Burger King Dollar Double Cheeseburgers Recently, the National Franchise Associa

Question

Burger King Dollar Double Cheeseburgers

Recently, the National Franchise Association (NFA) filed a lawsuit against Burger King Corporation (BKC) over the pricing of products on its value menu, and specifically its $1 double cheeseburger promotion. The NFA is group that represents more than 80% of Burger King Franchise owners.

Here are excerpts from the Associated Press[1] report on the case:

The National Franchise Association, a group that represents more than 80 percent of Burger King's U.S. franchise owners, said the $1 promotion forces restaurant owners to sell the quarter-pound burger with at least a 10-cent loss.

While costs vary by location, the $1 double cheeseburger typically costs franchisees at least $1.10, said Dan Fitzpatrick, a Burger King franchisee from South Bend, Ind. who is a spokesman for the association. That includes about 55 cents for the cost of the meat, bun, cheese and toppings. The remainder typically covers expenses such as rent, royalties and worker wages.

"New math, or old math, the math just doesn't work," Fitzpatrick said.

Burger King justified the move by stating that the company needs to remain competitive in a tough economic environment:

Restaurants, especially fast-food chains, have been slashing menu prices because of the poor economy. Executives hope the deeply discounted deals will bring in diners who are spending less when they eat out, or opting to stay home altogether.

When the $1 double cheeseburger was announced this fall, analysts said it could increase restaurant visits by as much as 20 percent. But despite that boost, a Deutsche Bank analyst said as much as half of the gain recorded from increased traffic could be lost because customers were spending less when they ordered food.

Burger King Franchisees pay a royalty to Burger King that is typically equal to 4.5% of revenues for the store.

The lawsuit alleges that the value menu restriction illegally sets a maximum price for the Burger King franchises, and that Burger King is not acting in “good faith” by forcing franchises to sell a product below its cost. The case was filed in U.S. District Court in South Florida.

Questions:

1. Analyze the merits of the National Franchise Association’s lawsuit claiming that the Burger King franchises are losing money by selling $1 double cheeseburgers.

2. Identify the relevant costs to a franchise of selling a double cheeseburger?

3. What are the factors Burger King considered to justify its $1 double cheeseburger promotion?

4. Is the $1 double cheeseburger promotion an opportunity cost for the Burger Kings’ franchise owners?

5.What is the goal of a Burger King franchise? What is the goal of Burger King Corporate? Are both their goals aligned?

6. If you believe that the fundamental problem is that incentives are misaligned, what would be your recommendation to realign them?

[1] ‘Food Fight: Burger King Franchisees sue chain over $1 burger promotion’ Ashley M. Heher, Associated Press, USA Today, Nov. 12, 2009.

Explanation / Answer

Ans 1: The lawsuit may hold merit for franchisees only if the franchise agreement terms with Burger King are violated. If they lose 10 cents over a burger,they may be earning more on other items, and the net contribution to the chain is the part of entire revenue of the unit. Violation of good faith does not seem to happen, as the policy is a part of a survival tactics in the face of unfavorble economic conditions, Further, this being a temporary promotion, is not going to affect the franchisees in long term. Hence the claim has little merit.

Ans 2: The cost of raw materials for a double cheese burger is 55 cents. Remaining 55 cents cover expenses such as rent, royalties and worker wages. Net cost is $1.1 which is 10 percent more than the cost.

Ans 3: Burger King justifies the move by claiming that it will attract more customers to the stores in face of economic downturn, and the move is essential to be competitive in tough economic environment.

Ans 4: Yes. The same efforts in promoting other items that yield more contribution per unit would be comparatively beneficial for the franhisees.

Ans 5: Franchisee's goal is to maximize the contribution through sales, that is directly proportional to the profits. Chain's goal is to increase the sales and remain profitable by attracting more customers and maximize the contribution through revenue earned from franchisees. These goals align with each other as long as the contribution from the product mix is profitable for franchisees. If their margin diminishes, they will still have to pay the royalty part of their sales, and will be left with little to manage the franchise with decreased contribution. In this case, the goals will no longer be aligned.

Ans 6: Realignment of the incentives calls for more autonomy to the frachisees in pricing and deciding the length of promotional schemes so that the loss incurred in the promotional items may be made up with margins gained in other items, and the net revenue and consequently the profits don't erode.

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