Is the FTC Threatening Efficient Franchise Relationships?

Cite this Article
Alden Abbott, Is the FTC Threatening Efficient Franchise Relationships?, Truth on the Market (March 14, 2023),

Franchising plays a key role in promoting American job creation and economic growth. As explained in Forbes (hyperlinks omitted):

Franchise businesses help drive growth in local, state and national economies. They are major contributors to small business growth and job creation in nearly every local economy in the United States. On a local level, growth is spurred by a number of successful franchise impacts, including multiple new locations opening in the area and the professional development opportunities they provide for the workforce.

Franchises Create Jobs

What kind of impact do franchises have on national economic data and job growth? All in all, small businesses like franchises generate more than 60 percent of all jobs added annually in the U.S., according to the Bureau of Labor Statistics.

Although it varies widely by state, you will often find that the highest job creation market leaders are heavily influenced by franchising growth. The national impact of franchising, according to the IFA Economic Impact Study conducted by IHS Market Economics in January 2018, is huge.

By the numbers:

  • There are 733,000 franchised establishments in the Unites States
  • Franchising directly creates 7.6 million jobs
  • Franchising indirectly supports 13.3 million jobs
  • Franchising directly accounts for $404.6 billion in GDP
  • Franchising indirectly accounts for $925.9 billion in GDP

Franchises Drive Economic Growth

How do franchises spur economic growth? Successful franchise brands can grow new locations at a faster rate than other types of small businesses. Individual franchise locations create jobs, and franchise networks multiply the jobs they create by replicating in more markets — or often in more locations in a single market if demand allows. The more they succeed, the greater the multiplier.

It’s also a matter of longevity. According to the Small Business Administration (SBA), 50 percent of new businesses fail during the first five years. Franchises can offer greater sustainability than non-franchised businesses. Franchises are much more likely to be operating after five years. This means more jobs being created longer for each location opened.

Successful franchise brands help stack the deck in favor of success by offering substantial administrative and marketing support for individual locations. Success for the brands means success for the overall economy, driving a virtuous cycle of growth.

Franchising as a business institution is oriented toward reducing economic inefficiencies in commercial relationships. Specifically, economic analysis reveals that it is a potential means for dealing with opportunism and cabining transaction costs in vertical-distribution contracts. In a survey article in the Encyclopedia of Law & Economics, Antony Dnes explores capital raising, agency, and transactions-cost-control theories of franchising. He concludes:

Several theories have been constructed to explain franchising, most of which emphasize savings of monitoring costs in an agency framework. Details of the theories show how opportunism on the part of both franchisors and franchisees may be controlled. In separate developments, writers have argued that franchisors recruit franchisees to reduce information-search costs, or that they signal franchise quality by running company stores.

Empirical studies tend to support theories emphasizing opportunism on the part of franchisors and franchisees. Thus, elements of both agency approaches and transactions-cost analysis receive support. The most robust finding is that franchising is encouraged by factors like geographical dispersion of units, which increases monitoring costs. Other key findings are that small units and measures of the importance of the franchisee’s input encourage franchising, whereas increasing the importance of the franchisor’s centralized role encourages the use of company stores. In many key respects, in result although not in principle, transaction-cost analysis and agency analysis are just two different languages describing the same franchising phenomena.

In short, overall, franchising has proven to be an American welfare-enhancement success story.

There is, however, a three-letter regulatory storm cloud on the horizon that could eventually threaten to undermine economically beneficial franchising. In a March 10 press release, the Federal Trade Commission (FTC) “requests [public] comment[s] on franchise agreements and franchisor business practices, including how franchisors may exert control over franchisees and their workers.” The public will have 60 days to submit comments in response to this request for information (RFI).

Language in the FTC’s press release makes it clear that the commission’s priors are to be skeptical of (if not downright hostile toward) the institution of franchising. The director of the FTC’s Bureau of Consumer Protection notes that there is “growing concern around unfair and deceptive practices in the franchise industry.” The director of the FTC Office of Policy Planning states that “[i]t’s clear that, at least in some instances, the promise of franchise agreements as engines of economic mobility and gainful employment is not being fully realized.” She adds that “[t]his RFI will begin to unravel how the unequal bargaining power inherent in these contracts is impacting franchisees, workers, and consumers.” The references to “unequal bargaining power” and “workers” once again highlight this FTC’s unfortunate fascination with issues that fall outside the proper scope of its competition and consumer-protection mandates.

The FTC’s press release lists representative questions on which it hopes to receive comments, including specifically:

franchisees’ ability to negotiate the terms of franchise agreements before signing, and the ability of franchisors to unilaterally make changes to the franchise system after franchisees join;

franchisors’ enforcement of non-disparagement, goodwill or similar clauses;

the prevalence and justification for certain contract terms in franchise agreements;

franchisors’ control over the wages and working conditions in franchised entities, other than through the terms of franchise agreements;

payments or other consideration franchisors receive from third parties (e.g., suppliers, vendors) related to franchisees’ purchases of goods or services from those third parties;

indirect effects on franchisee labor costs related to franchisor business practices; and

the pervasiveness and rationale for franchisors marketing their franchises using languages other than English.

This litany by implication casts franchisors in a negative light, and suggests a potential FTC interest in micromanaging the terms of franchise contractual agreements. Presumably, this would be accomplished through a new proposed rule to be issued after the RFI responses are received. Such “expert” micromanagement reflects a troublesome FTC pretense of regulatory knowledge.

But hold on, the worst is still to come. To top it all off, the press release closes by asking for comments on whether the commission’s highly problematic proposed rule on noncompete agreements should apply to noncompete clauses between franchisors and franchisees.

Barring noncompetes could severely undermine the incentive of franchisors to create new franchising opportunities in the first place, thereby reducing the use of franchising and denying new business opportunities to potential franchisees. Job creation and economic growth prospects would be harmed. As a result, franchise workers, small businesses, and consumers (who enjoy patronizing franchise outlets because of the quality assurance associated with a franchise trademark) would suffer.

The only saving grace is that a final FTC noncompete rule likely would be struck down in court. Before that happened, however, many rationally risk-averse firms would discontinue using welfare-beneficial noncompetes—including in franchising, assuming franchising was covered by the final rule.

As it is, FTC law and state-consumer protection law already provide more than ample protection for franchisees in their relationship with franchisors. The FTC’s Franchise Rule requires franchisors to make key disclosures upfront before people make a major investment. What’s more, the FTC Act prohibits material misrepresentations about any business opportunity, including franchises.

Moreover, as the FTC itself admits, franchisees may be able to use state statutes that prohibit unfair or deceptive practices to challenge conduct that violates the Franchise Rule or truth-in-advertising standards.  

The FTC should stick with its current consumer-protection approach and ignore  the siren song of micromanaging (and, indeed, discouraging) franchisor-franchisee relationships. If it is truly concerned about the economic welfare of consumers and producers, it should immediately withdraw the RFI.