McDonald’s Franchisees Rebel as Chain Raises Store Fees

July 24 (Bloomberg) -- Donald Thompson, chief executive officer of McDonald’s Corp., talks about the company's growth strategy, new menu items and business in China. Thompson, speaking with Betty Liu on Bloomberg Television's "In the Loop," also talks about the U.S. economy and hiring plans. (Source: Bloomberg)

McDonald’s Corp. (MCD), already struggling to sell burgers in the U.S., now must contend with a brewing franchisee revolt.

Store operators say the company, looking to improve its bottom line, is increasingly charging them too much to operate their restaurants -- including rent, remodeling and fees for training and software. The rising costs are making franchisees, who operate almost 90 percent of the chain’s more than 14,100 U.S. locations, less likely to open new restaurants and refurbish them, potentially constraining sales.

McDonald’s is “doing everything they can to shift costs to operators,” said Kathryn Slater-Carter, who in June joined other franchisees in Stockton, California, to brainstorm ways of getting the chain to lessen the cost burden. “Putting too much focus on Wall Street is not a good thing in the long run.

‘‘It is not as profitable a business as it used to be,’’ said Slater-Carter, who owns two McDonald’s stores and backs California legislation that would require good faith and fair dealing between parties in a franchise contract. It would also allow franchisees to associate freely with fellow store owners.

Asked if McDonald’s is shifting costs to franchisees, Heather Oldani, a spokeswoman, said in an e-mail: ‘‘We are continuing to work together with McDonald’s owner/operators and our supplier partners to ensure that our restaurants are providing a great experience to our customers, which involves investments in training and technology.”

Photographer: M. Spencer Green

Under pressure from franchisees, the company slowed the expansion. It opened 1,130 net new domestic restaurants in 1995; by 1998, it had cut that number to 92. Close

Under pressure from franchisees, the company slowed the expansion. It opened 1,130 net... Read More

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Photographer: M. Spencer Green

Under pressure from franchisees, the company slowed the expansion. It opened 1,130 net new domestic restaurants in 1995; by 1998, it had cut that number to 92.

‘Productive’ Meetings

Lee Heriaud, who chairs the National Leadership Council, a group of franchisees that meet regularly with company executives to discuss ideas and concerns, attended the Stockton meeting and others. In an e-mailed statement provided by Oldani, he said “owner/operators’ feedback and perspectives have been shared with McDonald’s and owner/operator leadership in the spirit of open dialogue.” The meetings were “productive,” he said.

Cooperation between McDonald’s and its store owners is deteriorating, according to an April 11 letter from a franchisee to other store owners reviewed by Bloomberg News.

“Many of you have said that you don’t feel that the top management understands the economic pressures that we face,” the letter said. “The tone has become much more controlling and less inclusive.”

This isn’t the first time the world’s largest restaurant company has found itself at odds with the people who own and operate its stores. McDonald’s in the mid-90s alienated U.S. franchisees when it expanded too quickly and new stores began cannibalizing other locations, said Dick Adams, a former McDonald’s store owner and restaurant consultant in San Diego.

Photographer: Mark Jackson/Getty Images

A patron texting at a McDonald's restaurant in Minneapolis. Close

A patron texting at a McDonald's restaurant in Minneapolis.

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Photographer: Mark Jackson/Getty Images

A patron texting at a McDonald's restaurant in Minneapolis.

Slowed Expansion

Under pressure from franchisees, the company slowed the expansion. It opened 1,130 net new domestic restaurants in 1995; by 1998, it had cut that number to 92.

“There was a time at McDonald’s when the franchisee morale was extremely low and everyone was extremely upset,” Adams said. “We’re getting there again.”

Today’s tensions between Oak Brook, Illinois-based McDonald’s and store operators coincide with the company’s struggles to grow after consumer confidence fell in July after increasing for the past three months and with the unemployment rate stalled at 7.4 percent or higher. On July 22, the shares fell 2.7 percent, the most in nine months, when McDonald’s reported second-quarter profit and revenue that trailed analysts’ estimates. Chief Executive Officer Don Thompson said economic weakness would hurt results for the rest of the year.

McDonald’s fell 0.6 percent to $98.69 at the close in New York. The shares have increased 12 percent this year, trailing the 19 percent gain for the Standard & Poor’s 500 Restaurants Index.

Franchisee Income

The Big Mac seller, which owns or leases most of its U.S. stores, has been generating more income from franchisees. Revenue from franchised stores, which includes rent and royalties, increased 8 percent on average during the past five years, while total revenue rose 4 percent.

Some franchisees are paying as much as 12 percent of store sales in rent, according to notes of an April 23 meeting attended by store operators. Instead, they want the company to return to a historic rate of about 8.5 percent, the document shows.

U.S. McDonald’s restaurants average about $2.5 million in annual sales, according to Chicago-based researcher Technomic Inc. That means franchisees who have recently renewed leases are paying an average of $300,000 a year, up from $212,500 at the 8.5 percent rate.

Local Markets

“Across the country, the rent owner/operators pay for their McDonald’s restaurants is determined by local market real estate costs, as well as the cost of doing business in a particular market,” Ofelia Casillas, a McDonald’s spokeswoman, said in an e-mailed statement. “The range for rent has historically varied based on these and other regular business variables.”

At the April meeting at a community center in Paramount, California, a group of franchisees spent five hours discussing ways to get the company to reduce rents and other costs. Another cadre of McDonald’s store owners met in Stockton in June to discuss similar issues. The group in Paramount suggested reducing rents, royalty rates and creating a regional real-estate team of store owners to help set lease rates.

Rent is “the firmest of fixed expenses,” said John Gordon, principal at San Diego-based Pacific Management Consulting Group and a consultant to restaurant franchisees. “You pay that before you remodel, you pay that before you take owner salary out.”

Alienating Customers

As a result, some run-down stores aren’t getting fixed up, which in turn is alienating customers, he said.

“People don’t want to be in an old space, even if they’re going through the drive-thru,” Gordon said. “You get better employees, you just get a better vibe if it’s a newer store.”

As it is, remodeling a McDonald’s store costs at least $800,000, according to Slater-Carter. That’s more than twice as much as at Burger King Worldwide Inc. (BKW), which after franchisees revolted cut the expense for its remodeling program by half to about $300,000, on average. Wendy’s Co. (WEN) is also paring its upgrade costs and has said it will get to $375,000 for its least-expensive model.

Oldani, the McDonald’s spokeswoman, said that it costs about $600,000, on average, to remodel a McDonald’s restaurant and $1 million to build a new store.

McDonald’s recently told franchisee Slater-Carter she must pay $80 a year to switch to the company’s e-mail system and she’s now forking over an extra $10,400 per store annually for new software, Wi-Fi and employee training costs -- all fees that McDonald’s has tacked on in the last five years. She won’t know until 2016, when her lease must be renewed, how much extra she may be paying in rent.

“What I see going wrong is the corporation itself is forgetting that its fiscal strength rides on the fiscal strength and the creativity of the operators, and it’s just going for such centralized control,” said Slater-Carter, whose family has owned McDonald’s franchises since 1971.

To contact the reporter on this story: Leslie Patton in Chicago at lpatton5@bloomberg.net

To contact the editor responsible for this story: Robin Ajello at rajello@bloomberg.net

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