News Column

Top 10 Franchises

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Success stories aren't hard to find among owners of franchises. Throw a muffler or a hamburger, and you'll hit one - a success story, that is.

Guy cashes out of a dead-end corporate job, takes his walking money and invests in, say, a pizza restaurant run by a worldwide chain.

Soon, he has another restaurant and another, and finally he's up to 10 stores and the money is rolling in, and he moves his family from the nice house in the middle-income tract to one closer to the country club. Big house, with a $500,000 price tag.

But it's not all Happy Meals and $3-off coupons in franchiseland. There's another, more troubling, side to franchising.

This one has to do with the sour relationships that can develop between the neophyte franchisee and the big, powerful franchisor, and what happens when those relationships turn bad.

Take the experience of Jeff and Carol Johnson of Lincoln.

From 1985 to 1994, the husband-and-wife team owned three Lincoln restaurants in the Schlotzsky's Deli chain, a franchisor based in Austin, Texas.

Schlotzsky's, a 31-year-old chain, had sales of $61.9 million last year, part of the $1 trillion a year in sales generated annually by all franchises, according to the International Franchise Association.

As of June 30, there were 671 Schlotzsky's restaurants in 38 states (five in Nebraska), the District of Columbia and nine foreign countries. Nationwide, the International Franchise Association estimates that there are 1,500 business-format franchises operating more than 320,000 outlets.

After the Johnsons sold their Schlotzsky's restaurants in 1994, their relationship to the chain was solely as area developers.

They acted as mini-franchisors, helping find prospective franchisees and setting them up in business in Nebraska and 10 other states in the region. In return, they received a portion of the royalties that franchisees in their area paid Schlotzsky's.

Today, the Johnsons no longer have a business relationship with Schlotzsky's. The connection was severed in the fall of 2001. Schlotzsky's paid the Johnsons $2.4 million to reacquire the territories and area developer rights from the couple, according to Schlotzsky's 2001 Uniform Franchise Offering Circular.

Details of most dispute settlements between franchisee and franchisor are kept secret under terms of their original contracts. But franchisors are required to disclose to prospective franchisees, in an UFOC, some information about lawsuits and arbitration proceedings.

In the Johnsons' case, the settlement resulted from a complaint the couple filed on Feb. 9, 2000, with the American Arbitration Association.

Most contracts between franchisee and franchisor require that disputes be resolved by binding arbitration, a stipulation that is, itself, a contentious issue with some franchisees.

In their complaint, the Johnsons accused the Schlotzsky's chain of obstructing their efforts, as area developers, to develop their territory.

"There was no new prospect that I turned in that was acceptable to Schlotzsky's, no new site that I turned in that was acceptable," Johnson said.

The company's goal, according to the Johnsons' complaint, was to eliminate the couple from the franchise system.

Why would a franchisor want to get rid of a longtime franchisee? The Johnsons' complaint suggested two reasons:

- Schlotzsky's wanted to avoid paying the Johnsons 2.5 percent of the gross sales generated by the franchisees in their territory. Area developers can earn huge amounts under the agreements. For example, in August, Schlotzsky's purchased the rights to its largest area developer in Texas, a territory that generated $116.2 million in sales a year, or nearly $3 million for the area developer.

- Schlotzsky's wanted to retaliate against the Johnsons for refusing to participate in a new company expansion program, the "Turnkey Program." Schlotzsky's would build large, free-standing stores rather than smaller stores in strip malls.

The Johnsons refused to develop a larger store in Omaha, as the company requested, because of the expense. They said franchisees who had bought Turnkey stores had suffered financial losses and had declared bankruptcy. Schlotzsky's ended the Turnkey program in 2000.

Johnson said relations between him and the company became "intolerable," leading to the complaint filing.

In a prepared statement, Schlotzsky's said "it would not be appropriate" for it to discuss the "statement of claim."

"We enjoyed a mutually successful and beneficial relationship with the Johnsons for approximately 15 years, first as franchisees, then as area developers who provided services to franchisees on behalf of Schlotzsky's," the company said.

Although Johnson said franchising "works terrifically the vast majority of the time," he is so disillusioned that he has become active in an organization representing franchisee interests - the American Franchisee Association, based in Chicago.

"There is no mechanism in place to deal with and protect the little guy in that arrangement when things go south," he said.

Sam Crawford, director of public policy for the association, said some problems rest with the contracts that are drawn up by franchisors.

"If the franchisor determines that it wants you out, whatever the reason, it has 150 different ways to get rid of you, and they are all in the contract," he said.

A spokesman for the International Franchise Association, whose members include 800 franchisors and 34,000 franchisees, defended the contracts, saying they are written to protect the reputation and integrity of the franchise system.

"That means it's the franchisor's obligation to enforce standards to ensure that all franchisees operate according to the terms and conditions of the business plan," said Matthew Shay, executive vice president of the Washington, D.C.-based group.

One appeal of franchising, he said, is that the franchisee doesn't have to do everything because there is a plan created by the franchisor to follow.

"But there is also a trade-off," Shay said. "The trade-off is that a significant amount of control has to be relinquished to the franchisor."

Too much, in the minds of franchisee advocates, who took their case to a June hearing before a U.S. House subcommittee on Commerce, Trade and Consumer Protection.

The hearing was on a Federal Trade Commission proposal to make a few, mostly minor, changes in its Franchise Rule.

For franchisees, the hearing provided a chance to express pent-up concerns about what they perceive is weak federal oversight of franchising.

Jerry Rizer, president of the Dairy Queen Operators' Association, testified at the hearing that the FTC Franchise Rule gives franchisees no protection against abuse "by our own franchisor in our supply chains."

He was referring to a lawsuit his association - whose members own 3,900 Dairy Queen stores - filed in 1994 against International Dairy Queen Inc., the franchisor that is owned by Omaha-based Berkshire Hathaway Inc.

The lawsuit alleged that the franchisor, which approved products for use in Dairy Queens, bought the products and then resold them to a distributor at a markup. The franchisees then were required to buy the products.

In 2000, a U.S. District Court ruled in favor of the franchisees, giving them the right to purchase goods, at lower prices, from alternate suppliers.

Rizer, who owns three Dairy Queen stores in Kentucky, said he reduced his food costs by about 6 percent a year by buying products at lower prices than before.

Johnson and other franchisees view the centerpiece of the FTC Franchise Rule - a requirement that franchisors disclose information about policies and practices in Uniform Franchise Offering Circulars - as ineffective in protecting franchisees.

As proof, the franchisees point at what the FTC tells prospective franchisees on the cover letter of the UFOC.

"To protect you, we've required your franchisor to give you this information. We haven't checked it and don't know if it's correct. It should help you make up your mind. ... If you find anything you think may be wrong or anything important that's been left out, you should let us know about it. It may be against the law."

In 1999 the FTC received 102 complaints involving franchises, down from the 108 it received in 1998, according to a General Accounting Office audit last year.

From 1993 to 1999, the FTC determined that 20 cases were serious enough to warrant court action. That, along with other GAO findings, proved that the FTC is effectively enforcing its rule that protects investors, according to the International Franchise Association.

Still, the GAO report concluded that the "extent and nature of the franchise relationship problems are unknown because of a lack of readily available, statistically reliable information."

Among states, the GAO said, Iowa has the most comprehensive franchise law. However, Brent Appel, a Des Moines attorney, said the statute has been weakened in recent years.

Among the ways that Iowa differs from other states is that it permits a franchisee to sue its franchisor for monetary damages if the franchisor develops an outlet in "unreasonable proximity."

Nebraska's law on franchising leaves virtually all regulation with the FTC's Franchise Rule. Any franchisor who provides a Uniform Franchise Offering Circular to a prospective franchisee is exempt from the state's Seller-Assisted Marketing Plan Act.

Top 10 franchises

The Web site entrepreneur.com ranks franchises according to financial strength, stability, growth rate, number of locations, years of operation, start-up costs, litigation, percentage of terminations and financing arrangements. The top companies, their specialties and their start-up costs:

    Subway, submarine sandwiches and salads, $63,400-$175,000
    Jackson Hewitt Tax Service, computerized tax preparation and electronic filing services, $47,400-$75,200
    Curves for Women, women's fitness and weight-loss centers, $25,600-$31,100
    7-Eleven Inc., convenience stores, variable
    Yogen Fruz Worldwide, frozen yogurt and ice cream, $25,000-$250,000
    Quizno's Franchise Co., submarine sandwiches, soups, salads, $170,000-$232,200
    McDonald's, hamburgers, chicken, salads, $489,900-$1.5 million
    Management Recruiters/Sales Consult/MRI Worldwide, personnel placement, search and recruiting services, $114,000-$162,200
    Holiday Inn Worldwide, hotels, variable
    Jani-King, commercial cleaning, $8,200-$33,500

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