Remembering those times, Katz takes a long, thoughtful draw on his cigar, and points an accusing finger. "We had franchisees," he says, "who were making fortunes and were spoiled -- you ran an ad in the paper, and the phones just rang. . . . Then there were less calls, and the margins went down, and some of them began looking for a scapegoat." The first place they looked, Katz argues, was at the franchisor. "They lost sight of the fact that they had to provide great service," he says.
The franchisees found it equally easy to be critical of the parent. Poor training of personnel, minimal field support, lack of credit, late deliveries, unimaginative advertising (for which they paid a monthly royalty of 2% of gross receipts), and low-quality diet foods were among the grievances."Our client . . . found a three-inch wood stick in her Nutri/Flakes . . . and a black stone in her orange nectar," wrote the manager of one center. "A number of my clients told me that not even their pet cats would eat the Seafood Scampi and Seafood Marinara," complained another.
But if there was one issue that raised near-unanimous ire, it was the markup on Nutri/System food. The margins that had padded everyone's pockets in fat times seemed like the one thing franchisees could no longer live with -- and the one thing Nutri/System couldn't live without.
"One of my landlords was in the restaurant business," says David Heinig, who has an interest in five centers in Chicago and Wisconsin, "and he knows a lot about food costs. He took one look at my bills, and said, 'Oh, my God, that's high.' "But it hardly required an expert to spot the excess. "All it took to figure that out," adds Heinig, "was a trip to the local grocery store."
For Heinig, who had once been a sales manager with a pharmaceutical company, the "golden" markup was more than a point of concern, it was a matter of survival. "For the past six months, I have been losing money every month," Heinig later said in a court deposition. "I now find myself in an extremely tight cash position, with not much hope for change in the near future, if I continue selling Nutri/System foods. . . . Without the introduction of . . . [a] new food line into my centers, I will certainly not survive the summer and fall of 1984, but will be forced into bankruptcy, corporately and personally."
Other franchisees were also distraught. "The financial status of [my centers] is precarious," Charles A. Lindquist said of his Crystal Lake, Ill., operation. "We are operating with a loss, and will have to close the center if we must continue on the current basis." Ellen Dunn Dauw, with an interest in three centers in Iowa and Illinois, noted that one had gone from a net pretax profit of more than $35,000 in 1980 to a loss of more than $39,000 in 1983 -- in large part, she charged, because of the high cost of Nutri/System food.
The financial plight of some franchisees was aggravated by a discount promotion launched by Nutri/System in 1982. Not only did the promotion cut their profit margins even more, it also improved the competitive advantage already enjoyed by company-owned centers, which paid no royalties and no stiff markups on food.
With growing uncertainty and mistrust for the franchisor," Heinig recalled in his deposition, "we formed a franchisee association, which first met in Dundee, Ill., on October 15, 1982." That meeting, attended by 30 or 40 franchisees, was followed, in December, by a meeting in Scottsdale, Ariz., which attracted some 140 franchisees representing more than 300 centers. The Scottsdale meeting set up a Nutri/System franchisee association that incorporated as NSF Corp., with Heinig serving as the president.
Some of the organization's objectives were simple enough: to provide a forum for the exchange of ideas on promotion, advertising, and personnel, for example. The meetings also served as a bulletin board for such grievances as the allegation that Nutri/System was overcharging for other goods and services. A management conference in Acapulco, which was sponsored by the company, would have cost $1,198 for two people for five nights, Heinig charged, while a comparable seven-night package for two at the same hotel could be had for $630. A computer system offered by the company for $2,950, according to Heinig, was available from Radio Shack at a 15% volume discount.
But if there was a single, overriding goal at NSF, it was "leverage," and leverage in this case meant the ability to obtain food elsewhere. At the Scottsdale meeting, NSF voted to develop an alternative source of food, and asked Robert Katz, who was present, to provide it with Nutri/System's specifications for each food product.
That, to the Katzes, was roughly equivalent to a slap in the face with a glove. In January 1983, at Nutri/System's national management conference in Philadelphia, Harold Katz met Heinig. According to several depositions, Katz's greeting was, "Who the fuck do you think you are?" Later, at the company's dinner dance, Katz took the microphone to tell NSF members, "If you don't want to be a part of my family, then I'll buy you the fuck out." The franchisee association's members, say Heinig and others, were routinely intimidated; one, Robert Sheridan, claimed a company official told him, "You son of a bitch, you're trying to wreck our company." Eventually, says Heinig, he came to fear for his physical safety.
