A nine-unit Steak ‘n Shake franchisee in Virginia, losing money at all of its restaurants, is suing the franchisor over its refusal to let the franchisee raise prices.
The lawsuit, filed last week in a federal court in Indiana, claims that the quick-service brand is violating its franchise agreement with the operator by not letting the franchisee increase prices.
The operator, Steaks of Virginia, says all of its restaurants “have suffered substantial financial losses, which will continue and likely increase over the remaining time period of the franchise agreements.”
In an interview on Wednesday morning, Tom Murray, CFO of Steak ‘n Shake Franchise Operations, said that operators sign an agreement before they build new units that hands over pricing control to the franchisor “to make it crystal clear what they’re signing up for.”
“We want to maintain a consistent pricing strategy,” Murray said. “We feel that gives the brand a competitive advantage.”
The lawsuit is not the first between franchisees and Steak 'n Shake over pricing. Operators and the company have routinely been at odds given the franchisor’s demand that they keep prices down. The company reached a settlement with multiple franchisees over pricing in 2014.
Steaks of Virginia became a franchisee of Steak 'n Shake in 2009, shortly after the investor Sardar Biglari took over as CEO of the company, which he would reorganize as an investment vehicle and rename Biglari Holdings.
Steaks of Virginia claims that its original development agreement gave it, and not the franchisor, the right to control prices.
The franchisee did not try to raise prices until last year, after losses led the company to request a “moderate” price increase.
Steak 'n Shake controls the franchisor’s point-of-sale system and therefore pricing in all of its restaurants.
The brand rejected the request. The franchisee wrote “several additional letters” to the franchisor in December of last year and early this year to resolve the dispute.
In March, Steak 'n Shake allowed the franchisee to raise prices at only one restaurant, the operator’s first location in Fredericksburg, Va., saying that the franchise agreement for that one location gives the operator the right to raise prices, but only at that restaurant.
The brand refused to allow the operator to raise prices at the other eight locations.
Steaks of Virginia disagrees with that sentiment, saying that the development agreement gives it the right to raise prices at all of its locations. In addition, the close proximity of all the restaurants would risk alienating customers at the Fredericksburg location where the prices were higher than at the others.
Financial losses aren’t the only reason the operator wanted to raise prices. As part of the original development agreement, Steaks of Virginia has to meet certain average unit volumes at its restaurants to be allowed to expand.
That threshold is now $1.7 million per location, which has increased 12% since 2009. The company cannot meet that threshold if it can’t raise prices, the lawsuit says.
In addition, the complaint also charges Steak 'n Shake with failing to provide support services. The complaint says the franchisor has failed to fix incorrect pricing or other information on menus and the website, charged the operator with “unsupported fees without explanation” and didn’t notify the operator about customer complaints for weeks—which left the operator unable to address the complaints. The franchisee also says it was overcharged by Steak 'n Shake’s food vendor in recent months.
The lawsuit from Steaks of Virginia is the first suggestion that recent sales and traffic challenges at Steak 'n Shake could be taking their toll on operator profits. Franchisees own 173 of the company’s 585 U.S. units. There are another 30 international locations.
After Biglari took over, the company dramatically lowered prices on many menu items and has kept them there. The result was 29 straight quarters of same-store sales increases, as consumers eagerly sought value.
But those increases stopped two years ago, and Steak 'n Shake’s traffic took a turn for the worse.
In 2017, same-store sales fell 1.8% and traffic fell 4.4%. “It was not a very good year,” Sardar Biglari said in a letter to investors earlier this year.
Traffic declines the past two years were equal to the loss of 7 million customers, he wrote.
In his letter to investors in February, Biglari suggested that the organization is working to improve quality and operations. “When faced with a decision to improve short-term profits by reducing product quality and customer experience, we opted to do the opposite, which in the near term contracts profit margins,” he wrote.
But he also seems determined to keep prices low. “Despite recent lackluster results, our formula for success remains unchanged,” Biglari wrote. “Provide the highest quality burgers and shakes at the lowest possible profit per customer from an ever-increasing number of customers.”