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Fitch Says Labor Board Ruling Won’t Impact Franchising

NEW YORK – Fitch Ratings, one of the big three credit rating agencies, has issued a statement that it does not anticipate that the National Labor Relations Board's ruling that giant McDonald's Corporation is a "joint employer" will change the economics of franchising.

"We believe the development will not have a direct impact on the credit quality of franchisors," wrote Fitch Ratings in a press release this afternoon.

The Labor Board on July 29 ruled that McDonald's Corporation could be treated as a joint employer in complaints by workers at its franchised restaurants whose employment was challenged because of participating in protests for higher pay. The golden arches has been the target of numerous demonstrations this year by employees seeking increased wages.

The National Labor Review Board stated, "The National Labor Relations Board Office of the General Counsel has investigated charges alleging McDonald's franchisees and their franchisor, McDonald's, USA, LLC, violated the rights of employees as a result of activities surrounding employee protests."

The NLRB ruled that 43 of 181 complaints involving McDonald's had merit and that 64 additional cases involving McDonald's restaurants are pending. It hoped the parties would settle. "If the parties cannot reach settlement in these cases, complaints will issue and McDonald’s, USA, LLC will be named as a joint employer respondent," the labor board warned.

McDonald's views the decision as wrong and plans to contest the ruling.

The International Franchise Association, a lobbying group founded in 1960 by franchisors, is worried that the ruling against McDonald's as a possible "joint employer" for interfering with the rights of workers at franchised restaurants to demonstrate could spread.

Steve Caldeira, CEO and president of the IFA, thinks the NLRB ruling is much bigger than just McDonald's and demonstrations. "Ruling that franchises [meaning franchisors] are joint-employers will be a devastating blow to franchise businesses and the franchise model," says Caldeira as quoted in The leader of the association thinks the federal government's ruling against McDonald's is master-minded by the Service Employees International Union. "By proposing this seismic change, a supposedly independent federal agency is yielding to intense outside pressure from labor unions led by the Service Employees International Union, which is seeking to unionize franchise chains and undermine the proven, time-tested franchise business model."

Source: McD 2013 10k, Franchised store EBITDA estimates by Pacific Mgt Consulting

But Fitch disagrees with the franchise association that the NLRB declaration will put any significant dent in restaurant franchising. It writes today, "Franchising is an extremely profitable business model, resulting in EBITDA margins ranging from 40% to 60% plus for US restaurants that franchise the vast majority of their units, such as Burger King Worldwide, Inc. (NASDAQ:BKW), DineEquity, Inc. (NYSE:DIN) and Dunkin' Brands Group, Inc. (NASDAQ:DNKN). Operating earnings and cash flow quality are stronger with franchising because the franchisor has limited direct exposure to food, labor and other restaurant expenses and lower capital requirements." In other words, the gains are too good for franchisors to leave franchising. It will grow. 

"Examples of companies still continuing to shift towards franchising in the U.S. include The Wendy's Co. (NASDAQ:WEN). Wendy's completed efforts to sell 415 company-operated units to franchisees during the first quarter of 2014, increasing the percentage of the brand's over 6,500 system-wide units to about 85% franchised from 82% at the end of 2013," states Fitch. 

It's not just Wendy's, Burger King, DineEquity and Dunkin'. In particular, McDonald's annual statement from last year declared a Big Mac-sized margin of 83 percent of revenue from its franchising and franchise support activities. That compares to an estimated profit margin for an average McDonald's franchise in the United States of 15 percent earnings before interest, taxes, depreciation and amortization are taken out (see chart).

Fitch states that even if joint-employer status were to somehow expand outside of McDonald's for employee claims of all sorts for other restaurant franchisors, it will not change the economics of franchising. Franchisors can shift the costs to franchisees. "Franchisors are likely to adjust terms, including ongoing royalty rates and franchise fees, of future franchise agreements to accommodate higher business risk from the sharing of potential employee-related liabilities," writes the rating agency.

The agency points out that the NLRB ruling, along with employer mandates under the 2010 Affordable Care Act and broad-based minimum wage pressures, show that there is change at work among low-wage employment. "Worker uprisings, continued negative press around worker pay and benefits, and potential unionization will continue to drive up labor costs, which represent about a third of the cost structure for US restaurants," writes Fitch. It warns that some restaurants could suffer if consumers perceive a brand as unfair towards workers. The release noted that Darden Restaurants Inc., which only has company-owned restaurants, admitted that it experienced negative publicity in late 2012, which "had a temporary negative impact on sales" when it shifted full-time workers to more part-time workers in certain markets in response to the Affordable Care Act.

Related reading:

The franchising cloud of mystery: Restaurant franchise issues with wage increases by John Gordon

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Don Sniegowski is editor of Blue MauMau, the daily news journal for franchise & small business owners. Call him at +1 (270) 321-1268, tweet @bluemaumau or email