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September 28, 2023
Is Now the Time for McDonald’s To Be Raising Franchisee Royalty Rates?
McDonald’s plans to increase franchise royalty fees throughout North America for the first time in 29 years, and franchisees reportedly aren’t happy about it.
Starting on Jan. 1, the fees will rise from 4% to 5% in the U.S. and Canada. The royalty rate, the fee franchisees pay to the parent company, has already been at 5% in all markets except for North America.
The higher fee will only be charged to new franchisees or when an existing franchisee opens a newly built restaurant and acquires one from the company. McDonald’s royalty rates are lower than most of its competitors, though franchisees also pay rent, technology fees, and other fees.
The higher fees come as McDonald’s North American business has been thriving. In the U.S., same-store sales have increased in each of the past 12 quarters and all but one since 2019. The fast-food chain has also been delivering record cash flow.
“While we created the industry we now lead, we must continue to redefine what success looks like and position ourselves for long-term success to ensure the value of our brand remains as strong as ever,” Joe Erlinger, McDonald’s U.S. president, told franchisees in a message viewed by CNBC.
However, the board of the National Owners Association, an independent McDonald’s franchisee group, in a letter sent to members attained by Restaurant Business said the increase will reduce the return on investment on new locations. The group said that operating margin is likely to hit a 12-year low this year.
McDonald’s has long had a rocky relationship with U.S. franchisees over fees and other changes that some claim have boosted corporate profitability at the expense of franchises, although franchise/franchisee disputes are common. According to Nation’s Restaurant News, the recent franchise backlash against McDonald’s has also included a technology fee first implemented in late 2020 as well as the recent creation of the Operations PACE system, which measures performance management.
According to Kalinowski Equity Research, McDonald’s franchisees assessed their connection with corporate management as 1.71 out of 5 in the second quarter this year, although that’s the highest score since the fourth quarter of 2021.
The franchise changes come as McDonald’s is seeing basket sizes shrink amid inflationary pressures and higher credit card debt, but traffic continues to be healthy as diners are trading down to save money. CEO Christopher Kempczinski said on McDonald’s second-quarter analyst call, “I think our value positioning in the market has put us into a good position to be able to weather that and continue to drive the share gains that you’re seeing.”
Discussion Questions
How would you weigh the benefits and risks of McDonald’s move to increase royalty fees for franchisees planning to open new locations in the U.S.? What drives the inherent conflict between franchisers and franchisees?
Poll
Loading …BrainTrust
Neil Saunders
Managing Director, GlobalData
Janet Dorenkott
President, Jadeco
Steve Montgomery
President, b2b Solutions, LLC
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McDonald’s doesn’t have the best of relationships with its franchisees, and this will only serve to worsen the situation. The current issue is that profitability at most restaurants is weakening thanks to higher costs. While these new fees will not affect existing restaurants, they will impact new additions and relocations and add further to the burden. All that said, sales are strong and I think McDonald’s has weighed the fact that while franchisees will grumble and make some noise, then will generally swallow the increase.
As prices have increased over the years, the absolute royalties have commensurately increased. In the last decade, McD’s prices have increased almost 70%. That means the company has reaped nearly 70% more royalty payments from then until now. With the introduction of a “mere” one percentage point, the increase is 25% in absolute royalty payments and a huge cut in the franchisee’s profit. No wonder the relationship between the company and franchisees is less than friendly.
Nineteen years ago, a gallon of gas was $1.88 and a dozen eggs were $1.34. Twenty-nine years is a long time to go without an increase, so it’s logical, as costs have skyrocketed in nearly every aspect of life, that franchisee fees would go up as well. Franchisees should push back, but they’ve got a rising tide against them here.
In 2000, the average U.S. price of a Big Mac was $4. Today it is $6. The royalty paid on the Big Mac in 2000 was 16 cents. Today, it is 24 cents. That is a 50% increase in royalty payments. That sounds pretty substantial to me.
Based on Jenn’s – and others’ – comments, I think there’s some confusion here: as you noted, the fee is a percentage, not a fixed sum, so the dollar amounts paid go right up along with prices. So the question is really : “why raise the rate at all? (And apparently the answer is “‘cuz we can!”)
You ever wonder if “someone” in finance does a calculation on raising rates, likes the result in their 5 year model, and somehow that rolls out without the real implications ever having been well reviewed? Kinda like the finance department who wants to raise retail prices by a penny having calculated the net profit increase, with no understanding of real world implications.
They can do whatever they want. If people keep buying franchises, they will deal with the higher fees, by just passing the cost increase onto the customer. If the customer really thinks a medium fry is with 3.69 or a Big Mac is worth 6.19 then let the good times roll.
Higher franchise fees combined with higher interest rates don’t strike me as a good combination for selling franchises but I guess McDonalds is such a hot brand that they feel very confident in their ability to keep selling franchises despite higher costs.
There is always some level of tension between franchisors and their franchisees If it is not fee is operational requirements etc. The Franchisee wants as much independence to operate what they regards as their business. and the franchisor believes that it is in both parties best interest to have close adherence to the rule that govern the franchise.
What drives the conflict?? I mean…reallly!
I went with the large majority who see little “risk” here: it’s a small increase – not so much “+25%” as “+25% in 29 years” – and, as noted, standardizes global conditions. Franchisees may not like it, but they’re getting an iconic brand that is delivering solid results…in the short-term at least.
With inflation, people everywhere are complaining about fast food prices sky rocketing. As franchisers margins are shrinking, this additional 1% will shrink the margin even further. McDonalds already gets 4% of the increased prices. I think this is a bad idea for McDonalds at a very inflationary time.