Stronger growth for brands that limit encroachment

simpsons image

The Simpsons almost go bankrupt when Marge opens a franchised sandwich shop only to lose customers to an “express” version of the same franchise across the street. But such sales cannibalization is far from funny for franchisees who face it.

In fact, FranchiseGrade.com, a leading analyst of the franchising industry, found that:

  • Established systems that protect franchisees’ territory are more likely to experience growth. Among the top quarter of all franchise systems ranked by unit count, systems that had positive growth over the last five years were significantly more likely than their shrinking counterparts to offer franchisees defined territory.
  • Startup systems that grant territory protections are also more likely to grow. Of franchise systems that disclosed their first unit openings in 2011, those that grew over the last five years were more likely to provide territory rights to their franchisees than systems that did not.
  • Fast food is the sector least likely to grant territory protections. Only 35 percent of all Quick Service Restaurant franchisors – just over one third – offer some kind of encroachment protection. McDonald’s is among the QSR chains that does not;

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Low point for McDonald’s franchisees: will all-day breakfast help?

McDonald’s franchisees more worried than ever

A quarterly survey of McDonald’s franchisees shows operators are more pessimistic than they were three months ago, when the same poll found McDonald’s operators had the worst outlook in the survey’s 12-year history. And McDonald’s recent announcement of its plan to serve breakfast all day could make things worse.

The survey, conducted by industry analyst Mark Kalinowski and released last week, recorded its lowest-ever ratings, both on franchisees’ financial expectations and their relationship with McDonald’s corporate.

The survey also revealed skepticism about McDonald’s CEO Steve Easterbrook’s ’s turnaround plan, announced in May, which calls for streamlining McDonald’s corporate structure, cutting menu items to speed up service, and removing antibiotics and complex ingredients from food items.

But what about recent news that McDonald’s may soon roll out breakfast all day?

An all-day breakfast menu will require additional equipment and investment from franchisees whose coffers have been drained by corporate-imposed capex projects in recent years. One franchisee noted, “All the re-investments over the last five years with MRPs [major remodel projects], rebuilds and kitchen and lobby remodels – not to mention the McCafé and blended ice machine remodels – have absolutely killed the operator’s equity in their business.”

A former McDonald’s franchisee and current industry consultant argues that that all-day breakfast will only work if the current rest-of-the-day menu is significantly reduced.

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Capital spending requirements put franchisees in a tight spot

McDonald's Headquarters

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.

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SEIU petitions federal watchdog to investigate franchise industry

SEIU petitions federal watchdog to investigate franchise industry

Citing evidence of a dramatic power imbalance between the nation’s top franchisors and their franchisees, the Service Employees International Union petitioned the Federal Trade Commission on May 18 to launch an investigation into the franchise sector and issue recommendations for curbing ”abusive and predatory” practices by franchisors.

The request for investigation marshals evidence from an extensive review of franchise agreements and disclosure documents for 14 of the country’s largest franchise systems. The review found that franchise agreements are consistently one-sided, often allowing franchisors to terminate franchisees for minor violations of thousands of pages of ever-changing rules and to refuse to renew franchise agreements for any reason or no reason at all.

[Read SEIU’s petition to the FTC]

The 32-page petition also contends that franchisors often provide inadequate information on the main issue of concern to potential franchisees: the financial performance of franchised units. This makes it all but impossible for many potential franchisees to make an informed decision on whether to invest.

The petition calls on the FTC to use its investigative authority to compel top franchise companies to turn over information about their franchising practices.

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