Is McDonald’s Making a Mistake by Raising Its Franchise Fees?

December 17, 2020

What the changes are

According to a company email obtained by Business Insider, McDonald’s is planning to change its franchise fee structure in three ways:

McDonald’s will end a Happy Meal subsidy that is meant to lower the cost of kids meals, which averaged $3,600 per restaurant per year.
Franchisees will be required to help fund the Archways to Opportunity program, which helps McDonald’s employees with their tuition payments. The new program will have the company match any contributions made by franchisees, instead of the old way, which was entirely funded by the parent company. It is estimated this will cost an extra $3,500 per restaurant.
Payments for technology investments will now be billed monthly instead of every six months. This will cost restaurants around $5,000 next year as the parent company wants to make up a $70 million “lag” from the old payment structure. It should be noted that after the transition, the annual cost for technology upkeep will be the same.

Ninety-three percent of the company’s restaurants are franchised, so these new fees are a big deal for its partners. Restaurant owners make around $150,000 in profits each year per location after paying for food, supplies, and employees, according to the food industry website Mashed, so adding $12,000 in fees would, on average, decrease franchise profits by 8% in 2021. That is a tough pill for these entrepreneurs to swallow, especially in the middle of the COVID-19 pandemic.

Why investors should be concerned

In the short run, McDonald’s investors may be delighted by these fee changes. With 36,000 franchised locations sending an extra $12,000 back to corporate headquarters, that would be $432 million in extra revenue for McDonald’s in 2021 and around $250 million in new revenue each year after.

However, in the long run, squeezing its partners may jeopardize McDonald’s relationship with its restaurants. One operator was quoted by the Restaurant Business website saying, “I really feel as if McDonald’s and operators were on the same team,” but that after these announcements, “it feels like we are on opposite teams.”

Optimizing for short-term profits and angering the people who interact with its customers millions of times a day during a pandemic is playing with fire, and the company is almost asking for franchisees to revolt. It also may cause McDonald’s to lose quality owners to competitors, which in turn could lead to a decrease in service quality at its locations.

And it is not like McDonald’s is in need of this extra cash right now. The company brought in $1.75 billion in income last quarter, up 10% from the prior year. Can its franchisees say the same? In all likelihood, no.

While these new fees will increase sales for McDonald’s and potentially expand its profit margins in the short run, adding costs without returning an equivalent amount of value is not a recipe for success in the long-term. The company should be focused on increasing stakeholder value, meaning that it is not only focused on helping its shareholders but all the constituents in its business. Investors in McDonald’s may need to worry if the company continues to lose sight of this in the coming years.

Brett Schafer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.