October 22, 2018

Franchises Are Large, They Contain Multitudes

If there were a corporate-structuring taxonomy in which small businesses were humans and big businesses were horses, then franchises would surely be centaurs.

Franchises — like Subway or McDonald’s — consist of two entities: a large franchisor responsible for developing the products and marketing the brand, and smaller businesses that actually operate the physical locations that serve customers. This hybrid business model can deliver rapid growth at relatively low risk for the franchisor by leveraging the capital and resources of the franchisees. But it can also lead to thorny labor problems related to employer liability and no-poaching agreements. Activists and pundits on the right and left take opposing views on these two issues, but they have one thing in common: both are contradicting themselves.

The division of corporate responsibilities in the franchise model can be immensely beneficial for both employees and employers, but it also raises important questions. If an employee gets hurt on the job or is the victim of wage theft, who is liable? Is it only the franchisee, or is the franchisor also liable as a joint employer? Contracts between franchisees and the franchisor also often include a no-poaching provision, which means the franchisees are prohibited from hiring one another’s employees. Similar questions about employer liability and labor mobility apply when corporations use contracting firms to outsource jobs — such as janitors and security guards — that aren’t core to advancing their competitive advantage.

Joint employment, or co-employment, is when two or more companies share the control and supervision of an employee. Given the duties and responsibilities that come with being labeled a “joint employer,” the breadth of that definition has become a sticking point between businesses and regulators. Those on the right tend to argue for a narrow joint-employer definition, limiting the liability for large corporate franchisors and making it more difficult for employees to collectively bargain. (In the fight for a $15 minimum wage, negotiating with a single franchisor is much more feasible than trying to bargain with hundreds or thousands of franchisees.) Conservatives also believe that no-poaching agreements are reasonable restrictions to prevent some franchisees from free-riding off the investment in recruiting and training by other franchise operators.

Those on the left generally support a broader joint employer definition. In fact, in 2015 the Obama administration expanded the definition to include most franchise business models. It reasoned that if a franchisor can dictate staffing levels, when bathrooms are cleaned, and where trays are placed on counters, then it should share the legal duties and liabilities of an employer. Last month, the Trump administration proposed a rule that would roll back this change by applying the joint employer standard only to firms that have “substantial, direct and immediate control over the hiring, firing, discipline, supervision and direction of another firm’s employees.”

Liberals also worry that no-poaching agreements hold down workers’ wages by limiting competition for labor among franchisees. Research from economists Alan Krueger and Orley Ashenfelter found that 58 percent of major franchisor contracts included these “no-poach” provisions. Fast-food chains recently came under fire from 10 state attorneys general for including no-poaching clauses in their franchise contracts. In August, eight large chains, including Five Guys and IHOP, announced they would end the policies rather than fight the investigation.

The sets of policy positions held by business conservatives and labor liberals are internally contradictory. We should treat franchises as either one large business or many distinct small businesses. In the former case, the franchisor would be free to limit poaching within its system, but it would also be liable for its employees. In the latter case, the franchisor would not be liable for the workers employed by its franchisees, but it would also not be allowed to facilitate collusion to limit competition for labor. When considering how to deal with a specific labor practice, we should remember that each one operates in a broader constellation of employer-employee dynamics that requires a coherent regulatory regime.

Policymakers can argue about which set of outcomes is better for society. But they shouldn’t pick and choose to satisfy their favorite interest group.