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Franchising and the Impact of McDonald’s
Gerhardt, Steve Tarleton State University
Dudley, Dan Tarleton State University
Hazen, Samuel Tarleton State University
ABSTRACT
As individuals decide to open or pursue a small business, an important option available to most entrepreneurs involves whether or not to purchase a franchise. An increasing number of small businesses started during the last 30 years have involved some form of franchising. One major reason small business owners choose to become franchisees is these small business franchisees are able to operate as if they were much larger enterprises. As one analyzes franchises and franchise fees it appears there is a variety of similar fees and monthly expenses related to all franchised businesses. It appears, however, a large majority of people are confused over what fees are actually required and what the various fees entail. It also appears a large number of franchise fees and monthly expenses are based on the McDonald’s Corporation fee structure. Important franchising insights can be gained by analyzing the concepts employed by McDonald’s with regard to fees and expenses. When analyzing the franchises of various companies, one can easily become confused with all the terms used to discuss the multitude of fees and expenses. Franchise fees, security fees, base rent fees, percent rent fees, service fees, and royalty fees, not to mention the various purchase cost options, all come into play. Based on the research of McDonald’s fee structures, hopefully, future conclusions can be made and comparisons of associated fee structures of other franchised companies can be drawn in a more enlightened manner.
Keywords: franchising, McDonald’s, franchisors, franchisees, small business, franchising fees.
INTRODUCTION
Having limited funds available can be a significant barrier to someone attempting to create their own business. Historically, financial resources for the individual entrepreneur have been obtained from various sources, such as immediate family members or other relatives. Franchising serves as a financial resource multiplier, effectively allowing the entrepreneur to operate a small business with many attributes more often associated with much larger corporate entities. A thriving large franchisor corporation is able to offer its franchisees an extremely large reservoir of resources. Experience and expertise covering all facets of business acquired from years of successful operation are two of the most critical resources franchisees gain from their relationship with their franchising entity. The typical large franchising corporation is able to offer marketing clout from name recognition in the relevant market. This is a resource that a smaller business would not be able to access otherwise. The retail service sector, especially the restaurant sector, has become one of the more recognized industries associated with the franchising form of business structure. Many such fast food franchising ventures have proven extremely successful. The one name in this industry sector that has risen to become the pinnacle of the fast food franchising sector is McDonald’s. McDonald’s first franchise was awarded in Des Plains, Illinois in 1955. From that beginning, McDonald’s has steadily grown to its present dominant position in the fast food restaurant industry. Today, 70% -80% of McDonald’s 31,000 restaurant locations are franchises operated by independent operators with the remaining restaurant locations serving as corporate stores. McDonald’s founder, Ray Kroc, decided that he wanted McDonald’s to be more than just a supplier to franchisees -- he wanted the McDonald’s corporation to be able to maintain quality control over its franchisees. Hence, the plan for McDonald’s franchising was born. (McDonald’s Corporation, 1988).
THE McDONALD’S FRANCHISING MODEL
When analyzing a McDonald’s franchise there are a variety of terms and conditions that come into play with regard to individual store franchise fees. For each McDonald’s restaurant, there is an operator’s lease with an assortment of fees and conditions appropriate to that specific restaurant. A portion of the table of contents from an Operator’s Lease with various articles is shown as Table I. The Operators Lease is a legal document signed by the franchisee that specifically states the rents and fees for that specific McDonald’s restaurant. Each individual store will have a separate and specific operator’s lease. In order to understand the full magnitude of this lease and its fees, three basic agreements that can originate in the Operator’s Lease become important and need to be further analyzed and discussed. These three agreements are the Conventional Franchise, the Business Facilities Lease and the Joint Venture. (McDonald’s Corporation, 1988)
CONVENTIONAL FRANCHISE
The majority of McDonald’s franchises are termed “Conventional Franchises.” This agreement is based on a 20 year agreement between the franchisee and McDonald’s Corporation. The Operator’s lease for a Conventional Franchise usually includes an ongoing service fee of
had corporate stores that they wished to sell, they may offer them to an existing franchisee as a joint venture. The agreement establishes the payment of a management fee to the franchisee from McDonald’s of approximately $5,000 per month for each store involved in the joint venture agreement (as many as 10 locations could be involved). In addition, the franchisee may get a percent of the bottom line of each store (40% - 60% - depending on the agreement in place with each joint venture franchisee). Today there is evidence that McDonald’s is mainly using the joint venture agreement with franchisees in countries outside the U.S. (McDonald’s Corporation, 1988) (Elango, 2007)
ADDITIONAL McDONALD’S OPTIONS
McDonald’s has also located restaurants in various retail stores within the past 10 to 15 years. Locations like Wal-Marts, airports, hospitals and universities that house a McDonald’s restaurant are usually called satellite locations, and usually are awarded to existing McDonald’s franchisees in the vicinity of the satellite location. The fees and expenses for satellite locations differ from the conventional McDonald’s stand-alone store locations and could serve as the basis for an entirely separate study of this type of franchising fee structure. (McDonald’s Corporation,
CONCLUSION
Base rents, percent rents, security fees, service fees, franchise fees and royalty fees are all terms used to discuss franchising costs. When looking at the fees and expenses associated with any company’s franchise, a good place to begin an analysis is with a comparison to McDonald’s Corporation. In this paper we have laid out the 3 basic agreements McDonald’s Corporation uses when franchising: the Conventional Franchise, the Business Facilities Lease (BFL) and the Joint Venture with all like associated fees. These three agreements serve as an excellent cornerstone for analyzing all companies that offer franchising opportunities. Herein, the authors have attempted to elucidate and explain the various terms associated with the numerous fees. One must also recognize McDonald’s, as with most franchises, makes money from the monthly expenses (percent rent) to the franchisee based on the restaurant’s “total revenues” (and not just profits). Each individual McDonald’s franchise is carefully researched prior to completion. McDonald’s corporation attempts to reduce its corporate risk exposure as much as possible. If the franchise holder is successful, McDonald’s corporation is successful. This concept appears to work very well for McDonald’s and equally well for the motivated franchisee. Franchising is not for the “weak-of-heart” or for someone looking for an easy way to become a small business owner. In addition to the financial requirements that one must consider when analyzing various franchise opportunities, there are numerous other basic requirements McDonald’s mandates of anyone attempting to become a franchisee of McDonalds’s. These McDonald’s corporate requirements include such restrictions as not allowing partners (operationally or financially) when purchasing a franchise. There are also extensive training programs that franchisees must complete in order to become a McDonald’s franchisee. This training can take up to two years with no compensation to the trainee franchisee. A more complete analysis of the many and varied requirements of the McDonald’s franchise model definitely should be pursued as an avenue for future research. (McDonald’s Corporation, 1988)
TABLE I
OPERATOR’S LEASE (SAMPLE)
TABLE OF CONTENTS
- Sec. 1.01 Term………………………………………………………………... ……. Article 1 SUMMARY OF FUNDAMENTAL LEASE PROVISIONS
- 1.02 Rent………………………………………………………………… …….
- 1.03 Security Deposit……………………………………………………. …….
- 1.04 Legal Description………………………………………………….............
- 1.05 Attachment, Exhibits and Addenda……………………………….............
- Sec. 2.01 Premises……………………………………………………………. ……. Article 2 LEASE, PREMISES AND TERM
- 2.02 Term………………………………………………………………….........
- 2.03 Quiet Enjoyment…………………………………………………………..
- 2.04 Use of Premises…………………………………………………………...
- 2.05 Rule Against Perpetuities………………………………………………….
- 2.06 Construction and Delivery of Building and Other Improvements…….......
- 2.07 Acceptance of Premises…………………………………………………...
- 2.08 Lessee’s Compliance with Various Requirements………………………..
- Sec. 3.01 Rent……………………………………………………………………….. Article 3 RENT, TAXES, RECORDS AND REPORTS
- 3.01 (A) Basic Rent…………………………………………………………….
- 3.01 (B) Percentage Rent……………………………………………………….
- 3.01 (C) Definition of “Gross Sales”…………………………………………...
- 3.01 (D) Taxes and Assessments……………………………………………….
- 3.01 (E) Other Charges and Expenses………………………………………….
- 3.02 Records……………………………………………………………………
- 3.03 Reports…………………………………………………………………….
- 3.03 (A) Discrepancy in Reports……………………………………………….
- 3.03 (B) Default in Reporting…………………………………………………..
- 3.03 (C) Inspection of Records by Lessor……………………………………...
- 3.04 No Abatement of Rent…………………………………………………….
- 3.05 Interest on Past Due Rent…………………………………………………
- 3.06 Lien for Rent………………………………………………………………
- 3.07 Security Deposit…………………………………………………………...
- Sec. 4.01 Utilities……………………………………………………………………. Article 4 OBLIGATION OF LESSEE
- 4.02 Maintenance and Repair…………………………………………………..
- 4.03 Alterations…………………………………………………………………
- 4.04 Surety……………………………………………………………………...
- 4.05 Lien Against Property……………………………………………………..
- 4.06 Assignment by Lessee…………………………………………………….
- 4.07 License Agreement………………………………………………………..
TABLE III
Conventional Franchise Cost/Expense “New” Restaurant
The following represents the fees and approximate costs of a new McDonald’s restaurant. Size of the restaurant facility, area of the country and style of décor and landscaping will affect costs. 25 to 40 percent of the total costs must be funded from non-borrowed personal resources. The remainder may be financed from traditional sources. McDonald’s does not provide financing or loan guarantees, nor does it permit absentee investors or partners.
Term 20 years – McDonald’s Corporation owns land and building
Ongoing Fees A monthly fee based upon the restaurant’s sales performance (currently 4% of monthly sales) plus the greater of: a) a monthly fee, or b) a percentage of monthly sales which is at least 8.5 %.
Initial Costs $45,000.00 Paid to McDonald’s. Initial fee earned by McDonald’s at the time the McDonald’s restaurant is ready for occupancy.
$15,000.00 Paid to McDonald’s and subject to refund. Interest free security deposit for the faithful performance of the franchise, refundable at the expiration of the franchise.
$537,000.00 Paid to suppliers. Approximate cost of kitchen equipment, signage, seating and décor, and pre-opening expenses.
$600,000.00 Approximate Total Cost (40% of the cost must be funded from non-borrowed personal resources. The remainder may be financed. )
(McDonald’s Corporation, 1989)
TABLE IV
Conventional Franchise Cost/Expense “Existing” Restaurant
Many new franchisees enter the McDonald’s system through the purchase of an existing restaurant business from franchisees of McDonald’s. The purchase price reflects the fair market value of the restaurant, and the buyer must invest 25% of the cost from non-borrowed personal resources. Generally, there are no costs other than the purchase price and the ongoing fees. The purchase price is usually between 50% - 75% of the store’s past annual sales.
“Purchasing Costs” For an Existing McDonald’s Restaurant – Common Example
Term – 20 years – McDonald’s Corporation owns land and building
Ongoing Fees – Same as for “new” restaurant
Sale Price Of McDonald’s Restaurant (Approximate) $1,000,000.
Franchisee must provide 25% of Purchase Price x. from non-borrowed funds (personal resources) $250,000.
Franchisee must pay franchise fee $45,000.
Franchisee must pay security fee $15,000.
Up-Front Expense to Franchisee $310,000. With $750,000.00 Mortgage still remaining
(McDonald’s Corporation, 1989)
REFERENCES
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