California franchise owners and consumers are bearing the brunt of rising costs.
After 30 years in business, McDonald’s franchisee and CEO of Rodrick Foods, Scott Rodrick, had to make the difficult decision not to renew the lease of one of his McDonald’s (MCD) locations in a San Francisco shopping mall.
“Unprecedented changes in California’s economic landscape, coupled with a host of untimely legislative mandates, have significantly reduced the restaurant’s ability to extend its mandate for another term,” Rodrick told Yahoo Finance. He added that an “inflexible landlord fixated on rent per square foot,” high property taxes and shopping center fees were additional reasons that “made the decision difficult, but clear.”
Rodrick still owns 17 other McDonald’s locations, but is preparing for further changes in the industry. His father was among the first to franchise a McDonald’s restaurant in the 1960s – a very different era for franchisees than today.
“An explosion happened in California,” Rodrick said, referring to a series of closures of other long-running franchises, including one In-N-Out location in Oakland And one Arby’s Restaurant in Hollywood which lasted for 55 years. “We will watch the shock waves propagate slowly over time.”
California Minimum Wage Law Takes Effect
One area of concern among California quick-service restaurant owners is how to respond to the new legislation.
April 1 marked the first day of the new fast food minimum wage lawwhich increased the starting wage for restaurant workers in the state to $20 an hour — up from $16 — for chains with at least 60 locations nationwide.
As franchise operators struggle to maintain profitability, consumers have begun to vote with their feet in the face of rising prices. Overall, the cost to dine at restaurant jumped 4% year over year nationally last month alone. In California, fast food menu prices increased 10.12% between September and April, with the largest increase seen in April following the legislation.
According to the data analysis platform Placer.ai, foot traffic at McDonald’s in California underperformed all U.S. McDonald’s locations by 2.48% in April and May compared to the same period last year. Before that, foot traffic was relatively the same.
Ab Igram, executive director of the Tariq Farid Franchise Institute at Babson College, said that while the closure of one unit of a McDonald’s does not appear to have an impact on the overall health of the business as a whole, it causes consumers to question the overall “brand health” of the company.
Additionally, it leaves a lasting impact on the community as workers who have been there for years are relocated and, as Rodrick mentioned in his letter to his clients, clients face disruptions to their routines.
McDonald’s California locations represent 9% of its U.S. restaurant portfolio. The company did not immediately respond to a request for comment on the total number of establishments closed in California after April 1.
McDonald’s executives briefly commented on the California wage increase during its latest quarterly report.
“There is definitely labor inflation,” McDonald’s CEO Chris Kempczinski said when asked by an analyst about the company’s current inflation expectations. “A lot of this comes from what happened in California. … Nationally, you can probably see that we’re expecting high single-digit labor inflation.”
McDonald’s isn’t the only one feeling the impact. Other chains like Burger King (QSR), Wendy’s (MAGNIFYING GLASS), Jack in the Box (JACK), and In-N-Out are also seeing a decline in foot traffic in California.
Chipotle (GCM), which increased prices 6 to 7 percent, saw its year-over-year trends below its national average in April and May, according to Placer.ai.
On a call with investors, Chipotle CFO Jack Hartung said the impact of the wage hike “will add nearly a full point to the company’s total pricing starting in the second quarter.”
He added: “California restaurant cash flow is below the company average, so this increase will allow us to maintain cash flow. However, it will have a negative impact of approximately 20 basis points on the company’s overall restaurant margin.
Igram believes the real impact will be felt in the coming months.
“I would keep an eye on … what the impact is on traffic between brands in California, three months, six months, nine months,” he said.
Meanwhile, some critics of the law hope the pressure will make California Gov. Gavin Newsom think again.
“California’s bad policies have real-world consequences,” Tom Manzo, president and founder of the trade group California Business and Industrial Alliance, told Yahoo Finance. “People are losing their jobs, businesses are leaving the state – or in this case, shutting down completely. Lawmakers need to wake up and start supporting our state’s job creators instead of punishing them.”
The group says nearly 10,000 fast food jobs were lost in the state following the introduction of the legislation last fall.
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Brooke DiPalma is a senior reporter for Yahoo Finance. Follow her on Twitter at @BrookeDiPalma or email him at bdipalma@yahoofinance.com.
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