McDonald’s was the best thing that ever happened to Michael Anton. He spent 32 years as a franchisee in the system and his kids got into the business. “I’m so happy, so fortunate,” he said. “I made a great living. I have nothing but good things to say about them.”
But he sold his stores last year. McDonald’s restaurants were selling at all-time highs. He also had concerns with many of the brand’s moves in recent years. Anton decided this was the perfect time to get out.
“I wasn’t comfortable with the direction the company was going,” he said. “My kids also have been in it for 30 years. I was a bit burned out. I didn’t like what was happening.
“It’s a completely different business than it ever was.”
Hundreds of other franchisees have made the same decision. Sources tell Restaurant Business that 400 franchisees sold their stores last year. According to the company’s most recent franchise disclosure document, 1,758 restaurants changed hands last year. That was a record for the chain, according to sources, and represents about 13% of the more than 13,000 franchise-owned locations at the start of the year. Multiple franchisees say other operators are looking to sell, too.
That’s a lot of franchisees. Burger King, by comparison, had a 6% transfer rate last year, less than half that at McDonald’s. Wendy’s had more than 900 transfers on some 6,000 locations, a higher rate than McDonald’s, but 40% of those transfers came in one deal, the bankruptcy of NPC International. Take that away, and 10% of Wendy’s locations were sold last year.
More than 700 McDonald's franchise locations were sold in each of the previous two years, too. Add in about 450 closures during that time, and 28% of McDonald’s locations have either closed or been sold since the start of 2019. More than one franchisee labeled it a “mass exodus.”
Sources say others are looking to be sold, too. “There’s a line to get out the door,” one operator said.
In many respects, the departures are to be expected. The operating environment is difficult. Many operators are near retirement age and are tired. Franchises of all kinds have traded hands at higher rates of late, and some sales might have happened earlier but for the pandemic. McDonald’s, for its part, says the departures are the result of “pent-up demand” after years of remodels and the pandemic.
Yet many operators say that they're the result of broad-scale culture problems that date back years and have led to periodic uprisings, from the creation of the National Owners Association (NOA) in 2018 over remodel requirements to a more recent dispute about an upcoming plan to reinstitute surprise inspections, despite protests from franchisee leadership.
The departures are changing a brand that has long prided itself on its roster of longtime franchisees, many of which started as crew members or are second or third generation operators.
“I have a dozen or two friends who’ve said, ‘I’ve had it,’” one operator said. “They’re just frustrated.”
A brief history
The McDonald’s brothers opened McDonald’s in San Bernardino, Calif., in 1948, selling 15-cent hamburgers. A milkshake machine salesman named Ray Kroc came upon the restaurant six years later and then became the brand’s franchise agent, opening a location in Des Plaines, Ill., in 1955. He later bought the rights to the company for $2.7 million.
The company grew based on franchising. Franchisees paid a royalty for the right to operate the brand. They also paid the company rent on the building and land, which McDonald’s controlled. Yet the company itself traditionally operated a healthy number of locations, generally opening one out of every four units.
The reason was simple: Store ownership meant the brand had skin in the game. And store operations provided a source for corporate leadership that understood the brand’s values. McDonald’s grew into the world’s largest restaurant chain and prided itself on leadership that started as crew members. Franchisees, too, usually grew up with the brand, stayed in it for decades and then handed the stores off to a new generation.
Store ownership dwindled over the years, and the brand’s support of franchisees declined, too. But things changed dramatically in 2015. That year, coming off three years of sales declines and weak performance, McDonald’s ousted former CEO Don Thompson and hired Steve Easterbrook, who previously led the brand’s U.K. division.
The company under Easterbrook made massive changes. It moved from its old headquarters in Oak Brook, Ill., to Chicago, in part to change corporate culture and attract new, younger workers. It cut costs by some $300 million, cuts that led to dramatic reductions in franchisee support staff. It also began selling restaurants to franchisees. Today, the brand operates just 5% of its 13,400 U.S. locations.
The brand also brought in outsiders to key executive positions. The belief at the time was the brand was too insular and needed some fresh perspective. Among the executives Easterbrook brought in was Chris Kempczinski, a former executive with Pepsico and Kraft, to become EVP of strategy and business development. He was soon promoted to head McDonald’s U.S. market. And by 2019, he was CEO after Easterbrook was ousted for having affairs with employees.
Many franchisees say the changes made under Easterbrook have been the cause of the morale problems and altered the company’s relationship with its operators for good. Inspectors were younger, less experienced and came in less often. It created more distance between the company and franchisees. And some operators say directives became more common.
“We were no longer partners,” one longtime operator said. “We became pseudo-employees.”
Major changes and low morale
McDonald’s U.S. market under Kempczinski operated differently, and clashes between the company and its franchisees would soon become seemingly commonplace.
In 2018, for instance, the company required franchisees to remodel the interior of their stores, with McDonald’s contributing 55% of the cost. The remodels would feature self-order kiosks while the company would provide table-order service. A dispute over the remodels led to the creation that year of the National Owners Association—the first broad-based, independent franchisee association in the brand’s history. It has become an advocacy group for operators’ concerns outside the company’s internal groups.
Other disputes have come up, too. Among the ugliest came in late 2020, when the company told franchisees they would have to pay extra in technology fees to recover yearslong debt. Both sides dug in. Franchisees voted in favor of taking legal action before the sides came to an agreement.
“There’s always a push and pull that exists between franchisee and franchisor,” Kempczinski told investors last year. “We’ll resolve these issues. But if you have me on a year from now, I’m sure there will be a new set of issues. That’s just the nature of the business. That’s the nature of the relationship.”
Tension comes with the territory in a franchise. Franchisors make their money from royalties, which come as a percentage of sales, and thus their incentive is to increase sales. Franchisees have to make profits off those sales. That leads to constant push-pull between the two.
Ultimately, Kempczinski said last year, franchisees make money. Franchisee cash flow hit records last year, a surprise coming shortly after the pandemic. The company’s same-store sales have increased all but one quarter since the fourth quarter of 2016—that one happening during the second quarter 2020 when dine-in restaurants were closed due to the coronavirus. Average unit volumes in the U.S. have increased by a third over the past five years, to $3.4 million from $2.6 million.
Operators are also free to raise prices now, no longer burdened by a Dollar Menu and a major discount focus that drove the chain for years and often kept them from raising prices for Quarter Pounders or Big Macs.
Yet morale remains remarkably low. Mark Kalinowski, of Kalinowski Equity Research, surveyed operators in April and asked them to rate relations on a scale of 1 to 5. The average score was 1.19, the third-worst in the survey’s history, ahead of only two surveys taken in 2018, during the height of anger over remodels.
One year after Kempczinski made those comments on tension, two other issues are creating concern among franchisees. The brand is stepping in to buy franchisees and sell stores to chosen operators. And it is reinstituting a series of inspections over franchisees’ objections.
“It does seem like morale needs improvement, to say the least,” Kalinowski said.
The future of McDonald’s
Much of the churn at McDonald’s today is due to a simple reason: Prices have never been higher. A typical location can be sold for as much as 10 times EBITDA, or earnings before interest, taxes, depreciation and amortization. That is among the highest valuations for any franchisee on the open market. And franchisees we spoke with have said the valuation played a big part in their decisions to sell.
Yet, in many cases, McDonald’s is stepping in to buy restaurants themselves and flip them to franchisees. All franchisors reserve the right to buy a franchise outlet that comes for sale at the rate negotiated with a different buyer, called the right of first refusal.
Anton, for instance, had a deal to sell his six restaurants to another operator. The company stepped in and bought the restaurants at the negotiated price and sold them to a different franchisee. “They took my stores,” he said, “and gave them to who they wanted to give them to.”
The right of first refusal has traditionally been left alone, though some brands appear to be using it more aggressively of late. Wendy’s, for instance, has used it to steer locations to better-performing operators. Yet its use can frustrate franchisees who work hard to negotiate a sale only to watch the company step in and take the restaurant.
But operators say the company uses this right to block certain operators from expanding, even when the company says they have the financial wherewithal to do so. “You can be a great operator and still be denied growth for reasons like that,” Anton said. “It’s unfair.”
Some franchisees we’ve spoken with view the effort at least in part as a strategy to push out older or more vocal franchisees. In some cases, they say, McDonald’s is selling them to newer operators the company is recruiting as part of its bid to diversify the franchisee base, an effort it announced last year.
Operators say in some cases, the company is increasing the rent on these new franchisees. It is often buying up stores grandfathered in with rents set at 5% of sales, then increasing the rents to 13% for the new owners.
Joe Erlinger, who took over as president of McDonald’s USA in 2019 when Kempczinski was promoted, spoke to franchisees at McDonald’s Worldwide Convention.
Toward the end of his comments, which were viewed by Restaurant Business, he said this: “We will look to grow with those partners who share our commitment to greatness. And this might come from within or outside the system. It means finding and making room for the best and the brightest. But everything, or I should say everyone, we need to build the future of McDonald’s is not in this room today. We must attract the right people, and we’ll do that together.”
The phrase “the future of McDonald’s is not in this room” was viewed as tone deaf by many franchisees, or perhaps a sign that the company wants to replace many of them.
Earlier in the speech, however, Erlinger praised franchisees. “McDonald’s is stronger today than we’ve ever been,” he said. “And it’s because of you—the people in this room.”
“We have never been prouder of you than we are today,” he added. “Thank you.”
Surprise inspections
The latest issue is over planned surprise inspections. The company is planning to institute a new assessment program next year called PACE, or Performance and Customer Assessment.
To McDonald’s, the inspections will improve operations and are an important part of the job of a franchisor. After all, one bad store can color many others.
But franchisees have been pushing hard against the inspections, citing the labor shortage. Operators say they risk losing valuable employees, particularly managers, who are the ones responsible for ensuring their stores pass the inspections and who may end up working longer hours when there is an unannounced inspection. Some franchisees say they may have to divert employees from one store to another that is being inspected, to ensure they pass.
“It puts undue pressure on our general managers and their teams,” the NOA board told its members in a letter this month. “Pressure that we cannot afford right now. The prospect of multiple, unannounced visits anytime of the week severely damages their quality of life.”
According to an NOA survey, 55% of owners said the inspections are not an accurate assessment of their operations, and 54% said they would not help their operations.
Franchisees also argue that the inspections are out of touch, given concerns with the labor shortage. Two-thirds of franchisees in the same survey said that staffing has either not gotten better or has grown worse.
“All they want to do is beat you up,” one franchisee said. “And if you don’t like it, they tell you to shut up or get out.”
McDonald’s, however, said that PACE is an assessment framework that is designed to help franchisees improve operations and profitability. The company says that the effort features a data portal that will help franchisees and staff identify trends and areas of improvement. The assessment process, the company said, is used as a mechanism to evaluate progress against improvement goals.
More to the point, it says, standards are important in a franchise business, and the company says operators will have an opportunity to learn the new system before it is put in place.
“We must remain laser focused on maintaining our world-famous standards of excellence in our restaurants,” the company said in a statement. “This comprehensive performance management system, designed with ongoing input from franchisees, will offer tailored support and coaching to restaurants to help them provide a seamless McDonald’s experience that will keep customers coming back.
“To give time for restaurants to learn the new system, optional learning visits are being offered in 2022 ahead of the official start in January 2023.”
The reaction
Kalinowski said it’s understandable that an inspection program would cause those kinds of complaints. “It’s a perfectly valid complaint,” he said. He said franchisees struggling with staffing issues understand the potential impact of surprise assessments on their scores and on employee morale. “I don’t want my stores understaffed and then have someone coming in with a white glove to have them inspected,” Kalinowski said. “I need help with my staffing. I need help with my costs.”
And, he said, it can be expected that major changes would cause older operators to bristle. Then there is the simple fact that these past two years have been difficult.
“Restaurants were already difficult to run pre-pandemic,” Kalinowski said. “It’s arguably the toughest it’s been in decades. That makes people feel tired. ‘Gee, I might enjoy my life more if I had the opportunity to sit on a beach. I’ve gotten through the worst environment I’ve seen and I’ve made it to such a degree that I’ve been successful. But darn am I tired.’”
One operator we spoke with, who sold his restaurants early last year, said that he doesn’t miss the business. “It was their plan to pick certain operators that went with their agenda at the expense of the rest of us,” the former franchisee said.
As for Michael Anton, he admits that the valuation of his restaurant contributed to his decision. Yet he also wanted to sell the stores to his kids, but they opted to leave the system with their father. They were concerned about the direction of the company, too.
And yet, after more than three decades in the business, Anton noted that nobody wanted to know why he decided to sell.
“No one from the company asks you a question,” he said. “Not a single person from the company had a question as to why I was leaving.”
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