McDonald’s Favors Larger Franchisees in Revamp Struggle

Fast food provider consolidating its restaurants to fewer operators in the U.S.

m1McDonald’s Corp. (NYSE: MCD), the world’s largest fast food provider, is in the process of consolidating its restaurants to have fewer franchisees in the U.S., where each franchisee owns an average of five to seven locations. This forms part of McDonald’s massive corporate restructuring initiative announced in May 2015, aimed at reorganizing its struggling business. According to CEO Steve Easterbrook, the restructuring effort is set to save the company $300 million annually. As part of this restructuring, only 10% of McDonald’s stores will be company-owned by 2018. Currently, 80% of its restaurants are franchisee-owned. McDonald’s is also selling about 3,500 of its 36,000 restaurants as part of these plans.

Focus on bigger franchisees

McDonald’s franchisees have traditionally been entrepreneurs with only one or two stores. The Company has been favoring such a system since smaller business owners would be able to better monitor their restaurants, resulting in better customer service. Lately, however, the fast-food giant has begun choosing bigger operators rather than mom and pop owners.

According to FranchiseGrade.com, and as reported by Bloomberg on September 2nd, 2016, since 2014, the number of McDonald’s U.S. franchise owners has dropped 2.6%, while the number of franchised locations has grown 1.2%. This shows that the chain’s biggest franchisees are getting larger, while those who own five locations or fewer are on the wane. McDonald’s has about 1,842 franchisees in the U.S. that own five restaurants or fewer, compared with 1,930 in 2014, a 4.6% drop. On the other hand, there has been a 12% jump in the number of franchisees operating more than 10 stores to 245 currently compared to 218 in 2014.

m2McDonald’s believes that its large-owner-focused franchise system enables it to speed up renovations at its restaurants and the implementation of new technology, such as the self-ordering touchscreens, which are being tested in about 250 locations. Also, larger franchisees with deeper pockets would be able to afford interior makeovers, digitally linked cash registers through mobile apps, espresso machines, muffin makers, and other expensive in-store equipment. McDonald’s feels that smaller franchisees often do not have the resources to fund such makeovers and are less willing to align their operations with the company’s plans. Moreover, it also becomes difficult for McDonald’s to monitor and update thousands of franchisees versus just a few.

Fast-food giant Burger King Worldwide Inc., the brand owned by Restaurant Brands International Inc. (NYSE: QSR), The Wendy’s Company (NASDAQ: WEN), Subway, and Yum! Brands Inc. (NYSE: YUM), owner of the Pizza Hut chain, all have franchisees that own hundreds of locations. However, McDonald’s largest franchisee in the U.S., Century Management in Memphis, has 69 locations, according to Restaurant Finance Monitor. The nine biggest McDonald’s franchisees, on an average, own 40 stores. By contrast, Carrols Restaurant Group, the largest Burger King franchisee, has about 727 in the U.S., while NPC International operates more than 1,240 Pizza Hut restaurants.

U.S. market reaching saturation

McDonald’s, which operates more than 14,000 McDonald’s restaurants in the U.S., is witnessing market saturation in recent years and has been trying to draw more sales out of each store and closing down underperforming locations. Adding to its woes, the fast food chain is facing intense competition in the burger segment with more nimbler brands like Shake Shack Inc. (NYSE: SHAK), Sonic Corp. (NASDAQ: SONC), Chik-fil-A Inc., and Whataburger that offer a more appetizing menu. Moreover, its competitors such as Wendy’s, Chipotle Mexican Grill Inc. (NYSE: CMG) and Five Guys Burgers and Fries have been fast expanding their operations.

In its latest Q2 FY16 earnings results, McDonald’s announced that revenue dropped by 4% to $6.26 billion despite its new all-day breakfast menu and turnaround efforts. Same-store sales in the U.S. rose only 1.8%, sharply below analysts’ expectations of a 3.4% growth.

More worrisome is the fact that franchisees are grappling with shrinking sales, slumping traffic, and stiff competition from rivals offering innovative food items. Moreover, the all-day breakfast menu, despite being a hit with customers, has been slowing down service at peak hours and franchisees have not been able to reap much financial benefit due to the low cost of most breakfast menu items. In all, it is clear that McDonald’s playbook of the 2000s is simply not working anymore.

Stock Performance

m3McDonald’s stock ended the day at $115.83, gaining 0.37%, at the close on Friday, September 2nd, 2016, having vacillated between an intraday high of $116.11 and a low of $115.70 during the session. The stock’s trading volume was at 3,397,131 for the day. The Company’s market cap was at $100.08 billion as of last Friday’s close. The stock also has a PE ratio of 22.08 and a dividend yield of 3.07%.

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