New Franchisees Plow Ahead Despite Barrage of Criticism

A McDonald's franchise isn't the sure thing it once was. The old certainties about steadily growing sales, profits and market value have given way to anxieties about disappointing new products, disastrous marketing efforts and consumer surveys showing rival burgers taste better.

The Wall Street Journal
August 1, 2000

New Franchisees Plow Ahead Despite Barrage of Criticism
Richard Gibson

STERLING HEIGHTS, Mich. — Laura Percival realizes these are uneasy times for McDonald's franchisees. At U.S. restaurants, sales are flat, new products have been fizzling and the competition keeps getting tougher.

But in a matter of months, Ms. Percival, a well-educated 36-year-old executive here, intends to invest at least half a million dollars in a McDonald's Corp. franchise. She and her husband "did the numbers and felt very confident and comfortable with the returns this organization is offering," she says.

Lots of others want McDonald's restaurants, too. In the past year, applications in the U.S. totalled about 1,000 — more than 10 times the number of outlets available. With the demand so far exceeding the supply, a serious candidate needs substantial savings, extraordinary enthusiasm and an impressive resume. Many are prepared to pack up and move across the country, if necessary. "Look at the kinds of quality people on that applicants' list," says Jack Greenberg, who heads U.S. operations. "These are terrific people," he adds.

But are they smart?
A McDonald's franchise isn't the sure thing it once was. The old certainties about steadily growing sales, profits and market value have given way to anxieties about disappointing new products, disastrous marketing efforts and consumer surveys showing rival burgers taste better.

Yet in a demonstration of the resiliency of brand image, McDonald's remains the holy grail for Americans seeking franchises. To possess one's own golden arches is still a powerful dream. And some of the dreamers discount all criticism of McDonald's. "Everybody likes to knock No. 1, don't they?" says franchisee-candidate Willie Cho, marveling that McDonald's still commands 41% of the U.S. hamburger market. "That's incredible."

Viewed as a Sure Thing
Just as going West was viewed as a sure ticket to prosperity a century ago, nowadays buying a McDonald's is widely regarded as a move that can't go wrong. When Ms. Percival decided to quit her family's printing firm near Detroit, where she oversaw 50 employees, to buy a McDonald's, the response was unanimous from her husband, relatives, friends and acquaintances at the University of Michigan, where she is wrapping up an M.B.A. All said, "'Wow! What a great opportunity!'" she recalls.

Over the years, of course, many McDonald's franchisees have become millionaires. Steve Bigari, a 39-year-old West Point graduate, gave up a desk job at Johnson & Johnson 11 years ago to manage restaurants for a multi-McDonald's operator in Colorado. He cleaned restrooms and took customers' orders until he was permitted to buy his own restaurant. Now he owns five.

"Hamburgers are a wonderful means to an end, a great way to be on the front line of society, a great way to earn a good living," Mr. Bigari says. Though declining to disclose his income, the franchisee says that his Colorado Springs stores provide him with a "very comfortable" life and that the "major value [of his franchise] is the net worth, the equity I'm building."

The Typical Operator
McDonald's says its typical operator owns more than three locations and has total income of about $600,000, before taxes, debt service, and general and administrative costs. But the heyday may be past. The average annual sales of a full-size U.S. McDonald's last year was $1.54 million, up only $2,000 from 1995. In a system long known as "McFamily," some unhappy franchisees have formed a coalition to demand greater consideration from management.

Even Mr. Greenberg concedes, "The business has gotten more complicated — and clearly far more competitive. We as the franchiser have an obligation on that score, [but] there is also an obligation on the owner/operator to run a great restaurant day to day."

Willie Cho is certain he will. A restaurant worker since high school, Mr. Cho, 37, says he has mastered the business from high end to low. His classmates at McDonald's Hamburger University, at company headquarters in Oak Brook, Ill., voted him the outstanding student. As he waits to learn which restaurant McDonald's will let him buy — newcomers usually get existing restaurants, while veteran operators get new sites — the Californian isn't worried about the prospect of depleting his savings and borrowing heavily.

Nor has he talked with former franchisees or paid much attention to news reports of McDonald's problems. He isn't troubled by a McDonald's offering circular mentioning 372 current and former franchisees who over an unspecified period of time had a store "terminated, cancelled, not renewed or otherwise voluntarily or involuntarily ceased to do business."

That's a fraction of the approximately 12,400 McDonald's outlets in America; the company had a net addition of about 300, many company-owned, in the U.S. last year. Anyway, Mr. Cho asserts: "I can run a restaurant better than anybody."

Perhaps, but some former franchisees are puzzled that so many people are competing to get in. Susie Kohout, who with her husband lost thousands of dollars on two McDonald's outlets they sold back to the company this spring, says she wishes new franchisees "all the luck in the world, because they're going to need it."

The Kohouts say that the company's sales projection for their restaurants in rural North Carolina proved unrealistic and that a mini-McDonald's they were required to operate in a Wal-Mart generated little traffic. Indeed, McDonald's closed it last month.

Discussing Mr. Kohout, McDonald's says, "Despite our best efforts, his problems were brought on by his own poor business decisions, including his own misleading sales projections. He asked to leave the system, and we accommodated him."

However, the recent spate of flat sales, marketing flops and unpopular new burgers is precisely why Ms. Percival wants to buy a McDonald's now. The problems have made management more sensitive than ever to franchisee concerns, she contends. Before attending the biennial franchisee convention in Orlando, Fla., this spring, she says, "I tried to take off the rose-colored glasses and look at it from a business perspective." After all, it wasn't too late to change her mind without financial penalty even though she had put in a year of training, including a no-tuition stint at Hamburger University.

Impressed by Management
But management's presentation at the convention impressed her. "The corporation really showed to me their commitment to making us, as franchisees, successful," she says. She returned to Michigan believing "the future is brighter than I'd anticipated." In a decade, she envisions herself running as many as 20 McDonald's.

Among other initiatives, Ms. Percival and other franchisees-in-waiting applaud top management's commitment to improve the taste, offering and presentation of McDonald's food. The company is implementing a new cooking system, called Made for You, that will allow restaurants to serve hotter food and to customer specifications — as its top competitor, Diageo PLC.'s Burger King Corp., has done for years. It also is conducting an extensive study of the menu to decide which items to scrap and what to add. It is promising to slow the spread of new restaurants that can steal sales from existing ones. And it is about to get its first new chief executive in 11 years when Michael Quinlan gives way to Mr. Greenberg in August.

"McDonald's has made changes that are causing the company to move forward at a phenomenal rate," Ms. Percival says. Noting that Mr. Greenberg was the company's chief financial officer until about a year ago, she says, "We needed somebody at the top who was a Wall Street guy." Mr. Quinlan was an operations manager famous for having worked his way up from the mailroom.

If her optimism is misguided, Ms. Percival won't be alone. Management's strategy for improvement prompted investors to send McDonald's stock to all-time highs recently, and several analysts are recommending it. But the new cooking system won't be fully installed for another 18 months; so it is far from certain that customers will find a marked improvement in the food.

However the future turns out, a long line of fervent buyers is good for the company. Steady demand will enable retiring operators to count on McDonald's providing buyers for their stores. And the difficulty of obtaining a franchise tends to ensure that those who succeed are highly motivated. "I'll be in the store all the time," Mr. Cho says.

Grateful Candidates
They are also grateful. Terry Stephenson, a downsizing casualty after 10 years as a salesman and manager in the trucking industry, can hardly believe McDonald's accepted him. "I'm totally committed to McDonald's for the long term," he says.

A prospective franchisee must be willing to train at least a year and work in restaurants without pay, performing jobs as unattractive as scrubbing bathrooms. On a recent day, Ms. Percival was working at the takeout window of a McDonald's here in Sterling Heights. When, in the weeks ahead, she finally gets her own restaurant, she can count on spending up to 60 hours a week in it, performing every imaginable job.

Franchisees pay an initial fee of $45,000, due at the agreement signing; between $332,000 and $441,650 for equipment, seating, golden arches and other signs; $12,000-$22,000 for opening inventory, plus miscellaneous opening expenses of as much as $33,000. Total price tag for a typical full-size McDonald's is $413,100 to $672,200. After opening, major expenses include labor, an 8%-of-sales fee, and rent — McDonald's typically owns the land and buildings.

In the end, the quality most important to running a successful McDonald's may be obedience. Franchisees must learn and adhere to the enormously detailed system that long ago made McDonald's famous for consistency around the world. And this same quality helps explain why many prospective franchisees believe the future is as golden as the arches: because top management says it is.

Mr. Stephenson paid scant attention to reports of trouble at McDonald's. Being demoted gave him a strong desire to be his own boss, and by purchasing a McDonald's he can do so without having to invent his own formula. His brother-in-law, Tom Burrell, is a longtime, and happy, McDonald's operator in Kentucky.

While going through training, Mr. Stephenson dreams of how it will be, running his own McDonald's. His wife, Trish, will manage the books. His three young daughters will plead endlessly for Happy Meals. Although no financial expert, he feels certain that "any company that can appeal to small children is a very big plus."

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