In the 20th century, big corporations sold franchising to Americans as a less risky way to buy into business ownership. But in recent years, the franchise industry has tipped hugely in favor of franchisors, extracting wealth from both franchisees and the employees who work for them through complicated contracts that kill competition and rig the system. Economist Marshall Steinbaum returns to the podcast to share the findings from his deep dive into the (intentionally) complex and arcane franchise system, and to explain the latest data from Washington State’s recent enforcement campaign against no-poach clauses in franchising contracts.

Marshall Steinbaum is an Assistant Professor of Economics at the University of Utah and a Senior Fellow in Higher Education Finance at Jain Family Institute.

Twitter: @Econ_Marshall

Vertical Restraints and Labor Markets in Franchised Industries https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4155571

The Effect of Franchise No-poaching Restrictions on Worker Earnings https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4155577 

David Goldstein:

You have so many people employed in an industry that is designed to be arcane and complicated so as to disempower them and lower their wages.

Marshall Steinbaum:

Basically, the structure of the franchise system is such that the national chain earns all the profits and has all the power, but the workers who work at the individual franchising restaurants who have no way of bargaining directly with or gaining access to the profits of the national chain.

Nick Hanauer:

It just makes you feel different about walking into that McDonald’s, doesn’t it?

Announcer:

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Nick Hanauer:

I’m Nick Hanauer, founder of Civic Ventures.

David Goldstein:

I’m David Goldstein, senior fellow at Civic Ventures.

Nick Hanauer:

Goldie, in a wide-ranging conversation with our old friend Marshall Steinbaum a few weeks ago, I was reminded by how much great work he’s done on the nefarious labor practices of franchises. Since we last had Marshall on the pod, he’s done a lot of really great research dissecting this fairly complex and arcane corner of labor law and our economy. I’m super excited to get to chat with him today about the research he’s been doing and to share with us the results of some changes that were spearheaded here in Washington among other places.

David Goldstein:

Right. A state where we don’t have franchises anymore because we imposed restrictions on them.

Nick Hanauer:

Exactly.

David Goldstein:

Made them pay their wages of their workers more and restricted no-poaching agreements and so forth, right?

Nick Hanauer:

No, yeah. We still have McDonald’s. They’re all still here. In the research for the pod, I quickly read some of his recent papers. What really struck me about his research is how it’s just complicated. I suppose it’s complicated for a reason, which is the more complicated it is, the harder it is for ordinary people to see through these business models and understand the way in which they take advantage of people. But with that, let’s chat with Marshall about his research and learn more about franchises.

Marshall Steinbaum:

I’m Marshall Steinbaum, assistant professor of economics at the University of Utah. I study labor markets and, in particular, power imbalance between employers and employees in labor markets. And that is what I always enjoy discussing with you.

Nick Hanauer:

Fabulous.

David Goldstein:

It’s always great to talk to an economist from one of the most progressive economic departments in the country. Who knew it would be in Utah?

Marshall Steinbaum:

Well, you know why that is. It’s because they kicked us out of Berkeley when you had to sign a note saying you’d never been a member of the Communist Party. A couple of my forbearers were unable to sign that oath. Earl Warren, the delightful governor of California, kicked them out of the state and so they migrated over here across the mountains to Salt Lake City.

Nick Hanauer:

I love it. That’s so funny. Marshall, you’ve got a bunch of papers out that focus on the labor practices within the franchise industry. First, what drew you to that little world? Obviously there’s a lot of complexity there, but just describe what’s going on generally.

Marshall Steinbaum:

Two things drew me to that world. One is that there, at least for a long time up until recently, was a consensus among economists and judges and the law and economics broader universe that franchising was a very efficient business model that the law should encourage to be taken up by more firms and to penetrate the economy more deeply. The reason why was because the ability of franchisors that is national chains with a recognizable brand that do something that consumers know about.

Think McDonald’s and its restaurants, all of them have Whoppers, all of them have the Dollar Menu. That is set at the national level, and then individual franchisees who own and run the restaurants are obligated to conduct their business in the manner prescribed by the national chain of McDonald’s. That business model was thought to be economically efficient and so the law should encourage it. Whenever I see a consensus among economists that sets my antenna off-

Nick Hanauer:

Thank you, Will Rogers.

Marshall Steinbaum:

-that is something wrong that needs to be corrected, let’s just say in that little subfield. That is one big way I got into it. The other way I got into it was learning more about how the world actually works from people like David Weil and other labor scholars who are more in touch with the ways that workers get screwed over, Theodore Runyon, in the labor market. A big one is that the franchisee is legally independent of the franchisor, which means that the workers basically are segregated away from the profits. This is one of the many ways that the so-called fissure workplace, as Weil has coined it, have proliferated in the economy.

Imagine that basically the structure of the franchise system is such that McDonald’s corporate, the national chain, earns all the profits and has all the power, but the workers who work at the individual franchising restaurants who are the ones being screwed by employer power in the labor markets have no way of bargaining with or directly with or gaining access to the profits of the national chain. This is a mechanism that employers have learned to use over and over again throughout the economy, which is to say, let’s keep this broad legal distance between the people who do the actual work and where the money is made.

Because the workplace as traditionally conceived where it’s one factory where the people who do the work are the same places where the money gets made, that’s an egalitarian social mechanism in the sense that workers have to be paid the same. If you see the CEO has a giant new yacht, then the workers are going to demand a raise. What the firms want to do is basically erect all these barriers such that the workers have no way of gaining access to the benefits of what I’ll call is the lead firm.

A couple years ago, there was a really nice piece in The New York Times by Neil Irwin, which I teach to this day, about janitor workers at Kodak, the camera and film manufacturer, the canonical lead firm of the old economy or the manufacturing economy in Rochester, New York, versus janitors at Apple and its headquarters in California where Apple represents the new economy and the fissure workplace. The Kodak janitor was an employee of Kodak.

Consequently, when Kodak had a firm policy that said, we’ll pay for workers to go to school, basically like continuing education, she got qualified in software, Lotus 1-2-3, for those who are old enough to remember, which I am not, and was one of the first people at Kodak to know how to use it, trained other people at the company to use the software, got promoted, and ultimately became the head of IT for the entire company. A senior executive at this world leading corporation from janitor versus the equivalent janitorial worker at Apple, who is not employed by Apple, has no access to company benefits because it’s a lead firm, and consequently, no way of moving up in any corporation.

She works for a janitorial services firm, santorini is all that they do, and there’s no equivalent mechanism to move up the rank. I thought that was a very telling illustration of the fissure workplace. The franchised industry or the franchising sector, if you want to call it that, is a very notable example of how it’s grown mightily over time.

Nick Hanauer:

I suppose it’s recognizable to anybody who’s listening to this conversation, but the franchising business is a large business. This is not some tiny corner of the economy. Do you happen to know what proportion of American workers work for franchisors? I think they try to hide that too, don’t they?

Marshall Steinbaum:

Yes. Unfortunately, I can’t answer your question. It is actually very high on my to-do list to exactly answer that question, and I have not done it yet because it is a very large number, as you say. We write about 530 franchising chains in the fast food industry, in hotel and accommodation, among cleaning service workers like personal services, which is fitness and beauty chains. That is a very wide swath of the low wage labor market in particular. I don’t yet have a number for exactly how wide of a swath it is, but that is on my to-do list to come up with, but it is way higher than some of the other…

We write about the effect of no-poach provisions, which I hope we’ll get into, that is prohibitions on one franchisee hiring workers from another franchisee. That kind of prohibition covers a large swath of the low wage workforce, that is it restrains their ability to switch jobs and thus to have a free market for their labor. In our view, a major constitutive element of the disempowerment of low wage workers. I want to quantify exactly how big of a disempowerment it is exactly along the lines that you’re saying.

Nick Hanauer:

But sufficed to say that that franchise employees must represent… I mean, it must be close to 50% of the low wage workforce or something like that.

Marshall Steinbaum:

Yeah, I think you’re in the right ballpark, 50% of the low wage workforce, many tens of millions of American workers. Yes.

Nick Hanauer:

In your papers, you talk about vertical restraints generally. Can you describe a little bit about what that means?

Marshall Steinbaum:

Yeah. The franchising business model, as I said, has this national chain that has a brand that consumers can recognize and assert certain services or products that go along with that brand, and then the local franchisees essentially carry out the work. The question is, how does the national brand make the local franchisees do what they want? How does it make it so that every McDonald’s has the Dollar Menu on offer at the same price of a dollar? That’s a good example because the franchisees don’t want to offer the Dollar Menu if it was up to each individual one. They lose money on that. Too cheap, basically.

But McDonald’s corporate says that’s how you get the people in the door knowing that they can get a McDollar Menu at any McDonald’s in the country. And then once they’re in the door, you, franchisee, might be able to sell them something more expensive. You should want to offer the dollar… I should say, the individual franchisee should want to offer the Dollar Menu so that every consumer knows that that’s part of the McDonald’s brands and every McDonald’s that they walk into can offer it, even if the individual franchisees are losing money on that aspect of their menu.

The vertical restraint is how the franchisor, McDonald’s in this case, makes it so that there’s a Dollar Menu on offer in every McDonald’s restaurant in the country. There are two specific vertical restraints that go into that, broadly speaking. One is what’s called resale price maintenance. That’s the antitrust vertical restraints jargon word for it, meaning the retail prices, the dollar in this case, what consumers have to pay for an item, that gets set by the franchisor who’s not legally a party to the transaction. You go into a McDonald’s, buy an item off the Dollar Menu. That costs a dollar.

Only the franchisee is a party to that contract and the consumer, not McDonald’s corporate, but McDonald’s corporate, this third party, does get to set the price at a dollar. That resell price maintenance is one such restraint. The other one is so-called full-line forcing. This is another jargon term that says that the individual franchisees can’t pick and choose among the McDonald’s menu items which ones they want to offer. If they are a McDonald’s, then they have to offer all of the items, specifically the Dollar Menu, which is the one they wouldn’t want to offer because that’s the one where they’re losing money on it.

It’s a loss leader, basically. Nonetheless, McDonald’s corporate can force them to say, “You know, have our trademark, the golden arches outside your restaurant. Therefore, you have to offer the Dollar Menu. You can’t drop it even though you’re losing money on it.”

Nick Hanauer:

I mean, let’s jump to the no-poaching thing. There’s bad news and good news there, I think.

Marshall Steinbaum:

I agree.

Nick Hanauer:

But it’s emblematic, I think, of the nefariousness of these approaches. Describe that.

Marshall Steinbaum:

The no-poach is an extension of the whole idea of vertical restraints, I would say, taking it one step further is given that we have all this legal precedent that says the franchisors can force the franchisees to do things like charge a given retail price, carry all of the menu items that the franchisor wants them to carry, the franchisor can also force the franchisees to treat their workers like shit. And in particular, not hire workers from other franchisees in the same chain. That is a vertical restraint that the franchisees would like.

If you think about full-line forcing and resell price maintenance as being things that disadvantage the franchisee because they have to do something that they don’t want to do that’s unprofitable for them that the franchisor imposes, the no-poach agreement basically is a pact among all the franchisees that says, if I don’t hire your manager to work at my restaurant and offer them a raise, you don’t hire my manager to work at your restaurant and give them a raise too, so we don’t have to bid against each other for the workers that we need to run our business.

Those restraints, even though they apply in many cases to all the workers at the franchisee, my inference from the research that we’ve done is they’re really directed at the managers of the individual franchising establishments. You think of a McDonald’s store manager as someone who knows how McDonald’s does business, has been to the so-called Hamburger Academy, which is the training system that McDonald’s corporate runs centrally in Illinois where they’re headquartered. That person is skilled at running a McDonald’s franchised restaurant.

Another franchisee might say, “Okay, well, I want a manager who knows what they’re doing. I’m going to go to the guy on the other side of town or in the next city over or whatever and get one of those managers to come work at my restaurant.” The franchise no-poach says you’re not allowed to do that, and the franchisees like that. Again, it’s a pact not to poach from one another. It can be orchestrated. I mean, this is a controversial view. There was a court hearing a couple of months ago on this question of whether the no-poach restraint is horizontal or vertical.

Most economists have by default considered it vertical because they see it as no different from the resell price maintenance and full-line forcing I was previously talking about. It’s something the franchisors are imposing on the franchisees, but it has a more horizontal aspect to that in the sense of orchestrating this agreement among parties at the same level of the supply chain, the franchisees, not to hire workers from one another.

The court was basically saying if it is really a horizontal restraint masquerading as a vertical restraint, then the legal liability is more threatening to the restraint. If the Seventh Circuit overrules the district court judge on that horizontal versus vertical question, that will revive a number of court cases on behalf of workers who were screwed by the franchise no-poach.

Nick Hanauer:

Okay, so this is like an internal non-compete.

Marshall Steinbaum:

Exactly.

Nick Hanauer:

You can see quite easily why it’s terrible for workers effectively if your skills are insulated from competition, I guess is what it is.

David Goldstein:

Nick, why do you hate capitalism? I mean, McDonald’s spends all this money building this capital in their managers by paying to send them to McDonald’s University. Obviously McDonald’s owns that human capital, not the actual humans.

Nick Hanauer:

Yeah, exactly. But the good news here is that our good friend Bob Ferguson, the Attorney General in the State of Washington, took a swing at this. Correct?

Marshall Steinbaum:

Indeed he did. I would say that campaign undertaken by the Washington State Attorney General was a great success we found in our research. There’s even more good news than that, but let me tell you about that good news, and then I’ll tell you about the other good news. The good news from Washington is we’re showing in our recently released working paper that enforcement campaign.

What the enforcement campaign consisted of is looking at all of the franchise chains that are active in Washington State, seeing whether they have a no-poach in place, suing them under state and federal law, I believe, to say your no-poach provision violates those laws, and then imposing a settlement of those lawsuits that says you have to take away your franchise no-poach provision. That creates what economists like to call a natural experiment where chain by chain we go and see what happened to chain specific wages when each one entered into that settlement that said we’re going to take away the franchise no-poach.

It makes a nice control group. In fact, a couple of different nice control groups as the paper goes into, in the sense of comparable employers who did not take away their franchise no-poach because they weren’t sued by the attorney attorney in effect. There’s a couple reasons why employers wouldn’t be sued by the attorney general. One is their franchise chain who has no presence in Washington. Another is that they’re a franchise chain that didn’t have a no-poach before, so there was no basis on which to sue them.

There’s no basis on which to impose the settlement. And then we have a couple of much broader control groups that just look at more or less employers in general, like how do these specific chains that were sued differ from all employers. In economics, you typically have a debate over the validity of each of these control groups. The strength of the paper is basically it doesn’t matter which control group you choose, you find the same thing regardless, which is entering into such a settlement, increased wages by a significant degree especially for store managers.

We find an effect size of something like 3.6% of annual wages for the workers at the chains that enter into those settlements. It’s higher. It’s in the neighborhood of 8% for managers at employers who entered into those no-poach settlements. That’s a great success for the attorney general of Washington, increased wages by… The effect size is something around $800 for all workers. I would guess for managers, it’s significantly more than that.

Nick Hanauer:

Can I ask you a clarifying question?

Marshall Steinbaum:

Sure.

Nick Hanauer:

I mean, obviously that amount will increase with time. How soon after the change did you measure the difference?

Marshall Steinbaum:

We go about three years after the change. I might extend it. We’re until the end of 2021. We have a whole set of specifications that’s like end in February 2019 just because the COVID pandemic, you might think like, oh, it’s a very chaotic time in the low wage labor market. Maybe you think that something else happened. At that point, you want to roll those out. Actually the pre-COVID specifications have larger magnitudes in general than the ones that include all the way to the end of 2021. I mean, I don’t think you need to drop the COVID era outcomes.

My preferred specification as the case goes or as the saying goes is until December 2021. This is for the longest treated chains, the ones that were treated first in July 2018. That is the first ones who settled with Washington State Attorney General in July 2018 that says that they’re being measured from August 2018 through December 2021, compare their wages at that time to before they entered into the settlement and also to the chains that did not enter into a settlement.

David Goldstein:

It’s weird because despite the government interfering in the perfect efficiency of the market, we still have all these franchise chains here in Washington State.

Marshall Steinbaum:

Yes. Oddly enough, despite having to pay their workers more or bid for their labor, they have an all shut down shop and said, “We’re leaving.” I’m sure they’ve threatened that, maybe not in response to this particular set of lawsuits, but in terms of other things that have been done in Washington. Somehow those threats never are made good. In fact, it’s worth further congratulating the State Attorney General. One chain, Jersey Mike’s, which has a reputation of being an especially nasty employer, did try to fight.

Most of the chains that were sued essentially agreed to the settlement of we’ll take our no-poach provision away without a fight because what the AG was offering was generous in some sense, no liability for having had it in the past. The AG was saying, “This is illegal. You have to take it away, but we won’t make you pay up for the damage that you caused in the past through this illegal action.” Most chains took that deal right away. Jersey Mike’s, this especially nasty chain, said, “No, we’ll fight,” and they got knocked out in round one, or at least they lost round one of the fight, and then they gave up.

They signed the settlement, plus had to pay a little bit more, which the other chains got away without because they didn’t fight through round one. That was good. I want to say also other good news which… Actually before I say that, to limit the importance of the Washington AG enforcement, one, as I said, it didn’t impose retrospective penalties. Workers that had been harmed by this illegal behavior have not been compensated and the private lawsuits that are seeking those retrospective penalties have not fared so well.

That’s what the Seventh Circuit hearing was about. Hopefully the Seventh Circuit will overrule the district court judge in that case, and then that will reopen the question of back pay for the workers that were harmed by the illegal conduct. The other thing is it only applies to the chains that entered into the settlements. As I said, the chains that entered into the settlements had to have two things. One, they had to be in Washington. The other is they had to have already had a no-poach in order to be sued in the first place.

There’s a bunch of chains that either didn’t have a no-poach to begin with, so in principle could later add one because they haven’t been bound by such a settlement, or they just weren’t in Washington at all, so they never had to take it away. There’s a couple of ways that there’s further available action for policymakers to tamp down on franchise no-poaches. One of them, Minnesota, just did. It certainly passed the legislature. I think the governor signed it, I forgot to look that up before we got on the call today, of basically prohibiting this as a matter of state policy.

Now it’s the case that no chain that’s active in Minnesota can have a franchise no-poach. Now, the jurisdiction of that policy presumably is only in the State of Minnesota. You can imagine a chain that doesn’t have a settlement with the Washington State AG that operates in Minnesota where they have to not have their franchise no-poach enforceable in Minnesota, but could have it operable nationally. This is why there’s room for federal policy.

At some point, I had hoped and I still hope that the Federal Trade Commission will adopt a rule that prohibits franchise no-poaches across the board. Just if you’re in the United States, you can’t use a franchise no-poach. I think there’s ample evidence justifying such a rule. The fact that there’s still some loopholes despite the Washington State AG enforcement plus the prohibitions that are active in some states, this says it’s time for the Feds to plug up all of the holes, so to speak, and just make it a blanket policy.

Nick Hanauer:

You don’t think the proposed elimination of non-competes covers that?

Marshall Steinbaum:

It explicitly does not cover exactly this. It’s actually wider an application and a very significant policy in its own right. Well, I shouldn’t say it doesn’t cover this. I could imagine there will be a court case. Supposing that rule gets adopted, then I can imagine a lawsuit from… The power of that rule is that only the FTC can sue. That doesn’t allow private plaintiffs to sue. I could imagine a lawsuit where the FTC sues basically enforcing the edges, the boundary cases of their own rule that says, actually this does apply to franchise no-poach. I don’t want to pre-judge that lawsuit against the FTC, but I think I would say that the FTC is…

The non-compete rule covers all employers. It’s not delimited to franchises or not franchises or any other employer. The FTC separately regulates franchising as a business model, as a sector itself. There is where I hope they would adopt the no-poach role that says franchises are not allowed to do this. To clarify that as a condition of being a franchise, basically you cannot use a no-poach. Right now the FTC has a request for information out, meaning the public should weigh in on franchising in general as a business model.

Franchisees workers should file comments in response to the FTC’s request for information that says basically how they’ve been screwed by no-poaches and other elements of the franchising relationship. I’m drafting up a comment right now that I’ll file in response to that request for information. My hope is that that is the first stage towards the FTC doing what I’m saying about altering the franchise regulation in order to specifically prohibit this.

Nick Hanauer:

You said there was even more good news though, correct?

Marshall Steinbaum:

Oh, that was the Minnesota battle.

Nick Hanauer:

The Minnesota. Okay, that’s great. My intuition is that there is a way… I mean, the franchise model does make some sense in terms of a market economy. Somebody comes up with an idea, doesn’t have the capital to expand and other people pay for the right to be in that business. Is there a form of franchising that wouldn’t be coercive and corrosive?

Marshall Steinbaum:

That’s a great question. I am definitely not of your opinion, Nick. I think that franchising is basically labor exploitation institutionalized. What you’re describing is exactly the reason why it’s allowed to exist at all, why would there ever have been a thought of let’s encourage this business model, not have the laws dismantle it from the get-go. It’s true that you can develop a business idea and then basically expand and distribute it in such a way that doesn’t require the upfront capital to begin with. It’s sort of like the proverbial inventor in a garage comes up with a great new idea, but doesn’t have the capital to take it to scale selling the idea or going into a partnership with someone who does have that capital.

That’s how the capitalism is supposed to work. My study of the franchising sector says that isn’t really how franchising functions. The way franchising really functions is as this labor middleman type business model. It’s like we have a national business, but we don’t want to pay our workers or we don’t want to include workers in the fruits of this valuable brand or valuable business model. We can exclude them and then we hire the franchisees as labor middleman. Basically their job is to screw over workers and get our product out into the market. How would you change franchising? It’s more like what you like, Nick, and less like what I’m criticizing.

I think you have to take away the vertical restraints. I mean, most of them. The key thing about the vertical restraints is that they channel the franchisee’s profitability such that all they can do is screw over workers in order to make money. If you lift the vertical restraints, then you give them the genuine independence of actual small business people and they wouldn’t be so dependent on labor exploitation to make a profit. They might come up with new businesses of their own or seek out new customers. For example, one of the vertical restraints that could potentially be bad for expansion is one franchisee is not allowed to try to poach business from another.

You could see why the franchisors might like that. The franchises might think, well, the good franchisee could take business from the bad franchisee, and that’s how capitalism’s supposed to work. Why does the law prohibit that? If the law doesn’t prohibit that, then you’re opening up the opportunities for genuine small business people to be capitalists in and of themselves and operate their business as they see fit, not as the franchisor is telling them. I would say the rebalancing the franchising business model to be more pro-social, doing what it’s supposed to be doing, is to weaken these vertical restraints, not strengthen them.

The status quo is in order to do what you’re saying, Nick, you have to have the vertical restraints be very onerous and I’m saying basically the opposite. In order to do what you’re saying, you have to have the vertical restraints non-existent so that the franchisees have genuine independence and can operate their business in their own way.

David Goldstein:

And to be clear, historically, none of this is coincidental. This was always part of the franchise model was to disempower labor. I mean, that was intentional from the beginning.

Marshall Steinbaum:

I don’t know if I would agree with that, honestly.

Nick Hanauer:

I was in the franchise business for a minute, and that is definitely not something we talked about. We were just like, we couldn’t afford opening stores in other places.

David Goldstein:

But it was certainly part of McDonald’s model was… I mean, you can’t unionize the franchises because you have to go and unionize all these individual stores instead of unionizing McDonald’s. This is a way to get around that. Also, Nick, I just wanted to point out on that idea of it being less capital intensive. Again, with McDonald’s, that’s not the way it works. McDonald’s actually buys the land and leases it to the franchisees and often lends them the money to build their stores. There’s a lot of capital investment from McDonald’s corporate in these individual franchisees.

Marshall Steinbaum:

That’s a great point that I think raises up the idea that the franchisee himself, him or herself, might be more akin to an employee than a partner, so to speak, or a lender even to the national chain. What Goldie said is right about the ring-fencing unionization and collective bargaining. I was just reading an interesting paper in the latest issue of the Journal of Law and Political Economy about some Canadian cases over franchising.

Basically the fact pattern there in one of those cases was a commercial bakery that had a bunch of unionized delivery drivers in its national chain and outsourced them all, so abrogated the union contract, laid off all of the unionized drivers and then said, “Oh, but you can be a franchisee as a small business. Buy back essentially your delivery route from us, but you have to abide by all of these restrictions. You can’t poach business from one another, for example, and you have to service the exact customers we tell you to.” That’s more like sharecropping, which is to say more like the gig economy.

To get back to how did I get into studying franchising, in some ways from the gig economy, which I view as an outgrowth of franchising, which is even more disempowering because the individual rideshare drivers, for example, are more akin to franchisees.

Nick Hanauer:

Franchisees.

Marshall Steinbaum:

Yes, exactly. Exactly. I think that gray area in labor law and antitrust law has given rise to these very exploitative business models that are exactly along the lines of what Goldie is saying. The gray area is the problem. What I have prescribed repeatedly in my academic research and public comments, articles, whatever, is you need to restore the sharp boundary between employment and independent contracting. The problem now is that you’ve got this gray area where you have a worker who doesn’t have labor rights, so no collective bargaining, no minimum wage, no health insurance, but can be fully controlled by there would be employer.

Instead, the employers have to be forced to make a choice. It’s like if you want control, then you have to pay minimum wage and abide by labor law. If you don’t want control, then you have to give genuine independence in the form of relief from all of these vertical restraints, like you can’t tell which individual gig worker or which franchisee, which customers they’re allowed to service. They have to be able to attract business on their own account.

Nick Hanauer:

Right. Can I ask you another couple of clarifying questions? I don’t doubt that the franchise model is optimized to extract maximum profits for the franchisor at the exclusion of wages for the frontline workers. Of course, no one buys a franchise unless they’re headed in pretty much the same direction. You don’t want to own a McDonald’s if it’s not profitable to do. But have you done your divided bys on how much profit the franchisors extract relative to the wages of the frontline workers? Is it that extractive?

Marshall Steinbaum:

Here’s how I would characterize it. The franchisors extract a lot from the franchisees leaving them with crumbs to nothing. In fact, a negative amount. And then the franchisees say, “I can’t do business this way. You’re running me into the ground,” and the franchisor’s response is, “Oh, just pay your workers less.” In fact, there’s a good article from like 2014 by Lydia DePillis I think at The Washington Post that has that exact thing of a McDonald’s franchisee saying, “I can’t carry the Dollar Menu. I’m losing too much money,” and McDonald’s says, “Just pay your workers less,” basically.

That conceptualization really puts the franchisees and the workers on the same side, which I think a lot of labor people, people who work in labor advocacy, really reject that idea, because in their view, the franchisees are the enemy. If you think about McDonald’s workers asking for a $15 minimum wage, the person on the other side of the bargaining table saying you can’t have a $15 minimum wage, are the franchisees. They view those interests as fully opposed. I don’t buy that.

I think that an alternative political economy is one where the workers and the franchisees have a joint interest in limiting the power of the franchisors and mitigating vertical restraints so the franchisees have more autonomy over their businesses exactly aligns the interests of workers and franchisees.

Nick Hanauer:

Let me ask you the benevolent dictator question. If it was you and you were writing franchise law, what would you do? Would you eliminate them all together? What would you do?

Marshall Steinbaum:

No, I would do what I described earlier, which is sharp, bright line between independents and dependents. If you want to control what the franchisees are doing, then you have to vertically integrate. They have to be part of your business and there’s no legal distinction. Then you have McDonald’s corporate employing all of the people who do the cooking and everything. That creates the equitable political economy like at Kodak in the olden days where you could be a line cook at McDonald’s, avail yourself of a company benefit to retrain, and eventually become CEO. I mean, that’s the dream, so to speak.

That’s vertical integration. Or else, if you don’t want to employ the workers, then the franchisees have to be genuinely independent. What does genuine independence look like? Fast food chains that are McDonald’s and Burger Kings, or if that’s going a step too far, at least they have the right to charge whatever prices they want and source inputs from wherever they want. A big grievance, again, of the franchisees is they have to source inputs like hamburger meat or whatever, potatoes, cooking oil. Actually there was a great article about the ice cream machines in McDonald’s being a total disaster, which the franchisees are obligated to license.

Basically those are kickbacks from the supplier to McDonald’s corporate. They overpay for the ice cream machine and the ice cream machine company gives a kickback to McDonald’s corporate. That’s legal basically other than under state kickback laws. There have been some lawsuits about that, but that should be illegal. Basically the franchisees, if they’re not employees of McDonald’s, they should have the ability to run the business however they want and get their ice cream machine from whoever they want, that is whoever gives them the lowest price for the highest quality ice cream machine, not whoever McDonald’s tells them to.

Nick Hanauer:

One final question, why do you do this work?

Marshall Steinbaum:

To empower workers. Having studied the question of why workers are disempowered, this is a big reason why there’s lots of complicated legal shenanigans going on behind the scenes that have the effect of segregating workers away from profits and segregating away from one another so that they can’t join together collectively bargain and seek an equitable distribution of power and resources. I view all of what we’ve been talking about today as necessary conditions for restoring and building an equitable political economy in the labor market in the country and economy as a whole.

Nick Hanauer:

I love it. Well, thank you so much for being with us and explaining this arcane corner of the economy to us and our listeners. It’s so interesting. It just makes you feel different about walking into that McDonald’s, doesn’t it?

Marshall Steinbaum:

Well, it’s hard to avoid. It’s hard to avoid. I have some photos in my slide presentation about this that show shopping centers in Utah, and basically every single store in the shopping center is a franchise chain, whether you like it or not. It’s not just walking into McDonald’s, there’s basically no consumer choice over this. You are consuming from the franchise poison chalice, so to speak.

David Goldstein:

A couple times, Nick, you described the franchise industry, the franchise model as arcane and complicated, and yet it’s odd that such an, as you say, arcane corner of the economy employs so many people.

Nick Hanauer:

Yes, it does.

David Goldstein:

Right? You suggested earlier that there must be a reason for this, and there is, but it’s not a reason as in the way that orthodox economics will often say, “Well, that’s just the way the economy works. It’s a law of nature. That’s the reason why it works this way.” No. The reason why it works this way is that it’s been intentionally designed to work this way to benefit the franchisors.

Nick Hanauer:

What you learn from talking to Marshall is that over decades, a bunch of different regulatory changes were made to advantage the people with the money and the power and disadvantage the workers in the process, right?

David Goldstein:

Well, no. In capitalism, that never works that way, right? Because I thought it all trickled down.

Nick Hanauer:

It’s at both levels. I mean, laws, norms, and practices that advantage the franchisees, franchisors, and a bunch of practices like the no-poaching agreements that benefited the franchisees, not much that benefits the employees of the franchisees for sure. It’s very interesting. One of the things that also some of our listeners may have been surprised that a person like Marshall who has put so much of his energy into understanding this business model could not easily tell us how many workers work in franchises.

There is a reason for that, and that is that the franchise industry has worked assiduously to hide that number from the public because they don’t want people to know. They don’t want people to know how big it is relative to the rest of the economy. Because if people knew, it would draw more scrutiny. The BLS, for example, does not report that.

David Goldstein:

A great example of that, by the way, Nick, was infamously the minimum wage study in Seattle early on when their early reports and they reversed it in their later reports. Their early reports were claiming that it looked like it resulted in job losses and no higher pay. It didn’t include franchises because the data wasn’t there for them to include franchises. They didn’t know how many of these employees were in Seattle or outside of Seattle. The segment of the low wage industry that was most dramatically impacted by the $15 minimum wage was excluded from the study because there just wasn’t good enough data to include them.

That’s how ridiculous this lack of transparency is. I will say, again, back to this idea that it is complicated, it’s intentionally complicated. We’ve talked about this. We’ve written about this some years back in the Journal of Democracy. We have this piece on shared security in which we talk about how complicated the franchise and contract and gig economy is. Again, it’s complicated for a reason because they’re trying to muddy these divisions, this idea of classifications of what type of worker you are. We use this example, by the way, of the hotel industry, which you might not know, your Hilton or Sheraton or Marriott, these are mostly franchises.

But it’s even more complicated than that because the front desk might be franchised out to a hotel management company and the restaurant is franchised out to somebody else. And then there’s the housekeeping. These are contractors from yet another company. None of these people actually work for Hilton or Marriott. They’re working for all these other companies. I think what we proposed back then was the very simple solution is that work is work and we stop it with these classifications altogether. That if you’re working, you get a certain amount of benefits. There’s ways to devise what those costs are and who pays them.

That sharp line that Marshall wants to restore between what is a franchisee and what is an employee, I think that needs to be done throughout the industry so that we take away the opportunity to play these games, which is what so much of the gig economy and the franchise industry is about. It’s about playing these classification games so as to disadvantage workers, to empower them even less.

Nick Hanauer:

Well, it’s super interesting conversation. Little wonky, but very important. It’s just a really important thing for people to understand if they want to understand how the economy in the United States of America actually works.

David Goldstein:

Or doesn’t work for a huge swath of Americans, which by the way is why the middle class is suffering. You have so many people employed in an industry that is designed to be arcane and complicated so as to disempower them and lower their wages and pull them out of the middle class and, as in that Kodak example, deny them the opportunity to rise into the middle class because that path no longer exists.

Announcer:

Pitchfork Economics is produced by Civic Ventures. If you like the show, make sure to subscribe, rate, and review us wherever you get your podcasts. Find us on Twitter and Facebook at Civic Action and Nick Hanauer. Follow our writing on Medium at Civic Skunk Works and peek behind the podcast scenes on Instagram, @pitchforkeconomics. As always, from our team at Civic Ventures, thanks for listening. See you next week.