On National Ice Cream Day, Thanks Dairy Queen

DQIn honor of National Ice Cream Day (July 20), here is a brief celebration of Dairy Queen, an institution of American culture—entrepreneurial, legal, literary, and familial—that helped put this cold concoction on the national calendar. I developed these reflections when researching my upcoming book, Berkshire Beyond Buffett: The Enduring Value of Values (Columbia U. Press 2014), which provides deep looks at the corporate culture of Berkshire Hathaway’s fifty-plus subsidiaries, including Dairy Queen.

While full treatment must await publication of the book (which can be pre-ordered now), here are a few passages along with many outtakes—i.e., sections that did not make it into the final book because they are too technical, but may appeal to readers of this blog interested in the history of franchising businesses and intellectual property rights.

Dairy Queen’s roots date to 1927’s founding of Homemade Ice Cream Company by John F. (“Grandpa”) McCullough (1871‒1963) and his son Alex near the Iowa-Illinois border. Innovative ice cream makers, they experimented with temperatures and textures and eventually pioneered soft ice creams. One discovery: ice cream was frozen for the convenience of manufacturers and merchants, not for the delight of consumers.

At first, the McCulloughs were unable to interest any manufacturer in building the necessary freezers and dispensers to serve soft ice cream. Luckily, however, Grandpa happened to see a newspaper ad in the Chicago Tribune describing a newly-patented continuous freezer that could dispense soft ice cream. Grandpa answered the inventor/manufacturer, Harry M. Oltz, and the two made a deal in the summer of 1939.

The McCullough-Oltz agreement entitled Oltz to patent royalties equal to two cents per gallon of soft ice cream run through the freezer; the agreement also granted the McCulloughs patent licensing rights in the Western U.S., while Oltz retained them for the Eastern part of the country. The agreements that McCullough and Oltz made with licensees seemed to cover only the patent, rather than the DQ trademark, and contained few quality controls.

After World War II, DQ stores hit their stride, drawing lengthy lines of increasingly loyal customers enjoying the cooling effects of soft ice cream all sultry-summer long. The customer throngs at one store in Moline, Illinois caught the attention of Harry Axene. An entrepreneurial farm equipment salesman for Allis-Chalmers, Axene wanted to invest in the business. He contacted the McCulloughs and acquired both the rights to sell the ice cream in Illinois and Iowa as well as an interest in the McCullough’s ice cream manufacturing facility.

Axene envisioned building this business via a crude version of what would develop into franchising. A novel form of business during this period, franchising has the hallmarks of the American dream. For a relatively low initial investment, an entrepreneur of modest means can own and operate a business. Today, this is a popular business model, drawing millions to the excitement of building a business supported by an organization that coordinates product standardization and branding.

Before World War II, franchising tended to be used in product distribution settings, especially service stations and automobile dealerships. After the War, innovation and expansion occurred in the franchise as a business format, involving not only a product or service and a trademark but the complete package, including a business plan, marketing strategy, operating manual and quality control standards. The model had been incubated as early as 1924 by Allen and White’s A&W Root Beer and 1939 by Howard Johnson; but it was after World War II when the business format franchise was perfected and proliferated, and DQ was a catalyst in that process.

The post-World War II era was ripe for the franchising boom as military personnel returned home to begin careers and families. Business format franchising would prosper in such an environment as personal incomes rose to drive expansion of the retail and service sectors. More subtle and profound cultural factors supported the growth of franchises. Business franchising offered a model that appealed simultaneously to two paradoxical beliefs of many Americans: the American Dream’s plank that celebrates small business owners and the reluctant article of faith that big business is necessary for success. Franchises offered both the personal payoffs of proprietorship along with the competence of corporate America.

In November 1946, Axene hosted a conference for 26 investors at the LeClaire Hotel in Moline, Illinois. Among those attending was Ray Kroc, a milkshake machine salesman, soon would build the McDonald’s restaurant chain by perfecting the business franchise model. Axene explained the concept for Dairy Queen: ice cream sales territories would be sold for an initial fixed fee plus ongoing royalties for the soft ice cream product. Word of the innovation spread and Axene quickly opened numerous franchises in the mid-West, and by the end of 1947 had helped establish 100 DQ stores nationwide.

The McCullough’s sold Axene the rights in large regions to both the patented machine and the trade-marked soft ice cream brand. Axene, in turn, sold smaller territories to others, many of whom would further sub-divide them. Axene did not, however, retain much control over the operators, making the first generation of DQs he facilitated more like the traditional product franchises rather than the business format franchises to come.

Axene gradually saw a clear need for centralized coordination, however. Hence he led the formation in 1948 of the Dairy Queen National Trade Association. It would set uniform standards for the group, secure chain-wide supplies such as cups and spoons and conduct national marketing and develop. In doing so, DQ provided the prototype for the modern business franchise model, one that Kroc would perfect at McDonald’s beginning in 1955.

The approach combined a strong central standard-setting and compliance organization riveted on quality customer service. In addition to DQ, franchises sprouted up around other now-famous brand names, including KFC, IHOP, Midas Muffler, Radio Shack and Ramada Inns. A boom in franchising spread across the country in the late 1950s and through 1960s, involving nearly one thousand brands run through 670,000 franchises.

By this time, Dairy Queen’s founding families had begun passing the torch. Both Grandpa McCullough and his son Alex had retired by 1953, succeeded by Alex’s son, Hugh; Harry Oltz retired during the late 1940s, while his son Hal remained active. Harry Axene left Dairy Queen in 1949, after a disagreement with the operators over an idea he had for an innovative freezer; after departing, he went on to found Tastee Freeze, a California-based soft ice cream chain eventually acquired by Galardi Group, a leading hot dog food store chain.

In 1954, Harry Oltz’s patent for the continuous freezer expired, prompting some franchisees to stop paying royalties. Hugh McCullough responded by suing, arguing that the royalties were not limited to the patent but encompassed payments for the Dairy Queen trade name. The stakes rose when some of those franchisees responded by saying that they had acquired their rights not from the McCulloughs but from Axene.

The litigation, following another American tradition, became protracted, costly and diverting—one of the numerous cases even reached the Supreme Court, which wrote an opinion addressing the scope of the right to a jury trial in a civil case.[1] The downside of American litigiousness caught up with the parties in 1962, when Hugh McCullough settled one of the big cases. He relinquished all claims and sold his interests to an investor group made up of several franchisees on the other side.

The new owners renamed the business International Dairy Queen—the name by which the Berkshire subsidiary operates today. They took a more business-like approach to handling trademarks and royalties as well more attention to the creation of franchises and the relationships with franchisees. For example, royalties due from franchises would now be based on total dollar sales rather than gallons of soft ice cream sold. Central management continued the roles of standardizing the DQ menu and conducting national advertising (eventually leading to the still-famous slogan, “The Cone with the Curl on Top”).

Around 1970, DQ and numerous other franchisors faced difficulties. The franchising boom of the 1960s assumed the shape of a bubble and burst. Many companies, following McDonald’s and KFC, had gone public, soon sporting inflated stock prices. They were the glamour stocks of the era’s bull market, alongside electronics makers. When the market bubble burst, the franchises suffered too.

In addition, the franchise had become something of a fad, attracting celebrities who did little more than lend their names to some concepts that would prove short-sighted. Among celebrities backing franchises were the likes of Arthur Treacher and Roy Rogers; they included Johnny Carson and Mickey Mantle, both of whom testified at Senate hearings on the topic chaired by Harrison Williams.

Meanwhile, a group of franchisees of the Chicken Delight chain sued the central corporation in a class action alleging antitrust law violations.[2] A federal court agreed, finding that the company unlawfully tied the acquisition of the franchise to the purchase of approved products. The legal fight destroyed the Chicken Delight franchise, as the franchisor stopped selling products, driving many franchisees out of business; the company eventually settled the case with the surviving franchisees, but all of them soon shuttered too.

State officials from Massachusetts and New York joined a chorus of critics who aired tales of unscrupulous franchisors preying on naïve aspirants, the “Moms-and-Pops” who dreamt of running a business but lacked requisite experience or sophistication. Harold Brown, a Massachusetts attorney, successfully advocated for turning the franchisor-franchisee relationship into a fiduciary one, not merely a commercial/contractual relation, but one in which the company owed story operates a high set of obligations, including duties of candor and loyalty.[3] A 1970 Wall Street Journal story captured the era’s mood:[4]

The spectacular early success of enfranchisers and the case of entry into the field prompted many entrepreneurs with neither experience nor capital to become either enfranchisers or dealers. The franchise holder today is often no businessman at all but perhaps a plumber or electrician who has been told he needs no experience to profit handsomely and that the enfranchiser will teach him all he needs to know. Some business greenhorns have sunk all their savings into franchises only to see everything evaporate.

The FTC’s position on the franchising debate of the 1970s suggested occasional rather than pervasive problems, and a general lack of good information about the overall marketplace.[5] After the Williams hearings in 1970, the Senate Business Committee published a report, The Impact of Franchising on Small Business, likewise lamenting a dearth of reliable information about the quality of franchising in the country. It commissioned a study by researchers at the University of Wisconsin, Urban B. Ozanne and Shelby D. Hunt, who endorsed this business model as follows:

We conclude that the net economic effects of franchising as a system of distribution are positive. Without franchising, thousands of small businessmen would never have had the opportunity of owning their own businesses. Similarly, franchising has enabled many entrepreneurs with little capital to take an idea and from it build a large multi-unit organization. Without franchising, these entrepreneurs would have had to give up their idea or attempt to sell it to some large corporation. Any system which opens up economic opportunities for the “little guy” should be carefully nourished and protected. Franchising represents a viable alternative to large, completely integrated corporate chains. Since the net economic effects of franchising are positive, any legislation which would cripple this very important segment of our economy should be avoided.[6]

The authors recommended, and later laws concentrated on, full disclosure, allowing franchisees to terminate agreements within short periods after signing them and allowing franchisees to terminate their agreements for cause.

As for Dairy Queen in particular, its woes during the 1970s translated into low or negative earnings and impaired cash flows. Observers could readily see the company’s problems and ready solutions, a combination that stoked the interest of an investment group featuring Rudy Luther, William B. McKinstry, John Mooty (a business lawyer) and others who had reinvigorated National Car Rental System in the 1960s.  The group won management’s backing to acquire a majority interest in exchange for cash and working capital commitments. The group returned DQ to profitability and liquidity.

DQ has since been a staple of American life, featured in such books as Larry McMurtry, Walter Benjamin at the Dairy Queen: Reflections at Sixty and Beyond; Bob Greene, Chevrolet Summers, Dairy Queen Nights; and Robert Inman, Dairy Queen Days.  The story of Dairy Queen detailed in my forthcoming book owes much to Mr. Mooty, whom I had the pleasure of interviewing for the book, and who kindly commented on the DQ section. It is a story of autonomy and entrepreneurship of which American dreams are made.

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[1] Dairy Queen, Inc. v. Wood, 369 U.S. 469 (1962).

[2] See Siegel v. Chicken Delight, 448 F.2d 43 (9th Cir 1971).

[3] See Harold Brown, Franchising: A Fiduciary Relationship, Texas Law Review 49 (1971): 650.

[4] See William L. Killion, The Modern Myth of the Vulnerable Franchisee: The Case for a More Balanced View of the Franchisor-Franchise Relationship, Franchise Law Journal, 28 (2008): 23, at 26-27 n. 54-55 (quoting Many Franchises Fall on Hard Times, Wall St. J. (May 29, 1970).

[5] Killion at 26-27 n. 56-57 (quoting FTC’s general counsel).

[6] Urban B. Ozanne & Shelby D. Hunt, The Economic Effects of Franchising (1971).

General sources, in addition to interviews with John Mooty: International Directory of Company Histories, Vol. 39. St. James Press, 2001; Caroline Hall Otis, The Cone with the Curl on Top: The Dairy Queen Story, 1940-1980, Minneapolis, MN.: International Dairy Queen, Inc., 1990; Bob Miglani, Treat Your Customers: Thirty Lessons on Service and Sales That I Learned at My Family’s Dairy Queen Store (New York: Hyperion 2006).

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