as a hurricane impacting the supply chain in a specific geographic region, franchisors have the capability to ensure uninterrupted supply to their franchise locations by reallocating raw materials from neighboring areas. This ability to leverage resources and coordinate logistics across the franchise network demonstrates the advantage to the consumer, society as a whole and franchisee.

Franchisors often establish specialized teams responsible for the procurement of products that adhere to regulatory standards. For instance, in the food industry, franchisors must ensure that the products are fresh, utilized within their designated shelf life, and account for any food allergies. Similarly, within the healthcare industry, a brand needs to guarantee that equipment meets regulatory requirements, maintains standardization across all stores, and ensures that store employees are adequately trained in equipment usage. With the increasing significance of compliance and regulatory obligations, particularly in areas such as IT laws and customer data privacy, franchisors recognize the need to prioritize these aspects. To address this, many franchisors maintain dedicated IT teams that handle the procurement of IT vendors. The objective is to ensure that the IT systems deployed by franchisees are robust and resilient against cyber-attacks, while also safeguarding customer data privacy.

Conclusion

Companies that use the franchise model are extremely diverse operating in different industries, with different regulations, different franchisee types, and various supply chain needs.  Fundamental to all franchise systems is a centralized supply chain function. By centralizing the supply chain function, franchise systems ensure that the complexities involved in procuring and distributing products in a franchise system provide a safe and consistent experience for the consumer while simultaneously preserving the equity in franchisee businesses due to the halo effect of the consistent positive consumer experience.

We believe that the Commission should provide additional disclosure requirements of franchisors to assist in the evaluation of a franchise opportunity and make informed comparisons within their industry. This approach would ensure that franchisees have ample opportunities to conduct thorough due diligence and make well-informed decisions.

Thank you for the opportunity to submit our views, and for considering our perspective.

Respectfully submitted,

FRANdata

Edith Wiseman, President