When McDonald’s announced plans to raise what it now calls its royalty charges to 5% from the 4% it had been for nearly 30 years, it effectively brought that charge up to average for large-scale restaurant franchises.
To put it into perspective, for instance, the sandwich giant Subway is raising its royalty rate to 10% from 8%, at least if the franchisee wants to keep the terms in their existing franchise agreement.
That’s surprising to many, for the simple reason that McDonald’s is the largest and most powerful brand on earth. In the nearly 30 years since it last raised what it has traditionally called a “service fee,” McDonald’s has only solidified its status as the largest restaurant chain on the planet. And its numbers in recent years in particular would seem to warrant a raise.
Yet McDonald’s has always been a different sort of franchise. The company, after all, is not so much a franchise as it is a real estate company that sells burgers and breakfast sandwiches.
The company controls its real estate. It owns or leases the land on which its restaurants sit. It will then charge lease rates to franchisees that will provide the company with a profit. How much it charges varies, based on the age of the restaurant and McDonald’s cost for that real estate. But it can be quite costly to the operator.
Few franchises do this. For the most part, brands will let franchisees pick their own real estate, with some assistance from the brand. By controlling its real estate, McDonald’s can determine where to place its locations and gives it an even bigger say in the movement of stores between operators.
McDonald’s real estate is a huge reason the chain’s restaurants do as well as they do. And we’re not even talking about the revenue that it generates. I’ve never understood why more franchises don’t do this.
But that also makes it difficult to compare McDonald’s with other brands, at least from a cost-to-operate standpoint.
One company we can use, however, is Jack in the Box. When the San Diego-based burger chain refranchised over a 15-year period, it kept much of its real estate. It now controls the real estate for all but 314 of the 2,000 franchisee-owned locations in the system.
That generated $219 million in revenue for the company last year, more than the chain received in franchise royalties.
Jack in the Box generally charges 9.5% of revenues for this rent.
By comparison, McDonald’s gets most of its revenue through that rental income. U.S. franchisees paid more than $9 billion in rent to the company last year, up nearly a third since 2020. Its exact rental rates have been difficult to pin down and can vary quite a bit. Existing stores generally pay between 11% and 13% in rent. New stores can range from 15% to 19%, franchisees say.
Operators can “buy down” their rent to 11% by paying the company $1 million to $1.5 million. That’s only worth it if the store generates more than $4 million in sales per year. “Otherwise it’s a debt bomb,” one franchisee said.
Jack in the Box, by the way, charges a 5% royalty.
If we say that the average in the McDonald’s system is around 14%, then it is 47% higher than the rent Jack in the Box operators pay. McDonald’s does charge a premium to operate its restaurants. That premium simply comes through its rent.
None of this is to say McDonald’s shouldn’t charge more. It certainly should cost more to operate a McDonald’s restaurant than a Jack in the Box or other chains. It is a powerful brand that is as safe an investment as a franchisee can make. And that real estate business the company truly operates is world class, helping a typical store make more than twice that of rival Burger King and 90% more than a typical Wendy’s or Jack in the Box.
But the company has been increasing its rental charges in recent years and, franchisees say, has been working to get more higher-rent locations. They also fear the company will increase rent further.
McDonald’s on the other hand has traditionally kept its franchise charges low and labeled them a “service fee.” Now the company is raising that fee and changing its terminology. That was bound to generate a lot of pushback.