McDonald’s, CITIC, Carlyle transaction – a happy deal?

Following the recent sale of McDonald’s’ operations in China and Hong Kong to the CITIC-Carlyle consortium for US$2.08 billion, the leading labour union in North America, voiced its concerns regarding the use of the McDonald’s franchise model, as being a risk for workers and investors.

According to the Service Employees International Union (SEIU), which represents 1.9 million workers in the US and Canada, the franchise model involves McDonald’s contracting a developmental licensee with a Master Franchising Agreement to operate many stores. The development licensee will then sub-contract many local sub-franchisees operating at the store level. The nature of the Master Franchising Agreement, as used in this model, is said to create a misalignment of incentives between McDonald’s, the developmental licensees, and the sub-franchisees.

For instance, McDonald’s benefits directly from topline sales growth, because its primary earnings are royalties based on a percentage of sales. Royalties paid by sub-franchisees are often passed on to McDonald’s in full, despite the fact that the developmental licensee is typically burdened with the running costs and risks.

In contrast, the developmental licensees’ profitability is driven by bottom-line considerations. Sub-franchising activities may lose money, since it introduces new expenses, yet the developmental licensees are cut off from royalties. Developmental licensees are then pressured to raise a profit by other means, for instance, raising rent. This squeeze on developmental licensees can the make it harder for them to provide adequate pay and conditions for their workers.

As an example, Arcos Dorados, a developmental licensee operating in South America, was hit with a $30 million fine – the largest ever imposed by the National Labour Prosecution Service – for repeatedly breaking Brazilian labour law. The SEIU point to an overbearing and unfairly weighted Franchising Agreement between McDonald’s and Arcos as the cause of the problem, which prioritizes aggressive sales growth targets over profitability, as well as other onerous contractual stipulations.

Scott Courtney, executive vice president of the SEIU commented, “we believe McDonald’s past practices pose risks for its future licensees, those firms’ investors, McDonald’s franchisees in Asia, and the workers employed at McDonald’s stores”.