Capital spending requirements put franchisees in a tight spot

McDonald’s has instituted a turnaround plan involving burger customization that may impose up to $125,000 in new investment costs on already struggling franchisees, according to the Wall Street Journal. The $125,000 price tag for McDonald’s burger customization program follows renovations undertaken by about half of McDonald’s restaurants in the past decade, which cost participating franchisees upwards of $650,000. The capex requirements exacerbate the combination of falling sales and rising payments to McDonald’s that have been hurting franchisees’ bottom lines. According to the Journal, McDonald’s operators are having difficulty meeting the company’s financial requirements, such as maintaining certain cash-flow-to-debt ratios.

The other big burger chains are also requiring franchisees to make major investments, and franchisors’ ability to impose large capex costs on franchisees is common in the franchise industry: The Service Employees International Union’s analysis of franchise agreements across the franchising industry in a recent petition to the Federal Trade Commission shows that franchise agreements typically allow franchisors to impose major expenditure mandates on franchisees. The review of 14 top franchise chains’ franchise agreements – including McDonald’s, Subway, Great Clips and Holiday Inn – found:

  • All but one of 14 allow the franchisor to impose capital expenditures on franchisees during the term of the agreement.
  • Only one of the 14 systems includes any limits on or estimates of the costs of these investments, and that system, Jackson Hewitt, recently doubled the limit from $12,500 to $25,000.

Here are just a couple of examples of the broad leeway franchisors give themselves to require franchisees to pay for improvements:

  • Subway: “At your sole expense, you will make any changes to the Restaurant necessary to conform to the Operations Manual within reasonable time periods we establish, including but not limited to any necessary repairs, upgrades and remodels.”
  • Great Clips: “Franchisee will be required periodically to remodel, modernize, and redecorate the Salon and to replace and modernize the furniture, fixtures, graphics, signage, supplies and equipment so that the Salon will reflect the then-current System standards. Franchisee shall implement changes in facility requirements when prescribed, even if additional investment or expenditures are required.”

Capex requirements are affecting franchisees across industries. A recent national poll found that 58 percent of surveyed franchisees reported being required to make major capital investments. The largest share of those, 49 percent, did not believe that the investments had improved their bottom line, according to the survey, conducted by FranchiseGrade.com, a leading market research and analysis firm for the franchising industry, and commissioned by Change to Win, a labor federation that includes SEIU.

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Staff