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By Ron  Ruggless

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MIAMI (Nov. 13, 2009) Burger King franchisees, who are suing their franchisor over the $1 double cheeseburger promotion, say they are losing a dime or more per sandwich and are challenging the parent company’s ability to set prices.

The chain’s National Franchisee Association in Atlanta, Ga., which represents about 80 percent, or 5,200 locations, of Burger King’s U.S. franchise base, filed a suit this week in U.S. District Court for the Southern District of Florida, claiming Burger King Holdings Inc. “does not have the authority under the franchise agreements to dictate maximum prices.”

In a statement, Burger King said it “believes the lawsuit is without merit.” The company noted that a U.S. 11^th Circuit Court of Appeals earlier this year ruled that Burger King “has the contractual right to require franchisee participation in its BK Value Menu program.”

Franchisees have twice since mid-summer rejected the $1 double cheeseburger promotion, saying they would lose money. Competitor McDonald’s had raised the price of its double cheeseburger late last year amid franchisee dissent that the item was not margin friendly. McDonald’s added a McDouble to its Dollar Menu, which still holds two burger patties but only one slice of cheese.

Burger King looked to a value-driven promotion to combat a same-store sales slide — same-store sales fell 4.6 percent in the September-ended quarter. In today’s economy, most consumers are drawn toward deals, and restaurants across all segments have dipped in to lower price points, couponing and buy-one-get-one offers. The $1 double cheeseburger promotion, which began in October, had improved traffic trends at Carrols Restaurant Group Inc., which is Burger King’s largest franchisee. At a securities conference in October, Carrols said sales were strong in the initial weeks of the promotion. The franchisor itself also noted that the promotion has been positive.

Still, Burger King franchisees said they are losing on average between 10 cents and 15 cents on every $1 double cheeseburger sold.

“You could conservatively indicate that it costs us between $1.10 and $1.15 per double cheeseburger that we sell with all of our fixed and variable costs being covered," Dan Fitzpatrick, a Burger King franchisee from South Bend, Ind., said. "So when your revenue is only a dollar, it’s pretty clear that we’re not making money.”

This is the second class-action lawsuit that NFA franchisees have initiated against their franchisor this year. In May, the NFA filed lawsuits against Burger King, and its soda vendors over the diversion of soda machine rebates to corporate advertising from what in the past had been used by the franchised restaurants for repairs.

“The action that we took here is regrettable,” Fitzpatrick said. “When you look at what the management team has attempted to do with these two actions, they have fractured the relationship between themselves and the franchise community … We’re a large stakeholder. We have more than $6 billion invested just domestically in the system. … We didn’t start this fight, but now we have to take it up.”

By Ron  Ruggless

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Fitzpatrick added: “The broader issue is that the Burger King Corp. maintains that they have the right to set prices for our products. They imposed a $1 maximum price on a double cheeseburger. They could have just as easily picked other products on our menu. We reject the notion that they have the authority, either through our franchise agreement or otherwise, to force us to charge prices for products of their choosing.”

The case, Fitzpatrick said, could affect other franchise systems. “When the franchisor crosses the line and begins to bully the system the way Burger King has done, it becomes concerning,” he said. “Our franchisor has a franchisee-revenue driven model. They make money when we ring up sales. We make money when we wring costs out of the revenue and make profit. When the franchisor crosses that line and says, ‘We’re now going to sell products at a loss, and we’re going to force this on your business model.’ And we have to deal with it. It gets to be very difficult.”

Steve Lewis, a former NFA chairman (1998-2001) and Philadelphia-based Burger King franchisee, said he was disappointed with Burger King’s relations with its franchisees. “Previously, as it related to pricing of products nationally, we would always take votes,” he said. “The threshold for those votes was always 67 percent. In this particular instance, we did take two votes on the $1 double cheeseburger [and] both votes went down to defeat. That’s when Burger King did what they did.”

Lewis was referring to Burger King's decision to price the sandwich at $1 for a limited time starting in mid-October.

Lewis said he felt Burger King “completely stampeded the rights that we had on pricing of products.” He added: “Because they lost, and they lost two votes, they made the arbitrary decision to do what they did with the double cheeseburger. If they were going to do that from the get-go, why didn’t they do that? Why did we go through the process we went through with two votes, and then they throw this on the system.”

Julian Josephson, a former NFA chairman (2001-2004) and San Diago-based franchisee who has units in California, Texas and New Mexico, said he was concerned that the sale of items below price of cost could violate state statutes. “There are quite a few states in the country – somewhere north of 20, and I’m in one of them, California – where it is illegal … to do this,” Josephson said.

Josephson said that the Burger King action has galvanized the franchisees. “I’ve never seen the unanimity in the franchise community that I’ve seen in these two lawsuits,” he said.

John A. Gordon, the principal of the Pacific Management Consulting Group in San Diego, Calif., said he was surprised to see Burger King roll out the $1 double cheeseburger offer after such intense push-back from franchisees. However, he said September and October were the best months of the year to push value messages, before the interference from the Thanksgiving and Christmas holidays.

Costly promotions are risky, he said. “Promotions involving big discounts and big portions of the product mix often need a 5 percent to 10 percent traffic increase just to get back to gross margin breakeven, let alone pay for the incremental marketing,” Gordon said. “A key goal of any discounted offer is that customers will trade up or buy more add on items when in the store. But the marketing and in-store point-of-purchase and execution must promote that trade up.”

Burger King has more than 12,000 stores in 74 nations.

Contact Ron Ruggless at rruggles@nrn.com.