California is set to increase the minimum wage fast-food chain restaurants pay in the state next year to $20 an hour, a far higher rate than any other state in the nation.
Restaurant executives thus far in earnings calls have either called this an “opportunity” for their brands or downplayed the potential impact on prices. Chris Kempczinski, CEO of McDonald’s, took this a step further. On Monday he acknowledged that the law, which creates a panel to oversee regulations of fast-food restaurants, will hit franchisee cash flow, even with efforts to mitigate the higher labor costs.
“There is going to be a wage impact for our California franchisees,” Kempczinski told analysts on the company’s third-quarter earnings call. “There will be a hit in the short term to franchisee cash flow in California. Tough to know exactly what that hit will be … but there will be a hit.”
But he then said this:
“This is an opportunity for us to gain share, because this is an impact that’s going to hit all our competitors. We believe we’re in a better position than our competitors to weather this, so let’s use this as an opportunity to actually accelerate our growth in California.”
We typically do not hear industry executives talk openly about growing more in California, not when the state has intensified its regulations of fast-food restaurants and of franchises. And there is some real truth to Kempczinski’s comments.
Generally, higher wages stand to benefit larger companies because they have more scale to invest in the types of programs and technology that could offset the higher costs. McDonald’s, the world’s largest restaurant chain, can certainly afford to put robots and artificial intelligence in its restaurants. A 100-unit chain can’t necessarily do that.
And McDonald’s tends to be in better position than many others in the fast-food space because of its immense size and the fact that all of its restaurants have been remodeled in the past six years. Indeed, during the call executives noted that remodels the company has done to its restaurants between 2017 and 2020 put the chain in a better position than its competitors.
“This is the situation that some of our competitors are in today, that you’re trying to [remodel locations] in an environment of pressured cash flows and higher interest rates,” CFO Ian Borden said. “I mean, we’ve got a fully modernized estate.”
At the same time, the new law in California has already revealed fissures that exist between franchisors and franchisees. And at McDonald’s, the law added to the tension between the two groups that has been at a fever pitch over the past couple of years.
The National Owners Association, an independent group of franchisees, has argued that the higher wages will cut typical store cash flow by $250,000.
And franchisees have also argued that the company stands to benefit from the higher wages because franchisees will have to raise prices, which will lead to higher revenue and higher royalty and rent payments to McDonald’s. “It benefits McDonald’s tremendously,” Robert Zarco, an attorney for the association, told me last month.
Still, it fits with the company’s strategy to take advantage of its size to meet its goals. California is a big market. McDonald’s operates more than 1,200 locations in the state, or just under 10% of its U.S. restaurants.
In theory, the company could greatly expand that presence if its restaurants can better withstand the high-cost environment and gain share on competitors that don’t have its capabilities.
But that will put pressure on the company to make sure that its franchisees can generate enough cash flow to make that workable for operators. As it is, franchisees say that demand for locations is down. It’s also worth noting that franchisees who do build those gleaming new California restaurants will pay a 5% royalty rate, 25% higher than legacy franchisees pay.
“That does need to be worked through with pricing,” Kempczinski said. “There’s also going to be things I know the franchisees and our teams are going to be looking at around productivity.”