Article "Food Fight: Franchisees Caught in the Middle"

Food Fight: Franchisees Caught in the Middle
October 1, 2009
By Diana Ransom

IF YOU’VE BEEN to a fast food restaurant lately, you’ve probably seen some of the fallout of the downturn. You may have eaten some of it, too.

In an effort to convince consumers to open their wallets wider, franchisors are not only requiring franchisees to officiate (and pay for) new promotions, they’re also requiring them to serve new products, extend operating hours and hand over more of their profits.

“The whole restaurant industry is struggling,” says Bonnie Riggs, an analyst for the market research firm NPD Group, which tracks industry revenues. Although total sales at quick-service restaurants were flat during April, May and June, overall restaurant sales fell 1% over the same period a year ago — the first decline of that magnitude in more than three decades, according to NPD research.

To boost sales, franchisors are taking a scattershot approach. “Franchisors are trying to be everything to everyone right now,” Riggs says. Given that penny-pinching consumers are eating more meals at home, franchisors are pulling out all the stops to reel them back in. They are asking franchisees to pitch cut-rate sandwiches and burgers and dreaming up premium, often exotic menu items to lure consumers back.

Just ask Mike Wright, a McDonald’s franchisee in Shalimar, Fla. To make way for McDonald’s new McCafé espresso-based coffee drinks, which launched nationally in May, he was looking at paying upwards of $125,000 to remodel the interiors of each of his seven stores. The company eventually changed its tune – after substantial pushback from franchisees – but Wright and his fellow franchisees were still strongly encouraged to purchase the necessary coffee and frappucino-style drink equipment. “At $14,000 a pop, you’ve got to sell a lot of coffee to make it up,” Wright says.

In Southern markets, selling hot coffee isn’t easy, Wright says. “When you start selling Bubba a cappuccino, it’s like trying to sell grits to a New Yorker,” he says. “They forced everyone to put this in their stores regardless of profitability.”

McDonald’s is telling its franchisees to have faith in the new menu. “Despite the economy, we are still seeing consistent growth in both our premium and value offerings,” says Julie Pottebaum, a McDonald’s spokeswoman.

Although offering premium products could be an indication that franchisors think the recession is over, many of the nation’s franchisees are still struggling. And even though offering tantalizing new items and discounts can help prop up sales, those tactics don’t always translate to higher profits for franchisees.

“There is a big difference between traffic and bottom-line profitability,” says Darren Tristano, the executive vice president of Technomic, a food industry research firm in Chicago. “From a franchisee perspective, they are looking hard at their cost structure,” he says. Imagine the profit margin on a $1 double cheeseburger, he says. “There isn’t much.”

Meanwhile, franchisees are also coping with added overhead. Adding new menu items often includes taking on more inventory, equipment and maintenance charges, as well as training expenses.

Franchisees have always been tasked with meeting franchisor demands; it’s the mechanism by which chains offer standardized products and ensure quality control. However, fielding a rush of new demands amid slumping sales and rising materials costs – while paying employees a new, higher minimum wage – is proving to be much more challenging than many franchisees expected.

“We are in a retail business; we don’t have software that takes care of itself,” says Daniel B. Fitzpatrick, the chief executive of Quality Dining, which owns 116 Burger King (BKC) franchises in the Midwest. “We still have to clean the signs and take care of the grass. When real estate taxes go up, we pay it. When the minimum wages rise, we pay it,” Fitzpatrick says.

For years, Fitzpatrick and fellow Burger King franchisees regularly paid for these added costs by dipping into their portion of Burger King’s restaurant operating fund, which is funded in part by rebates that Coca-Cola (KO) and Dr. Pepper Snapple (DPS) contribute in return for being Burger King’s exclusive soda vendors. However, Burger King now plans to reallocate 20% to 40% of those rebates each year to bolster its advertising budget.

Faced with increasingly stiff competition among other quick service restaurants – a risk factor the company noted in its most recent 10k filing – Burger King plans to reallocate restaurant operating funds “for marketing and other promotional purposes in line with industry practice,” says Susan Robison, a BK spokeswoman.

The company says it expects to allocate $25 million in 2010 and increase the sum to almost $40 million in 2012. That’s roughly $5,000 to $6,000 a store each year. For Fitzpatrick, that amounts to a roughly $600,000 loss in the first year alone. “Times are tough; I don’t have $6,000 — much less $600,000 — to give up.”