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Franchisee crisis ramps up pressure on McDonald's management

Creation of the National Owners Association signals a major shift in franchise relations, says RB’s The Bottom Line.
Photograph courtesy of McDonald's Corp.

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An estimated 1,300 people descended upon Dallas this week for the second meeting of the National Owners Association, the first independent franchise association in the storied history of McDonald’s Corp.

That’s three-quarters of the domestic franchisee base—a massive surge in interest in a group that was only broached with a single operator’s email just a few months ago.

For McDonald’s, it’s a major crisis in its U.S. business, one that is suddenly ramping up the pressure on executives to produce results from a costly and complicated plan that was supposed to take the brand into the future.

It’s a major test for company executives, one arguably as significant as the one current management faced when Steve Easterbrook was named CEO in 2015 with a mandate to overhaul the company and its culture.

The immense interest in the association is important, suggesting deep skepticism of the company’s long-term plans in its biggest market among the people responsible for running the chain’s restaurants—the franchisees.

Those operators could seek more input on company plans, likely through the company’s existing channels for working with franchisees, such as the company’s National Leadership Council.

That means company management faces a far more skeptical audience as it tries to convince operators to invest in their business or buy into marketing and other changes.

At the heart of the issue has been year-long traffic declines. While McDonald’s has outperformed its major competitors in generating sales, including 2.4% same-store sales growth in the third quarter, it has come at the expense of transactions—which have fallen all year long. That means customers are ordering more food and coming in less.

To be sure, traffic has been a problem everywhere. Fast-food chain traffic declined 4.6% in September and 1.2% in October, and total traffic was down 1.9% during the latter month, according to the Technomic Chain Restaurant Index.

The weak sales and traffic, coupled with labor cost increases, are a major factor in the growth of franchise disputes throughout the restaurant business.

At McDonald’s, however, the challenges have come despite an active executive team and franchise base that have made numerous changes in recent years that were all designed to pull the company out of a multi-year sales stagnation. Those changes won over investors that have sent the company’s stock price to record highs.

The company lost sales and traffic between 2012 and 2016, leading the company to bring in Easterbrook in 2015. Easterbrook overhauled management, replacing many long-time company executives with people from outside the company and even the industry in a bid to inject new voices.

One of those voices was Chris Kempczinski, who joined McDonald’s in 2015 having spent a career at consumer companies like Kraft Foods Group. He was named president of McDonald’s U.S. division effective Jan. 1, 2017.

The company sold stores to franchisees and now operates just 700 of its 14,000 U.S. locations. It cut corporate overhead and moved its headquarters to downtown Chicago, done at least in part to change the company’s culture.

The company also added all-day breakfast, quickly expanded delivery, developed a new mobile app with curbside service, brought back an evolved dollar menu and other discounts, expanded the coffee program and introduced new chicken products.

The efforts appeared to work last year, when McDonald’s generated strong sales growth.

The company then started aggressively remodeling locations, adding self-serve kiosks inside restaurants. It required operators to remodel their restaurants by 2020, a requirement the company has since backed off on.

The temporary closures from the remodels have created some near-term sales pain for operators, and the company acknowledged in October that traffic gains once stores re-open have taken longer than expected.

As we wrote about recently, McDonald’s operators worry that as much as 40% of their restaurants would not qualify for lease renewal based on McDonald’s own financial requirements if the sales don’t grow as projected.

While McDonald’s clearly isn’t going to kick 40% of its franchisees out of their stores, to the franchisees it’s an indication of the financial strain they face after the remodels. While the company is paying 55% of the cost for most of the remodels, it still costs operators $500,000.

McDonald’s, for what it’s worth, takes strong issue with the 40% figure—arguing that the vast majority of its franchisees are in strong financial health. There’s also a sense that a movement to create an association is an inevitable result of the number of changes the company has made.

Still, operators at the first meeting of the association in Tampa in October took issue with the hardline stand the company has taken more recently in requiring franchisees to do the remodels and make other efforts.

“You’re not in Europe anymore,” 62-unit franchisee Blake Casper, whose email ignited the creation of the NOA, said during the Tampa meeting. He was speaking of Easterbrook, who led the turnaround of McDonald’s U.K. business before he was named CEO. “While the U.S. has had challenges the last few years, we are not a failing brand like the one you took over in England. The operator platform is different from the American model. And the American consumer is different from the European consumer.”

All that said, there is no reason why McDonald’s and its independent franchisee association can’t work together once they solve issues that led to its creation in the first place. While this is the first such group in McDonald’s history, associations are common throughout the franchising world.

“Even if they start in crisis, they get over the crisis and want to work more collaboratively,” Robert Purvin, chairman and CEO of the American Association of Franchisees & Dealers and an expert on franchise associations, told me in October.

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