Time For Transparency BY ER I C H . K A R P, E SQ . | G E N E R A L C O U N S E L T O N C A S E F
The single most important ingredient in the recipe for success is transparency because transparency builds trust. These are the prophetic words of Denise Morrison spoken in 2017 as the CEO of Campbell Soup Company, who radically changed the culture of the enterprise by emphasizing ingredient transparency. She was at the cutting edge of the philosophy that if customers know where their food comes from, they will trust the product more and thus buy more of it. She even created the website https://www.whatsinmyfood.com. Her approach transformed the company and not incidentally, doubled its stock price. Since January 1, 1979 every franchisor in the United States has been required to furnish a franchise disclosure document (FDD) to a prospective franchisee. This document must contain a substantial amount of information regarding the franchise opportunity. The goal of the FDD is to allow the prospective franchisee to make an informed decision about whether or not to invest. The document must be complete and accurate in all respects. In this respect, the FDD is about selling a product, in this case a franchised business. But the principles of transparency and trust advanced by Denise Morrison with respect to canned soup applies with equal force to the sale of a franchise. This summer, the National Coalition conducted a survey of franchisees in the system resulting in responses from franchisees who own more than 1,100 stores. Seventy-one percent of the respondents said they had been franchisees for at least 10 years. More than three-quarters of franchisee respondents disagreed with the statement, “7-Eleven trusts its franchisees. The same percentage of respondents indicated they do not trust SEI. When asked if they thought SEI executives were honest and ethical, 74 percent disagreed. For comparison, in the National Coalition’s 2018 survey of franchise owners, 64 percent disagreed with that statement. What has 7-Eleven, Inc. learned from the visionary corporate executive, Denise Morrison? Is the company transparent with its prospective and current franchisees and does it aspire to be trusted by them? When it comes to information provided
to existing and prospective franchisees, the answer is sadly, not very much. Here are some specific examples. In 2018, we wrote to the United States Federal Trade Commission to inform that agency that the financial performance representations (FPR) in Item 19 of the FDDs of SEI were incomplete and misleading. Those FPRs included what the franchisee could be expected to assume was a complete profit and loss statement for the stores in a specific market. The FPR provided components of sales and the franchisees’ gross income after the gross profit split with SEI. It also provided a
total of average selling expenses and general and administrative expenses, but failed to do the math by subtracting those expenses from the gross income. In the case of the bottom third of the performers in one particular market, the FPR indicated that the franchisees’ average gross income was $208,903 and the total average selling expenses were $161,881, which would seemingly represent average net income to (and before compensation to) the franchisees of $47,022. However, the FPR went on to state that franchisees reported other general and administrative expenses with a high of $81,641, a low of $75, and an average of $12,581. As can be seen from the foregoing computations, the high end of the administrative expenses would put stores in the bottom third in the red by more than $34,000, before any payment or compensation to the franchisee owner. We also pointed out the FPR contained three lines for store manager payroll, bonus and taxes, but no information regarding compensation for that essential position. Each of
“ For many years we have been able to discern the national average franchisee gross margin, not because SEI was disclosing that information as part of its FPRs. Rather, we were able to glean that information from the notes to the audited financial statements of SEI which are also part of the FDD.” the lines was listed as a zero. The expenses presented were thus grossly misleading because no store can act without at least one manager. Did SEI respond by remedying these defects and providing a full, complete and thoroughly transparent average profit and loss disclosure? Did SEI dispute the accuracy of our observations and conclusions? To the contrary, it dispensed with providing the kind of profit and loss statements that it had disclosed for many years and replaced it with disclosures limited to total sales, gross profit and gasoline commissions for a particular market. In the context of a system where gross profit appears to be on a downward slope and employee wages are trending in the opposite direction, many franchisees are rightfully complaining about declining profitability. In that circumstance, it is deeply troubling that SEI did not opt for transparency but for opaqueness, eliminating all disclosures relating to net profit. Unfortunately, SEI has chosen the same path with respect to what it chooses to report about franchisee gross margin. For many years we have been able to discern the national average franchisee gross margin, not because SEI was disclosing that information as part of its FPRs. Rather, we were able to glean that information from the notes to the audited financial statements of SEI which are also part of the FDD. One of those notes routinely disclosed the total of all franchisee merchandise sales, cost of goods sold, and franchisee gross profit continued on page 32 J U LY | A U G U S T 2 0 2 1 AVANTI
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