Inflation, higher interest rates, and a slew of other macroeconomic factors have swirled as a dark cloud over the restaurant industry, but McDonald’s financial results remain unfazed. CEO Chris Kempczinski attributed that to the brand’s largest growth engine—franchisees.
Franchise cash flow is up this year and increased during the third quarter. U.S. same-store sales rose 8.1 percent in Q3, rolling over 6.1 percent growth in the year-ago period, thanks to menu price increases, marketing campaigns, and continued growth in digital and delivery. That’s after seeing a 10.3 percent rise in Q2 and a 12.6 percent increase in Q1.
“It’s much more challenging as you would imagine to continue to drive the business if the franchisees are not seeing it flow through,” Kempczinski said during the chain’s Q3 earnings call. “And fortunately for us, we’re seeing good flow-through for our franchisees despite having to absorb quite a bit of inflation, both on the food and paper side as well as on the labor side. So that’s another thing that gives us confidence as we head into the New Year.”
Optimism is indeed high, but the quick-service giant—like everyone else—is bracing for what’s to come in California with the new fast-food wages law. The legislation will create a statewide council to monitor the pay of quick-service workers, starting with hiking minimum wage up to $20 per hour. Kempczinski is unsure at this point how much the law will impact California franchisees’ wage inflation and how much of it will be passed along to consumers in higher pricing.
However, he does know there will be a short-term hit to cash flow. Longer term, Kempczinski is looking for McDonald’s to take full advantage. The brand reported in June that it has nearly 1,300 stores in California, along with more than 230 franchisees and over 70,000 hourly employees and managers. The company is open in 90 percent of the state’s counties, including 300-plus in Los Angeles County alone. Only counting McDonald’s presence in the Golden State, it would be among the top 30 biggest quick-service chains in America.
“What we’ve been talking about with our franchisees is this is an opportunity for us to gain share because this is an impact that’s going to hit all of our competitors,” he said. “We’re in a better position. We believe we’re in a better position than our competitors to weather this. And so let’s use this as an opportunity to actually accelerate our growth in California and accelerate our growth along with the [cost] mitigation. The two of those in combination is the best way to minimize any impact long-term on franchisee cash flow.”
McDonald’s average pricing is just over 10 percent for the year, but the chain hasn’t seen any deterioration in customers. The brand still holds leads in affordability and value for money. It’s also gained market share from middle and higher-income households because of trade down from casual-dining concepts. Lower-income households, defined as $45,000 and under, have been sluggish, but that’s no different than what’s been seen across the industry, Kempczinski said. Traffic is up for the year, but there was a slight dip in Q3. The decrease was expected because of a tough comparison to 2022; when looking at the two-year stack, traffic significantly increased.
In light of this recent traffic dip, Kempczinski praised McDonald’s efforts on the top line. He pointed to the chain’s digital business, which represented more than 40 percent of sales in the top six markets, or nearly $9 billion. There are now more than 57 million active rewards members across these major trade areas. Additionally, operational execution is humming along. Service times are down seven seconds on the year and declined nine seconds in the third quarter. Roster sizes and applications are increasing while turnover is decreasing.
“The only way you sustainably work through periods of higher inflation in the business is obviously to continue to grow the top line and deliver strong performance and that’s what we’re focused on,” Kempczinski said. “And we’re obviously very confident as we’re able to continue to do that, that we’re going to be able to see improved restaurant margin from a percentage basis performance in addition, obviously, to the really strong dollar growth that we’re seeing on the back of those strong top-line sales. I think no change to what we expect for the full year this year. But I think we feel like we’re in really good position with the momentum we’ve got across the business.”
Another obstacle for McDonald’s is the recently announced joint employer rule, of which Kempczinski isn’t a fan.
There isn’t much reason for him to be. The new law, passed by the National Labor Relations Board, widens the scope of when companies would be considered a joint employer, meaning it will be easier for franchisors like McDonald’s to be connected to labor rights violations, unionization, and other lawsuits at the franchisee level. Kempczinski told investors Monday that he and his team “strongly object to last week’s NLRB ruling” and that it will undermine small business ownership in the U.S.
“The franchise model, it’s really a great American innovation,” the CEO said. “It’s created wealth for thousands, particularly underrepresented minorities and women. And this is something we think that needs to be supported, not attacked. So in our mind this is yet another example of agency overreach coming out of [Washington] D.C.”
The expectation is that it will be tested in courts and Congress. But don’t get Kempczinski wrong. McDonald’s may disapprove, but there’s no concern with how the law will impact its ability to perform.
“This is something that’s going to affect everybody,” Kempczinski said. “And as we’ve shown throughout time, so long as there’s a level playing field and that McDonald’s is on the same level as everybody else, we tend to win. And so even if this NLRB ruling were to pass, it’s going to affect the industry at large, and we think we’re better positioned than anybody else to withstand it.”
McDonald’s ended Q3 with 13,459 U.S. restaurants, including 12,700 franchised units and 689 corporate stores. Internationally there were 27,739 restaurants. The burger brand is the only chain in the world with more than 40,000 locations.