California franchise owners and consumers are feeling the brunt of higher costs.
After 30 years in business, McDonald’s franchisee and Rodrick Foods CEO Scott Rodrick had to make the difficult decision to not renew his lease at one of his McDonald’s (MCD) locations at a mall in San Francisco.
“The unprecedented changes to the economic landscape of California, coupled with a host of ill-timed legislative mandates, greatly narrowed the restaurant’s path to extending its tenure into a new term,” Rodrick told Yahoo Finance. He added that an “unbending landlord set on rent per square foot,” high property taxes, and mall charges were additional reasons that “made the decision difficult, but clear.”
Rodrick still owns 17 other McDonald’s locations but is bracing for further changes in the industry. His father was among the first to franchise a McDonald’s location in the 1960s — a far different time for franchisees compared to now.
“An explosion has gone off in California,” Rodrick said, referring to a series of closures of other longstanding franchises, including an In-N-Out location in Oakland and an Arby’s restaurant in Hollywood that had stood for 55 years. “We are going to be watching the shock waves pass through slowly over time.”
California’s minimum wage law takes effect
One area of concern for owners of California’s quick-service restaurants has been how to respond to new legislation.
April 1 marked day one of California’s new fast food minimum wage law, which raised the starting wage for restaurant employees in the state to $20 per hour — from $16 previously — for chains that have at least 60 locations nationwide.
As franchise operators battle to maintain profitability, consumers have started voting with their feet about the higher prices. Overall, the cost to dine out jumped 4% year over year nationwide last month alone. In California, menu prices at fast food restaurants rose 10.12% between September and April, with the largest increase seen in April following the legislation.
According to data analytics platform Placer.ai, foot traffic at McDonald’s in California underperformed all US McDonald’s locations by 2.48% in April and May compared to the same time last year. Prior to that, foot traffic was relatively the same.
Ab Igram, the executive director of Babson College’s Tariq Farid Franchise Institute, said while one unit closure of a McDonald’s may not seem like it impacts the overall state of the entire company, it does make consumers wonder about the company’s overall “brand health.”
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 patrons, customers face disruptions to their routines.
McDonald’s California locations make up 9% of its US restaurant portfolio. The company did not immediately respond to a request for comment on the total number of locations that closed in California following April 1.
McDonald’s execs weighed in on California’s wage raise briefly during its latest quarterly report.
“There’s certainly labor inflation,” McDonald’s CEO Chris Kempczinski said when asked by an analyst about the company’s current inflation expectations. “Much of that is coming out of what happened in California. … On a national level, you could probably see we’re expecting high-single-digit labor inflation.”
McDonald’s is not alone in feeling the impact. Other chains like Burger King (QSR), Wendy’s (WEN), Jack in the Box (JACK), and In-N-Out are also seeing lower foot traffic in California.
Chipotle (CMG), which raised prices by 6% to 7%, saw year-over-year trends underperform its national average in April and May, per Placer.ai.
On a call with investors, Chipotle CFO Jack Hartung said the impact of the higher wages “will add almost 1 full point to total company pricing beginning in Q2.”
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 to overall company restaurant-level margin by about 20 basis points.”
Igram believes the true impact will be felt in the months to come.
“I would keep my eye on … what’s the traffic impact among brands in California, three months out, six months out, nine months out,” he said.
Meanwhile, some of the law’s critics are hoping the pressure makes California Governor Gavin Newsom think again.
“California’s bad policies have real-world consequences,” Tom Manzo, the 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 claims nearly 10,000 fast food jobs were cut 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 her at [email protected].
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