FRANCHISES

Fast Food Companies Are Screwed, but Not by Striking Workers

You might think franchise owners' biggest challenge is the prospect of rising federal and state minimum wages. But something else takes a bigger bite out of their revenues.
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Doubtless you've heard of the recent fast food labor protests in something close to 130 cities, not counting additional protests in upwards of 125 other cities. The demand is $15 an hour and an easier time unionizing.

Will these employees get it? Not a chance. But recent activity suggests that $10 or $11 an hour is likely in some big states. Even the CEO of McKinsey & Co. says that income inequality is the biggest challenge to capitalism that exists today. And even conservative businessman and activist Ron Utz in California has called for $12 an hour, with hopes that it would take pressure off government programs for the poor.

Yup, there's likely a big jump in minimum wage rates coming, which means entrepreneurs operating many franchises will likely find themselves screwed. And yet, don't point fingers at the employees. The real money vacuums are the central franchising companies themselves.

The financial mechanics of a franchise can be painful to contemplate. Consulting firm Deloitte & Touche produces a "Restaurant Industry Operations Report" with the National Restaurant Association. It is the result of surveys completed by association members and gives as good a view of the business of the restaurant industry as you might find. The 2010 version is available online.

Let's look at the basic numbers behind so-called limited service restaurants:

  • About half the restaurants were independent, 38.6 percent were standalone, and 18.6 percent were restaurants with sandwich, sub, or deli themes.
  • Median average check was $8 per party.
  • Median food sales per seat were $10,000; media beverage sales were $1,197.
  • Median total cost of sales were 31.9 percent.
  • Median salaries and wages (including benefits) were 29.4 percent of revenue.
  • Median income before taxes was 5.9 percent of revenue.
  • About 90 percent of the restaurants grossed less than $2 million, which means, at the very top, profits are about $118,000 for a restaurant. Most will make significantly less.

That is hardly an overwhelmingly large profit margin. Now comes the kicker, which franchise operators know all too well: They must pay money to the central franchisor. Depending on the franchise, that can be lots of money. Look at McDonald's for a moment. Franchise owners pay a service fee of 4 percent of gross sales. Then there's an ongoing royalty of roughly 12 percent.

Next, they pay rent for the location to McDonald's, but that doesn't leave the option of pricing other property as a way to control expenses. The franchisee must also buy its supplies, food, and anything else from McDonald's, and so miss the logical cost control tool of looking at competing vendors.

Add it up, and you're probably at a conservative 20 percent coming off the top, either in the form of actual fees or as likely inflated food and goods costs. There's a reason that McDonald's brought in almost $9 billion in revenue from franchisees in 2012.

Fees from other chains will vary. Burger King charges an average 4 percent in royalty, plus a 4 percent advertising fee. Carl's Jr. charges about 9.5 percent between royalty and advertising. Domino's Pizza? About 9 percent in royalty and advertising fees.

Clearly not all chains are like McDonald's, but often the financial impact is heavy on the entrepreneur. No money for employee raises? No kidding--there's not that much money period. The New York Times mentions a fast food restaurant actually replacing some workers with robots. Perhaps others could, as well. That is, if they could afford to buy the robots.

IMAGE: Corbis
Last updated: Dec 6, 2013

ERIK SHERMAN | Columnist

Erik Sherman's work has appeared in such publications as The Wall Street Journal, The New York Times Magazine, and Fortune. He also blogs for CBS MoneyWatch.

The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.



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