How McDonald's puts the squeeze on both franchise owners and workers

Late last week, the National Labor Relations Board issued a ruling that capped an ongoing struggle between franchises and organized labor in the fast food world.

The way franchising works in a nutshell is the you have the franchisor, which is the central company. That central company owns a certain amount of units — individual storefronts or restaurants or whatnot. But then you also have the franchisee, who can separately own one or multiple units, and who pays a fee to the central company along with certain other obligations. In exchange, the franchisee gets the benefit of the franchisor's brand, proven business model, advertising, etc. Fast food and hotel chains tend to be the biggest players in the franchise world, though other services like car repair and janitorial work are also taking advantage of the franchise model in growing numbers.

Depending on how enmeshed the franchisor-franchisee relationship is, they can be termed a "joint employer." If they're a joint employer, then when their workers organize into unions, those unions bargain with the central franchisor as well as the individual franchisees.

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The NLRB's decision broadened the framework by which a franchisor-franchisee setup can meet the "joint employer" standard — and that's where all the sturm and drang came in.

Worker and labor organizations have been pushing in recent years to organize employees at McDonald's — one of the countries biggest franchise models. The company has come under fire for low pay and poor working conditions, and the NLRB's new ruling is seen as a big boost to organized efforts to force the company to clean up its act. Meanwhile, critics argue the decision will put a damper on a big source of small business creation and possibly destroy the franchise model.

The funny wrinkle in McDonald's case is that a lot of the company's franchisees really don't like the model. They have to pay the corporate mothership 4 to 5 percent of their revenue for a franchise fee, and then another 4 to 5 percent to go into an advertising fund. The franchises then have to pay another 12 percent to McDonald's for rent. Meanwhile, the central company gives franchisees a slew of requirements in terms of remodeling, computer systems, and other expenses they must incur to stay in the franchise agreement.

All of which raises the question: Should McDonald's franchise owners view themselves as natural allies with the workers against the corporate mothership, rather than labor's adversaries?

Arturs Kalnins — a professor at Cornell University who specializes in franchises and small businesses — doesn't think you could take things that far. "In general, McDonald's franchisees are doing very well for themselves," he said, pointing out that after all labor and operating costs are accounted for, including all the franchise fees, owners are still netting around $100,000 per individual store annually. (McDonald's U.S. franchisees took in an estimated $1.6 billion in profits in 2012, which works out to well over $110,000 per restaurant.) Most franchise owners are also managers, which means they get paid a manager's salary out of general operating costs as well. Throw in the fact that many franchise owners boast multiple restaurants, and you can be looking at an annual income of $1 million or more, Kalnins said.

Kalnins continued that he "wouldn't doubt" franchise owners feel they're on thin ice, financially. "But I don't think that's an objective reality. These are very comfortable, well-to-do people."

By all accounts, McDonald's has cracked down on its franchisees in recent years. It controls most of the prices on the menu, and between that and its hefty operating demands, it's squeezing franchisees so that the way to make the business model successful is to pay the workers less. Dissatisfaction amongst McDonald's franchise owners is reportedly at an all-time high, so they clearly feel they're under fire.

But then you have to ask: Under fire compared to whom? The average American worker, or other small business owners pulling down $100,000-plus a year?

Another wrinkle, according to Kalnins, is that McDonald's is genuinely an outlier in the aggressiveness with which it deals with its franchises. In other chains, franchisees can own hundreds of stores, and sometimes be public corporations unto themselves. But "McDonald's really wants small owners," Kalnins explained — somebody overseeing three, four, or five units. "Somebody who's checking out what's going on in those units every day."

The upside for McDonald's is franchisees who are "much more loyal and will do what you want them to, because of their smaller size." The downside is a far more aggressive interference on the part of McDonald's in terms of the running of the stores and its relationships with workers.

Another thing that makes McDonald's an outlier is it's one of the few chains that owns the property for every last one of its stores, and thus charges its franchisees the rent. Kalnins said he's spoken with franchise consultants who figured that while the 12 percent of revenue that McDonald's charges for rent is high compared to the standard 10 percent small businesses usually face from real estate owners, it's not extraordinary. But "if you add the rent to it then certainly they're paying more than for other chains. And that's relatively unusual."

In fact, Kalnins contends that — while he thinks the NLRB's new framework for determining who is a "joint employer" is appropriate — McDonald's should've qualified as one even under the old framework.

Perhaps the best way to think of the situation is concentric circles of possible exploitation. The rent and fees McDonald's charges its franchisees may not be off the charts, but when combined with its control of prices and demands for how the individual restaurant units are run, the squeeze is real. And because so many lower class workers lack unions and bargaining power, and because their wages are legally allowed to sink so low, franchise owners get out of the squeeze from McDonald's by putting the squeeze on the workers instead.

And yes, this logic implies that if minimum wages for these workers are hiked, and if they're able to unionize under the new joint employer framework, then some — maybe a lot — of the business models for individual McDonald's franchisees will become unworkable.

But then, this logic also implies they should be unworkable. Because if they are, the only franchise agreements small businesses owners will be willing to enter will be ones on more equitable and reasonable terms. That will force the central companies to adjust their demands.

Upping the power and wages of the most vulnerable people in this particular transaction will have positive ripple effects further up.