Value Menus Cost Operators Dearly

Burger King Franchisee in New York Shutters Stores, Blames Dollar Offerings

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CHICAGO ( -- The ubiquitous under-a-buck value menu that boosted the fast-food industry is hurting some franchisees.

As the economy worsens, the menu that's become a staple among the industry's biggest players is being backed by an increasing share of fast feeders' marketing dollars and gaining popularity with consumers. But as value menus approach 15% of sales for some top chains, the double whammy of high commodity costs and low margins for the value products are walloping operators -- to the point where some claim the pricing is driving them out of business.
Dethroned: One of two Manhattan locations that have closed recently.
Dethroned: One of two Manhattan locations that have closed recently. Credit: Lisa Fain

Luan and Elizabeth Sadik, a brother-and-sister team that once operated five Burger King stores in midtown Manhattan, charge that being forced to serve high-cost items at low prices sent two of their stores into insolvency.

"The value menu increases foot traffic," said the Sadiks' attorney, Oliver Griffin. "But [consumers] buy all of the cheap items -- and so regularly. Burger King takes its royalties off of the gross sales, so they're making a profit on the increased foot traffic while the franchisees essentially pay for it."

Value for some
The Sadiks allege that the value menu cost them about $100,000 a year once it was introduced in early 2006. It should be noted that the stores in question had failed to produce a profit since 2001.

"We believe the franchisee used the value menu as a pretext to breach his contractual obligations," said Burger King spokesman Keva Silversmith. "We have no evidence the value menu hurt his profitability." Mr. Silversmith added that value-menu transactions account for between 12% and 13% of system-wide sales.

Burger King has allowed value-meal exemptions to some franchisees in New York, typically a high-rent district, but Mr. Silversmith declined to say how many. Franchisees follow an application process to be granted an exemption, and there is disagreement as to whether or not that was done in the Sadiks' case. It is also clear from court documents that the Sadiks attempted to sell the first two stores it closed to Burger King, but the parties couldn't agree on a price.

The Sadiks held on to two other Manhattan locations, which operated until January 2008, when the parent company terminated their franchise agreement. Those restaurants were profitable -- with value menus. Mr. Griffin maintains this was a matter of lower overhead.

Location, of course, plays a role. A Wendy's franchisee in a suburban region said the chain's December introduction of the 99¢ Stack Attack has boosted business. "For us it does well," the franchisee said. "I'm not sure it works everywhere."

Fries with that?
Fast-food chains take royalty payments based on owner-operators' sales, meaning the corporation is insulated from increased commodity and labor expenses. Low-cost and giveaway promotions generally increase traffic and total sales, but franchisees are expected to pick up the difference with the understanding that while customers are buying a burger for a dollar, they'll also grab a soft drink, which has a much higher profit margin.

But that doesn't always happen. "Your hope as an operator is they'll trade up and change their mind when they get to the store, and in the absence of that, you're hoping they'll order side dishes like french fries or a beverage that's more profitable," said Technomic President Ron Paul. "To the extent that they don't, that's when you're ... getting squeezed."

And it isn't only Burger King operators feeling the pinch. McDonald's, which has posted some of the best sales numbers in the fast-food industry, has had a few operators in New York take double cheeseburgers off the Dollar Menu because skyrocketing beef prices have made them too expensive.

Dick Adams, a McDonald's-franchisee-cum-consultant, said that enough franchisees, especially in big cities, have raised or are planning to raise prices on the sandwich that it could well affect McDonald's fall advertising. In some areas -- including New York -- it's advertising the addition of the double cheeseburger to its Dollar Menu.

"While the company does not set menu prices for franchised restaurants, our franchisees overwhelmingly support the Dollar Menu as well as our overall value-menu strategy," said McDonald's spokeswoman Danya Proud.

Price inflexibility
Another problem, Mr. Adams said, is the chasm the value menu creates between dollar deals and regular-priced items. "With the increase in commodity costs and minimum wage, franchisees normally would turn to the menu board and raise prices, but there's a limit to what they can do," he said. "If they raise prices too much, it forces people over to the dollar menu."

Value menus have been a big battleground in the category since Wendy's introduced its Super Value Menu in 1989. The Dollar Menu, introduced at McDonald's in 2002, anchored by the high-cost double cheeseburger, has been a key component of the company's turnaround.

Burger King made its first attempt at a 99¢ menu between 2002 and 2004, but the effort was scrapped. The chain brought back a value menu in early 2006, much to the chagrin of some owner-operators, and it is testing a double cheeseburger for a dollar at 233 restaurants. Wendy's launched the 99¢ Stack Attack in December.

Following the Sadiks' contract termination and closures, they sued Burger King in New York. That case was thrown out in December 2006, and has since been refiled in Miami. It has been consolidated with other claims, including a case Burger King filed against the Sadiks, and is scheduled for trial May 12. The Sadiks are seeking damages in excess of $1 million and to have their franchise agreement reinstated. Burger King is seeking back royalty payments. Last week a separate New York case was dismissed. The Sadiks argued the forced closures of the last two locations have rendered them incapable of keeping up with continued lease payments on the two stores. Mr. Griffin said the same case will be filed in Miami this week. A clause in the franchise agreement stipulates that claims must be brought in Miami.

Belly up to the Whopper Bar

For Burger King, the big money's in beef.

The chain plans to unveil a Whopper Bar concept at its franchisee convention next month as a method of maximizing sales in smaller locations.
Hot concept: Burger King brings Whoppers to you.
Hot concept: Burger King brings Whoppers to you.

"We understand that real estate is in a different place than it was five, 10, 15 years ago, so small-footprint, high-cash- on-cash-return business models have become a necessary part of a mature industry, and you see places like airports, casinos, strip centers and mall locations become more practical locations for more-reasonable occupancy costs," said Russ Klein, president-global strategy, marketing and innovation at Burger King.

Also contributing to the decision was the realization that the Whopper trademark is "arguably as big or bigger than Burger King," Mr. Klein said.

The chain also is getting back into growth mode. Burger King has posted nearly five consecutive years of same-store-sales gains, Mr. Klein said. But those gains follow seven consecutive years of sales declines.

Whopper Bars may be one answer. Mr. Klein said he expects to open several franchised and company-owned Whopper Bars by the end of the year but declined to make projections for 2009.

The Whopper Bar idea was born on a trip to Germany five years ago, when Mr. Klein visited a Burger King location where the back wall had been knocked out and customers could watch their Whoppers being assembled. The resulting concept is less Roy Rogers retro than "theater," he said, and it simultaneously addresses increasing concerns about food safety.

Burger King has successfully promoted Whopper variations over the years, including Western Whopper, Rodeo Whopper, Texas Double Whopper and Angry Whopper.

Mr. Klein said all of Burger King's agencies are working on this concept at the moment, including Crispin Porter & Bogusky, Miami. Marketing strategy is still in the "formative stages," he said. The chain is weighing whether it's better to use a broadcast campaign or a "grass-roots," "word-of-mouth" approach.
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