Financing

McDonald's and its franchisees paint different pictures of the brand's rules

A group of operators argued in comments with federal regulators that the franchisor’s changes cost them important profitability and drive up their prices. To the company, the changes are necessary to evolve the brand.
McDonald's franchisees
McDonald's and some of its franchisees differ over franchise rules | Photo by Jonathan Maze

To get an idea of the differing views over the state of franchise rules, look no further than the world’s largest franchise.

In a comment filed with federal regulators looking into franchise rules, a group of McDonald’s owners said the company’s requirements and rule changes in recent years have shifted costs from the franchisor to the franchisee. And they have little choice but to accept it.

“Their attitude is clearly that we are disposable and easily replaced,” the National Owners Association (NOA), a group of more than 1,000 McDonald’s franchisees, said in its comment with the U.S. Federal Trade Commission, referring to commentary from one of its own members. “If you do not accept our agreement, someone else will.”

On the other end is McDonald’s, which argued in its own comment that brand changes are necessary to keep pace with consumers’ changing tastes. They've enabled the brand and its franchisees to maintain a stable and consistent economic growth over several decades, a feat virtually unmatched in the franchise business.

“McDonald’s shares the Federal Trade Commission’s view that the franchise model should benefit everyone: consumers, franchisors, franchisees, workers, suppliers and local communities,” McDonald’s USA said in opening its 14-page comment with the agency. “That’s precisely what our franchise system has done for over six decades.”

The FTC spent several weeks in the spring and into early summer collecting comments from the public on the state of franchising. The agency wanted to know about franchise business practices, particularly the control they exert over their franchisees and employees. It has received thousands of such comments.

The request was the biggest signal yet that the agency plans to take a tougher approach to franchise regulation than it traditionally has taken. The FTC has historically taken a laissez-faire approach to franchise regulations, requiring franchises to file annually a massive franchise disclosure document but largely leaving actual enforcement of what’s in those documents to states. Most states do relatively little.

But the agency has signaled for a while that it may change that approach. It sued the defunct fast-casual franchise Burgerim early last year, for instance, and agency comments have revealed a willingness to take a tougher stand.

McDonald’s could become a focal point. The brand is the world’s most recognizable franchise and is often used as a proxy for the business model, for better or worse. And thus these comments could carry considerable weight.

NOA, which has more than 1,000 members within the McDonald’s system but isn’t an officially recognized association, has been at odds with the franchisor off and on since its 2018 creation. Most recently, they’ve pushed back against a series of new inspections that operators say were foisted upon them with little discussion.

Operators have since taken their complaints with regulators looking to step up franchise regulations. NOA’s efforts are believed to have influenced a set of new regulations in Arkansas, for instance. But the FTC would be a big get.

Franchisees’ frustration with McDonald’s centers around the control the company exerts over the operators. The company can make changes to the franchise agreement, and franchisees have little choice but to accept those changes if they want to keep operating their restaurants.

“There are numerous areas of concern that have begun to arise during the last few years, and which are becoming more prominent today, that are substantially further impairing the already uneven bargaining balance of the franchisor/franchise relationship,” the association said in its comment.

McDonald’s will often make changes to the franchise agreement and franchisees have little choice but to accept them. “Nearly none” of the terms are negotiated. These changes hurt profitability “and transfer more restrictive provisions of additional risk to the franchisee,” which lowers the value of the business “and makes it more difficult to maintain the existing business and obtain the funds to buy additional ones.”

Operators argue that the brand is providing fewer services than it has typically provided in exchange for franchisees’ “service fee,” which is 4% of their revenues. Franchisees then have to pick up the cost.

For instance, according to the association, that fee once covered tools for recruitment, training and employee development. “Most face-to-face training has evaporated, and we are largely responsible for the development of our employees,” one NOA member said. “Yet, we are still required to pay the same 4% service fee.” Field officers that once helped with operations, meanwhile, now cover a larger number of locations and don’t have as much time for individual stores.

And the franchisor can also require more remodels. For instance, nearly a decade ago the company began requiring franchisees to remodel their dining rooms every 10 years, at a cost of $300,000 to $500,000. “We only have 7% of our guests that actually eat inside the restaurant,” one operator said, according to NOA.

To McDonald’s, however, its service fees help pay for the right to operate one of the most powerful brands on earth. The franchise business model, meanwhile, gives opportunities for people to own businesses where many of them otherwise would not.

Its franchise agreement and the rules in it ensure consistency across tens of thousands of restaurants around the world, including 13,500 restaurants in the U.S. “Customers who choose to visit franchised restaurants value and expect consistency,” the company said.

Its rule changes help ensure that the company is keeping pace with constantly changing consumer needs, the company argues. Remodels in particular are important, given that consumers tend to prefer visiting restaurants that look up-to-date.

Many of these rule changes, including the remodels, are done with considerable input from the National Franchisee Leadership Alliance, an internal franchise group voted upon by the company’s operators.

And McDonald’s operators in particular are generating more cash flow. Average cash flow for a typical McDonald’s location is up 35% since 2018. The chain’s restaurants are sold at valuations that are higher than almost any other brand.

Sixty percent of McDonald’s franchisees generate annual operating income of more than $800,000 before rent and service fees. That said, rent costs within the McDonald’s system can vary greatly, from 5% to over 20% in some cases depending on the location. That rent cost can influence how much cashflow a restaurant generates—and the prices they charge.

As for the training, McDonald’s funds Hamburger University, its franchisee and management training program, and develops a curriculum for in-crew training, the company said. Franchisees may use that curriculum or they may use their own.

The company also quoted an Oxford Economics study that found McDonald’s GDP impact in Cook County, Ill., alone was $2 billion.

“This is a healthy and growing model with a unique balance that will be threatened by potential regulatory interference, which will weaken or eliminate the very framework that facilitates consistency, limits free-riding, preserves quality and recognizes the need to modify standards to adapt to changing competitive circumstances,” the company said. “Our model works because it makes cooperation possible between franchisees, suppliers and McDonald’s.”

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