McDonald's Franchisees Could Revolt Against New CEO

Steve Easterbrook, largely credited with whipping fast-food behemoth McDonald's (NYSE:MCD) back into shape since taking over as CEO in 2015, is out. Easterbrook was terminated for violating company policy by developing a relationship with a fellow employee. He'll be replaced by Chris Kempczinski, president of McDonald's USA, effective immediately.

It's an unfortunate but understandable decision. In an era of heightened awareness of inappropriate conduct, corporate boards must exercise great care in defending a company from any form of liability. Easterbrook even publicly agreed with the board of directors' decision.

The new CEO, however, may be inheriting a network of restaurants owned by franchisees becoming increasingly frustrated with the parent company's decisions. Franchisees may see the newcomer's ascension as an opportunity to force disruptive and costly change.

Frustrated franchisees

Last year, McDonald's franchisees did something they'd not done at any point in the restaurant chain's 65-year history as a franchisor. They officially organized, creating the self-funded National Owners Association as a means of advocating for those who assume most of the financial risk in operating a restaurant.

It was a development that had been brewing for a while. By 2013 the effort to offload operating costs onto owners was driving palpable franchisee pushback, but in 2015 franchise owners' morale fell to an eleven-year low in response to decisions being made by then-new CEO Steve Easterbrook. Higher hourly wages and corporate-imposed menu changes were pegged as the key reasons owners were "feeling betrayed and less of a partner."

Matters have changed little in the meantime; they've arguably gotten worse. By 2017, with the company's plans to sell a wide swath of its own restaurants to franchisees in sight, Easterbrook was looking to force upgrades that could ultimately cost franchise owners on the order of half a million bucks per restaurant.

Easterbrook's gambit worked. Net profit margins on revenue improved from 17.8% in 2015 to 28.2% last year. Franchisees are the ones feeling the pinch from that movement, though, and Kempczinski isn't helping on that front.

Not everyone is a fan of the new guy

"You need a strong relationship with the franchisees. Now you have the guy that is causing all the anxiety running the company," says Hedgeye Risk's Howard Penney, adding "This is McDonald's in crisis."

The specific anxiety Penney was referencing wasn't clear, although it's not the first time the new CEO has been pegged as a public relations problem. It was Kempczinski who helped Easterbrook apply added cost pressures to franchisees while the parent shifted its focus to being a franchisor rather than an owner.

Regardless of the tense history between restaurant owners and the new CEO, however, franchisees as well as shareholders are concerned about any new chief executive.

"Our franchisee discussions highlight concern around the changes/uncertainty, while the leadership transitions come at a pivotal point in US franchisee-franchisor relations," noted UBS restaurant analyst Dennis Geiger. He went on to say, "Today's news likely adds uncertainty to investors' list of concerns, which already include: decelerating US comps, negative EPS revisions, & US breakfast competition, against the backdrop of valuation reratings across QSR [quick service restaurants]."

Rising wage pressure will only add to franchisee angst.

The movement is broad and loose, though it has centralized itself around a "Fight for $15" mantra, referring to a minimum wage per hour, that's been generally aimed at the restaurant industry, and often directly at McDonald's. With more than 14,000 U.S. locations, it's one of the country's bigger employers, but it relies on low-cost labor -- employees classified as "fast food workers" at its restaurants earn an average of $8.54 per hour -- that's increasingly tough to find in order to hold prices down.

While Kempczinski can do little to combat growing pay expectations, he hasn't demonstrated much in the way of sympathy to the store owners footing the rising employee overhead bill.

Coming to an explosive head

Four years in the driver's seat bolstered by more than twenty years of fast food experience before coming back to McDonald's in 2013 may explain why Easterbrook kept a franchisee revolt at bay. Kempczinski doesn't have quite the same depth of experience. His first job in the industry was with McDonald's, when he came on board as head of strategy in 2015.

His time as an employee of Procter & Gamble, PepsiCo and Kraft Foods surely has some value in his new role, but it's arguable that many franchisees resent the fact that they have more fast food and McDonald's experience than he does.

Store owners may well remain patient. But they were already frustrated enough to organize. This latest change may set the stage for a disruptive power struggle that ultimately takes a toll on already-tepid top- and bottom-line growth. It may not yet be a reason to sell, but it's certainly a reason not to buy in.

James Brumley has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

This article originally appeared in The Motley Fool.