McDonald's Owner/Operators Temperature Check
Recently I gained additional perspective on the issues and discontent in the McDonald's U.S. owner/operator community. McDonald's (MCD) had a rough year with a new CEO, softened sales growth, executive turnover, franchisee unhappiness and considerable attention from the press on their problems.
It is striking to now see the depth and breadth of this bellwether chain's franchise problems. After reviewing a summary of issues and remarks by McDonald's franchisees, I think that both franchisor and franchisees have work to do to better their circumstances and the brand.
- First, there has to be basic respect of the franchisee's place and importance. Franchisees are investors too, and deserve the same level of respect as MCD common stock shareholders. The report of franchisee concerns that I have seen show a growing lack of confidence with McDonald's. Franchisees quote replies by franchisor employees to their problems such as, "So what if you don't make money in the first ten years?" And then those franchisor representatives add that there is a line of franchise buyers who would love to take the disgruntled franchisee's place. This deaf ear to owner-operator problems is ill served and contrary to McDonald's founding values.
- Having considerable angst regarding the growth of the dollar menu, franchisees must be aware that as a publicly traded entity, MCD has a pass fail same store sales bumper sticker put on it by Wall Street. Either the number is high enough or it is not. Either low prices drive traffic or it does not. If not, MCD stock price plunges. What is encouraging is that McDonald's does have the capability to offset the low price effect that hammers down franchisee profits by lowering rents, which it did in the old days, to help new franchisees survive.
- Franchisees have expressed the hope to get back to 8.5% rents, with some paying now 11 to 12% of revenue to MCD for its company-owned property leases. The problem is that restaurant economics were never built to support astronomic 12% rents. That's just too high. MCD could and should find restaurant G&A savings to offset the rent spread reductions.
- Finally, an appeal to both sides. It is easy to complain. Solutions should be offered by franchisees and the company alike and properly vetted through the McDonald's OO Committee structure. Franchisees speak about the plethora of advisory committees as a maze where ideas lose their way. That's a loss for McDonald's. Working together can work and has worked at McDonald's in the past.
One can only wonder — if these problems are at play with stellar McDonald's, the biggest restaurant chain in the U.S. by sales, then what is underway with lesser franchise networks?
Comments
Ronald Is Not A Bad Guy
The problem Zee's have is McD has not stayed relevant with the Millennial generation - the upcoming group with real purchasing power. McD is forced to tap markets where consumers are simply looking for cheap eats.
Being a publicly traded company, for McD to reduce franchise fees/rents means lower gross margins for the franchisor. Wall Street "shareholders" want higher gross margins, increases in SSS, and more profits. Hmmm...not many concessions available to poor'ole Zee stakeholders.
If there are many franchise buyers willing to acquire disgruntled Zee stores, it might be time to get out while the getting is good.
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Inherent conflict of interest?
Aren't the expectations of shareholders vs. franchisees opposed at such a basic level that franchisors really shouldn't even be allowed to go public? No matter what, to me, it seems that the franchisor's first responsibility should always be to their franchisees - which you can't do if you have Wall Street to answer to. The public franchisor then will always push top line first and store profits to second place at best. During my days at Domino's back in the '80s I can remember numerous times Monaghan always saying that he'd never go public because he wasn't going to have Wall Street tell him how to run the business. That we had to be in it for the long term.
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Re: Conflict of Interest?
Franchisees are at the front line of service. They are the most important variable in sustaining and enhancing brand equity. Traditional franchise contacts are between 2 parties with one bearing greater control over the other and a common goal to build brand equity by increasing sales and profits mutually.
When the franchisor sells out, new shareholders focus solely on building their profits quarterly. Ever changing franchisor management teams have a perverse incentive to extract value from franchisee store level P&Ls.
Shareholders have no contractual obligation to the franchisees but they do control the management of the franchisor - the party with the greatest control over the franchisee. Makes me wonder what the value of those franchisee cash flows are worth in mature publicly traded brands like McDonald's.
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Franchisees a driver to franchisor enterprise value
Bean: I think you are looking at this from a debit/credit narrow accounting standpoint, and not seeing the forest for the trees.
From a forensic perspective, there is no doubt that the franchisee's investment and operations powers franchisor enterprise value, for publicly traded companies, or its potential market value, if privately held. Franchising= asset light, low CAPEX, higher valuation premium. That premium comes from somewhere: the franchisees.
The MCD threat in 2006 came from Bill Ackman, hedge fund investor, who failed his with Target, Borders (Chapter-11) and perhaps to fail soon with JC Penney investments. MCD was right to reject his financial engineering.
MCD is a sum of its parts. All of the parts have to work. I wouldn't at all throw up my hands just because a franchisor is publlicly traded.
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John - You are right that the
John - You are right that the business model does not support 12% rents. This is why the only way to survive in McDonald's is to have a minimum 5 to 10 units or more. McDonald's Corp. is actively working to reduce the number of one, two, and three store franchisees. These smaller Operators are considered to be a "liability". Actually 12% rent is on the low side for new stores
that can come in as high as 16 - 17%. And that's in addition to a 4% Service Fee (royalty).
The business model is further strained by the requirement that the franchisees rebuild or rebrand the restaurants. It's tough to get an ROI rebuilding or remodeling your landlord's building.
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Franchisees are not
Franchisees are not investors in the Franchisor. They are invested in the brand but have no inherent ownership interest in the Zor. MCD is one of the best Zors in working collaboratively with the Zees but they can't go too far. A few years back there was talk (threat) of private equity making a run at MCD to break it up. Into a REIT (more or less) and a Zor. And an operating company for company-owned stores that would probably have existed only long enough to sell them off.
If a publically traded company doesn't keep the stockholders happy, management gets the boot. MCD corporate management's defense against this is to perform strongly enough that stockholders (NOT "stakeholders") don't care to vote them out. "Stakeholders" don't have a vote. The only way the Zees can keep the collaborative culture going is for the Zor to remain profitable enough to satisfy Wall Street.