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Earnings Claims of Top Franchises Revealed

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Franchise Chatter Guide: Why McDonald’s Franchise System Struggles While New Fast-Casual Burger Restaurants Gain Market Share

by Brian Bixler on March 17, 2014

in Franchise Chatter Guides, Hamburger Franchise



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McDonald's Photo by Blueiscool

This McDonald’s franchise report was written by Brian Bixler.

“Do you want fries with that?” used to be an oft-heard punch line to a joke, but it’s doubtful many McDonald’s franchise operators are laughing these days.

The golden arches may be losing some of their shine with investors as the company’s sales continue to decline in the United States. With more than 14,200 locations in the country, a sales slump in America brought overall global sales down 0.3 percent in February 2014 and the 1.4 percent drop in U.S. sales for February marked the company’s fourth consecutive month-to-month drop in same-store sales in the country. Overall U.S. same-store sales were down 0.2 percent in 2013.

After tinkering with its menu throughout 2013 to emphasize both value and healthier choices on its menu, the company’s poor performance has wrought stinging headlines such as “McDonald’s Ends ‘Challenging’ 2013 with Lackluster Earnings” (Forbes) and “McDonald’s: Americans Aren’t ‘Lovin’ It’ Like They Used To” (Seeking Alpha).



What’s Going On?

Analysts rack up a number of reasons why Mickey-D’s seems to have lost some of its footing in the quick-service restaurant segment of the fast food industry. They say McDonald’s menu has become too complicated; that it is trying to be all things to all people; it is having trouble luring Millennials (customers ages 18 to 32) from competitors; and McDonald’s image as a fried-burger joint no longer attracts consumers who are looking for healthier food options. Others point out that the growing popularity of fast-casual concepts, sometimes described as “upscale fast food,” is also biting into McDonald’s sales.

While trying to please the healthy eaters and fast-casual crowd, McDonald’s axed some underperformers (such as the Angus burgers) last year while introducing a string of new options: McWraps, Mighty Wings, steak and egg burritos, Fish McBites, new Quarter Pounders, grilled onion cheddar burgers, and Hot ’n Spicy McChicken. It also altered its popular Dollar Menu by introducing the Dollar Menu & More, with five new burger varieties and a new range of prices.

Complicated Menu

Combine those menu changes with the introduction of the McCafe line of coffee beverages and smoothies in recent years and the McDonald’s menu expanded by 70 percent between 2007 and 2013, according to Bloomberg. While it peaked at 145 items, the menu still has more than 120 choices for customers, which some say has increased ordering time, food preparation time and delivery time. In other words, it’s getting harder to classify McDonald’s as fast food.

The world’s largest restaurant chain also continued to face well-publicized criticism and revolt from some of its franchisees and employees. The company has pushed for remodeling of older units in order to meet the challenge from modern fast-casual establishments, which left many owner-operators fuming about the cost. Higher operating costs have also been blamed by franchisees on increases by the company in rent and training fees. Franchisees operate 90 percent of McDonald’s restaurants.

Most recently, employees in at least three states—California, Michigan and New York—filed lawsuits against the parent company and several franchisees, claiming they were consistently underpaid because of such practices as erasing hours from timecards, eliminating overtime pay and requiring employees to work off the clock, according to Bloomberg Businessweek.

Market Share

Still, don’t expect the golden arches to topple any time soon. McDonald’s has much to offer franchisees in terms of brand recognition and a tested franchise system that has been around since 1954. And while it may have saturated the American market, prospects for new growth in Africa and Asia are still strong.

In the United States, McDonald’s has nearly 20 percent of market share in the fast-food industry, according to an IBISWorld industry report. The firm defines the industry as those restaurants where patrons pay before eating and purchases may be consumed on-site, taken out or delivered. The category also includes pizza, taco, chicken, subs, roast beef and other establishments.

When narrowed to just hamburger restaurants such as Wendy’s, Burger King and Hardee’s, McDonald’s market share is close to 50 percent, according to Technomic market research.

Future Plans

Earlier this year, McDonald’s CEO Don Thompson spoke to investors about how the company plans to boost sales after a “challenging” 2013.

“Our primary focus is on resetting and strengthening the relationship that we have with our customers,” Thompson said. “They are the driving force behind our mission and we continue to place them front and center in all that we do. We continue to execute against our three global growth priorities to optimize our menu, modernize the customer experience and to broaden accessibility, because these are the areas where we have the most significant opportunities to differentiate our sales.”



Already this year, the company has introduced the Bacon Clubhouse burger, is testing pastries in some units and will try to capture even more of the breakfast daypart with both food and enhancements to its McCafe line. According to Technomic’s data, McDonald’s already accounts for 31 percent of all fast-food sales in the morning.

Industry Overview

Despite the troubles at McDonald’s, competitors in the burger segment of quick-service and fast-casual restaurants continue to multiply with success. Much of it is due to the so-called “better-burger” category, which includes chains like In-N-Out Burgers, Five Guys Burgers and Fries, Smashburger and Burger 21. The “better-burger” chains are generally distinguished by a fast-casual environment and serve a higher quality beef with a choice of unusual toppings and bread.

In fact, it’s unlikely that America’s taste for burgers will ever fall victim to healthy eating trends. In its 2013 Burger Consumer Trend Report, Technomic gathered from those surveyed that 95 percent of all consumers reported eating burgers at least monthly. The report also stated that more than two-thirds of burgers (68 percent) were purchased away from home and nearly two-fifths of all burgers (37 percent) were purchased at a fast-food restaurant.

Distinguishing between the rapidly growing fast-casual restaurants and more traditional quick-service businesses such as McDonald’s, Technomic also reported that the top 150 fast-casual burger chains grew by 15 percent in 2012, while the limited-service burger segment grew by just 5 percent.

“The rapidly growing better-burger category is giving consumers more options and meeting their standards for quality, variety and customization, while still allowing them to enjoy burgers at prices that represent a trade-up from fast food or a trade-down from full service,” the report states.

Trends

There are a number of trends being watched by industry experts.

  • While the beef burger won’t disappear from menus, expect to see more burgers advertised as being better for consumers, such as those made from unique vegetables, white or exotic meats and even seafood.
  • When customers are asked if they want fries, they might be offered gourmet versions along with other accompaniments such as milk shakes of unconventional flavors.
  • With McDonald’s announcement that it will expand a “build-your-own-burger” concept that has been tested in California, expect the entire industry to remain focused on customization and serving burgers the way the customers want them. Freshness will be key, as well as offering something new and unusual on a burger, including different flavors of mayonnaise.
  • Loyalty programs will become more important to the burger category as various players attempt to attract new customers and retain regulars. Burger King has been one of the trendsetters with its BK Rewards program and McDonald’s announced late in 2013 an electronic loyalty program at nearly 600 locations that will reward customers with smartphones free food and other giveaways.
  • Value menus and promotions will continue to evolve. While $1 offerings may dwindle, they will be replaced with low-cost items that will also emphasize quality and freshness, which is becoming more important to burger eaters.
  • Burger restaurants will continue to experiment with signature burgers, theme burgers and what some call over-the-top “indulgent burgers” that may be hard to eat in one sitting.

Major Players

Traditional Limited-Service

Hardee’s

Hardee's Burger Photo by powerplantop

While the chain ranked only No. 7 on QSR’s list of top burger restaurants last year, Hardee’s scored a coup by being the only burger purveyor in the top 15 of Entrepreneur’s Franchise 500 list for 2014, surpassing even McDonald’s which ranked No. 16. Coming in at No. 11 on Entrepreneur’s list, Hardee’s has nearly 1,500 units, about a third of them company-owned.

Founded in 1961, it is an iconic brand concentrated primarily in the South and Midwest. It differentiates itself in the market with handmade biscuits, “premium” burgers considered a step up from competitors and, most recently, freshly baked buns.

At the end of 2013, Roark Capital Group announced it had completed acquisition of Hardee’s and its sister brand Carl’s Jr. from CKE Inc. Roark is a private equity firm with an impressive roster of 17 franchises, including those under Focus Brands (Carvel Corp., Cinnabon, Auntie Anne’s, Schlotzsky’s and Moe’s Southwest Grill).

Wendy’s

Wendy's Classic Double Hamburger Photo by _gem_

The Columbus, Ohio-based restaurant runs neck-and-neck with Burger King in being the second largest chain behind McDonald’s in terms of market share among burger restaurants. Technomic estimates that both players have about 11.5 percent market share, but Wendy’s has a slight edge over Burger King with 4.8 percent share of the entire fast food industry (including pizza, tacos, chicken and other offerings), according to IBISWorld.

While McDonald’s floundered in 2013, Wendy’s reported North American company-operated, same-restaurant sales growth of 1.9 percent and record average annual sales of $1.51 million. The company attributes the growth to a brand transformation that will continue in 2014, that includes extensive remodeling of existing stores and continuing introduction of new and limited-time menu offerings.

Wendy’s also expects to complete the sale of some 415 company-owned restaurants to franchisees in 2014, raising a total of about $235 million.

Burger King

Burger King Photo by Marr3wk

Long considered a major competitor to McDonald’s, Burger King is estimated by IBISWorld to have 4.6 percent market share of the entire fast-food industry (that includes pizza, sub shops, chicken restaurants and other limited-service restaurants).

The iconic brand was founded in 1953 and modeled itself after McDonald’s with flame-broiled burgers and customization being its main differentiators. About 90 percent of Burger King’s stores operate under franchise agreements. But like Wendy’s, it has concentrated efforts on selling more franchises in order to reduce risk and overhead costs of running company-owned restaurants.

While the brand has remained consistent, ownership during the last decade has not. In 2006, the company became a publicly traded entity but struggled until 2010 when private equity firm 3G Capital purchased it for $4 billion. In 2012, 3G Capital sold 31 percent of Burger King to investment vehicle Justice Holdings, but it remains the majority owner in what is now Burger King Worldwide Inc., with shares sold on the New York Stock Exchange.

The market share of McDonald’s, Wendy’s and Burger King combined is estimated to be more than 70 percent of the $75 billion limited-service hamburger restaurant industry, with chains such as Sonic Drive-In Restaurants, Jack in the Box, Checkers, Steak ’n Shake and others following their lead.

Fast-Casual “Better-Burgers”

Five Guys Burgers and Fries

Five Guys Burgers and Fries Franchise Photo by Lodigs

While it failed to make Entrepreneur’s Franchise 500 list this year, Five Guys Burgers and Fries is considered a leader in the “better-burger” field of up-and-coming fast-casual restaurants. With sales of $1.1 billion, it was ranked No. 1 in the category when Technomic released its Top 150 Fast-Casual Chain Restaurants Report in 2013 and QSR put it at No. 10 when ranked against all burger chains, including limited-service restaurants. It noted that the chain had joined the “billion-dollar-brands club” with $1.1 billion in sales.

The chain started in the late 1980s when four brothers forfeited college to open a burger restaurant. Eventually a fifth Murrell brother was born and the guys started franchising in 2002. Ten years later, in 2012, Forbes magazine called Five Guys “America’s fastest growing restaurant chain.” With more than 1,100 units in more than 40 states, Five Guys leads the pack of fast-casual burger operations, however growth in the number of establishments has slowed since 2011.

The chain differentiates itself by offering a variety of toppings, which make it possible to serve a burger more than 250,000 different ways.

Smashburger

Smashburger Photo by jwsobeck

There’s no doubt that Smashburger has been a smash in the fast-casual “better-burger” category. As 2013 closed, the company posted its seventh consecutive year of double-digit growth. Though it falls well behind Five Guys in number of units with just 256, it has only been franchising since 2008.

Chief Executive Officer Scott Crane, who replaced David Prokupek at the helm last November, told the Denver Post earlier this year that the company will open about 75 new units nationwide and in a few foreign markets in 2014. Sales will grow to an estimated $300 million compared with $228 million in 2013, he said.

Technomic reports that among all limited-service hamburger chains, Smashburger’s market share is 0.2 percent. By comparison, Five Guys has a 1.4 percent share.

But observers continue to tout Smashburger for its long-term growth potential. Forbes magazine ranked the chain as one of the top 10 “Most Promising Companies” and Crane was named one of the “10 Executives to Watch” by Nation’s Restaurant News.

The company is also differentiating itself by offering healthy menu choices, including gluten-free products. It is currently testing organic milk and juice, low-sodium bacon and preservative-free salad dressings in some stores.

Mooyah Burgers, Fries & Shakes

MOOYAH Burgers, Fries, & Shakes Photo by Simon Miller

Made-to-order hamburgers, hand-cut fries and shakes made from 100 percent ice cream are just some of the things that set Mooyah Burgers, Fries & Shakes apart from others in the fast-casual burger category. The company has shown consistent growth with 14 new restaurants opened in the United States in 2013 and two in Dubai and Bahrain. Moreover, the company reportedly signed 26 deals in the last year in addition to receiving recognition from trade press.

It ranked No. 314 on the Entrepreneur Franchise 500 this year after being named a top new franchise by the magazine in 2012. It also earned a No. 8 ranking in Fast Casual Magazine’s annual rankings of the Top 100 Movers & Shakers. The company has already said it expects to open 49 new restaurants in 2014.

The brand is based on quality with restaurants using American lean beef, all-natural Jennie-O turkey burgers, buns baked in house, real cheeses and toppings made from fresh produce. Among other recent accomplishments, the Plano, Texas-based Mooyah ranked No. 1 on Restaurant Business’s Future 50 list and the brand was named “best burger” in its hometown by DallasChild and NorthTexasChild magazines.

Mooyah was founded by restaurant industry veterans Rich Hicks, founder of Tin Star, and Todd Istre, founder of Boudreaux’s Cajun Kitchen and Taters Kountry Kitchen.

With so many new companies joining the burger bunch, a McDonald’s franchise is no longer the only game in town; and with its recent slide in sales, you can bet your happy meal that investors are glad it isn’t.



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