Class-action lawsuits poised to make franchisors eat humble pie

Ontario justices are sending a strong message to franchisors to play nice when sharing profits.

Pet Valu, Midas, Shoppers Drug Mart, Quiznos, Tim Hortons, Bulk Barn, Sunoco…just the first.

The cases often revolve around how the franchisor uses its power to set the prices – both the prices that franchisees must pay for the products they sell, and how much they can sell them for.

“It’s about dividing up the profit pie. And the person who has the pie cutter is the franchisor. And so, they cut themselves the biggest piece,” Mr. Sterns said. “But on the other hand, the franchisees are the ones who put a lot of investment into making the pie.”

Mr. Shaw is absolutely right and absolutely wrong:

1. The technology for organizing pre-trial franchisee groups is improving (daily) but
2. This is just the tip of the iceberg.

I guarantee that.

[see Revolt of the Franchisee: Behind some of the biggest brands - Midas, Quiznos, Tim Hortons - the messy class-action battles or The Globe and Mail]

Food truck encroachment: Why sunk cost investments and change kills mom/pop franchise life savings

A legal civil war will mask franchising’s unavoidable investment flaw: opportunism arising from inevitable change.

The #1 business risk is franchisor opportunism: the self-interested exercise of contractual discretion via deceit. This one risk comes cloaked in hundreds of types.

Systemic Factors: At one time, franchisees were granted a geographic monopoly but that ‘s history, mostly. Franchisees own the majority of the assets but franchisors control the use/exit of this capital. Franchisors take $ from the top; franchisees only from the bottom. Pre-sale due diligence is irrelevant because the franchisor reserves the right to unilaterally change the model. Sunk cost chains draw off-balance sheet capital in from all s0urces of “love money”.

High-end, branded roach coaches will be franchisors’ new crack cocaine:

1. lower capital barrier to sales (easier financing),
2. boost total market retail sales (royalties/ad fund %),
3. product sales margin increases (tied buying provisions),
4. same control via central commissary innovation and tied buying to outfitters,
5. 100% flexibility (scaled territories),
6. streamlines process when an intentional insolvency is chosen,
7. centralized social media promotion, and
8. margins by contracting with a secondary space rental company (more than make up for franchisors giving up hefty lease margins).

Benefits for traditional mom-and-pop investors?

At best, a generous offer from your franchisor for you to buy 3 new trucks to replace your outdated bricks-and-mortar store.

I would suggest that billions of $  existing franchisee-owned assets just shrunk. Permanently. Never to return.

Think: Dunkin’ Donuts, Tim Hortons,  Quiznos on wheels.

• Food trucks are rolling into the mainstream: Restaurant chains such as Sizzler and Subway are joining the parade of roving gourmet kitchens that started with Kogi two years ago., Sharon Bernstein, LA Times
• Streetza Pizza Social media, event planning.

Thanks for the tip, Michael.

It’s nice to see the Tim Hortons’ trash being taken out.

A narcissistic executive culture is tolerable to discerning franchisees as long as the wiser lion sticks around to mediate the organizational pathologies. Civil war breaks out, however, when senior management starts believing their own garbage.

Canada’s national magazine has an article on Tim Hortons and their near $2-billion legal problem. In the Maclean’s story, Tim Hortons’ extra-large trouble trouble: The bitter battle inside the country’s favourite coffee shop:

Officially, the case is about a few disgruntled franchisees who claim their profits are shrinking because the company, via Maidstone, is charging “inflated” prices for those frozen goodies. But flip through the court file—through thousands of pages of exhibits and affidavits—and a much deeper storyline emerges: an old-fashioned power struggle between those who are still loyal to Ron Joyce, and those who replaced him at the top.

Ron Joyce (originally a  franchisee) appears to have a fine memory and a nose for bullshit.

The acme of strategy: Winning without a single blade being drawn.

Franchising: a mixture of flattery and threats

Are some systems fundamentally “better” than others?

No.

Some are just better at managing their image. That’s all.

Take a closer look and they all are operate under the same sign.

Image used with permission.

Aislin.com/stuff : Montreal Gazette, Feb 11, 2010

franchise Churning: Sell ‘em, Take ‘em back and Sell ‘em again

“I should have bought a fucking Hortons,” so Peter told me.

Maybe yes. Maybe no.

Peter Bell is an original.

He and I were Ontario Nutri-Lawn franchisees in the 1990s. He was in a partnership with a “friend” Marc Thiebaud at OGS, in the Oshawa/Whitby area.

Peter is smart. He didn’t take the legal dead-end like I did. But both he and I signed based on false earning claims delivered by wonky pro forma income statements.

In 1998, from the franchisor’s unusual point of view, Nutri-Lawn had 24 successful Ontario territories (ie. open, paying royalties).

From the franchisee investor another picture emerges. From 1990 to 1997 of the 24 territories:

1. there were 17 franchisee ownership changes,
   
2. 3 were on their 3rd franchisee, and
3. 11 were on their second.

In 8 years in Canada’s most prosperous province.

Zero bankruptcies because everyone else sold their pig of a business to the next mark. I defied their stupid, hard-to-enforce non-compete clause and took my customers into another company while I fought them in Court. Mine (I think) was the only legal challenge and subsequent, rather high-profile bankruptcy.  Summary

Peter and I both got hung out to dry, but God, we had a few laughs.

Churning: the rapid selling, failure, retaking and re-selling of franchises. Can be intentional or unintentional but the outcome is the same for the investor. Useful to change the logo (old on top).

Lipstick on a pig.

A hallmark of even the bluest of “blue chip” systems.

Cause of franchise deaths: usually 1,000 cash cuts

The cause of a franchise death is often viewed too simplistically.

There is very seldom one reason for a small business failure.

With franchising, the complexity and lack of control results in a fundamentally higher level of business risk (see WikidFranchise.org section, The Marriage of Franchising).

After having read hundreds of news articles, talked and interviewed nearly as many franchisees, you come to appreciate that a single franchise failure has certain similar elements but very many very common issues.

A new franchisee’s cash position is quickly weakened by hidden profit “bleeds” (high margins on supply, leases, equipment, leaseholds and tied/forced buying, contracting, etc.) that were not expected or budgeted for.

Sales don’t show up nearly as quickly or inexpensively as was planned on.

Reserves quickly dwindle, leaving the organism of your franchise vulnerable to a “fatal” adverse business incident. This culminating incident might be what you see as your franchisor’s bright idea, such as Tim Hortons’ frozen food centralized commissary decision. The extra 3 or 4% on COGS is too much for some marginal stores: Most simply slip away, largely unnoticed.

Some decide to fight with a $2-billion lawsuit against a Canadian “blue chip” system.

• The latest cut (which has asymmetrical payoffs: ee v. or) is simply the straw that broke the camel’s back.

The franchisors’ means for extracting wealth from franchisees (acting opportunistically: self-interest with deceit) are so many that many smart investors have concluded that business franchising is unsafe at any brand.

Reza Solhi and 3 for 1 Pizza & Wings

Sean over at FranchisePick asked me if I knew of Mr. Solhi’s work.

• I do and
• I keep an eye on AnthonyFranchiseInformation.com, too

Please note the first 6 articles that the Information Sharing Project would return if it were alive on the internet (searched for tradename). Download the entire article if you like.

1. Frustrated franchisees call for legislation, The Globe and Mail, December 3, 1998 Excerpt from article: Jesu Dasan figures he lost $180,000 in the 20 months he operated a fast-food franchise in Scarborough, He alleges the franchisor changed the terms of the contract, which drastically reduced the number of homes his business was allowed to service. [download pdf]
2. Ontario introduces bill to protect franchisees, The Toronto Star, December 4, 1998 Excerpt from article: “Everything goes to (the chain) … These people cheat us and we’ve lost everything.”…Vahdati said she and her husband spent $100,000 on legal costs in a fruitless court fight against the pizza-chain owner. [download pdf]
3. New franchising  law called sales job: Ignores ongoing illicit practices, operator rep say, The Toronto Star, December 5, 1998 Excerpt from article: “This is the wooliest thing I’ve ever seen,”…Commercial Relations Minister Dave Tsubouchi “is just like one of the franchise hustlers,” said Stewart. “He’s selling an idea and there’s nothing in it.” [download pdf]
4. Franchise laws welcome, The Toronto Sun, December 8, 1998 Excerpt from article: “What a disappointment.”…“This law is worse than what exists now, which is nothing,” snapped Les Stewart, founder of the Canadian Alliance of Franchise Operators. “It will only lull potential entrepreneurs into a false sense of security.” [download pdf]
5. A declaration of war: breaking into the business, The desperation tactic of gaining entry to a locked business, known as ‘self-help’, is seen as an occasionally useful skill when relations hit a sour note., The Globe and Mail, January 13, 1999 Excerpt from article: Gaining entry to a locked business under cover of darkness isn’t taught in franchise manuals, but it’s a skill that both franchisees and franchisors occasionally find useful. [download pdf]
6. The great franchise trap, The Indo-Canadian Voice, January 15-27, 1999 Excerpt from article: The family lost $150,000 and sadly, the man who put his life’s savings on this scheme, is today on welfare…“These people need to be protected. It is mostly the new immigrants who fall victims to such schemes. And in Ontario, there is very little by way of laws that can protect them in times of dispute.” [download pdf]

Anyone know what happened to these franchisees who were mentioned in the articles?

• Wasim Ansari,
• Tarek Fatah,
• Rayappu Jesudasan [Jesu Dasan],
• Ali Mahmoudzadeh,
• Nhan Van Nguyen,
• Fereshteh Vahdati, or
• Ali Mehmood Zadeh

Or the other  people?

Richard Cunningham, John Deverell, Peter Macrae Dillon, Howard Hampton, Mike Harris, Murray Katzman, Linda Leatherdale, Ned Levitt, Tony Martin, Reza Solhi, John Southerst, David Sterns, David Tsubouchi, Dawn Walton

And these organizations?

Ministry of Consumer and Commercial Relations, Canadian Alliance of Franchise Operators, Canadian Franchise Association, 3 For 1 Pizza and Wings, McDonald’s, Tim Hortons, Golden Griddle,  Siskinds, Cromarty, Ivey & Dowler, Canadian Tire, 3 for 3 Pizza Ltd., Canada Post, Ontario New Democratic Party

The sympathetic Toronto lawyers are there to manage your anger. That’s their job for the industry: a soft landing, breeding passivity.

A franchisee white knight (the appearance of franchisee advocacy while acting to weaken franchisees’ rights; a traitor) lawyer:

• to ensure that learned helplessness infects the immigrant leaders by raising then dashing your hopes for justice.

No Canadian lawyer can survive financially by representing only franchisees. It is impossible. They HAVE to have to behave in an acceptable manner (don’t rock the boat) or the industry elite will not allow them to exist.

1. The appearance of an opposing position provides the pretense of industry balance to outsiders.
2. You are NOT protected by a lawyer’s theoretical fiduciary duty to a client when you talk to them initially. That protection is ONLY when you are in a solicitor:client relationship (a contract: agreement, money exchanged, etc.). Do NOT rely on his advice at this stage: He maybe protecting the industry’s interests (not yours).
3. Because law services are a credence good, you never know exactly how or when your interests were sold down the river.

The antidote to compromised legal representation is a knowledgeable second opinion (ie. a consultant who does not make his living from the industry). They’re rare but if you know where to look for them, they’re out there.

But I’m the most special of all:

I seldom charge anything for my advice to franchisees.

It’s my way of giving back to an industry that has given so much to me and my family over the last 10 years. Call today 1-705-737-4635 and let’s discuss if the lawyers or I was more accurate in predicting Ontario’s franchise industry’s degeneration from 1998 to 2008.

The Role of Equity in Franchisee buying groups

If there is one business truism, it’s Pareto’s Principle

• 80% of something comes from 20% of another thing.

Therefore, you get observations like:

• sales gurus talking about “80% of your sales coming from 20% of the number of your customers”,
• labour relations [80% of grievances -- 20% staff]
• hospital errors [80% -- 20% Drs.] and
• so on.

Testing Theories: This passes for management wisdom and is largely only good if you actually do some work to see how a specific situation is the same [integrates or supports a theory] or is different [differentiates itself from the conventional wisdom].

Observation: I have noticed, though, that every franchise system that I have studied has recurring patterns. One can be split apart [segmented] by annual sales volume.

There are a few very high volume operators, most are middle and a few very low sales volume franchisees.

Not surprisingly, one subset I’ve noticed is:

• the higher the volume — the more professionally run it is (ie. able to decide based on sound business analysis).

High Volume: The operators understand business better and are willing to fund and act on innovative ideas quicker and hold the course over a longer time horizon. They’re often early innovators in all areas of business: marketing, human resources, technology and cost containment.

They are also keenly aware of their dominant status among their trademark franchisees. They are deferred to by their peers and their franchisor. Their success and authority is often used by the franchisor to seal the deal on new franchisees.

For all these reasons, they have a sweeter deal financially and a greater latitude with thier franchisor when compared to their trademark peers(ie. the unwashed masses: uniformed, lower volume operators).

Current Buying Groups: Most groups that I am aware of can be split into 2 categories:

1. by industry association (ie. the Chamber of Commerce’s general insurance program) or
2. by trademark system. (ie. bunch of Tim Hortons operators use the same health and safety training contractor).

Sure they help but it’s mostly amateur hour. There is a third way that I think is much more interesting.

3. Transtrademark Buying Group, TBG: The few, high volume operators in several systems commit to buying common goods and services. In a sense, an independent franchise-only buying group administrator cherry-picks based on volume and ability to decide (rather than on what brand you belong to).

The fundamental problem with the two traditional buying group types is that they institutionalize differential free riding: The whingy low volume freak is a drag on the decision making and administrative processes for the higher volume, more competent operators.

When you bundle buying groups with advocacy (as the AAFD does), you bitch up both.

A membership or democratic model (one member, one vote)

• is fundamentally irreconcilable with

buying good and services (the higher volume = higher benefits, big fish eats little fish).

The higher volume guys (after the initial cost drop) rapidly lose interest because they are penalized for their strength [not rewarded] AND have to be associate with a bunch of weaklings who have very little to teach them.

These “two master” associations rapidly accumulate an ossified, out-of-touch  leadership, a predatory associated member class who capture the organization or/and association groupies [a species that gets their jollies from hanging out with other butt-sniffers].

It is only franchisees’ inexperience as a member of ANY group [before in their life] that they are such sheep when it comes to the strengths and weaknesses of a group of businesspeople.

• They figure it takes a couple of hours, and poof, you have a competently, well-functioning not-for profit. Sorry sport: Never was like that. Never will be like that. NFPs are different.

Irreconcilable Differences: Either you serve social justice or capitalism. Trying to do both is just silly and leads to incompetence and irrelevance. Sure the associate membership:active membership cross-subsidization allows the association to live but it lives as a castrated entity.

Equity: I think a smarter way is to reward existing competent business owners and investors with higher returns [the more the whole group buys, the more ROI via annual dividends].

A TGB should be structured as a direct investment in an independent company by several core franchisees. More can become partners but they pay a higher rate for committing earlier.

Prices would be negotiated with, say, office supply companies for a specific annual volume of business at a certain % off retail. Each equity member commits to annual volume. Results are monitored over the year and buying group members that do not live up to their volume commitments, are penalized. (This selective “opting-out” is what kills 90% of  buying cooperatives).

1. The administration of the group is covered by retaining a portion of the negotiated savings (ie. the vendor remits x% of sales of each contract to group, members of group receive, say, 8% instead of 10% as they order independently from the vendor during the life of the contract.)
2. Progressive discipline (promise v. actual buying behavior) is maintained by transparency, reports of free riding to Board, retaining portion of savings and then remitting at end of year (along with dividends).
3. Termination by Board clearly known. Adding equity partners possible.

I would much rather work with

• a few, high volume, competent operators from Brand X plus
• a few, high volume operators from Brand Y plus
• a few, high volume operators from Brand Z.

than a dog’s breakfast of operators from any one system.

If the industry had any ability to act or an instinct for self-preservation, they’d get busy developing this capacity. There’s only about 100 years of work to do before any need to address any win:lose items for franchisees and franchisors.

• NOTE: If this sounds harsh, it is meant to.

Most business  innovation dies because of a mushy, “shot gun” approach to positioning. I am much more interested in a rifle approach to innovation and then, once it’s successful, broadening it out or hiving off a related entity.

1. Custom first.
2. Mass-produced services as warranted.

Tobacco industry-type defence

I have frequently been baffled why franchisors react so poorly when challenged by the media or informed observers. They tend to give the impression that they are as guilty as sin, although the allegations that are leveled at them seem, at first blush, to be quite minor.

In an advocate’s world, it is the opponent’s re-action that is most telling. And if they choose to behave like a tobacco company, then they may very well have other secrets to hide as well.

A good case is Tim Hortons. I picked up a terrific news article from the perennially useful New Zealand franchise article aggregator franchise-chat.com.

In Trouble is brewing in doughnut land, a local reporter muses aloud why he can’t get a tour of a massive distribution centre in his home town, let alone the doughnut-making central commissary in another local city.

It sounds like a simple enough request: One most corporations would want to show off as the usual corporate spin. But wait…

…why Tim Hortons seems reluctant to allow Guelphites a look into the giant distribution centre it built two years ago in Guelph’s end, serving its coffee shops in southern Ontario and further afield.

I’ve had no success with Tim Hortons’ public relations department getting into the massive, fortress-like building. It’s been difficult even getting calls returned by the department, which insists Tim Hortons is busy resolving operational glitches in Guelph.

A little touchy maybe with a new, potential $2-billion franchisee lawsuit putting head office on edge these days?

The franchise owners claim profits have plunged since Tim Hortons, the franchisor, switched to frozen baked goods and expanded its lunch menu, alleging in part negligent misrepresentation as costs for frozen food rose higher than expected.

Tim Hortons is a Canadian cultural icon with 3,200 stores across North America. The system is named after an actual hockey player, Tim Horton, who was as tough, unyielding and flawed as any northern Canadian winter.

As is frequently the case, franchisors are only interested in engaging in good news communications with the media and the communities where they draw their $62-million 1st quarter profits from.

The Apprenticeship of Les Stewart

Most people believe I hate franchising.

Listed below are the roles I have played in the franchise industry:

• twice a franchisee (Arjay Painting and Nutri-Lawn),
• a franchisee’s crew Barrie and 1st assistant manager, Orillia 3254, McDonald’s Canada (B.O.C., Silver Hat, & AAA, 1972-80),
• The University of Western Ontario, London Canada: general BA, 1983 and MBA, 1987,
• Medical audit coordinator, St. Thomas Psychiatric Hospital, St. Thomas, Canada, (1987, provincial psychiatric hospital),
• Budget analyst, Victoria Hospital, London, Ontario, (acute care regional teaching hospital, 1988-92),
• founded Canada’s 1st national franchisee association, Midhurst, ON (Canadian Alliance of Franchise Operators, CAFO, 1998-2005),
• been sued twice: Nutri-Lawn’s then owner, The Franchise Company (FirstService Corporation) and then then by a consulting client’s franchisor (Tupperware Canada Inc.),
• took my franchised lawn care business independent in 1998,
• represented myself at an injunction hearing, franchisor unsuccessfully sought to enforce their non-compete clause, Barrie, ON, 1999 (Justice Paul Herminston, Barrie),
• experienced a 5 day trial, (Justice Katherine Swinton, Toronto,  May 1999),
• lost while running up a debt to my lawyer (+$125,000 unfavourable award)
• promised of free appeal if I paid off my legal debt,
• appeal notice filed (stayed award),
• cut & then honoured six post-dated cheques,
• filed bankruptcy papers for self and corporation when the fee waiver agreement was withdrawn (Jay Harris, Harris & Partners Inc., 2001),
• expert witness at public hearing which lead to Ontario’s first franchise law, Toronto, ON (Arthur Wishart Act (Franchise Disclosure), 2000),
• policy analyst for Tony Martin, MPP Sault Ste. Marie, 1998 to 2001 (provincial, federal politician),
• created the Information Sharing Project and submitted unsuccessful project proposal to the Ontario Ministry of Consumer and Commercial Affairs in 2003 (digital teaching, due diligence and business risk assessment tool; embryonic form of WikidFranchise.org),
• identified Predatory Franchise Lending to Industry Canada, 2005 (18 month investigation: bank, consultant, franchisor, Office of the Privacy Commissioner of Canada, Minister of Finance, RCMP Commercial Crime Unit, OBSI, FCAC, PMO, etc.),
• case preparation for a +$6-million civil law suit based on predatory lending principles,
• media contributor, 1997 – present,
• contributed to the Prince Edward Island, Ontario, West and South Australian franchise inquires, www.cafo.net (ret.),
• Blue MauMau contributor: 459 posts (since Oct 2007),
• founded and editor of FranchiseFool weblog: 835 posts & 109,183 views (since Feb 2008),
• founded and co-editor of WikidFranchise.org, world’s 1st independent industry reputation wiki (repository of franchise-specific documents, unique business risk search capability, and open source archive for investment-grade information): +2,300 documents, 324,054 hits  & 7.5 GB bandwidth downloaded, (since Feb 2009),
• endorsed Bill 102, An Act to amend the Arthur Wishart Act (Franchise Disclosure), September 23, 2010,  Legislative Assembly of Ontario (start @ 1440),
• attended the International Association of Franchisees and Dealers annual conference, Indianapolis, 2010,
• attended Ontario Bar Association annual Franchise Law Conference (2009 and 2010),
• named Knight of the Year – 2011, Barrie Council 1626, Knights of Columbus, Barrie, ON, and
• continue to work with individual and groups of franchisees who recognize the dangers of credence good cheaters (Les Stewart Consulting, 2000, LinkedIn).

— The Knight Errant, 1870, Sir John Everett Millais (1829-96)

“The distressful maiden has been despitefully used by robbers, who have been dispersed by the gallant knight. Some of them can be seen in the right distance. This is the only nude female figure painted by the artist.” (From the Tate Gallery) WikiMedia Commons