Relations between McDonald’s and its franchisees had been at a high point in recent months, buoyed by numerous post-pandemic moves and a marketing machine that generated strong sales and cash flows for the owners.
That changed with a single email last week. Leadership for the chain’s U.S. market told operators that they would be paying higher charges for technology and a tuition program and that a decades-old Happy Meal subsidy would end. The technology fees would be temporary.
The new charges would amount to just over $12,000 per location, an estimated $170 million for all U.S. operators. It led to an uproar rare in its vociferousness—hundreds of franchisees attended a meeting of the National Owners Association on Sunday and pushed back against the company at an internal meeting between franchisees and the U.S. leadership on Monday. It also generated some pointed criticisms of executives from an internal franchisee leadership group.
“These decisions do not represent a winning brand on the doorstep of a very ambitious year,” the leadership group, the National Franchisee Leadership Alliance, told operators in an email last week, a copy of which was obtained by Restaurant Business.
Though the charges may seem small, they speak to one of the biggest flashpoints in the franchising world—the bevy of charges and requirements franchisors make on their operators—as well as the sense from some operators that they’re not quite the independent business owners they thought they were.
Ripe for conflict
Rather than sell hamburgers or tacos, franchisors sell the right to operate their brand for a cut of the sales—though in McDonald’s case, most of its charges are for rent, which is calculated as a percentage of sales. Franchisees also typically pay into a marketing fund.
Franchisees also agree to abide by certain rules to ensure the brand is operating consistently from one location to the other. It’s in these rules where some of the charges can come from. For instance, a company may want all of its restaurants to have Wi-Fi service in the lobby. It then requires each operator to provide that service, oftentimes dictating what company they can use.
Mostly, these fees and charges pit a franchisor’s desire to keep its brand moving forward against a franchisee’s desire to earn a profit and operate like an independent business. An independent operator may or may not add Wi-Fi to their restaurant. The franchisee has little choice. As these requirements creep up, disputes flare up as franchisees push back.
“Franchisees generally believe that their royalty payments should cover the services received and the reinvestment in the brand by the franchisor,” said Keith Miller, a Subway operator and franchisee advocate, speaking generally. “However, franchisors have increasingly seen opportunities for revenue streams from franchisees on services rendered. Unless there is collaboration, there will be conflict.”
Technology in particular has become a flashpoint in many systems over the years. Franchisors require their franchisees to add certain types of technology such as mobile ordering and purchase from select vendors. Or they take control of the technology and charge franchisees.
At McDonald’s, the technology fee operators pay per store has increased by a multiple of 10 over the past decade, sources tell Restaurant Business.
McDonald’s had been charging franchisees for technology every six months and plans to start charging operators monthly.
To do so, the company argues there is a lag, or a debt, that must be funded to get the technology payments up to speed. Under the old model, franchisees paid for their technology after the fact, and McDonald’s wants operators to fund that debt next year as the company moves to its “pay-as-you-go” model. That amounts to $70 million in total, or about $5,000 per location.
The company had planned to implement the change earlier this year but opted against it because of the coronavirus. Officials have indicated that the change has been under discussion for some time.
But operators question whether they owe any additional funds at all. The National Owners Association, an independent association created three years ago following a previous controversy over remodels, pointed out in a note Tuesday that there was no technology debt.
“If McDonald’s thinks we owe them $70 million, they need to come up with a better explanation than the one we got yesterday,” the association’s board told its members this week. “Which speaks to the heart of the issue that we have with McDonald’s as our technology vendor. The technology isn’t very good, the cost transparency is even worse, and now we have evidence of accounting mistakes.”
The other fees add up, too. Operators we spoke with were unaware of a potential charge related to Archways to Opportunity, the tuition program McDonald’s has funded over the past four years that is considered a key tool to recruit and retain workers. McDonald’s wants franchisees to fund the program, with the company matching it—which officials believe will improve the program. Franchisees say it would cost $3,571 per store, per year.
Franchisees also view the Happy Meal subsidy as an important gesture that ensures the toys are an upgrade over competing chains’ kids meal add-ons while keeping the price for the meals to a minimum. Losing that subsidy could lead to higher prices for those meals—or they could lead some operators to pushing for a shift to lower-end toys. That subsidy amounts to $3,600 per store, per year.
In the works
McDonald’s has argued that the issues raised in the email have been in the works for years—the end of the Happy Meal subsidy, for instance, and franchisee contributions to the tuition program known as Archways to Opportunity, were both mentioned in a 2017 “Bigger Bolder Vision” agreement, for instance.
What’s more, the company has argued it took numerous steps to help operators this year, many of which are paying dividends.
For instance, McDonald’s is giving operators rent and royalty breaks on fees paid to delivery companies, breaks that have helped franchisees improve the orders’ profitability—a move McDonald’s U.S. president, Joe Erlinger, mentioned in the company conference call on Monday. The company’s marketing push has also generated strong sales this year.
The company also argues that it is not reducing its own commitment as part of the changes. McDonald’s says it will still fund Archways to Opportunity, for instance, but that franchisees’ contribution expected next year will increase the size of the program and its effectiveness. The Happy Meal subsidy, they say, will be used to invest in employees. Franchisees operate 95% of the chain’s 13,800 restaurants and therefore employ all of those locations’ workers.
“Our goal as the franchisor is to keep the system operating from an absolute position of strength,” the company said in its email. “An important part of that is maximizing our collective investments in the business and putting our resources where they will have the biggest impact and drive growth, while protecting the brand and your equity for generations to come.”
Franchisees’ biggest concern in the dispute is the manner in which the issue came up, as well as when—in an email, at a time of good relations.
Several operators we spoke with were taken by surprise by the email and had not heard of the Archways charge or the end of the Happy Meal subsidy. Perhaps more importantly, they believe the email came across as a directive rather than a collaborative discussion between two business partners.
The email “more reflects an attitude and operating mode of our past,” the NFLA wrote.
On the call with operators this week, McDonald’s executives acknowledged that they could have communicated the changes better—but they also reiterated that all of the issues had been discussed beforehand. “The communication could have been better,” one company official said. “But it doesn’t change the fact that we are extraordinarily confident in what we said.”
Some franchisees told us the company might have gotten everything it wanted, eventually, had it simply gone through typical channels. They also wondered, why go through with the additional charges, given the additional expenses franchisees have had to fund because of the coronavirus? “We have to pay for plexiglass and PPE and have vendors coming in to sanitize everything,” one franchisee said. “Why now?”