Franchisee revolts threaten the asset-light model

Tension at Jack in the Box, McDonald’s and others show the model’s limitations, says RB’s The Bottom Line.
Photograph courtesy of McDonald's Corp.

The Bottom Line

This has been a bad couple of months for proponents of refranchising, as a growing number of franchisee revolts have shed light on the limitations to the most popular strategy for operating restaurant brands.

The asset-light model of running a restaurant system has been all the rage for years. Companies from Papa Murphy’s to Uno to Yum Brands to McDonald’s and everybody in between have sold stores to franchisees.

In so doing, companies concentrate on franchising. And they make stronger margins, no longer responsible for building locations or hiring workers. In theory, franchisees do a better job, anyway, and are closer to the customer.

But by refranchising so many locations, these companies have also ceded full control of their brands and put their growth at risk if things don’t work out. Restaurant brands that don’t operate locations themselves are too frequently distant from the impact their decisions can have.

This is especially true in a tough operating environment where sales are weak and costs are high and demands for remodels and new technology increases. That is leading to growing discontent in many franchise systems.

In recent months, brands such as McDonald’s, Jack in the Box, Tim Hortons and Papa John’s have joined others, such as Applebee’s and Subway, as systems that have faced tension with their operators. Other companies face similar challenges if they can’t get their systems growing again.

The rise of the franchisee activist is arguably the most underplayed story in the restaurant business today, but it is one of the most important. Franchisee revolts like these are clear signs of stress within a system. If franchisees are stressed, brands will have a tough time getting things done.

Yet there is a disconnect between these revolts and Wall Street. For this we go to McDonald’s.

The Chicago-based giant is outperforming its primary rivals from a sales standpoint this year, even if traffic is declining again. It is also undertaking a massive overhaul of its restaurants in what has to be one of the most significant brand transformations in industry history.

But last month, the brand’s franchisees formed the National Operators Association. That was the first independent association in the company’s history. While the association is keeping things positive, franchisees don’t create independent associations if they’re happy.

This week, McDonald’s delayed its aggressive remodel program, giving some operators extra time if they’re willing to forgo some of the company’s contribution—a clear reaction to the franchisee discontent.

McDonald’s has refranchised most of its remaining company stores to franchisees in recent years. It now operates 5%, or fewer than 700 of the chain’s 14,000 domestic locations.

Much of the tension between the franchisor and its operators is over the chain’s numerous demands this year: the aforementioned remodels, the shift to fresh-beef Quarter Pounders, expansions to the coffee program, delivery and other operational changes.

McDonald’s stock has responded with a string of record highs, including one on Thursday.

Then there is Jack in the Box.

Jack’s franchisees recently took the virtually unprecedented step of calling for the hiring of a new CEO. They then asked for a board seat and filed a complaint with California regulators over the company’s planned real estate reorganization.

Like McDonald’s, Jack in the Box has aggressively refranchised its locations to become the asset-light model that Wall Street loves so much. Jack has also pulled a lot of other levers to make its business look better: cutting corporate overhead, for instance, and selling Qdoba.

None of this has kept the company from dealing with angry shareholders—it has two activist investors.

And it appears that many of the steps the company has taken have angered operators. That includes cuts in corporate overhead that franchisees believe is hurting the company’s franchisee support system and its marketing.

Now, Jack in the Box is apparently for sale. It probably should be: The company has few levers it can pull to satisfy Wall Street, and angry franchisees make it less able to grow and remodel the way it wants to.

Plenty of companies do well even though they are all franchised, and plenty of companies thrive after selling their stores to operators. But it’s clear that refranchising and the shift to more asset-light models is contributing to the rise in franchisee tension—a risk that Wall Street doesn’t appreciate.

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