How Franchise Restaurants Opened the Door to the Gig Economy

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2:13Hello and welcome to another episode of the Odd Thoughts Podcast. I'm Tracy Alloway. And I'm Joe Weisenthal. Joe, I will fully admit, I think I have a romanticized view of fast food chains. Yeah, you're the only one. Yeah, I know. No, I mean, literally. I know. I like fast food chains. I don't have a romanticized view of them. I blame coming to America and the restaurant that was in there and also my overseas upbringing that probably made American fast food seem a lot more exotic and interesting than it perhaps actually is. But I was thinking the other day about the

2:46franchise model. It is really weird once you start digging down to it because it's like this in coming to America is you have the small business owner. They want to be all entrepreneurial. So they get this franchise. But then everything is basically dictated to them about how to do the business by the actual corporate franchise owner. Wait, in coming to America, he didn't open a McDonald's. No. He opened a McDonald's. It was. Yeah. Right. But no, but that was the whole thing. There was like a legal fight against, you know, because they claimed that like he won't. But he won't. But he

3:20wanted to do it his own. It's a good memory, Joe. I mean, he really just wanted to commit intellectual property theft. I mean, that's really what was going on. I suppose you could tell an optimistic version. He wanted to go his own way and do his own thing. But he was really just committing. I love it. It's a perfect summary of why people are interested in the franchise model, which is like, OK, you're ostensibly supposed to be your own business person, I guess, independent. But you get a leg up because you get that like built in customer base and the existing brand and all of that. But to your point, like the pitch in many franchise-esque relationships, it's like this is

3:56your chance to be an entrepreneur, et cetera. Except when you think about entrepreneurship, you don't think about like so many constraints. Like here's the thing and here's the price and here's the thing, you know. And also in a typical entrepreneurial environment, there is quite a bit of like, you know, people often go into entrepreneurship for like big like right tail outcomes, you know. So, for example. Yeah, the big payoff. Yeah. And so, like, for example, I remember, you know, in the I guess you still hear it, but like the glory days of like Uber and stuff like that or being like an Amazon van driver or something like

4:28that, they talk about start your own business. And on some level, it was like on paper, it's like there was legally a business. It's not going to be like a high scale, high margin business the way many people hope for when they do, quote, entrepreneurship, unquote. The sort of like parameters of the outcome, it's like, OK, maybe they've taken off some of like the really bad outcomes, but it's not the sort of like really good right tail outcomes that many people associate with like the aspirations of the entrepreneur. Well, this is the other thing I'm interested in, because certainly in in the 80s and 90s, you would

5:02hear stories about people who became relatively wealthy by running like franchise empires. So I'm curious if that still exists. But the other thing that's really interesting to me is like, OK, you're an independent owner of a franchise. What levers do you actually have to pull to improve the business? I know. I always think like sometimes you see those stories, again, not to keep picking on McDonald's, which we both love, but like you'll see these stories from time to time about like a bad product rollout, right? They introduce a new sandwich and nobody likes it or something like that.

5:34And I always think, man, it would be so annoying to be a franchisee and to be at the whims of some like how much do they have to carry the sandwich? Can they change the price? Like, you know, you're really putting a lot of faith and money on people who like make big decisions that are or you're like, let's say you run a bad ad, right? Let's say you run an ad that McDonald's corporate runs an ad that tarnishes the whole brand, which could could theoretically happen. And it's like you've just like totally outsourced some of your future outcomes. A CEO seems reluctant to eat their own meal product.

6:06Oh, yeah. Okay. Well, we should talk about, I guess, the franchise model and the franchise economy, because it is really interesting. Yeah, we've never done a franchise episode. So I am happy to say we have the perfect guest. We're going to be speaking with Brian Kolachi. He is the chief economist at the Open Markets Institute and author of the book Chains of Command, The Rise and Cruel Reign of the Franchise Economy. So, Brian, thank you so much for coming on AdLots. Yeah, thanks for having me. Can you maybe just give us an overview, like the actual legal and corporate structure of a

6:39franchise? What does it look like and how does it differ from, I guess, either like... McDowell's. McDowell's. Yeah, there we go. Yeah. So legally, it's a very simple structure. It's really an artifact of trademark law. So, you know, you've got a brand owner, a McDonald's, let's say, and they license, you know, ostensibly. We can get into how independent they really are, but an independent business owner to run a McDonald's restaurant and use a McDonald's trademark. And in exchange, the franchisee, both the one, the operator called the franchisee, kicks a percentage of their sales and royalties,

7:12usually between six or, you know, 20%. And so McDonald's takes that revenue stream. And in return, also, the franchisee, this is the key sticking point, agrees to follow all of their instructions. And it is quite minute. I mean, everything from the, you know, in many cases, even the prices, hours of operation, product mix, and even things like, you know, how long does your employee have, you know, to serve as a customer in the drive-thru? What words do they use to greet the customer? There's very little left to discretion of the franchisee. They're basically a middle manager for a large corporation, but with a little bit more risk and a little more skin in the game

7:44because of that, the way that the structure of it works. They even, like, constrain the equipment you can use to repair ice cream machines, right? That is a famous, yeah, example of, yeah, franchisees. I'm an avid consumer of fast food. I love it. As a consumer, I love it. But yeah, that's a joke among us McDonald's fans is their ice cream machines are always broken. Do you remember we did that episode a couple of years ago, and the guy who we're talking to was bullish on that company that makes the ice cream gear? But he was very straightforward, which I respected. It was like, they have the monopoly, their equipment breaks a lot,

8:18and only they can repair it. And so that's a lot of, I mean, that's how investors should be thinking. A popular business model, especially in the tech world where we see companies create problems that only they can solve. Anyway. Okay. So you mentioned skin in the game there. Give us the sort of origin story of the franchise model, because my understanding is part of this was about incentives, right? So you tell people, well, you're not just going to be like a person working for us. You're actually going to have ownership in this particular restaurant and the revenue that it's throwing off.

8:51You want to incentivize people to, I guess, work harder for you. Yeah. So it solves, you know, what, you know, we economists call the principal Asian problem, you know, where you have the local manager more incentivized to exert effort to put in, you know, put in work than a salaried employee would be because, you know, their life savings depend on it. You know, they invested their family's money in that restaurant or that other whatever kind of business it is. But the other reason why franchising was so appealing to these franchisors is that the fact that they were a separate business, they were not employees of the chain, meant that they were covered by overtime or minimum wage. Or if, you know, the McDonald's

9:25workers wanted to, you know, join a union or something like that, they weren't able to do so. They had no rights against McDonald's. All of their rights are only against this franchisee who really doesn't have the money. The money is all, you know, sort of coming to the top. So that acts as a barrier, a legal barrier to exclude workers from those rents. And the other aspect I would say, again, back to those incentives is that, you know, what are these franchisees incentivized to do? As I was, you know, researching the book, I met someone, I'm from New England, so Dunkin' Donuts is our big chain. And, you know, someone who had worked at a Dunkin' Donuts said, yeah, my franchisee was obsessed with bananas. Why bananas? And so, well, because all the other

9:59ingredients, you know, were controlled by Dunkin' Donuts, but bananas, you can send us around to look at the stop and shop, you know, for the cheapest banana. So there was that aspect of it. So, yeah, they're highly incentivized because nothing else is under their control. Pretty much what they do outside of bananas is they extract effort and push down wages for their franchised employees. So it's a high stress, a high, if you've ever been to one, you know, very high motivated workforce. You know, the phrase that workers at these restaurants use is their managers always tell them, if you can lean, you can clean. You know, you always got to be doing something. Yeah. All right. So that explains the sort of

10:33corporate logic. What is, like, the history of it? Yeah. Who are the real, like, innovators? We've just mentioned Dunkin' and McDonald's, but who were, like, the early players? What did they realize? What were the conditions, et cetera? Tell us about that period. Yeah. So, you know, the initial legal structure comes out of, you know, like, auto dealers and, like, these, you know, manufacturing companies in the 19th and early 20th century. But the fast food and modern franchising as we know it, where you have that, you're licensing, like, an entire business package to a small entrepreneur, that really dates to the post-war period, 1950s, 1960s. And the innovators who invented this

11:05business model, they are fascinating. It was a joy to research the book. Very colorful people. Colonel Sanders was a real guy. You know, Ray Kroc, there's a movie about him. It's fantastic. His autobiography is very good. Yes. That's also excellent. Yeah. A lot of quotes from there in my book, because, yeah, he's such a verbose guy. But, you know, I'm an economist. And so I just started looking. I just wanted to know a little bit of the background so I could run my regressions, you know. But as I, you know, got deep into the history, like, I decided I really wanted to write a book about how it was founded. It's very fascinating because, you know, these guys had a great idea,

11:36but they also, they said this openly. There was no secret to unearth. They said pretty clearly, what we're doing isn't really legal. We need to change the laws to make it legal. Let's form an association, a trade association, an international franchise association to make this business model legal. And the body of law that actually they've been up against, it's kind of hard to believe now, but it was antitrust. Antitrust law protected these small business owners from that kind of control. So would the issue be that under a prior regime, a McDonald's or a franchisor would be the monopoly

12:08seller of McDonald's IP and so forth to all their, like, how did this run up against franchise or antitrust law? Yeah. So a lot of the, a lot of the case law actually comes from the petroleum industry, petroleum refiners who had branded stations, you know, like a Shell station or a Chevron. And they came up with a way to get around chain store taxes and, and also antitrust to control the independent dealers, make sure they're only selling Shell oil and also only selling approved brands of, you know, batteries and tires and other accessories. So, but they also did this to avoid

12:41when the Fair Labor Standards was packed in 1938. And, you know, Ray Kroc and Colonel Sanders and all his founders of the franchise, well, we should do that in service industries, not just product distribution. But the antitrust body of law was sort of like, you know, 19th century anti-monopoly idea of, you know, like there's like meaning to being like owning a business, you know, owning your own farm or, you know, employment is like a, is, is, you can't have a democratic society where people are taking commands from someone else. So the antitrust courts through the mid 1970s are still enforcing that, not in every case, but for example, if McDonald's wanted to set the price of a,

13:13of a big Mac, that was against the law. If they wanted to, you know, tell a franchisees, you know, what territories they could operate, that was against the law. And so you, so for example, there's a great moment that I've now talked about so many times that I've basically memorized the quote is there's a series of hearings in front of the Senate antitrust committee. There's a bunch of them in 1963, and then a more robust set in 1965, where you have the chair of the Senate anti-monopoly committee, a guy named Jerry S. Cohen. He's, he's interviewing or questioning the president of the International Franchise Association, a guy named Monty Pendleton. And he can't really believe his

13:47ears that franchisers are trying to get away with this. You know, he tells him, wait a minute, you know, the, the argument that you're giving us for why we should allow this business model under antitrust is that, you know, it creates all these opportunities for independent business owners. It allows an independent man. And so it's a very gendered thing here, but independent man to be independent. But if he's told what products he has to sell, what price he has to charge, what operation he has to operate in, well, he's not really independent, is he? He's part of an integrated franchisor's operation. And, and franchisors themselves say repeatedly throughout this period, we're trying to get vertical integration by other means. We don't want to

14:19own the assets. We don't want to employ the workers. Those are risks we'd rather do without. We want the benefits of that control, but we really don't want to be held liable for it. So somehow the franchisors are able to successfully argue that they should be, I guess, treated like single entities when it comes to antitrust law. But at the same time, they should be exempt from I guess the obligations and liabilities that would normally come with that. Yeah, absolutely. So there's another, a few years before the hearing I just mentioned, the Teamsters Union was trying to organize gas station attendance. And they sent their guy to

14:53testify and he complained about this. He called it double barrel immunity. You know, so, you know, when you're going to antitrust courts, you tell them that you are a single entity. You know, you're all just one company. So it's like logically impossible for you to violate the antitrust laws because that requires a conspiracy. You know, two people have to agree. But at the same time, when we try to organize your workers, you say, no, you know, the labor laws don't apply. They are a totally separate company. They have nothing to do with this. And, you know, that was the 60s. The same thing happened in franchising, is happening in franchising. You know, people remember the fight for 15 whole thing a few years ago, but they've been able to win

15:26this. So far, they can just sort of have those two worlds stay separate. And it's interesting that they've been able to do that for so long. What if you could use AI to research your investment portfolio and ask, how would a 10% decline in the S&P 500 affect my portfolio? Or show me option

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18:49So, okay, I see in one version of it, the parent company or the franchisor has taken a lot of risk off the table. They don't have to make as many capital investments. They don't have to worry about their employees going on strike. On the other hand, any franchisee enters into this voluntarily, right? Like, no one has to, like, open a McDonald's until they, like, can see the risk rewards. The McDonald's will ensure, I believe, or the franchisor will ensure that, say, like, another one isn't going to open up on the same block, which is a risk if an independent business, right?

19:25I open up, like, my own independent pizza shop. Someone opens one in the next door. Suddenly, like, they undercut me, et cetera. So, it's, like, I don't have, like, the risk of, like, another McDonald's undercutting me. You could still have a McDowell's. You could have a McDowell's. But, you know, like, since we're talking about brands, like, there is a McDonald's brand affinity in a way that many independent burger shops have, like, you know, either have yet to or never achieve. So, like, at least some of these sort of, like, classical business risks are taken off the table for the franchisee.

19:57And also, it's my understanding, like, generally, McDonald's franchisees have done very well, and they're consistently quite profitable. Yeah. Is this an all-fair characterization? Yeah. Well, a lot of that is fair, yeah. Particularly if you got in with McDonald's, like, at the beginning. If you're on the ground floor with these, I think it's fair to say, yeah, Ray Kroc, he allowed his franchisees to get rich before he did. You know, that's a brag that the company does. It's kind of true. So, there definitely was that. There was that dynamic. On the other hand, there are some chains that don't give that protection, for example. Okay. A subway is an example of one where they will open one up across the street from you.

20:30Right. Or if there was some litigation in the past with, let's say, Church's Chicken merges with Popeye's, well, you know, the contract might protect the Church's, but they could put a Popeye's across the street from you. So, there is still some of that risk. But, you know, if you have any, you know, like, more, you know, Marxist-inclined listeners, you know, who's a worker? You know, it's someone who doesn't have access to the means of production, so they have to, you know, sell their labor, you know, to a capitalist. But, you know, franchising has this whole other layer of, these are people who can afford to open a restaurant. They have some capital. Yeah. They supply capital as well as labor.

21:01They're investors. But they don't have the means of marketing at the scale. They don't have a brand. And so, another thing you see in the whole history of franchising is franchisees saying, yeah, you know, I kind of wanted to be an entrepreneur or I used to own, like, my own donut shop. But, you know, once Dunkin' Donuts or at that time there was another chain called Mr. Donut, you know, came to town, I really couldn't compete. I had to sell out, you know, and join their chain. And that brand is very powerful. So, there's, this is even in the film, you know, Ray Kroc famously, you know, he stole all the, they agreed to sell their whole business, basically, the McDonald brothers, the guys who created McDonald's, to him.

21:33And he, but after he controlled the McDonald's name and the trademark, they thought they could keep operating, you know, and doing, and he just opened a McDonald's right across the street from their original place and put them out of business. And so, that's something that you see, that brand is very powerful, but it also gives the franchisor power for the franchisee to do what they say. You know, I'm not surprised that McDonald's did this. Probably the only fact that really sticks out at me from Ray Kroc's autobiography, where he's, like, talking about his personal life, and he was, like, in love with some woman, and in, like, one sentence is, like, oh, she was married at the time, and I took her away from her husband.

22:07Or it's, like, one paragraph. So, I was, like, oh, he's very forthright about that. So, I can't say I'm surprised that he opened up a McDonald's across the street from a... A normal aside, but actually... A goal-pursuing individual. Yes. Related to this, one thing I was very surprised to learn from your book is that there are no poaching agreements between McDonald's. So, if I'm a worker at a particular McDonald's franchise, and I want to go work for another one, I have to get the permission of my current franchise owner in order to do that.

22:38Yeah, and they may have since dropped those, but they had them, and a lot of chains did, for a very long time. And that sort of gets at this weird niche that they've been able to occupy in antitrust and labor law. So, this is the... I think I would characterize it, I think, fairly as the absurdity of antitrust law, where there is this, what, you know, is called the vertical-horizontal distinction. And what that means is that, you know, for two McDonald's, you know, across town to pick up the phone and say, hey, don't hire any of my workers, I won't hire any of yours, that's a horizontal agreement. That is so, so illegal you're going to face.

23:08You might go to jail for doing that. But if McDonald's from above tells them unilaterally, don't hire each other's workers, it's not per se illegal. It gets put under what's called the rule of reason, which just means that now you have, it keeps people in my profession employed, but you have competing econometric reports. You know, it's very difficult for a plaintiff, for a worker to challenge these kinds of no-poach agreements, though they have tried, because, yeah, it's very difficult to win. Because once it's vertical, now McDonald's can enter evidence that says, yeah, maybe, you know, it has a bad effect on our wages, but, you know, it helps us sell more hamburgers.

23:41Because, again, we're a single entity, you know, we should have, this just makes it more efficient. And in that sense, low wages can be more efficient. I think I'm just going to accept that we're just going to use McDonald's as like a standard for franchising. Let's say we're talking about McDonald's. Some do very well, some maybe less so. Is there anything that the franchisee actually has discretion on that could either improve or lessen their odds of success? Other than bananas at Dunkin' Donuts. How hard they work. And I think the key to that is looking at what are they then incentivized to exert that effort towards.

24:15And it is because the one thing that McDonald's doesn't directly touch is, besides bananas, is their labor cost. So how big is your crew? Actually, the staffing requirements are even required. So how hard are they working? How low are their wages? And making sure everyone's, you know, working as hard as possible. The owner doesn't have any discretion about the staffing levels? No, staffing levels are mandated in the operations manual, which is incorporated into the contract and can be unilaterally changed at any time by McDonald's. So it's a very one sided contract. You know, to be fair, the pro argument for that is that, you know, again, willing consenting buyers and sellers and it incentivizes those franchisees to follow the system and to work as hard as they possibly can.

24:52Sorry. Just to make this very clear, the major lever that franchisees have to be a better business, to produce more money is to basically squeeze wage costs. Yeah. Wow. And you can see, you know, in the and this is something, again, franchises are very open about. I think there's a quote in the book that's from another book called Franchise Dreams. But, you know, a franchisor just look at entrepreneur makes the worst franchisee. You don't want someone who's an independent thinker who has their own business ideas. Similarly, you know, Ray Kroc said, you know, it doesn't take any particular aptitude or intellect to make it in one of our restaurants.

25:25You know, it just takes grit and hard work. He wanted workers. As a matter of fact, he sought out people who really needed this. You know, his first investors in McDonald's were his friends from the country club. Oh, yeah, it's a nice investment opportunity. You know, yeah, I'll put in some money and sure, I'll manage the restaurant in my spare time. It didn't work out. They didn't put in the work. And so he found people who were a little more scrappy, you know, immigrants, you know. Yeah. There are constraints or are there not? Like, let's say I wanted to open a McDonald's, but I didn't want to work hard.

25:55I just wanted an investment. Am I allowed to, like, front someone else's capital to do that? How does that work? I don't know. You never hear very much about, like, say, I don't know, P.E. or finance, like, backing, like, a thousand new franchisees. Is that allowed? Yes. A lot of the franchise contracts, my other work outside the book, a lot of this work joint with Marshall Steinbaum and Sergio Pinto, we actually coded. We read hundreds of franchise contracts. Those guys have since, like, digitized and, you know, they have thousands of contracts and one key contract clause in, across most chains, is a personal obligation to work.

26:30So you are not allowed to be a passive investor. And you also have to, also, there's no corporate shield. If you mess up, they can come for your house and your car and your savings and all that stuff. That said, there has, you know, I wouldn't want to hide this. There has been a move in recent years to more of a different kind of franchise operator. Some of them are incorporated now. Some of them own multiple, even hundreds of locations. Some of them even own locations across multiple chains. And since then, also, there's been a migration. Private equity used to only own the franchise brands. And that's a great business.

27:02Like, Burger King famously has flipped, you know, from private equity owners. All you got to do is get those royalties. Someone else already built the brand. You know, just all it is is cash. But since then, there's been private equity franchise operators. So it's a very different dynamic. It's no longer, obviously, a private equity firm is a legal entity, not a person. They can't exert effort. They can hire people that do that. But there is a new breed of franchisee that, in some chains, that's a little bit different than the old model. Again, I hate to bring up AI in every single conversation that we do nowadays.

27:32But I think it's kind of unavoidable. We have all this new technology. And Joe and I have done plenty of trucking episodes where we talk about, you know, tech that monitors whether people's eyes are open and things like that. Does that new technology play a role in, I guess, exerting more control over some of these franchises? It absolutely does. And it started in the 1990s with broadband internet and is accelerating now with AI, for sure. So think about the 1960s, right? You want to have this legal structure where this independent operator is operating the restaurant.

28:05They kick me back a royalty. I try to control everything they do. But how can you really control it? There's fax machines. There's telephones. You can send secret shoppers. But there's only so much you can really do. By the 1990s, particularly with broadband internet connected to the cash registers through, you know, point-of-sale systems, there's a steady data stream now going back to headquarters where they have an intense amount of control. And I think one of the interesting things about that technological change is, first of all, in terms of, you know, the motivation for these kinds of outsourced industrial structures, it's usually technology is the story. But they started doing this way before the technology.

28:36But now that technology exists, it allows, just think about like a truly vertically integrated corporation like U.S. Steel or General Motors in 1950, the control they have over all of their plants is less than McDonald's that they own. And they employ, you know, those hundreds of thousands of industrial workers. McDonald's now hardly employs anybody, but they have way more control because they're able to get that stream of data. And now the AI has made that surveillance of workers themselves. And by the way, you don't have to fire them if they're too slow with the register. You just send a note to the franchisee.

29:07Hey, so-and-so, they even know the names of the employees, you know, is a little too slow. Do something about that, you know, so. Wait, can you say, just talking more about like, I guess this is theory of the firm type stuff. Explain this notion that like a U.S. Steel, it's not intuitive to most people, is like would be a more distributed type of entity than a McDonald's. Why is that? What do you talk, when you say that, what do you mean? Yeah, so I think, you know, so theory of the firm, I think, you know, no matter your political proclivities. Sure. I, you know, like for, you know, Marx called the firm the hidden boat of production.

29:40What happens there is that there's an entity that owns assets and there's someone who works and you put them together and it happens inside a firm. Coase, you know, the great Chicago conservative economist had a similar notion where what the nature of the firm is, is command. You know, a workman doesn't go from department Y to department X because of a change in relative prices, but because it's ordered to do so. So that was sort of the reason why, that's the classical economic reason why firms exist. And then there's, you know, of course, you know, Chandler with his, you know, Visible Hand book, which is, you know, the foundation for most business history of this is why do we have these big corporations?

30:13And his answer was the economics of high throughput and the efficiencies of, you know, if you want to make steel, you can't really rely on the uncertainties of those of those prices. You kind of want to have everything under control and have managers, you know, sort of running it. What they're trying to do with franchising is get sort of that same type of control, but without having the legal risks and liabilities. And I would say just one more thing is that the legal door that franchisors opened in the 1960s and 1970s has since been, you know, started as a little loophole. Now it's just a huge, you know, bay door that, you know, an Uber or Amazon can walk through.

30:47So, you know, Amazon's fascinating because they are very much like a U.S. steel in that they found a need to totally reorganize distribution in the United States. They didn't want to rely on USPS. They didn't rely on UPS or FedEx. They brought it all back in-house in economic terms and the fact that they controlled it. But they did not bring it in-house in terms of legal liabilities because those trucks, you know, driving around your neighborhood are independent contractors. And they are able to control them because of this litigation and legislation battles that franchisors fought in the 60s and 70s to legalize those kinds of controls.

31:18What exactly is, I guess, the concrete lineage between the franchise model and the gig economy and the independent contractors? Yeah. So franchisors on the 1960s and 1970s, you know, don't like the antitrust jurisprudence that says you can't control independent businesses through, I don't know if I've used this term yet, but vertical restraints is like the term of art in antitrust for that. So they go about filing cases to, you know, a very concerted, very smart strategic effort to change the law. They ended up having a huge, very important ally in the University of Chicago economics department and law school who have the same ideas that, you know, we shouldn't be judging.

31:53You know, what is this, you know, hoary old idea of the independent entrepreneur? Like, it's efficiency. That's all we care about. So they won those battles in the courts. And then after that, they also were able to head off any any, you know, after they win those, get in this control. You start seeing the Department of Labor, the National Labor Relations Board and litigants say, wait a minute, all that control, you probably should be responsible, you know, for the underpayment of wages. Or let's say, you know, for example, Domino's, you've got this 30 minute delivery rule. You're your driver speeding to make that delivery. He hits somebody. That's kind of your fault. You know, that's not the franchisee's fault or even the driver's.

32:26So they win all these. So they are able to say, well, no, that doesn't really apply to us. You know, we they're still so they're able to have their cake and eat it, too. And so that's just that there's not only there's any explicit coordination. But once you start getting companies to try to do this with, you know, rather than explicit contractual vertical restraints, it's algorithmic. You know, here's the route you're going to drive. Here's the price you're going to charge. They're able to do it that way. And that would not have been or that would have raised some judicial eyebrows if they had tried to do Uber in the 1960s. So, you know, obviously, the technology is highly important.

32:56But there's the other story I think is important, too, is that the fact that these things are legally permissible is the result of this of a franchisor's efforts. This is the Bloomberg Tech Minute brought to you by ChatGPT. Now with ChatGPT work. I'm Carol Masser.

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36:45Yeah, they do. But with the Amazon models, even closer to franchising Uber, because, you know, Uber and Lyft, it's each driver is, you know, treated as sort of like an independent entrepreneur. You know, they own their own business. Yeah, yeah, yeah. Where, yeah, be your own boss. And that's probably a powerful thing. You know, I want to be my own boss. I mean, no, no, it is, I think it's an American, like a very American, that's how you, you know, get your nest egg and take care of yourself and your family. But Amazon, it's called their delivery service partner, or DSP model, is much closer to a franchise in that every driver is not an independent entrepreneur. It's the contractor company.

37:15Right, so they might have like 30 or whatever, some, yeah, 30 trucks or whatever. Yeah, so it's a small, it's a relatively small business. You know, Amazon, I think, even fronts some of the capital, but it's a legally distinct entity, even though it's painted with the Amazon logo, you know, and tightly controlled. Since you're an economist and you mentioned regressions before, do you have any empirical research about the relationship between the growth of the franchise model and wages in the U.S.? Because, again, like if we're talking about the primary lever that an independent franchise owner can actually pull to improve the business, it's all wages.

37:49Yeah, so I don't have that time series of the growth of franchising and the growth of wages. But there are, you know, my work and other work. We do know a couple of things about franchising. One is that if you're a wage worker now, there's work from Kruger back in the 1990s. There's David Weil, who's, I should have mentioned him before. He's like the economist on this stuff. He wrote a book called The Fishered Workplace, where we do know that even within the same chain, you want to be at the company-owned one, not at the franchised one, because your wages will be higher. You'll have a higher tenure wage profile, meaning you're going to get promoted and your wages are going to go up more over time.

38:22And also, franchised establishments violate their workers' safety and other rights at a much higher rate than ones that are company-owned. So we do know that stuff. And then we have my work. We have one. We were able to take advantage of a really nice natural experiment where Washington State entered a consent decree with McDonald's and a bunch of other chains to get rid of those no-poach agreements I mentioned earlier. And we found, I mean, maybe not surprising, but there's a causal effect. Once they got rid of those no-poach agreements, wages went up. And then, you know, again, because it's very hard, you don't want to be careful as an economist.

38:52You know, it's hard to get those natural experiments. So we don't have that for, like, specific contract terms. But in work, again, with Marshall Steinbaum and Sergio, we found, you know, correlations with lower wages. And then they have a new paper where they look at franchise contracts over time and find that they have gotten more restrictive even over the past 20 years. Wait, how do they actually measure that? Now I'm really interested because if we're talking about, well, I guess I'm interested in how the actual, like, franchisor communicates a lot of the restrictions to the actual business.

39:22Like, how did they do that? And then how do you tally that up in an empirical way? Yeah. So studying franchising, I was very fortunate because these contracts are sort of public records. So there's a requirement from a 1979 Federal Trade Commission rule that requires franchisors to furnish to a franchisee a what's called a franchise disclosure document, which is sort of plain English, lays out key contract terms, what the royalty is going to be, and basically is meant to, you know, inform the franchisee. The idea being franchises are getting swindled into, you know, entering these incredibly one-sided contracts.

39:56They should know what they're getting into. Let's make a law to disclose that. So there's this franchise disclosure document. And then usually the franchisor will file as an attachment the entire franchise contract. So we have the contracts. And they're not filed with the FTC, but some states require them to be filed. So you just go to Wisconsin or California, anyone who wants to do a study on this, you can get the contracts. Back in when I was doing this 10 years ago, I had to read the contracts and hand code them. It took me like 18 months. But, you know, I got through 530 contracts, hundreds of contract terms. So we got a pretty good, but it's only a cross-section.

40:28But what my colleagues have been able to do since then is, I mean, just, you know, text recognition software and, you know, text scraping abilities and, you know, AI. In an afternoon, you know, you could program a computer to just scrape thousands of these contracts and you can get them over time, which I wasn't able to do. But yes, these are public records. So anyone could do this. You mentioned treatment of workers and wages at McDonald's franchise locations versus the McDonald's owned and operated locations.

40:59What about franchise locations versus just pure independent restaurants? Because it seems like one of these things that people don't want to talk about that much, that when we talk about like wages, when we talk about wage theft and some of these other things, we all like to glorify small businesses, but there's a lot of like these pathologies seem to be fairly prevalent or more prevalent, I think, at small businesses than, say, like large corporations. Is that is that accurate? You know, I haven't looked at that comparison between independent restaurants and between fast food restaurants.

41:34Yeah, not. But yeah, but I think that's a that's a fair case. And I think what franchises are trying to do is capture that small business labor model and then graft it to a large corporation, but make sure that all the rents go up, you know, to the shareholders and the top corporation and not not be shared with the workers, where if you're at a Starbucks or a Chipotle, which is totally corporate owned, not saying they have great working conditions, but some of those rents do appear to be shared because wages are higher at Chipotle than Taco Bell and they're higher at Starbucks than at Dunkin Donuts. And also Starbucks workers, even they don't have a contract yet, but they were able to at least, you know, vote for a union in a way that has never happened in fast food.

42:10Can you explain the logic either like why companies aren't all franchises? So, first of all, like, why would a Chipotle? Why did they not go down the franchise road? But why does McDonald's actually have a pretty significant number of owned and operated restaurants? Yeah. You know, so I think there's a there could be a few reasons for that. You know, one is owning the assets and employing the managers is there is a little bit more control that you get there than if then then if it's franchised. And particularly if you're not if you don't have the McDonald's model or McDonald's and Ray Kroc talks about this in his book.

42:43He really has a hammer over those franchisees in that if they lose that trademark, you can evict them from their own business because McDonald's owns the land. But if you're starting a chain now, you probably don't have the money to actually own all that real estate. So there is there. There are those those elements of it. But, yeah, I think there's and there's also there the Chipotles or the Starbucks are a little bit more high end, you know, like a few cents more. It's not quite the same quality ingredients. It's just a little a little bit of a different model than the, you know, churn out high throughput as low wages as possible model of a franchised fast food restaurant.

43:17You mentioned unions just then. And one of the interesting things in your book, I think it's maybe in the preface or something like that. But you talk about like the legal structure of a franchise, even if you wanted to unionize or negotiate with the franchisor, it's not entirely legally clear that you can do that because of the corporate structure. Is that right? Yeah, that's absolutely correct. Yeah. So the and this is something, again, that the franchisors were they were clear this is what they wanted to achieve with their business model.

43:47They didn't want to deal with unions up until, you know, the 20 teens and the five or 15. No one really thought that there was a way for workers who wanted to form a union to negotiate with McDonald's. But McDonald's could willingly do this at any point. But, you know, they choose not to. There's something called the Taft-Hartley Act, which is an anti-labor law from 1947 that makes it illegal for workers. You can't go on strike. You can't pick it. You can't target McDonald's Corporation. You can only target your immediate employer. So that creates enormous incentives. You know, franchising, not coincidentally, takes off after the Taft-Hartley Act.

44:17But there had, you know, during the Obama administration, they enacted something called a joint employer rule, which did make it possible for or made it easier for workers to say, you know, I really can't, you know, look at the realities of the situation, the economic realities. If I'm to get a raise or I'm going to get better working conditions, we need to bargain with McDonald's because they control the staffing levels. They control the supplies. They control how what hours we operate and all that stuff. So that had under Obama, of course, it was overturned during Trump. It flipped back during Biden. Now it's flipped back. So it's just no one really knows their rights are.

44:48It's not. Yeah, it's a whole other issue that we could get into. But yeah, so there has been have been attempts to sort of fix that problem. But we have not fixed it yet. From a sort of like broader public policy standpoint, I mean, my doorbell rings a lot or too much because it's a random like grocery deliveries and stuff like that. But like clearly the Amazon distribution logistic system that they built out, it's clearly more like rapid than the U.S. Postal Service, more flexible, I think, than UPS.

45:20How should we think about the sort of like the public benefit of this model that like has made it you can order all kinds of stuff and frequently have it delivered in an hour, which seems pretty nice. Plus, we do have McDonald's, which is also great, which we also love. Yeah. Yeah. So, first of all, there are benefits to the Amazon distribution model. And I think, yeah, we should acknowledge those for what they are. There are also costs. And, you know, we should we should make sure those are counted, too. Yeah. You know, whether it's pollution in neighborhoods where those distribution centers are or delivery centers, I should call them.

45:51There's the cost to workers, you know, famously peeing in bottle stories. Can you just quickly say you distinguish between distribution centers and delivery centers? So the distribution centers are owned. Those are those are owned by Amazon. Yeah. So Amazon. But then they go to a delivery center before they go to your house. They don't. OK. Right. And that's where the. Yeah. And the delivery center is not owned by Amazon. The center is. But the trucking companies. Oh, OK. Well, they all. So they all go. So if you're if you're a driver for these companies, you show up at an Amazon facility, you put on Amazon uniform, you drive an Amazon truck.

46:25But your employer is one of these contractors. So, yeah, I think we should. First of all, you got it. We have to account for the cost on workers and other communities and all that kind of stuff. But also, I mean, my proposition for policy here is pretty simple, is that the problem is not that there's innovation, that there's control. That's what a firm is. That's what a corporation is, is, you know, market shouldn't do everything. Sometimes having a little central planner, you know, a mini central planner, you know, coordinating activity is a great thing for, you know, getting more efficient and innovating. So we should have that. The problem is then you can't avoid the obligations and liabilities and risks that go with owning assets and employing workers.

46:59And we used to have, you know, our whole legal architecture for regulating and holding these companies accountable was based on that, like, archetype. You know, we pretty much only our wave of regulation. It was like 1935, you know, to the mid 1960s. And we know what a company is. It has a smokestack, it employs a bunch of workers, and it owns a factory. Like, that's what a company is. Now, with all of these, you know, and partly due to franchises creating this loophole, it's no longer so clear what an employer is. And all I would propose we do is, well, hey, if you want to direct and control the work of these drivers, well, look, you're their employer.

47:32And if you're not paying them the, you know, the legal wages, or if they want to bargain with you for a union, or if, you know, because of you, because of your algorithm, they ran a red light and hit someone, that's, those are all those things you caused, you should be held responsible for those. All right, Brian Kalachi, we're going to have to leave it there. Thank you so much for coming on All Pots. Thank you. I had a great time.

48:02I had a great time.

48:32That it really is literally about the intellectual property. Like, that is literally what coming to America is about, is about a guy who, you know, commits intellectual property theft by making something that looks like a McDonald's. But that is the core thing. That's it. You know, most people aren't going to be able to manufacture that, et cetera. So being able to plug into that. No, I thought it was, like, really interesting, the history. I am not surprised at all. The Ray Kroc book is so good. He's so forthright. Like, he's so unselfconscious about everything that he did in life.

49:04It's just, like, a very, like, weird and fun read for that purpose alone. I'm going to have to read it. Yeah, it's a really good read. But I kind of want to read the Colonel Sanders one first. It's so funny to hear Colonel Sanders, and it's like Ray Kroc, and Colonel Sanders, like, wait, that's a, it still feels like that's just, like, a made-up character. Really? Yeah, to me it does. I mean, I knew who was real, but it still feels like that's, like, a real person. Do you know about the whole KFC Christmas thing in Japan? I, oh, I've, yeah, they're really into it, but other than that. Yeah, because, I think it's because Colonel Sanders, like, kind of looked a little bit like Santa.

49:37Oh, interesting. So, a lot of the Japanese KFCs, at least when I was there, they used to have, like, big statues of Colonel Sanders out. That's amazing. And it was kind of, like, you know. That's great. Very American, very Western. That's a great avatar of American, you know, both cultural and business traditions of Colonel Sanders. I do think, like, you know, I always found it weird when the marketing for being an Uber driver or, like, starting a van line was, like, either, like, be your own boss or, like, start your own business.

50:09It's, like, maybe, like, the math, look, the left tail is reduced and the right tail is reduced. So, there's maybe, you know, and clearly people have done well entering franchise, but they do not look anything like what we typically think of as, like, quote, entrepreneurship as business ownership. It's, like, a very, it's clearly a very different thing. No, that tension is also remarkable. The idea that, like, you're an entrepreneur, you're independent, but also the franchisor is going to dictate basically everything to you. I also just think, I like that. Except wage costs. Except wage costs.

50:40I like that Brian brought up, like, you know, even the most, like, UChicago schooled economists is, like, no, it's really good. And there are a lot of efficiency gains when you do a lot of activity under a centrally planned umbrella, such as a large corporation and the sort of, like, thing that hardly anyone talks about, which is, like, how much of the economy is literally under central planning. We just don't call it central planning because it's corporate. Yeah. I mean, yes, there are clearly some benefits to it.

51:10Yeah, yeah. Both you and I, it sounds, I think you use Amazon Prime, do you? I do, yes. Yeah, so do I. And McDonald's, of course. Okay, shall we leave it there? Let's leave it there. This has been another episode of the Odd Lots podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway. And I'm Jill Weisenthal. You can follow me at The Stalwart. Follow our guest, Brian Kalachi. He's at Brian underscore Kalachi. Follow our producers, Carmen Rodriguez at Carmen Armand. Dashiell Bennett at Dashbot. Kale Brooks at Kale Brooks. And Kevin Lozano at Kevin Lloyd Lozano. And for more Odd Lots content, go to Bloomberg.com slash Odd Lots.

51:41We have a daily newsletter and all of our episodes. You can chat about all of these topics 24-7 in our Discord. Discord.gg slash OddLaws. And if you enjoyed this conversation, if you like it when we talk about how IP underpins the franchise fast food model, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad-free. All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.

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