McDonald’s will start gradually increasing the royalty rate it charges to its U.S. and Canadian franchisees by 25% starting next year, adding to a series of major changes in its relationship with the people who operate most of its restaurants.
The Chicago-based burger giant will increase what it has traditionally called a “service fee” to 5% of revenues from 4%, starting in January, according to a system message on Friday from McDonald’s CFO Ian Borden and Andrew Gregory, SVP of global franchising, seen by Restaurant Business.
The new rate, they said, will only be charged to newly built restaurants or locations acquired from the company, and McDonald’s will now call it a “royalty” fee, in line with what other franchises call such charges.
Existing franchisees will not be affected if they sell restaurants to one another, or when they sign new 20-year franchise agreements. The new royalty will also not affect stores transferred from parents to children.
“The royalty rate has not increased in nearly 30 years after having increased five times in the roughly 30 years prior to that,” Borden and Gregory said in their message. “Also, unlike all prior royalty rate changes, which affected every restaurant, this change is more limited in scope.”
The new rate will also bring McDonald’s in the U.S. and Canada in line with the company’s other global markets, which already pay 5%.
Franchisees heard of the changes early Friday morning and were still trying to digest the news. But operators we spoke with were angry at the news, arguing that the move increases the company's revenues while opening the door to potential service cuts down the road, thanks to the change in terminology from "service fee" to "royalty." "They continue to take more share of the pie," one operator said.
In a statement sent to its membership late on Friday, the board of the National Owners Association, an independent McDonald’s franchisee group, said that the increase will reduce the return on investment on new locations. The group argued that EBITDA margin, or earnings before interest, taxes, depreciation and amortization, is about to hit a 12-year low this year.
And the group argues that changing the terminology from “service fee” to “royalty” will give McDonald’s more license to reduce services.
“It’s time for every owner/franchisee to begin focusing on protecting their business, their employees and their family,” the board said in its statement. “Every reinvestment decision should be reconsidered; only investing in programs and items that generate a commercially reasonable return on investment.”
“If you are looking at opening a new restaurant, making such investment at this time will not provide a historical return for the franchisee.”
The limited scope of the fee increase means it will be gradually implemented in the system over time. In theory, there could be some restaurants that pay 4% for decades, given that new franchise agreements can keep the old fee and next-generation operators could also keep that rate. But McDonald’s appears set to eventually get the U.S. to the higher royalty rate.
The higher royalty would be charged in sales of corporate restaurants and in deals in which the company uses its “right of first refusal,” a contractual provision that gives it the right to step in and buy any franchise restaurant put up for sale.
McDonald’s had been more aggressive in using that right in recent years, after which it typically sells restaurants to another operator, though the company says it has slowed its use of the right more recently. The company said it only does so “as a last resort” when a sale doesn’t align with its franchising strategy.
Most franchisors charge franchisees a percentage of their revenue for the right to operate their brand, known as the royalty. At McDonald’s, franchisees operate about 95% of the chain’s 13,500 U.S. locations.
The brand initially started with a 1.9% service fee in 1955 but increased it several times thereafter, yet traditionally that charge has been low, particularly considering the overall strength of the McDonald’s brand. The company has instead chosen to generate most of its revenue from the rent it charges franchisees, which is also calculated as a percentage of revenue.
That rent charge can range from single digits to more than 20%, depending on the age of the restaurant and the underlying value of the real estate.
At 5%, however, McDonald’s would be right at the average of the 100 largest restaurant franchisors, according to a Restaurant Business analysis.
A typical McDonald’s restaurant generates $3.6 million in revenue per year, meaning the additional 1% royalty rate would increase the restaurant’s charges by $36,000.
Yet the increase in service fees is likely to add to a rift between McDonald’s and a number of its operators, angry over a series of changes in the relationship between the two groups in recent years. The two sides have been at odds over technology fees, changes in rules over franchise renewals and stepped-up inspections.
More recently, operators expressed anger over compromise legislation in California that will raise the minimum wage for fast-food restaurants there to $20 in April and could, over the next five years, cost franchisees $250,000 per store in cash flow. Franchisees say that demand for McDonald’s locations has waned this year, bringing down the value of their restaurants—though others say it is within historical norms.
They have also argued that the services McDonald’s has provided over the years has decreased, largely through a series of cuts to corporate overhead that has reduced the number of field staff. There have been rumors among franchisees for weeks that McDonald's was planning to increase its service fees. The change in terminology from service fees to royalty is significant in that way, franchisees said on Friday, suggesting that it could give the company an excuse to reduce services further.
McDonald’s has argued that the company has been performing well in recent years and, indeed, its same-store sales have increased each of the past 12 quarters. Last quarter, the chain’s same-store sales outdistanced that of the smaller-volume Burger King by 200 basis points. Franchisee cash flow in the U.S. has increased 35% over the past five years.
The brand is also one of the most valuable in the world—the consulting firm Kantar says McDonald’s is one of the five most valuable brands in the world. That’s a key component when operators acquire a franchise company.
“We are outpacing the competition, and our combined investments have made the brand stronger and more accessible than ever,” Borden and Gregory wrote.
UPDATE: This story was updated to add comment and some additional context.
UPDATE (Sept. 23): This story was updated to add comment from the National Owners Association.
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