Counterfeit Capitalism, Food Delivery Apps, and the Attack on Franchising

7-Eleven franchises are the canary in the coal mine.

Hi,

Welcome to BIG, a newsletter about the politics of monopoly and finance. If you’d like to sign up, you can do so here. Or just read on…

Today I’m writing about why money-losing food delivery platforms funded by Wall Street might destroy independent franchises and local restaurants. Also in this issue:

• Slack calls Microsoft a monopoly

• The United Kingdom antitrust authority recommends breaking up Google

• Another weird monopoly, the roll-up of college sports viewing rights

• Kentucky Attorney General gets aggressive against PE giants Blackstone, KKR

First, some house-keeping. I was on the Beautiful Losers podcast last week, and tomorrow at 1pm ET, I’ll be giving a speech for the American Sustainable Business Council on the relationship between small business and monopolies, which you can watch here.

And now…

Wall Street Arsonists Go After Restaurants and Franchises

Back in September, I coined a term, “Counterfeit Capitalism,” to describe the money-losing business model of WeWork and Uber, which seems increasingly pervasive in our economy. Losing money to acquire market power, or to steal from investors, is a form of counterfeiting, because it drives honest competitors that have to generate a profit out of the market. What we’re seeing in the food delivery app space, with Grubhub, Uber Eats, Postmates, and DoorDash, all of whom lose money, is precisely that, the burning of capital by Wall Street in an attempt to acquire market power.

But the way these food delivery platforms are engaged in Counterfeit Capitalism is a bit subtle, and involves weird terms like ‘ghost kitchens.’ It also intersects with franchise law, and a fight between 7-Eleven franchises and the corporate headquarters that controls the 7-Eleven brand. There are three clues in this story.

The first is that last November, the founder of Uber, Travis Kalanick, raised a bunch of money from the Saudis to form a new venture called Cloudkitchens, Kalanick’s idea would be to create a centralized cooking area for chefs who did not want to open up sit-in restaurants but wanted to focus on delivery and catering. It would be a WeWork for chefs, much cheaper to open than a sit-in restaurant. And though there’s nothing inherently wrong with the idea of making it easier and cheaper to cook for delivery or for catering through centralized kitchens, Kalanick has a nose for wasting Saudi money on extractive business ideas in fragmented spaces. So it’s worth paying attention to what he’s up to.

Kalanick’s venture brings us to the second clue, which is the question of how one is supposed to make money via food delivery through centralized ‘ghost kitchens,’ as they are sometimes called. The ability to sell such food depends entirely on who controls access to the consumer. And who are those new would-be gatekeepers? Food delivery apps. A few weeks ago, food delivery app Uber Eats, Kalanick’s old company, bought Postmates, attempting to shrink the food delivery market from four large players to three (pending antitrust review). Before the pandemic, delivery was a nice-to-have rather than a must-have for restaurants. But the pandemic has made restaurants, with thin margins at the best of times, dependent on these Wall Street funded middlemen, who often charge something like 30% of the total amount of an order.

The relationship between restaurants and platforms can be quite hostile, because it’s a fight over the customer relationship. In a public letter, restaurant owner Erin Wade attacked platforms use ghost kitchens for leverage to force restaurants to sign up with their platform. She claimed that Grubhub set up fake restaurant websites for real restaurants, took orders, and caused customers to get angry at the real restaurant when their food wasn’t delivered. When her restaurant manager called the platform to complain, Grubhub’s representative said, "Well, none of this would happen if you would just sign up with us." Wade observed that Grubhub “sounds a lot like what the mob boss says, after they burn down your house.”

One result of bad platform behavior, as well as high fees, is that cities from Seattle to San Francisco have imposed price caps on food delivery apps, setting a maximum fee of 15% of the total amount of the order. So far twenty three cities have imposed price caps. These rules have set up a political battle; Uber Eats has simply decided to ignore the law in Portland, placing a $3 surcharge on all deliveries.

Maureen Tkacik, a writer and colleague, wrote a piece for the Washington Post about what is happening to local restaurants. She interviewed the former head of innovation for Grubhub, Collin Wallace, who is now something of a whistleblower. Wallace laid out that food delivery app strategy is far more insidious than it first appears. As Tkacik wrote:

Their Silicon Valley backers are raining cash on companies like Reef Kitchens, which has a fleet of food trucks in which anonymous cooks prepare meals for an array of fake restaurants exclusively available on the delivery apps. For a few weeks this year, one of those “ghost” kitchens was peddling food on the delivery apps under the name and address of a Michelin-starred Thai restaurant in San Francisco.

More disturbingly, Wallace, the former Grubhub executive, says the apps are using the troves of information they collect on who eats what, when and where to build menus and scout locations for ghost kitchens — a variation on what Amazon’s private-label division does with mom-and-pop suppliers and distributors that use its platform, as former employees told the Wall Street Journal. “Amazon is in hot water for this now, but DoorDash is doing the same thing with DoorDash Kitchens,” Wallace says, citing the ghost kitchen the company opened in Redwood City, Calif., last fall.

So that’s the second clue, food delivery apps and ghost kitchens being part of a vertically integrated organization to control access to the end consumer.

The last clue came last week, when a group of 7-Eleven franchises sent out a press release attacking their own franchisor, the corporate 7-Eleven, for changing the terms of its own proprietary delivery service, 7Now. It’s a very weird fight; why would 7-Eleven attack… 7-Eleven?

The reason is that 7-Eleven is actually not just one corporation, but a hybrid known as a franchise. A franchise combines small business ownership and big business branding. In a franchise, independent franchisee own their own pieces of a large chain, but have to obey rules and pay fees set by a central headquarters. Franchising is why someone can own a local McDonald’s, yet McDonald’s itself can be a multi-national corporation. There are around three quarters of a million franchises in America, in everything from pizza to plumbing to fitness centers. Franchises are usually owned by independent businesspeople. These men and women own and run a store and make and sell products, but they have to run their store through a branded formula developed by a corporate franchisor, and pay those franchisors various fees, in return for marketing services and a method of delivering a set of products.

7-Eleven has among the worst franchising relationships in America, with its franchises actually organizing on behalf of stronger labor law in California because, they claim, that 7-Eleven corporate treats them not like owners but like store managers. But 7-Eleven isn’t an isolated case; franchise law has tilted more and more towards corporate franchisors in recent decades. The business is so skewed that one big tech antitrust lawyer compared Denny’s, Domino’s, and Yum Brands and their massive return on capital employed to Google. He was defending Google, showing that its massively profitable operations returns less per dollar of capital employed by comparison to what corporate franchisors can extract from franchisees. Now that’s impressive!

This extractive relationship set the stage for the fight over 7-Eleven corporate and its delivery app. The corporate franchisor is using its network of franchised stores to do delivery to customers, which would normally be a boon (more customers! Yay!). The problem is that it is also forcing its franchises to hire extra staff, potentially rewarding favored franchises arbitrarily, and charging them opaque fees for delivery. The power relationship here puts franchises at the mercy of headquarters. And it could get a lot worse. “What would happen if [corporate HQ] decided to one day open fulfillment centers for 7NOW orders,” asked 7-Eleven franchise owner Rehan Hashmi. In other words, 7-Eleven can simply bypass its franchises through its own delivery app, if it chooses.

7-Eleven is something of an outlier, but not overly so. In fact, Washington Post columnist Steven Pearlstein reported, food delivery apps are now signing exclusive deals with major franchises, such as Yum Brands, Chili’s, the Cheesecake Factory and McDonald’s. Let’s take the next step. What would happen to McDonald’s franchises if Uber Eats was able to buy a McDonald’s franchise? I spoke with one franchise owner who fears that his corporate franchisor will do to him what 7-Eleven is doing to their franchises, and simply centralize cooking and delivery in a city. Put these three clues together - ghost kitchens, food delivery apps, and bad franchise law - and you have a setup to undermine both independent restaurants and franchises in America. That’s hundreds of thousands of independent restaurant owners and franchisees, who are civic leaders in their communities, wiped out, or severely curtailed in their ability to run their business.

And this all brings me back to the original point, of Counterfeit Capitalism. What’s interesting about this entire situation is that food delivery platforms, despite high fees and the massive surge in pandemic-related business, are not actually profitable. They are massively burning capital, likely due to their attempt to monopolize an industry with overpriced technology and expansion-related overhead. The CEO of Uber, CEO Dara Khosrowshahi, claims that the Postmates acquisition will lead to the company finally making money. “We want to get bigger in [food deliver], and really scale is how you bring the category into profitability,” he told CNBC.

Uber may be able to use its market power to raise prices, depress wages, control restaurants and franchises, or it may never find a profitable model. Its last CEO, Travis Kalanick, never could figure out how to actually make money. But Kalanick is still a billionaire, because he was able to grab enough boodle from investors as he spun a story about automated taxis that will not exist for decades, if ever. I suspect that Uber Eats, if it can extract more revenue using market power and somehow avoid political blowback, can make money. But what’s irritating here is that this kind of monopolization is simply not necessary. The business of food delivery could easily be done city-by-city, by medium size regional firms who live in the places they organize and charge reasonable prices because they lack the high-priced overhead of food delivery goliaths. That’s what’s so destructive about Counterfeit Capitalism; Wall Street is trying to turn all restaurants into sharecroppers, and is willing to lose a lot of money to do it.

That said, I don’t think this plot is going to work. Antitrust authorities might block the Uber Eats/Postmates deal, and even if they don’t, cities have significant amounts of regulatory authority over local commerce. Given that dozens of cities have already enacted price caps, there’s no reason they won’t also prohibit the kinds of collusive arrangements we’re beginning to see with Ghost Kitchens. Independent business people are pretty resourceful, and you can only push them so far.

Slack Goes After Microsoft: It’s bugged me for some time that Microsoft escapes scrutiny for its anti-competitive practices in the business software space, just because Facebook, Google, Amazon, and Apple are so much worse. But finally, Slack, which is being targeted by Microsoft Teams, filed a complaint with the European Commission.

Slack claims that Microsoft has illegally tied its collaboration software, Microsoft Teams, to its dominant suite of productivity programs, Microsoft Office, which includes Outlook, Word, Excel and PowerPoint. That bundling tactic, Slack contends, is part of a pattern of anticompetitive behavior by Microsoft.

About time. Still, even though the Europeans aren’t openly corrupt like American antitrust enforcement chief Makan Delrahim, it does look like they’ll allow the Google-Fitbit merger, which I can only imagine they are doing to retain their title as the most overrated antitrust enforcement authority in the world.

Weird Monopolies, College Sports Viewing Rights: Today’s niche monopoly is the 2019 a private equity roll-up of college sports viewing rights, which the Department of Justice Antitrust Division approved because nothing matters.

UK Recommends Breaking Up Google: I was reading the UK’s Competition and Markets Authority report on digital advertising, and found an interesting nugget on the part of Google that runs the plumbing for non-search digital advertising.

To address concerns relating to Google’s conflicts of interest in the open display market, we are considering the case for a range of separation remedies. These could include, for example, the separation of the ad server (which plays a key role in the selection and pricing of adverts and in which Google has a very high market share) from the rest of Google’s business, or a requirement on Google to trade on an arm’s length basis with its analytics business and offer analytics to third-party providers. Separation could cover a range of options, from management separation to full ownership separation (divestiture).

The break-up recommendation isn’t super strong and adtech is only a part of Google’s business. But this remedy is more aggressive than anything I’ve seen anywhere else. And that is good news.

Kentucky Attorney General gets aggressive on Blackstone, KKR: This lawsuit from Kentucky state Attorney General, Republican Daniel Cameron, is remarkable. Cameron shows how these large mega-cap private equity shops drained the Kentucky pension through what looks quite close to fraud and bribery. If you’re really interested, I recommended reading the complaint in full, but I’ll leave you with this tidbit on how Blackstone and KKR billionaires ripped off Kentucky pensioners.

Privately owned jet planes of Kravis and Roberts in the case of KKR/Prisma and Schwarzman in the case of Blackstone were used by their respective companies to fly their agents to Kentucky, for which the companies were charged and for which Kravis, Roberts and Schwarzman were reimbursed, in amounts, on information and belief, often in excess of $5 million per year. Thus each of Kravis, Roberts and Schwarzman personally profited from Kentucky business.

In other words…

Thanks for reading. Send me tips, stories I’ve missed, or comment by clicking on the title of this newsletter. And if you liked this issue of BIG, you can sign up here for more issues of BIG, a newsletter on how to restore fair commerce, innovation and democracy. If you really liked it, read my book, Goliath: The 100-Year War Between Monopoly Power and Democracy.

cheers,

Matt Stoller