Mar 16, 2023
McDonald’s Faces Fed-Up Franchisees Decrying ‘Destructive Path’
(Bloomberg) -- McDonald’s Corp. is facing rising unrest among certain US franchisees — a potential stumbling block as the burger chain plots aggressive expansion.
Squeezed by higher costs and grumbling at new operating rules, franchisees are joining a meeting this month with the company’s board to press their case in person. The session will give US operators “an opportunity to share with the board of directors why we believe we are on a destructive path,” one group of owners said in an emailed newsletter to about 1,000 members.
The discontent represents a risk to McDonald’s growth plans, said John Gordon, principal at Pacific Management Consulting Group, a restaurant and franchisee adviser. If this unrest leads longtime franchisees to “hang up the towel,” then it’s an “inherent operating risk” for McDonald’s because replacement franchisees may not be as well capitalized, he said. Newer franchisees would likely face higher borrowing costs, he added.
McDonald’s says that its longstanding relationships with lenders allows the company to connect franchisees with competitive financing options for growth. In an emailed statement, it acknowledged that inflation trimmed profitability for franchisees last year, but said cash flow has risen 35% per restaurant on average, since 2018 and long-term returns are “strong.”
Owners’ increasingly vocal criticism comes amid a sales boom that has bolstered McDonald’s shares and won over Wall Street, where 29 analysts recommend buying the stock, versus only a single sell rating. (Eleven say hold.) Same-store sales have grown in recent quarters as customers flock to the chain’s affordable options and a menu that includes a revamped chicken sandwich. The company attributes gains to better staffing as well as improvements to operations and marketing.
McDonald’s plans to open 1,900 new locations this year worldwide, including additions in its home market. This week it announced the hire of Tabassum Zalotrawala away from Chipotle Mexican Grill Inc. to serve as US chief development officer and help lead the efforts.
“Having spent the past five years investing our capital and energy in modernizing our business, we’ve earned the right to build new restaurants and set aggressive goals,” the company said in the announcement.
But as it eyes the expansion, management is having trouble winning over franchisees, who operate 95% of US locations which generate about 70% of revenue in the country. Certain franchisees are concerned by the unrelenting climb in wages and costs for ingredients and packaging which is eroding profit for operators. The National Owners Association estimates that McDonald’s locations, on average, will generate less cash for a second straight year in 2023.
Some franchisees are also angered by what they say is an increase in surprise visits from corporate inspectors, which they argue are scored unfairly and drive talented managers away. Some report their restaurants remain short staffed even with higher pay. New lease rules are another point of contention, as well as a policy that no longer gives family of current owners preferential treatment for contract renewals.
“Most of these people like to pass this business down to their kids. It’s like an annuity that you pass down through the family,” BTIG LLC analyst Peter Saleh said. He added that if new leases cost more — an area of franchisee concern — then owners are less likely to invest in further initiatives.
In a recent internal bulletin, the National Owners Association called on management to “to slow down the chaos and allow our restaurant teams to focus on providing the best experience to our loyal guests.”
The issues are likely to come up when Dorothy Stingley, who recently became head of the National Franchisee Leadership Alliance — another group that represents McDonald’s owners — meets with company directors on March 28. Stingley and her husband operate 15 locations.
McDonald’s said the meeting will include “a variety of voices” such as franchisees and suppliers as new board members get familiar with operations. “These invitations include specific topics and questions we expect the attendees to discuss with the company’s directors,” the company said.
In a March 1 letter accepting the company’s invitation to the meeting, seen by Bloomberg News, Stingley praises the leadership of McDonald’s Chief Executive Officer Chris Kempczinski and cites pride in the chain’s growing market share.
“Our business is changing, the challenges are real, and we are working to set the next generation up for success,” Stingley writes. She didn’t respond to requests for comment.
Meeting topics listed in the letter include “how to improve plan execution in restaurants” and “how we define economic success and our perspective on current performance.”
It’s unusual, but not unheard of, for franchisees to go before the board of their parent company, said Bill Ide, an attorney and company counsel at Akerman LLP who served on the board of Popeyes’s former parent company.
“If the management and franchisees are out of line with each other, then the board would need to know that, because it could have a material impact on the company,” he said.
Related: McDonald’s Raises Bar for Franchisees in Diversity Push
The company has said changes to how it grants franchises are meant to help recruit and train a more diverse set of owners: It’s vowed to provide $250 million in owner financing to help these franchisee candidates. McDonald’s has also emphasized that any new franchise agreement should be earned, not given. The company delayed the new inspection practices to allow owners more time to learn and prepare.
Sales at the average US McDonald’s store are $3.6 million annually, according to Technomic data. Franchise owners must pay for everything from coffee makers and trash cans to insurance and landscaping before collecting profit.
Evercore ISI analyst David Palmer wrote this week that McDonald’s has changed its decision-making process as it shores up US operations, resulting in “more top-down and less consensus-building” with franchisees. He added that this may be needed “to drive improved execution at the restaurant level.” The company’s overall strategy should boost low customer satisfaction scores, spark market-share gains and justify expansion, he said.
Credit Suisse analyst Lauren Silberman estimates that the average McDonald’s restaurant generates cash flow of about $500,000 per year. That’s above peers such as Burger King. Still, pressure on profitability strains ties.
“You see with these franchised systems, when cash flows and profits are pressured, naturally there’s more friction,” she said.
(Updates with additional company comments in 13th paragraph, franchisee letter in 14th paragraph.)
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