McDonald’s franchisees who add new restaurants will soon have to pay higher royalty fees.
The fast-food giant is raising those fees from 4% to 5%, starting Jan. 1. It’s the first time in nearly three decades that McDonald’s is hiking its royalty fees.
The change will not affect existing franchisees who are maintaining their current footprint or who buy a franchised location from another operator. It will also not apply to rebuilt existing locations or restaurants transferred between family members.
However, the higher rate will affect new franchisees, buyers of company-owned restaurants, relocated restaurants and other scenarios that involve the franchisor.
“While we created the industry we now lead, we must continue to redefine what success looks like and position ourselves for long-term success to ensure the value of our brand remains as strong as ever,” McDonald’s U.S. President Joe Erlinger said in a message to U.S. franchisees viewed by CNBC.
McDonald’s will also stop calling the payments “service fees,” and instead use the term “royalty fees,” which most franchisors favor.
“We’re not changing services, but we are trying to change the mindset by getting people to see and understand the power of what you buy into when you buy the McDonald’s brand, the McDonald’s system,” Erlinger told CNBC.
Franchisees run about 95% of McDonald’s roughly 13,400 U.S. restaurants. They pay rent, monthly royalty fees and other charges, such as annual fees toward the company’s mobile app, in order to operate as part of McDonald’s system.
The royalty fee hikes probably won’t affect many franchisees right away. However, backlash will likely come, due to the company’s rocky relationship with its U.S. operators.
McDonald’s and its franchisees have clashed over a number of issues in recent years, including a new assessment system for restaurants and a California bill that will hike wages for fast-food workers by 25% next year.
In the second quarter, McDonald’s franchisees rated their relationship with corporate management at a 1.71 out of 5, in a quarterly survey of several dozen of the chain’s operators conducted by Kalinowski Equity Research. It’s the survey’s highest mark since the fourth quarter of 2021, but still a far cry from the potential high score of 5.
Late Friday, The National Owners Association, an independent advocacy group of more than 1,000 McDonald’s owners, sent out a memo to its membership regarding the news from corporate. The memo, viewed by CNBC, called Friday an “extremely hectic day” as U.S. owners woke up to emails from CFO Ian Borden and U.S. President Erlinger about the decision to increase service fees for new owners and reclassify the name to royalties.
“Although McDonald’s believes they have the right to make changes to their fee structure, franchise agreement terms and the conditions of engagement, these self-proclaimed rights do not establish that the changes are the right thing to do for the business, the relationship, or the future of our Brand,” the memo said, adding that while system gross sales have increased to start this year, resulting in “record-breaking revenue” for corporate, the benefits are not evident in franchisee cash flow. The memo goes on, adding that franchisee restaurant cash flow has not kept pace with inflation, and that owners are flowing less money today than they were in 2010.
“What’s more, per restaurant EBITDA percent is crashing and will likely hit a 12-year low of around 12.25% in Q4, or certainly in 2024. In spite of the incredible sales growth the restaurants are driving, franchisees are making less money per restaurant today than they did in 2010,” the memo states.
The NOA memo also says the change in terminology from service fees to royalties is “very significant” and will have a key impact on the owners’ “rights to receive the all-important services, support and assistance that McDonald’s is now obligated to provide us,” claiming it removes the company’s duty to provide services. It urges owners to carefully review agreements received from the company and have an experienced attorney review them before executing, and says reinvestment decisions should be reconsidered, as those looking to open new restaurants will not have a “historical return” provided, due to the change.
This is the latest outcry from owner advocates against corporate, as the NOA just last week sent out a communication to its members regarding California’s AB 1228, claiming the legislation would have a “devastating financial impact” on operators in the state.
McDonald’s declined to comment on the NOA’s position on both the service fee change and the California negotiations.
Despite the turmoil, McDonald’s U.S. business is booming. In its most recent quarter, domestic same-store sales grew 10.3%. Promotions such as the Grimace Birthday Meal and strong demand for McDonald’s core menu items, such as Big Macs and McNuggets, fueled sales.
Franchisee cash flows rose year over year as a result, McDonald’s CFO Borden said in late July. The company said average cash flows for U.S. operators have climbed 35% over the last five years.