When Academics Fail to Get the Full Picture on Franchising

Last month, the University of Pennsylvania’s Wharton School of Business Management posted a blog (Knowledge@Wharton) entitled: “How the McDonald’s Franchise Labor Case Could Upend an Industry.”

Indeed.

Wharton, of course, is one of the most respected business schools in the country.

Which makes the blog that much more incredible. The authors completely fail to understand the “joint employer” issue and the broader workings of the franchise model.

The authors were Peter Cappelli, the Director for Wharton’s Center for Human Resources, and Cesar F. Rosado Marzan, a contracts, labor law, and comparative labor law professor at the Chicago-Kent College of Law.  Also included were quotes by Janice Bellace, a professor of legal studies and business ethics/professor of management at Wharton, whose expertise is in the area of labor and employment law and employment relations.

These are surely qualified scholars on labor issues, but something is missing.  Did anyone think to get the views of a franchise business management expert or a franchise attorney?  Someone who is an expert on the franchise business model?

To the labor professors, a franchise relationship looks like an employment relationship, but this comparison brings new meaning to the trite expression that “if you are a hammer, everything looks like a nail.”

For example, Professor Cappelli states there are two types of franchises in vogue.  One is the “trade name franchise,” where the franchisee gets the rights to use the franchise owner’s brand name. The other is an “operating agreement,” which McDonald’s uses, where it sets the rules on how their franchisees must operate the restaurants.

Herein lies the error; there is no such thing as a “trade name franchise.” Any license of a trademark must be accompanied by controls on quality and use of the brand or the trademark “owner” will likely forfeit their rights to the mark, which would be embarrassing to say the least.  The authors should have reviewed the Lanham Act before commenting on the franchise business model.

The authors also mention an “operating agreement,” where there are “rules” on how the franchisees must operate the restaurants. I think they must mean a business format franchise, where the franchisor transfers know-how to the franchisee in addition to the right to use the names and marks.

The brand standards associated with the marks and system are fundamental to franchising—without them, the consuming public would have no assurance as to the origin of the goods and/or services branded and would not know if the expected quality is there. Standards in preparing the hamburger—temperature, patty thickness, safe handling instructions, etc. ensures no one gets sick. Menu consistency guarantees mom and dad know when they pull off the road at Junior’s request who has seen the brand on a sign, that Junior’s favorite will be served at the restaurant. And so forth. But fast food is not the only franchised business. Practically any business can be franchised if the operating know-how is replicable.

Professor Cappelli continues, “in the operating agreements you can tell franchisees pretty much how to do everything.”

What?

In each and every franchise system, the franchised businesses are independently owned and operated. These franchisees are entrepreneurs. While they must follow certain rules relating to brand standards, they set their own course as to everything else. They determine their day-to-day functions of their businesses. They determine who to hire and fire, the hours of the employees, the pay scale, and the duties of each employee, just like any other small business owner. And it’s their capital that finances the business; their capital is at risk.

Further underscoring the authors misunderstanding of franchising was Professor Rosado’s statement lumping McDonald’s and Walmart in the same category. While they are both “large corporations,” Walmart is not a franchise.

Professor Cappelli asserts, “Over the last generation, there have been lots of efforts by employers and businesses to get out from under the requirements of employment law.” So by implication, franchising is simply a ploy to avoid employment law compliance.

Nothing could be further from the truth.

The business format franchise in its current form has been around since the 50’s. Franchising now accounts for 5.6% of the GDP and 9.1 million direct jobs. It is successful because it harnesses the extraordinary drive of the entrepreneur.

In a public policy blog, one must consider the public policy implications of taking a business model that has been around for 60+ years, and has become a substantial part of the economy, and “upending” it. At the very least, this piece lacked insight by failing to include franchise experts and instead solely considered the thoughts of labor/employment professors.

And as relates to public policy, Professor Cappelli even says “[p]art of the knowledge [imparted by the franchisor to the franchisee] is, frankly, how to employ low-wage unskilled people and get them to turn out this consistent, stable product.  Maybe it is not a bad thing to take a person without work experience and teach them how to make a good product, interact with the public, show up on time, and maintain a professional appearance – things needed to get and keep a job.  For most workers, a fast food job is not their ultimate goal—rather, it is a first step, a bridge to a better place in the workforce.

So Knowledge@Wharton? You’re absolutely correct for diving in on a significant labor policy, but you should not have made the mistake of only analyzing one side of the equation. It could hurt America’s economy and deprive entrepreneurs of their livelihood.

IFA Launches International Toolkit

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The International Toolkit is now live at franchise.org/InternationalToolkit.  The Toolkit is designed to be a core resource for IFA Members interested in international franchising.  At the heart of the Toolkit are webinar courses that comprise a curriculum in franchising across borders.  Six courses are now accessible with more to come.  The Toolkit can be found prominently featured on the main international page of IFA’s website.

The free courses now available are:

  • Preparing Your Company to go Global, presented by Edwards Global Services
  • Development Models for Global Expansion, presented by DLA Piper
  • Legal and Regulatory Requirements of International Franchising, presented by Gray Plant Mooty
  • Drafting and Negotiating an International Franchise Agreement, presented by Dickinson Wright
  • Commercial Strategies to Export a Franchise to the U.S., presented by MSA Worldwide
  • Legal Aspects of Bringing Your Franchise to the U.S. – Myth v. Reality, presented by Gray Plant Mooty

IFA’s International Toolkit offers a number of resources beyond the courses. IFA has partnered with Getting the Deal Through Guide to bring members profiles of franchise laws in 42 countries. In an effort to support your international development, IFA has posted a calendar of international franchise shows in 2016 online.

Country profiles on IFA’s site will soon be dramatically improved. IFA worked with the Department of Commerce and World Bank to rebuild these pages so fresh data relevant to franchise companies is constantly available. Finally, if you want personal feedback, look at the international tracks of the FranShip program to get mentoring from an IFA member expert.

Speaker Ryan Creates Environment for Vibrant Policy – Will Congress Deliver?

Yesterday morning, Speaker of the House Paul Ryan (R-WI) delivered an address geared towards future generations and the promotion of policy debates, noting that Congress can play a vital role in restoring the American people’s faith in elected officials.  During his speech, the Speaker noted the political climate in Washington has devolved from meaningful policy discussions and turned to a game of identity politics that often leaves the public yearning for more. Even worse, Ryan noted that Congress should be part of the solution, rather than part of the problem. This entire narrative comes full circle with the Speaker’s promise to focus on making America thrive again, especially for those who are most vulnerable.

The American people are frustrated, and Speaker Ryan’s address serves as an elucidating moment for Congress: start serving the people or run the risk of diminishing America’s future potential. For those in franchising, and small business owners in general, the message could not be more salient. Entrepreneurs serve as the foundation for America’s economy and opportunity. Franchising alone accounts for nearly 8.9 million jobs – with an expected growth to 9.1 million in 2016 – and nearly $900 billion in economic output. For a business model that is churning out jobs and income for so many, one would think those in Congress would be working to promote and protect the industry. Unfortunately, Washington bureaucrats and organized labor groups are orchestrating a strategy that will hamper job growth and threaten the dream of small business ownership for countless Americans over the coming years.

If Congress takes to heart the Speaker’s message detailing efforts to eradicate poverty and promulgate effective policy solutions, the franchise model is a perfect place to start.  Take, for example, the National Labor Relations Board’s (NLRB) nebulous new “joint employer” standard.  For years, franchisors were legally separate entities from franchisees until pro-union bureaucrats flipped the standard on its head. As a result, franchise small business owners are cast into an abyss of uncertainty. Last year, Sen. Alexander (R-TN) and Rep. Kline (R-MN) took the initiative to introduce the Protecting Local Business Opportunity Act, a bill aimed at restoring the traditional standard. Unfortunately, partisan jockeying on the legislation prevented a floor vote, despite the fact it passed the relevant committees. This legislation represents a clear opportunity for Congress to get back to policy making and facilitating avenues of advancement for America’s impoverished. Speaker Ryan has made his intentions clear; now it’s time for elected leaders in Washington to serve their constituents by promoting a business model that positively impacts millions of America’s success stories.

States Lead the Charge Against Joint Employer Overreach

The National Labor Relations Board’s (NLRB) August 2015 ruling in Browning Ferris Industries completely upended the standard definition of “joint employer,” throwing thousands of business arrangements into limbo.  In doing so, the NLRB ignored legal precedent and can now hold franchisors liable with their franchisees for labor violations.  Despite this sweeping federal regulation, a plethora of state legislatures are defying the NLRB and passing legislation that preempts the new “joint employer” standard, opting instead for the traditional definition that franchisors and franchisees are separate entities.

A recent Bloomberg BNA article highlighted the role that IFA, along with other business oriented groups, has had on facilitating this proactive franchise legislation across the US.  “We are actively pursuing this legislation this year and have a strategy to continue pursuing this legislation in as many states as we can going forward,” said Jeff Hanscom, IFA director of State Government Relations. The IFA has successfully passed bills in Michigan, Louisiana, Tennessee and Texas, while legislation is moving in Colorado, Georgia, Indiana, Utah, Virginia, and Wisconsin.

Michigan is the most recent state to codify the franchisor-franchisee relationship, and bill sponsor Rep. Eric Leuthesuer (R) explained why he chose to take action on this issue: “What you are seeing in the states is legislatures looking at things that probably never needed to be addressed in statute because they were largely considered settled, common sense or intuitive for a long time. And now, because of court rulings, a lot of things that were common sense are now being thrown into some confusion, or potential confusion, or potential chaos. That’s not good for anybody.”

Through the Coalition to Save Local Businesses, the IFA continues to pressure Congress to act on the “joint employer” issue and provide a remedy for small business owners in America.  Judging by the success the IFA has had in state governments, it is clear that these legislators see the negative consequences impacting business owners in their districts, and states continue to lead the way.

Berlitz’ Pioneering Role in the History of Franchising

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One of the earliest marketing efforts of Berlitz, from the Atlanta branch

Records accidentally discovered during a renovation, together with company archives, prove that Berlitz started franchising in 1889 and is perhaps, the oldest franchisor still franchising today.

In 1978, Berlitz was conducting some renovation works at its Brussels center.  During the renovation, one of the contractors accidentally knocked off a wall and, to the surprise of the construction crew and the center staff, they discovered a hidden chamber.  What they found in that chamber was a treasure of history; not only for Berlitz; but also, for the franchise community as a whole.

Berlitz was incorporated in Providence, Rhode Island, USA in May of 1878 by German immigrant Maximilian Berlitz.   Some of the files that were found in that chamber included student records, contracts, lease agreements, pictures, certificates of business incorporation and more.  For example, there was a memo from the then current Queen of Belgium, requesting to keep her enrollment with Berlitz discreet.  There were documents from Nicholas the II, last Tsar of Russia, records of Mr. Berlitz being personally responsible for teaching English to Emperor Wilhelm II and, more relevant to this publication, documents related to the beginnings of Berlitz franchising, dated over 127 years ago.

Records found in this incident, together with archives from Berlitz France, proved that Berlitz started franchising in 1889 and is, perhaps, the oldest franchisor still franchising today.  Singer, although it does not franchise anymore, has been often credited to be the oldest franchisor in modern history.  Nevertheless, if we go by the modern conceptualization of Franchising, Singer probably lacked one element: royalties.

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Maximilian Berlitz

In 1888, Maximilian Berlitz granted its first Area Development Agreement for Europe to Henri Mallat, a dedicated Berlitz professor.  In 1889, Mr. Mallat granted the very first Berlitz Franchises in Germany and France.

In 1907, the Société Internationale des Ecoles Berlitz (SIEB) was set up. The new company was managed by Benoît Collonge & Wellhoff. The value of the company was based on 30 schools owned by the SIEB, 20 schools belonging to partners, 27 British schools and the franchise rights of 260 centers in Europe, Africa, Latin America and Australia. North America and Canada were managed by the Berlitz Schools of America (BSLA), of which Maximilian Berlitz was President.  By 1910, Berlitz already had more than 400 centers around the world.

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One of the early Berlitz schools

At that time, French was a widely used language for business.  The French term that was used for Berlitz Franchises was “Concession”.

Berlitz started with five common types of Franchises:

  1. With obligation to open a Language Center in a city(ies), town(s) or a region (Designated Territory); within one year (Development Schedule)
  2. With obligation to open a Language Center in the Designated Territory within three years
  3. No obligation to open in the Designated Territory but payment of a higher annual [royalty] fee
  4. Franchise License for a private teacher to teach at a particular place; typically granted for smaller towns, or
  5. À la carte

Since the early years, the Berlitz Franchise Agreements were well-structured, and contained the modern Elements of Franchising.  Among other information, they contained:

  1. The use of trademark “The Berlitz School of Languages”
  2. The right and know-how to “open, operate and profit from a living languages school”
  3. Designated territory
  4. Term of agreement
  5. Renewal terms
  6. Use of “Operations manual” or detailed guidelines for the setup and management of the center, including advertisement, insurance, payment of taxes, heating and lighting
  7. Royalties, typically paid every 6 months
  8. Initial fee
  9. Transfer of Franchise rights upon agreement by Franchisor

By 1912, Berlitz Franchise Agreements where approximately 10 pages long and, in essence, they were very similar to the franchise agreements we use today.

Franchisees and their families were often housed in the school and managed the centers as family businesses.  Some centers were owner-operated and others had Center Directors, upon approval by Franchisor.  It was not uncommon for franchisees to own multiple units, even in multiple countries.

The Edwardian era was a period of expansion, where royals and celebrities were teaching or being taught at Berlitz Centers.  Alfonso XIII, King of Spain, was being taught English, French and German; while Leon Trotsky, James Joyce and Wilfred Owen were teaching at Berlitz centers in Mexico City, Trieste and Bordeaux, respectively.

Then, the period of the two World Wars came.  It was a veritable calamity for Berlitz.  The international and multicultural nature of Berlitz had encouraged mutual respect and admiration among its staff and students.  The company, which had always transcended borders, would become the victim of its own success.  Disaster was unprecedented.  Many schools closed following bombing raids, or as a result of regime changes or because of redefinition of national borders.  The Berlitz teams were largely made up of French, British and German teachers.  People who had been close friends would become future enemies**.

In 1940, during WWII, Thérèse Delpeux was elected President and Managing Director of Berlitz becoming, perhaps, the very first woman in history to lead a global organization.

After WWII, the era of The Wonderful World of Berlitz came**.  There was a fast recovery, mostly due to a special grant that the American Army awarded to all veterans based in Europe.  GI applicants living in Europe could register up to 25 lessons a week (1 lesson is 45 minutes) in one or more languages of their choice.  Then, in the Sixties, franchising took a second breath.  For companies and society, it was a carefree time of great optimism, renewal and rebirth.  Classes took place in an extraordinary atmosphere and coming to Berlitz meant combining the useful with the pleasurable**.

The Berlitz Opera center in Paris, also known as the “Palais Berlitz”, was a veritable hive of language activity.  It was frequented by stars from the world of entertainment (Maurice Chevalier, Louis de Funès, Gérard Depardieu, Claude Brasseur), politicians (François Mitterrand), members of royal families (the Duke of Windsor) , and other celebrities whose paths crossed in the enormous maze of classrooms (more than 100 in this center!)**.

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Gina Lollobrigida and President Nixon using the Berlitz Italian Book

In 1966, Berlitz was acquired by Macmillan Inc. and, changing corporate strategy, the new ownership did not allow franchises from 1967 to 1972, with the exception of those granted in perpetuity; these being mostly in Egypt.

Then, in 1988, Macmillan Inc. was acquired by Maxwell Communication Corporation.  Upon the death of Robert Maxwell in the early nineties, Berlitz became fully owned by Fukutake Publishing Company (now Benesse Corporation); previously, a minority shareholder. Today, Benesse is one of the largest privately held education companies in the world, with annual sales of approximately 4.5 Billion USD a year.

Today, Berlitz continues to be the leading language and communication skills training company worldwide.  It operates over 450 centers in more than 70 countries.  Berlitz has taught millions of people how to speak a new language, better communicate and helped achieve their dreams.

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From left to right: Mark Harris, Rogelio Martinez, Constant Reinders and Marc Verger, during the Berlitz 2015 Franchisee Convention in Zagreb, Croatia.

Special thanks to Mr. Mark Harris, Chairman of Berlitz Corporation, who appointed Mr. Constant Reinders to study, sort and protect the Berlitz archives containing over a century of Berlitz history.  And thanks to Constant Reinders who, after 40 years of service as Berlitz employee, took this new assignment and published the book “Berlitz – 130 Years of Innovation and Passion for Teaching”.  This article based most facts and figures from Mr. Reinders book.  ** indicates excerpts from Mr. Reinder’s book.

About the author: Rogelio Martinez, CFE, is the President of Berlitz Franchising Corp., www.berlitz.com.  He is a member of the IFA’s International Committee and speaks 5 languages.

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