Can McDonald's new CEO Steve Easterbrook lead the company through a franchisee rebellion? (Click Image To Enlarge)
According to a new survey, McDonald's franchisees believe the brand is in a "deep depression" and could be facing its "final days."
One franchisee wrote in response to the survey by Nomura analyst Mark Kalinowski.
"We are in the throes of a deep depression, and nothing is changing. Probably 30% of operators are insolvent."
"The CEO is sowing the seeds of our demise. We are a quick-serve fast-food restaurant, not a fast casual like Five Guys or Chipotle. The system may be facing its final days."
More than a dozen franchisees expressed frustration with McDonald's management, saying that CEO Steve Easterbrook's turnaround plan — which includes initiatives like all-day breakfast and a shift to digital ordering kiosks — is a distraction from the core issues of McDonald's, like food quality and customer service.
One franchisee wrote.
"The lack of consistent leadership from Oak Brook is frightening, we continue to jump from one failed initiative to another."
A second wrote.
"I have been in this business since the early 1970s but have not seen us this leaderless in all my time."
The company's reaction to their frustration, one franchisee claimed, is for operators to "get out of the system" and quit the business.
Several franchisees complained about all-day breakfast, saying that it has complicated kitchen operations and goes against Easterbrook's repeated promises to simplify the menu.
One franchisee wrote.
"The system is very lost at the moment. Our menu boards are still bloated, and we are still trying to be too many things to too many people. ... Things are broken from the franchisee perspective."
Franchisees also criticized the "Create Your Taste" program, which allows people to customize their burgers with premium ingredients.
One franchisee wrote.
"They are throwing everything they can against the wall to see what will stick."
Kalinowski interviewed 29 US franchisees covering about 226 restaurants for the survey. McDonald's has more than 14,000 restaurants in the US.
In response to the survey, McDonald's said it's hearing a different story from franchisees — specifically pertaining to all-day breakfast.
A company spokeswoman told Business Insider.
"We’re hearing from customers and the overwhelming majority of our 3,100 franchisees that all-day breakfast is a hit! In fact, since the launch, McDonald’s has reached its highest brand score in two years according to YouGov BrandIndex."
McDonald's is trying to revive business following seven straight quarters of same-store sales declines in the US.
In addition to adding all-day breakfast and "Create Your Taste," McDonald's has also made some changes to its core menu items.
The company started toasting its hamburger buns longer, making its beef patties slightly larger, and changing how the patties are seared.
McDonald's has also announced plans to remove antibiotics from its chicken.
There are at least a few franchisees who are on board with the changes.
Among the myriad negative responses to Kalinowski's survey, several franchisees expressed hopeful attitudes.
"I think our leadership is headed in the right direction. It will take time."
"The CEO seems to be doing OK so far!"
COMMENTARY: Although McDonald's new CEO Steve Easterbrook does not have the confidence of a lot of franchisees, there seems to be a disconnect between how McDonald's shareholders perceive Easterbrook's leadership and how the franchisees feel about him. Proof this lies in the performance of McDonald's share price.
McDonald's Stock Up 10% For Year
McDonald’s has been the target of relentless analyst fire for all of 2015; yet here we are in mid-October and McDonald’s shares are up 10% for the year. This week they hit a new all-time high of $103.84.
McDonald's Corporation Share Prices Last Five Years - Jan 2011 Through Oct 2015 - Google Finance (Click Image To Enlarge)
McDonald's Brand Stronger Than Ever
The naysayers mistakenly aim at the small target, but they miss the big picture: McDonald’s formidable brand recognition and performance-oriented culture virtually guarantee long-term success.
On the former, McDonald’s is a top 10 global brand, according to Interbrand, a brand management consultant. McDonald’s ranks ninth on Interbrand’s list, with a $42.3 billion market value. Strong brands have the same effect on consumers that magnets have on metal shavings – they draw them in.
McDonald’s magnetism is especially strong on kids, and not just kids in the United States. Here, I speak from experience. On a weekday road trip from Antibes, France to Geneva, Switzerland, my wife and I stopped at a McDonald’s near Digne, France. We stopped not because of hunger, but because of curiosity. The parking lot was packed. When we walked in, we found a restaurant overflowing with middle-school-aged kids. So much for indomitable French cuisine.
McDonald's Culture Remains The Same
But it’s really McDonald’s culture that magnetizes the brand. As Steve Wynn, chairman and CEO of Wynn Resorts (NASDAQ: WYNN), said in a 2014 Wall Street Journal interview,
“You got the culture, you got the problem solved.”
McDonald’s has the culture, and has had the culture for decades, so the problem always gets solved.
Franchisee Rebellion Is A Distinct Possibility
After much anticipation, the newly installed chief executive officer of McDonald's, Steve Easterbrook, has announced a sweeping turnaround plan aimed at cutting annual costs by around $300 million at the struggling fast-food behemoth. Wall Street was unimpressed: the stock fell after Easterbrook made his announcement.
But a far important constituency is also grumbling: the franchisees who own most of the outlets. Many have already expressed skepticism about Easterbrook's leadership, complaining that McDonald's was imposing new burdens, products and obligations without any understanding of the strain the changes will place on franchise owners.
There's little evidence that Easterbrook's plans to turn McDonald's into a "modern, progressive burger company" -- which include selling 3,500 of the restaurants it owns -- allayed the concerns of the franchise owners, who have experienced falling sales in many parts of the world.
Easterbrook's plan seemed largely aimed at creating value for shareholders, not helping franchisees. The vexed history of franchising suggests it may be a mistake to disregard this constituency.
After World War II, McDonald's and other fast-food restaurants introduced "business format" franchises. Unlike conventional franchises, this wasn't a way to delegate distribution; it was a means to sell an entire way of life to aspiring small-business owners. McDonald's founder Ray Kroc described this as an "updated version of the American Dream," and his company, along with Howard Johnson's and other restaurants, made it a mainstream phenomenon.
In business-format franchising, the parent company maintains a rigorous level of control over franchisees, holding them to standards of appearance, cooking times, the dress of employees, accounting methods, and just about anything else that can be standardized and controlled. McDonald's went so far as to create its famed "Hamburger University" in 1961.
In principle, this insured success for both the corporation and the franchise owners. But in practice it relegated franchisees to a genuinely subordinate position. Harold Brown, a lawyer and critic of business format franchising claimed in 1970 that "numerous franchisors have stated that their franchisees are like children, demanding constant discipline and control."
This attitude didn't always sit so well with franchisees. The control imposed from above was fine so long as the decisions made at corporate headquarters worked well on the ground, but that wasn't always the case. In the late 1960s, a number of high-profile franchising ventures ended in revolts.
- Domino's Pizza, for example, expanded its franchise operations throughout the 1960s, but failed to deliver sufficient support, financing and training. Profits plummeted and the company almost went bankrupt in 1969. Two years later, enraged franchise holders sued Domino's, alleging that the corporation had imposed obligations on outlets without providing the necessary support. There was much anger as well at Domino's insistence that outlets only purchase supplies from the parent company or an approved supplier. Eventually, Domino's bought out the embittered franchisees, increasing the number of outlets under direct ownership.
- Chicken Delight, founded in 1952, expanded over the course of the succeeding decade, but then failed to deliver the necessary support to franchise owners, despite forcing them to pay the corporation higher prices for everything from paper plates to batter for the chicken. A number of franchisees eventually sued the company, setting in motion a chain of events that led to what the Wall Street Journal described in 1972 as "the virtual dismantling of the Chicken Delight organization."
- Shakey's Pizza, Mister Donut and other companies faced similar revolts around the same time. Some, notably Mr. Donut, mended fences with their franchisees, granting them increased control over local decision-making, financing, accounting, and even the expenditure of ad dollars. Others moved away from top-down decision-making, setting up venues where franchisees could express their concerns. Still others sought to curtail the number of franchises, bringing stores back under corporate control. All of this worked: many companies turned around, and the reputation of business-format franchising eventually improved.
McDonald's, which sailed through this period without problems, might want to take a page from the past as it tries to right the ship. It's suffering from many of the same problems. In a recent survey, franchisees struck much the same tone as their disgruntled predecessors of the 1960s, citing an out-touch management that seems more interested in off-loading costs onto franchisees than fixing the problems that beset the chain.
Unfortunately, Easterbrook's turnaround plan made almost no mention of the franchisees that are the public face of the company. Worse still, is his vow to increase the number of stores in the hands of franchisees from 81 percent to 90 percent — which some franchisees believe will make the company even more remote from the concerns of the owners on the front lines.
Easterbrooks Turnaround Plan
In May 6, 2015, McDonald's CEO Steve Easterbrook announced a restructuring plan to help it compete with fast-casual restaurants like Chipotle Mexican Grill. To foster a quicker reaction to changing trends, McDonald’s is restructuring its units into four groups based on the maturity of its presence in the particular market, where previously the business was segmented by geography.
- The flagship U.S. market.
- Established international markets such as Australia and the United Kingdom.
- High-growth markets such as China and Russia.
- The rest of the world.
McDonalds also said that 90 percent of its more than 36,200 restaurants around the world will be franchised over the next four years. This is up from 81 percent currently, and will mean the company will rely more heavily on franchising fees and move away from the daily running of restaurants. The organizational changes will contribute to 300 million dollars in cost-cutting targeted by McDonald's, most of which will be realized by 2017.
The company is working on streamlining its menu recently cutting seven items including the Deluxe Quarter Pounder burger and six chicken sandwiches, while at the same time working on improving perceptions about the quality of its food with a trio of new sirloin burgers being added.
Standard and Poors were left underwhelmed by the plan and subsequently downgraded their rating on McDonalds to A-, while Moody’s put their rating on review for downgrade. Both rating agencies showed concern over McDonald's plans to return between 8 and 9 billion to shareholders in 2015 and to hit the high end of its 18 to 20 billion 3-year goal by the end of 2016, worrying that any stock repurchases will be at the expense of higher debt levels than initially anticipated.
The fast food chain in April reported first-quarter comparable sales down 2.3% and revenue of 5.96 billion, falling short of the 6.02 billion analysts had expected. Unfortunately for McDonalds shareholders, the quarterly results were a familiar tale, which for nearly two years has seen its share price fall and same-store sales crumble in the U.S. market and abroad.
Having served as the CFO for a tanning salon franchise, I was at the forefront of a franchisee rebellion. This taught me some valuable lessons: 1) Do not deviate from your core franchise principles and vision, 2) Always deliver on your franchise promises, 3) Select the most qualified and experienced franchisee owner/manages, 4) Location, location, location, select the best franchisee locations, 5) Invest in adequately training and providing marketing support to your your franchisee network 6) Don't let unresolved problems and differences vent themselves into an allout franchisee rebellion.
It would not surprise me if McDonads top management has ignored or strayed away from some of the above franchise must-do's. In many businesses the customer comes first, but in a franchising business environment, the franchisees come first, because they are the face of McDonalds. It is doubtful that the vast majority of McDonalds customers know who McDonald's CEO is. They don't care either. They want their Big Mac sandwich made exactly the same each time they visit and served as quickly as possible.
By paying more attention to the bottom line and improving shareholder value, McDonalds top management may have violated one of the most important covenants of franchising. Take care of the franchisees, and they will take care of you.