McDonald's vs. NLRB

Richard Epstein*



Under the Obama Administration, the National Labor Relations Board has taken strong pro-union stances on collective bargaining. One of its most salient initiatives has been its recent effort to expand the definition of an “employer” under the National Labor Relations Act. Thus on December 19, 2014, Richard Griffin, the NLRB’s General Counsel, issued a short announcement that it would file unfair labor charges against both McDonald’s and its franchisees for “making statements and taking actions” against those employees who participated in nationwide fast food worker protests.

That decision has set the stage for one of the most contentious management labor disputes of recent years. In the two weeks following the announcement, some 61 new complaints were filed, and more are coming in steadily. And why not, with such a huge target to shoot at? McDonald’s, of course, runs a major operation with its many independent franchisees. Its standard business arrangements are, in broad outline, typical of other franchisee operations, of which there are today, according to the International Franchise Association—whom I have advised on these matters—about 750,000 outlets, employing some 8.1 million workers, whose direct economic output is about $770 billion per year, and whose indirect impact is surely larger.

The most obvious explanation for the growth of the franchise system is that it works economically, wholly apart from any direct concern with labor relationships. The standard economic set-up is needed to create a system of optimal incentives for all its participants. The basic job of a franchisor is to create a standardized product that will allow its strong and reliable brand to lure in customers across the franchisor’s entire national or global base. Customers want the ironclad assurance of consistent quality of both product and service, no matter what franchise they attend. A franchisor that allows its franchisees to work without explicit guidance or close supervision is in mortal danger of brand deterioration.

The business set-up is yet another variation of the common pool problem. Each individual franchisee knows that it will pocket the full gains from any small decline in the quality of its goods or services. At the same time, the astute franchisee knows that it will bear only a tiny fraction of the overall system loss. Without close supervision, every franchisee will be tempted to cut corners, at which point all franchisees—and all their customers—are worse off than they would have been if uniform standards had been enforced against each of the outlets. No individual franchisees can police all the others, so it falls to the franchisor to police them all, not only for its own benefit, but also for that of all franchisees and consumers.

In response, it may be said that if quality control is the dominant issue, let the franchisor take direct control over the operations, which gives it ample means to curb cheating. But that possible response overlooks the huge business drawbacks inherent in such a monolithic arrangement. Individual outlets operate in different markets, with different workforces, different consumer tastes, and different local and state regulations on everything from waste disposal to signage.

A remote company could easily find it difficult to manage thousands of different outlets on a daily basis, because of the difficulties in first finding and then motivating the managers of the individual outlets to make the best business decisions. It would of course be foolish to ban direct ownership of some or all outlets. But the huge popularity of the franchising arrangement with its long-term franchisees gives strong empirical evidence that better execution at the local level comes from independent franchisees who have their own cash in the game and thus stand to suffer the direct consequences of faulty business execution.

In effect, taking the system as a whole, the complex division of control allocates to the franchisor those activities that it does best, and to the franchisees those activities that they do best. The overall improvement of the business operations translates into lower prices and better products for consumers, greater opportunities for ordinary men and women to start their own businesses, and increased jobs for workers seeking full or part time employment. Tampering with a successful business model by ad hoc regulation is a recipe for disaster.

The NLRB does not deny that there are powerful efficiency advantages to the creation of a franchise arrangement. Nor does it deny that there are no cases on the record in which franchisors under the standard business arrangements have ever been treated as employers of the workers of the individual franchisees. Indeed, virtually the only way under current case law for a firm to be treated as a joint employer is for it to fire employees who are under the divided control of the two firms in question, which never happens under standard franchisee arrangements.

The standard franchisor is not, as union lawyers like to say, “the boss” of the franchisee’s employee. Nor does the relationship between the franchisor and franchisee, as union supporters claim, exist in "a make-believe world in which responsibility for wages and working conditions falls squarely on the shoulder of franchisees." That rhetorical flight of fancy cannot be sustained in light of all the tasks that franchisors donot take on with respect to the franchisee’s employees. Franchisors do not recruit, interview, hire, fire, promote, or discipline individual employees. They do not set wages or individual terms of employment. They keep no records of any kind on any franchisee employee. They are only in the standards business. Consciously and sensibly, they leave all personnel decisions to the franchisee, who is in the best position to make those judgments, and faces potential liability under the labor acts if it crosses the line.

It is no secret that these arrangements are structured in this fashion in part to ensure that the franchisor will not be treated as an employer under the NLRA. But these franchise contracts are not sham arrangements that say one thing and mean another. Their explicit terms are scrupulously observed, and there is no obligation whatsoever for any firm to sacrifice its business efficiency in order to maximize union power and influence.

The decision of General Counsel Griffin to prosecute these cases does not mean that in each and every case a franchisor will be treated as if it is an employer. It is rather the case that, as the NLRB’s General Counsel and the Service Employees International Union (SEIU) have separately argued in briefs before the NLRB, that the Board should return to some “traditional” standard that “would make no distinction between direct, indirect, and potential control over working conditions and would find joint employer status where ‘industrial realities’ make an entity essential for meaningful bargaining.”

It is important to note that this supposed standard drips with uncertainty as to which franchisors should be responsible in which particular cases. The term “potential control” has no clear meaning, for it could easily be stretched to include any situation in which a franchisor could demand direct control over employee relations even if it has no desire to exercise it. Any case-by-case determination on franchisor power is not possible in an industry this complex, where the basic franchising structure is subject to small variations in individual cases which may—or may not—tip the balance under this test for or against the franchisor’s alleged employer status. In addition, this open-ended standard allows for SEIU and other labor organizations to file constant claims against franchisors like McDonald’s, which are costly to defend even if the claim is dismissed years later.

These charges of unfair labor practices, moreover, need not command the support of the particular workers at any given franchisee who, given the rapid rate of turnover in this business, may much prefer to work in an environment in which they do not have to pay stiff initial membership fees and annual dues as a condition of employment. Indeed, the high rate of turnover in many franchise businesses means that a large fraction of the mandated union members will have had no say whatsoever in deciding whether to join the union approved by workers, many of whom have already left their jobs.

It is also critical to note that if the NLRB General Counsel does prevail after challenge in court, it will necessarily undo many of the advantages of the current business relationships. Put yourself in the position of a franchisor that is told in no uncertain words that it is jointly liable for an unfair labor practice for each and every decision made by its franchisee/joint employer.

At this point, it becomes foolhardy for the franchisor to remain indifferent to the behavior of an individual franchisee who can expose the high visibility franchisor to major damage awards and much adverse publicity. But once the franchisor decides that it has to take over much of the business, then the entire business model is at risk. After all, what individual franchisee wants to be saddled with additional costs of coordination while facing higher wages and less business flexibility?

At this point, the shrinking pie will lead to frantic efforts to renegotiate the basic deal in ways that both sides can live with, fully knowing that any new arrangements have to be far worse than the ones that they have displaced. The union profits handsomely from fees and dues, but individual workers are likely to be displaced in larger numbers, as everyone looks for various automated devices to reduce the dependence on unionized workers under a collective bargaining agreement that imposes onerous and unnecessary working conditions. Right now, the SEIU knows that the workers of any one individual outlet will not sign on to a union, because those workers fully understand that the competitive conditions in the franchise business mean that successful unionization is a pyrrhic victory from which they will never recover.

Unfortunately, this point is often lost on writers like David Weil, who in condemning “The Fissured Workplace,” treats the breakdown of the monolithic form as some kind of neglected social problem. But any new form of organization is no more of a problem than is the decline of Life Magazine after the rise of specialized and niche publications, each of which is better able to serve its targeted constituency than one all-purpose magazine. The simple point here is that more powerful metrics mean that transactions across independent firms have made it less costly to run a dispersed network, with or without unions. Contracting out allows the business to concentrate its efforts on its core competence, without having to take on duties that are more cheaply and effectively handled by others. Heavy-handed efforts at regulation to block these innovations can only make matters worse.

The NLRA imposes a heavy tax that hurts employers and employees alike. Ironically, the rise of independent contracting generally is an effort to escape these explicit or implicit taxes that the government imposes on the employment relationship. The irony should not be lost. In undertaking the effort to expand the scope of unionization, the NLRB General Counsel will only add new fissures to the workplace that is reeling under the onslaught of ever more onerous regulations. The law of unintended consequences applies with full force to the NLRB’s ill-considered flirtation with an expanded joint employer doctrine.

*Considered one of the most influential thinkers in legal academia, Richard Epstein is known for his research and writings on a broad range of constitutional, economic, historical, and philosophical subjects.