The McDonald’s Franchise Fee keeps People returning to McDonald’s

Posted by PITHOCRATES - January 26th, 2014

Week in Review

Minimum wage workers are trying to raise the wage in fast-food restaurants.  Like McDonald’s.  They say it’s only fair as the company makes billions a year.  And can afford higher wages for their workers.  But most McDonald’s are independent franchises.  Operated by a small business owner on very thin margins.  For a large portion of their earnings go to the corporate office in franchise fees.  Which does all the work that allows a franchise owner to open for business and have a thriving business from day one.  Because of all they do with those franchise fees (see McDonald’s Says Its Restaurants Got Too Complicated by Julie Jargon posted 1/24/2014 on Yahoo! Finance).

McDonald’s executives say they have learned from their mistakes of the past year and are moving to correct them. The company rolled out numerous menu items in quick succession, creating a bottleneck in the kitchens. They also rolled out products that were too expensive for many consumers, including chicken wings that were priced far above competitors’ offerings, leaving the chain with approximately 10 million pounds of unsold wings, according to a person familiar with the matter…

The chain is revamping its kitchens to include expanded prep tables to give employees more space to assemble food. It also plans to add more employees at peak hours and during weekends.

Mr. Thompson said the marketing needs to reflect efforts to improve its menu. McDonald’s on Wednesday announced the appointment of Deborah Wahl, formerly chief marketing officer of home builder PulteGroup Inc., to be its new chief marketing officer for McDonald’s USA…

For 2014, McDonald’s is budgeting for $3 billion in capital expenditures, which will cover up to 1,600 new restaurant openings and the refurbishing of more than 1,000 existing locations.

A small business owner doesn’t have the time or resources to develop new menu items to attract more customers to their stores.  Pay for costly mistakes.  Or spend billions each year to build new stores and renovate existing ones.  So that wherever you are in the world when you walk into a McDonald’s you are home.  In familiar territory.  With the same delicious food you enjoyed back at home.  When you weren’t homesick in a strange world.  This is what corporate does with that franchise fee.  It makes the McDonald’s experience what it is.  Not the minimum wage workers.  They help.  As does the franchise owner.  But it’s those franchise fees pouring into corporate that get reinvested into McDonald’s that keeps us wanting to return for the comfiest of comfort foods.  The food of our childhood.

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A ‘Living’ Wage would probably push Quiznos into Bankruptcy Court

Posted by PITHOCRATES - December 7th, 2013

Week in Review

Minimum wage workers just picketed for a ‘living’ wage.  Wanting $15/ hour.  About twice what many are making now.  For they believe that the fast food restaurants they work at are getting rich off of their unskilled labor.  And they want a piece of the profits they’re making.  And they’ll cite the profits of, say, McDonald’s and say they can afford to pay their workers more.  But the thing is, most of those McDonald’s stores are independent franchises.  And the fact that McDonald’s may be making the big bucks it doesn’t mean their franchisees are.

Owning a franchise is a way to own a restaurant without having to spend money on marketing.  And you don’t have to create a menu.  In fact, when you buy a franchise it pretty much comes with an operating manual.  Something most other restaurants don’t come with.  Which is why restaurants are the number one business to fail.  Because running a restaurant is hard.  Even a franchise (see Crisis Quickens at Quiznos by Julie Jargon, The Wall Street Journal, posted 12/6/2013 on Yahoo! Finance).

The once-booming sandwich chain Quiznos is stumbling two years into a major turnaround effort, prompting the company to seek concessions from creditors owed nearly $600 million.

The Denver-based chain, known formally as QIP Holder LLC, has struggled with store closures and tension with franchisees. It recently missed a payment on a loan, and has been negotiating to restructure some or all of its debt load with creditors, who have hired bankers and lawyers, people familiar with the matter said…

Quiznos…shrank to about 3,000 stores world-wide two years ago, and to around 2,100 today, including roughly 1,500 stores in the U.S., people familiar with the matter said. Hundreds of the U.S. stores are underperforming and could close in the next year, some of these people said…

Franchisees long have complained that Quiznos requires them to buy food and other supplies from a Quiznos subsidiary, which they allege charges more than what they would pay to purchase those goods themselves.

To address franchisees’ concerns, current management decreased costs for food and supplies this summer, a person close to the company said. Quiznos reviews food and supply purchases annually to compare market prices, and shares results with franchisees, this person added.

Current and former franchisees said high costs ate into stores’ profitability, causing many to close. With fewer stores contributing to an advertising fund, the chain had fewer resources to promote new products, hurting sales, which resulted in more store closures, they said.

“It’s a vicious cycle,” said Brian Peticolas, who owns a Quiznos in Alton, Ill. “I almost closed my store five months ago, but I didn’t have any other prospects so I kept the doors open.”

Mr. Peticolas said his store averages $5,000 a week in sales, down from $7,000 a week three years ago. He estimates the restaurant is losing up to $300 a week.

Owning a franchise is a lot easier than trying to open and run your own restaurant.  Because it comes with the menu, the restaurant layout, a list of the equipment you’ll need, an ‘operating manual’ that tells you everything you need to do, etc.  New items are researched and developed.  Then marketed.  And everything you need to sell is shipped to your store.  But this comes at a price.  The franchise fee.  And in the case of Quiznos, owning a costly supply chain.

Pizzerias and sub shops are some of the most competitive businesses.  Most are forced to sell ‘a low price’ because of the great competition.  But when you lower your price you hurt your ability to introduce and market new items.  To get an advantage over your competition.  But if you raise your franchise fee or your food/supply costs to your franchisees you will make it impossible for them to operate at a profit.  Causing store closures.  Which makes it even harder to introduce and market new items.  As the one store owner said, it is a vicious cycle.  That usually ends in bankruptcy court.  Or in an out of court settlement with your creditors.

There is only one thing that can make all of this worse.  Higher wages.  Which will only accelerate franchise closings.  And the trip to bankruptcy court.  Of course the people picketing won’t believe this.  Until the store they work at closes.  Which will most likely happen if they raise the minimum wage to a ‘living’ wage.  Especially at these Quiznos franchises.  Which are struggling to stay out of bankruptcy court.  And will probably lose that struggle.  Even if the minimum wage isn’t raised to a ‘living’ wage.

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McDonald’s 2012 Annual Report

Posted by PITHOCRATES - August 6th, 2013

History 101

The Benefit of a McDonald’s Franchise is getting the Benefit of their Years of Building their Brand

Recently a late-night comedy show attacked McDonald’s for being greedy.  Because they don’t pay their minimum wage workers a living wage.  Because what were once entry level jobs are now the primary support for some families.  And why have entry level jobs come to support families?  Because the anti-business policies of the current administration have destroyed better-paying jobs.  But they don’t attack that on late-night television.  They attack a company actually providing jobs in a jobless economy.

Today McDonald’s is huge.  You can find them pretty much anywhere in the world.  Which can be a welcome site for a weary traveler.  For they know they can walk into a McDonald’s wherever they are and have the comfort of a meal exactly like that at home.  Which is pretty amazing if you think about it.  And why McDonald’s is so successful.  The sight of those Golden Arches can attract a foreigner in a strange land or a construction worker on a new project in a distant city.  They know exactly what they can get at that McDonald’s.  What it will taste like.  And what it will cost.  Even if they’ve never been in that McDonald’s before.

This is because McDonald’s has very successfully built their brand.  Which is one of those intangible things.  It has great value.  But you can’t physically touch it.  Those who own a McDonald’s franchise can enjoy a thriving business.  From day one.  Without doing any marketing to get people to walk into their restaurant.  They don’t have to.  Because McDonald’s has already done it.  And continues to do it.  This is the benefit of the franchise.  You get the benefit of all those years of hard work McDonald’s did to build their brand by simply paying a franchise fee (see Restaurants and Franchises posted 8/5/2013 on Pithocrates).  It’s not cheap.   But it’s such a fair deal for both franchiser and franchisee that McDonald’s had 27,882 franchised stores in 2012 (see McDonald’s 2012 Annual Report, page 11).

Owning a McDonald’s Franchise allows you to own a Restaurant that has been Successfully in Business for 72 Years

In addition to the intangible value of the brand the franchise fee also includes rent.  For McDonald’s “owns the land and building or secures long-term leases” for the franchisee’s store (see McDonald’s 2012 Annual Report, page 11).  While the franchise needs to foot the bill for the “equipment, signs, seating and décor.”  This makes sure all stores are modern and up to date and uniform.  Helping to maintain that comfortable familiarity for the customers.  While splitting the capital costs between the franchisee and franchiser.  So both parties have a major investment in the business.  And each shares in the profits of the business.  Perhaps the best of the deal for the franchisee is getting a mentor.  And a detailed operating manual telling them everything they need to know and do.

Owning a McDonald’s franchise is costly.  But you get to step into a restaurant that has been successfully in business for 72 years.  Give or take.  Considering that half of all restaurants fail within the first five years of business this is a HUGE benefit for the franchisee.  And something well worth the franchise fee.  As evidenced by 27,882 franchised stores in 2012.  So what is that franchise fee?  And how much money does the franchisee get to keep after paying the franchise fee?

Well, if you do a little number crunching with the financials included in the 2012 annual report you can get an approximate number.  McDonald’s also has stores they own and operate.  In 2012 they had 6,598 company-owned stores.  The average per store revenue was $1,358,594 (calculated by dividing the total revenue from the company-owned stores by the number of company-owned stores).  A similar calculation gives an approximate $667,205 franchise fee per franchised store.  Subtracting the typical franchisee fee from the typical store revenue (assuming all stores have the same average revenue as the company-owned stores) gives the franchisee an annual income of $691,389.  From this income the franchisee has to pay for food, labor and overhead.  And whatever is left over is profit.

High School Kids and College Students work at McDonald’s because they need no prior Restaurant Experience

The rule of thumb in restaurants is that costs are broken down into thirds.  One third is food cost.  One third is labor cost.  And one third is overhead and profit.  So if we divide that $691,389 by 3 we get an annual food cost per franchised store of $230,463.  Ditto for labor.  And overhead (gas, electric, water, insurances, taxes, licenses, fees, waste disposal, light bulbs, toilet paper, soap, garbage bags, etc.) and profit.  Let’s look at the labor cost more closely.  To see if McDonald’s is greedy when it comes to paying their employees.

The benefit of owning a franchise is that it comes with very explicit instructions.  A McDonald’s distributor delivers prepared food ready for the grill and fryer.  As delicious as it is, though, it doesn’t take a highly skilled chef to prepare it.  As the franchisee operating manual has it down to a science.  Which is why high school kids and college students work at McDonald’s.  They need no prior restaurant experience as it is an entry level job.  Typically their first job.  Where they learn what it’s like entering the workforce.  The importance of being on time.  Following instructions.  Being responsible.  Skills that they will use in later jobs.  Which most do.  As there is a high turnover of employees at McDonald’s as there is for all fast food.  Because these are entry level jobs for unskilled workers.  Who learn the skills they need on the job.  So let’s assume a restaurant that is open 24 hours a day, 7 days a week.  Assuming an hourly rate of $8.50 and an overhead of 40% for direct labor costs (workers’ compensation insurance, unemployment taxes, health insurance, uniforms, training, etc.) the average hourly labor cost comes to $11.90.  Dividing the labor cost of $230,463 by this hourly cost gives us 15,758 annual labor hours.  Or about 53.06 hours per day.  Or 17.69 hours per 8-hour shift.  Giving us an average of 2.21 workers per 8-hour shift.

During the breakfast and lunch rush a typical McDonald’s may have between 5-8 people working.  With fewer working in the evening.  And a skeleton crew over night working the drive-thru.  So the labor fluctuates during the day to correspond to the amount of business.  Which is why there are a lot of part-time workers at McDonald’s.  Ideal for high school and college kids.  In addition the owner typically works during those busy periods to help with the rush.  And works on paperwork during the slower times.  Putting in about 12 hours a day.  If you assume an overhead rate of 18% and multiply that to the franchisee annual income of $691,389 we get an overhead expense of $124,450.  Subtracting that from the $230,463 (overhead & profit) leaves an annual owner income of $106,013.  Or, based on a work week of 84 hours (12 hours a day X 7 days a week), the owner earns about $24.27 an hour.  A rate a lot of people can earn working for someone else without the headaches of owning a business.

That late-night comedy show attacked McDonald’s for being greedy.  Saying they should increase their pay rate to a living rate.  Like picketers were asking for.  $15/hour.  A labor cost increase of 82.6%.  Or an additional $190,382 each year.  Which would bring the franchisee’s annual income from $106,013 to an annual loss of $84,369.  So are these McDonald’s franchisees greedy because they refuse to pay a living wage?  No.  They simply can’t afford to pay more than the minimum wage for these minimum wage jobs.  Unless they can get people to spend $6-$7 for a Big Mac.  They are delicious.  But are they $6-$7 delicious?  And can a low-income family afford to take the family to McDonald’s when they are charging $6-$7 per burger?  Probably not.  No.  McDonald’s is just fine.  What we need to do is to un-do the anti-business policies of this administration that is killing those higher-paying jobs.  And forcing the primary earner in some families to work a minimum wage job.  Because that’s all that is available in this jobless economy.

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Restaurants and Franchises

Posted by PITHOCRATES - August 5th, 2013

Economics 101

Changing a Restaurant Name can be Costly and hurt the Marketing of your Brand

What is the number one business most likely to fail?  Restaurants.  About half of all new restaurants fail within the first 5 years.  Why?  Because people who can cook typically open up restaurants.  And that’s all they know.  Cooking.  Sadly, cooking is the smallest part of owning a restaurant.  And it’s these other areas that people who can cook fail miserably.  Because when they open up a restaurant there’s no operating manual that comes with the building they buy or lease that clearly tells them everything they need to know or do.

Chefs in the finest restaurants are masters of their craft.  Because they study how to master the art of cooking.  They didn’t go to business school.  They went to culinary school.  But running a restaurant is more than cooking.  It’s a business.  A business that must produce revenue to cover all of its expenses.  Which is kind of hard to do when you don’t know how to market your restaurant to get people to walk through the doors.  Without which there is no revenue.  Or when you don’t know all of your expenses.  Which starts with the restaurant’s name.

A good name will not guarantee success.  But a bad name can hurt business.  It should not confuse people.  Such as ’57 Chevy, for example.  Which may be your favorite car.  But people will think cars instead of food when they hear it or see it.  And it shouldn’t discourage them from eating there.  Like Average Joe’s, for example.  Because people rarely go out to restaurants that have just received an average review.  So a name is important.  And if you start with a bad one it can be very costly to change.  There’s building signage.  There could be a pylon sign near the road.  Signage inside the restaurant.  Not to mention replacing all of your menus.  These things cost.  And cause confusion with the identity of the restaurant.  Which could hurt the marketing of your brand.

Getting Menu Prices just Right is often the Difference between Success and Bankruptcy

Choosing a good restaurant location is critical, too.  A nice building you may be able to easily afford will do you no good if it isn’t near people.  As people aren’t going to travel great distances to dine at an unknown restaurant.  Which means choosing a good location may require choosing a costly location.  The purchase price/lease price may be much higher than anticipated.  Property taxes may be higher.  Both real (the land) and personal (the equipment inside).  And may be a cost item that a person who can cook didn’t even know was required.  Like the additional expenses to get all the permits and licenses to open for business.

Once opened there’s payroll.  Which you have to pay even when you’re not doing much business.  And a sit-down restaurant requires a lot of people.  Kitchen help to cook, clean and prep food.  Someone to bus tables and wash dishes.  A hostess to seat customers.  And cash them out.  A wait staff to wait on customers.  A bartender (if you have a bar).  A restaurant needs a general manager, a front of house manager and a back of house manager.  And an executive chef.  If the owner is the executive chef he or she will have to hire others to manage those other areas.  Have a spouse split all management duties with the executive chef.  Stressing the marriage.  Or risk poor service that will prevent customers from returning.

Then there are the utility expenses.  Electric, gas, water and telephone.  A point-of-sale system to track sales and manage inventory.  Or longer hours to allow manual bookkeeping and inventory control.  Dishes, cutlery, napkins, toilet paper, light bulbs, dish soap, filters, grease disposal, etc.  And a pleasing interior design.  As people want to enjoy a good meal in a pleasant environment.  Things that cost.  And things revenue must pay.  Which brings us to the menu.  The thing that will make or break your restaurant.  If you have a 10-page menu to appeal to as many people as possible you will have too much of your money in your food inventory.  And you’ll end up throwing away a lot of slow moving product.  If it’s not unique enough people will have little reason to come into your restaurant.  As will menu prices that are too high will, too.  But if those prices are too low you won’t have enough money to pay for all of these expenses.  Getting these menu prices just right is often the difference between success and bankruptcy.

Buying a Franchise is like Buying a Restaurant that comes with a Complete and Detailed Operating Manual

A big reason why restaurants fail is because owners don’t understand their costs.  And because they don’t understand their costs they don’t know how to size their food portions.  Or how to price their menu items.  Portion sizes that are too large require a bigger inventory.  Which costs more.  Leads to more waste.  And that waste leads to more costs.  While prices too low won’t generate enough revenue to cover those portion sizes.  As well as labor and overhead costs.

In a restaurant the menu is everything.  A person highly skilled in cooking can populate a menu with some delicious dishes.  But a menu too large can confuse customers who don’t want to read a book before ordering.  It could expand the inventory to include a lot of frozen and canned items because they will last longer.  But are more costly than buying fresh.  Whereas a large inventory of fresh items will not last as long.  Leading to a lot of waste.  So a shorter menu allows a smaller inventory of fresh product.  Which increases the quality of the food served.  And keeps costs down.

The restaurant owner can get all of this right but if they can’t get people to walk through that door it’s all for naught.  And getting people to walk through your door can be the hardest part.  There are many options but they all require more time and more money.  And these are things a restaurant owner has little left to spare.  Which is why so few restaurants succeed.  But there is another way to own a restaurant.  One that has a much better chance of succeeding.  And you don’t even need culinary training to succeed.  You can do this by buying a restaurant franchise.

Buying a franchise is like buying a restaurant that comes with a complete and detailed operating manual.  That tells you everything you need to know and do.  It gives you your menu.  Your portion sizes.  Your menu pricing (or at least a starting point that can be adjusted for your geographic location).  And something even more valuable.  A built-in, extensive marketing program.  So that you can have a flow of people coming through your door the day you open for business.  Because people already know everything about your restaurant because it’s part of a great national (or international) chain.  And they may have just been waiting for one to open near them.  Something a chef opening his or own restaurant can only dream about.  But that franchisee can’t have the satisfaction of bringing their dream to life like that chef can.  As long as he or she is not in that half that fails in the first 5 years.

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