To Be Or Not To Be: The Franchise Business Model
“To be, or not to be…” is the opening phrase of a soliloquy in the “Nunnery Scene” of William Shakespeare’s play, Hamlet. In the speech, a despondent Prince Hamlet contemplates death and suicide while waiting for Ophelia, the love of his life.
I have not submitted articles to Avanti for several issues. This was intentional, as I have been on a quest, like Hamlet, contemplating my future and the future of the franchise business model. In many ways I have felt like a spectator to a sad play. On the stage I watch the actors—franchisees and company executives—talk past each other, not really listening to the genuine concerns of either party. A few short years ago the general mood of the franchise community was one of happiness and joy. We had our problems, to be sure, but for the most part store operators were enjoying financial success. That has changed rapidly, and now franchising as a business model is under tremendous stress from external and internal factors.
External factors include intrusive regulatory oversight, competition and the arbitrary doubling of the minimum wage. This last item, because of our unique arrangement with our franchisor, will lead to many of our peers losing their stores. Internally, the stress is coming from unrealistic sales planning goals, ongoing acquisitions with stores in close proximity to existing stores, and yes, our unique franchise agreement, which has been formulated to make windfall profits for our franchisor, but provides very little help or extra resources for the franchisees whose stores are facing a huge wage increase.
Let me explain. The only way for a franchisee to address a huge wage increase is by raising retail prices. Cutting labor costs only contributes to lost sales because service suffers. When we increase retail prices, our franchise partner derives a windfall due to the splitting of gross profits. So when your local SEI field team sheds those big crocodile tears while they tell you of your coming mandated $15-an-hour minimum wage scale, remember—those are tears of joy because they are about to make their bonus from your misfortune.
With most of the stores going to the Graduated Gross Profit Split (GGPS), SEI is having the best of times. Several years ago I wrote an article called “A Tale of Two Stores,” based on Charles Dickens’ famous novel A Tale of Two Cities. The article ended with the line, “It was the best of times and the worst of times. Which is it for you as a franchisee?”
Based on SEI’s own unabashed statements and audited financials by KMPG, clearly “it’s the best of times” for Dallas! The most recent audited statement shows a $780 million gross profit on gasoline for SEI. By the time I decided to write this article, Seven & I Holdings was rumored to have put in a bid to purchase CST Brands, Valero Energy. SEI has denied making the bid, having recently paid $450 million for just 79 CST gas stores in mid-June of this year.
NCASEF recently commenced a comprehensive gasoline study to find out more about 7-Eleven’s gas business and the findings were alarming. (Ask your FOA leadership about this.) While I do not want to write any more on gasoline, I am personally aware that gas stores (one out of four 7-Eleven stores) are not adequately compensated. It’s shameful when your franchisor is hauling in nearly $1 billion dollars on gasoline profits on one quarter of the stores and you get a penny and a half. Perhaps all of the new acquisitions, including the soon to be rebranded competitor down the street, is being purchased with dollars that formerly were yours.
Let’s get back to an issue that will drive the profits out of the stores: minimum wage and GGPS. In any other franchise business the franchisee raises the price and the parent company collects a simple royalty. In my 7-Eleven business, any amount I raise Dallas gets half. So by raising prices I may put my location at a disadvantage once my store crosses a certain threshold, because SEI takes a bigger chunk out of my income through GGPS. The more successful I am, the more SEI punishes me. There was a time when, if a franchisee was successful, SEI was successful, which was a clear win-win for everyone. Now if I win, I lose, and if SEI wins … well, you know the answer. Add to all of this the prospect of high inflation in the economy, and we have a prescription for disaster, as all new profit flows directly to the franchisor.
Moreover, I signed a franchise agreement to become a convenience store franchisee, but somewhere along the line I became a fast food restaurant that sells pizza, wings, burgers and chicken sandwiches. I am also a bakery. SEI’s current mantra is, “Hey, we are investing loads of capital on equipment and therefore you should invest in payroll.” A smart business entrepreneur will figure this out in a minute: a capital expenditure is depreciated over time and under provisions of the tax code recaptures those dollars by reducing SEI’s taxable net income. This also assumes that SEI is actually purchasing the equipment and not receiving freebies from vendors.
My payroll is NOT an investment. In fact, each dollar I spend on payroll not only reduces my net income, it also increases my Worker’s Comp premium and causes me to pay more for my employees’ Social Security and Medicare. This is a false equivalent. When your FC feeds you that line about “investing” in labor dollars, tell him or her that would best be accomplished by a 45-55 split in your favor.
As the saying goes, “This country was built by men in denims and will be destroyed by men in suits.” Franchisees built this brand by hard work, determination and many sleepless nights. We endured bankruptcies, LBOs and megalomaniacal management teams. We suffered through El Taco, Santiago and Gameday beers, the Simpsons, and numerous other marketing or merchandise plans that didn’t quite succeed.
I’m not sure it’s worth it any more, and I do not have any hope that the 2019 franchise agreement will right the ship. SEI has become addicted to the model that rewards them for our hard work.
Having said this, I want to know your thoughts about “To be, or not to be … a franchisee?” I’ve shared mine, and I would love hear yours.