September 3, 2014

The Dairy Queen Franchisee Revolt

In the year following graduation from college, Aaron and I looked into opening several Dairy Queen franchises in Kansas City, Missouri and the surrounding suburbs near where we had grown up before leaving for the east coast.  Even though we figured we’d end up in a no-income-tax state such as Texas, Washington, or Nevada (paying an extra 6% to 7% of your income in state income taxes per year starts to add up over time), we really liked the idea of owning local businesses that hired local employees and generated local sales tax and property tax for a community that we held in high regard.

It also didn’t help that we despised the Dairy Queen franchises in the town where we grew up because they didn’t offer food, still operated from the same edifices that had been built long before our parents were born, and even the most recent upgrade consisted of a larger building on the outskirts of town that only offered hot dogs and chicken.  It made us angry that someone wouldn’t pour the money the brand deserved back into operations, especially since this particular family had owned the rights for several generations.  Part of this was no doubt influenced by the fact that such a large portion of our net worth, as well as our family’s net worth, was invested in shares of Berkshire Hathaway, the parent company of Dairy Queen.

Dairy Queen Blizzards

Dairy Queen franchise owners are upset that the company and its parent, Berkshire Hathaway, and pushing the new Grill & Chill restaurant concept. They are balking at the capital expenditures that, you know, are a required part of doing business and standard in the DQ franchisee contract.

As I read the business news, it was deja vu all over again when I read about a revolt stirring in the ranks of the Diary Queen franchise owners.  Apparently, a law suit is brewing …

Dairy Queen has developed a new franchise concept called DQ Grill & Chill.  It offers wraps, flame grilled cheeseburgers, french fries, chicken baskets, fresh panini sandwiches, premium salads, popcorn shrimp, and more.  The interiors were also substantially upgraded, making it comparable to a nicer fast food concept that you would enjoy sitting in for an actual meal.

As part of the Dairy Queen franchise contract, Dairy Queen can require franchise owners to upgrade their restaurant to protect the brand and keep it relevant.  The Dairy Queen company has capped the required investment at $75,000 for 2008, $85,000 for 2009, and $95,000 in 2010, giving the Dairy Queen franchise owners plenty of time to generate the earnings necessary to fund the expansion into the new Grill & Chill concept.

Most of the Dairy Queen franchise owners seem really excited about it (as I would be).  A few, however, are … how do I put this without coming across as mean? … whining, entitled, and lazy.  They are throwing an absolute fit over the fact that Dairy Queen is – horror of horrors – requiring them to reinvest in their stores!

Let me enlighten you as to what is really going on with the Diary Queen franchise system based on my perspective as an investor.  You have a minority of the franchisee owners, who have likely drained a substantial portion of the profit from their Dairy Queen restaurants over years of ownership in the form of cash dividends and salaries, who are balking at the idea of coming up with $400,000 to improve the customer experience, offer actual food, and provide expanded capacity.

These are small-town, small-minded folks who, in many cases, either stepped into the role as a Dairy Queen franchiser through family ownership or who have been with the system since time eternal.  As they see it, they have a good life and their Dairy Queen franchise provides them with a stream of earnings they use to live in a nice home, drive a nice car, and maybe even take a vacation or two each year.

They have, in other words, bought themselves a job and not a business.  Instead of focusing on growing their assets so it is a business (I define a business as a “system that generates profit for its owners without the owners ever stepping foot in it or having any day-to-day involvement), they are angry that the big-bad executives at Dairy Queen and the parent company, Berkshire Hathaway, are actually making them do something and invest money to keep the brand relevant.

Mint Oreo Blizzard from Dairy Queen Franchise

Shouldn't you love your business so much that you want to keep expanding it as long as you can earn good returns on capital?

Frankly, I don’t like the idea of living out of your business.  I’ve never taken a salary from any of my companies.  I like earnings to get plowed back into more assets that provide more cash earnings.  If I were to suddenly develop an interest in franchising Dairy Queen restaurants, I can tell you that my nature is that within ten years, I’d want to own a dozen of them in a tight geographic area.  It’s just my personality.  I also wouldn’t be involved personally.  Instead, I would find an honest, hardworking restaurant manager who had been in the industry for 20 years and was willing to take a minority stake by investing their own money along with mine.  They take care of the company, and I expand the store count under their control.  We both prosper as our shares of whichever limited liability company that owns the Dairy Queen franchise increase in value.

Maybe it’s because I follow Charlie Munger’s advice and keep a lot of “silly needs” out of my life.  I avoid debt, I pay my taxes, and I try and live on a modest amount taken from my writing royalties, advertising earnings, and other comparable sources.  In fact, the odds are very good that I live on less than many of the people reading this blog.  I’d rather the money go into my businesses or investments.  Is it really that difficult to live on, say, $65,000 or $100,000 per year and reinvest your profit?  Really?

  • Austin H

    Joshua,

    This article hit home for a number a reasons. A) I own a multifamily property right next to one of these older DQs that looks like it came from the 40s B) As soon as I was able to work at 15 I started working for a Subway with owners that fell into the ‘bought a job’ concept versus buying a business. I remember asking them why they didn’t fix some minor adjustments that bothered the customers. I was told that I was paid to make sandwiches and clean the bathrooms, not to have ideas. C) I still remember the first time I saw a Grill and Chill on the way home to Houston from Austin. I don’t remember any other fast food remodels and am not sure why this one stuck with me.

    I spent a few hours looking into starting up a Quiznos in an area where there were none. I reached a similar conclusion that it would only be worthwhile to operate multiple stores at once with an experienced manager. There is definitely an economy of scales with fast food restaurants, especially to reach the point of being able to afford an experienced manager and reach a minimal annual rate of return on capital.

    • http://www.joshuakennon.com Joshua Kennon

      Yeah, I came to the conclusion that a restaurant franchise worked for several different types of people or situations:

      1. A mid-career family that had saved up a few hundred thousand dollars and thus had the money necessary to pay for a lot of the franchise costs without a huge (although still substantial) loan. That would give the franchise more room to “breathe” as the debt payments were lower.

      2. A married couple that were early in their career and committed to spending 5 to 8 years working 18+ hour days, building up equity, and obliterating a small business loan so they owned the first restaurant outright and could then buy a second, third, and fourth. They would be using “sweat equity” in effect, whereas the first family was using mostly financial capital.

      3. An investor who is sitting on a substantial enough pile of capital that he or she can create a franchise development territory, like with Panera Bread or Dairy Queen, and agree to build 5-10 restaurants over a multi-year period. The economies of scale kick in, management is in place, and it becomes a regular cash generator for his or her holding company and/or family depending upon how the deal is structured.

      And, by the way, any business owner that says, you are “paid to make sandwiches and clean bathrooms, not to have ideas” is destined for failure. Some of the best ideas in business history come from the ground-up because the people who are on the front lines actually SEE what is going on in the business. They know the problems, the potential solutions, what makes customers happy, and much more. I’m not so sure people can change but I’d like to think so. Either way, competing against people like that makes the job of the serious investor much easier (as Buffett said, what better competition is there to have than people who have been told there is no point in thinking or researching investments?).

  • renodottie

    Hi Joshua,
    I find your article interesting, coming from someone who apparently grew up in a family rich enough to own BH stock. Anyway, we have 2 DQ Franchises that I would love to sell you. They are under the old DQ franchise agreements written in 1962, so you would not have to pay the huge royalties on the non-system food and drinks. Only .29 per gallon on the Dairy Queen that you purchase to sell.

    I can tell you think it would be easy work, hire somebody to do it and sit back. Well, in this day and time a large percentage of your labor base will steal from you every chance they get. Even your most trusted employees and partners. I would love to hear your bright solution for that. So, in owning 1 or 2 or 15 DQ’s you do have to be available and watching it 24/7 or you will not be in business long. A Dairy Queen is a business that you have to be working in and taking a personal interest in, people come to the Dairy Queen , not for fancy chairs a beautiful marketing materials, but to hear the people working there call them by name and to feel like their business is appreciated.

    My grandparents started the stores in our area and grandmother worked all day and night every day of the week. She took the Winters off to rest and she built a business with a good reputation. There is a lot of love and labor that goes into being the little, local Dairy Queen and that is why customers come back.
    As for remodeling and improvements, well from what I have heard that has completely bankrupted serveral owners. I say that is not fair, why doesn’t corporate just buy back the franchises. And Joshua, I would love to have $65K to live on per year, that would be like a sweet ivory tower.

    Anyway, my Grandmother is gone now, Dad passed away a couple of years ago and Mom is old and unable to work at the store now either. My brother is not interested in it, I sold out my share of the business over 10-years ago, because I couldn’t stand the family bickering–now I am back running it or letting it run me to get the profits back in line so it will sell. It just never seems to make the same money with hired managers running it. So if you are interested in trying out your management style theories, I am sure that you can pick up the 2 stores at a great deal, also there are several more owners in my geographical area that wouldn’t mind getting out of it either.

    • http://www.joshuakennon.com Joshua Kennon

      Renodottie,

      I have written an in-depth response to you so you can understand where I am coming from and why I think the way I do. Before we get to that, however, there are a few things that need to be cleared up:

      1. I (not my parents or siblings) was the first member of my family to own shares of Berkshire Hathaway, as well as the first member of my family to graduate from college because i had to pay my own way through school. When I became obsessed with finance and investing in elementary school, I read about a man named Warren Buffett and his company in some of Peter Lynch’s writings. That led me to discover the company and spend years talking about it the same way most kids talk about pro athletes or movie stars. Years later, my parents and siblings finally got their own shares, with their own money. Although my parents are very successful and wealthy now, they became rich after I did. We did it in separate businesses, at separate times, with separate employees, without any assistance from each other.

      2. Any time you assume someone “comes from money” you are betting against the odds. According to the Federal Reserve data and other studies, approximately 90% of wealth in the United States is first-generation made by people who were previously middle or lower class with only 10% being inherited. In the late 18th century, those figures were reversed. Saying that those who are successful and have money inherited it is like saying the world is flat. The data just doesn’t bear it out any longer and hasn’t for more than 100 years. Still, the myth persists. You instinctively know this, however. Think of the super-rich that come to mind: Martha Stewart, Warren Buffett, Bill Gates, Murdock, Ruffin, Lampert, Walton, Wexner, etc. All made their fortunes on their own through a business.

      3. I know precisely how difficult it is to run a small business because the first real success I had was at a startup Aaron and I created in college. The business was begun with nothing more than $3,500 and an idea. Within a few years, we had taken over the entire industry and never issued a single share to anyone else or taken out a bank loan.

      In that line of questioning, you asked how I *would* handle employee theft when the better question is how I *do* handle it. It’s not that difficult. There are systems, and have been for about ten years, where you can install low-cost HD video cameras that record everything from multiple locations and have them stream to a password protected web system. You could be sitting by the pool and watching ten different Dairy Queens on an iPad, iPhone, or notebook computer. With everything recorded, if you come up short at inventory time, you review the tapes, which are all digital and on the net. You find who did it, and you prosecute them. It won’t happen again. Most of these cost less than a few thousand dollars and there are almost no maintenance costs. Some of these systems allow you to electronically lock a store, turn off the lights, and much, much more.

      In our businesses, I can literally see every keystroke that has ever been typed into any computer system at our companies and watch anything that has ever been displayed on screen.

      This includes our web servers. For example, I can see that you accessed by site from somewhere very specific within Gloversville, New York. In a few seconds, I can view a satellite image of your location, study your past visiting behavior, find out the operating system you are running, screen resolution, and much more. So it isn’t just our employees we monitor, it’s our customers, too. This isn’t new; almost every commercial site on the Internet does it with varying degrees of sophistication.

      As such, there is no “trying out” my theories. If anything, I had to start my businesses on my own (you had a head start – your family owned the franchise). It wasn’t because I was some genius who descended from on high … instead, I spent my youth studying people who were far more experienced and successful, reading nearly every biography I could and learning how other people became wealthy. I knew, for example, that Cisco had an accounting system that calculated the financial statements in real-time and that it wasn’t that expensive. Technology made tools like that accessible to a tiny start-up with no money.

      4. Still, let’s presume that none of that matters. I’m going to assume that your business is capable of coming up with $10 per week. You probably spend more than that on toilet paper if you have public restrooms. I wrote a two-page parable explaining how your grandparents could have literally left you a $10+ million fortune. I even explain the math. Since it was tailored especially for you, I do hope you read it. Even if someone had been a complete and total idiot, as long as he or she could have put aside a tiny, tiny amount of money, the power of compounding would have created substantial wealth with very little sacrifice. That is why I am so confident that business isn’t that hard – harness compounding and even a failed company should be liquidated several decades later for a few million dollars. Read my full response to you and you’ll see why …

      You can click here to read the article, which I published on About.com, a division of The New York Times.

  • wonderwoman

    I know this is an old topic but this person has never run a DQ.  Have you looked into what a franchise costs these days.  More power to you, I think you need to walk a mile in our shoes before giving your opinion, on how great you think what they make us do is.  Yes stores do need up grades but there is way more to this than what meets the eye.

    • Joshua Kennon

      I’m aware of what they cost. I’ve run businesses, some of which required far more money and were infinitely more complex than a restaurant. I’m also aware of average sales figures, profit margin, capital structures, and a host of other factors because every few years, I contemplate buying something like a Dairy Queen just so I know I own it as I drive by before I come to my senses. (The last one was in a market called Clinton, Missouri, because it was formerly one of the highest grossing DQ’s in the country and I was curious as the demographic trends that would have caused that given its location in a very small area.)

      If someone can’t support the capital requirements of a DQ franchise, I don’t think they should have a right to continue it. The only reason you don’t see these sorts of arguments breaking out in the McDonald’s system, which is kicking DQ’s figures to the curb on a relative basis, is because the DQ arrangement is so old that many of the franchise agreements were done on paper napkins generations ago (literally. Napkins. Pens. Paper.) Now that DQ is trying to move to a more “grown up” model, the people who don’t have the net worth to support the upgrades are understandably upset.

      But I think it’s better for customers in the end, better for the system, and better for the parent company, Berkshire Hathaway. As I’ve said before, it is possible my views are biased on the subject not only due to my ownership of Berkshire shares but, more likely, due to the intense hatred I have for how under-invested the DQ stores in my hometown are. I’d do a happy dance if the chain took the franchise rights away from the owner and brought in bigger investors to build 3 Grill & Chills. So would almost everyone I know.

  • jos.knopick

    Hi Joshua,

    I do not have the education nor all the experience that I can access that you have. What I am reading is that you are someone I could learn from. I found your article today as I was looking into the DQ Franchise system. I live in an area that has not seen Dairy Queen in more than 20 years. I may have been less than 10 years-old since I had step into one. This of course would be more than 30 years ago.

    So why am I writing this. My soon to be wife, Mary, and I have seen the many DQ ads on television. She always comments that DQ menu looks like something she would care to try. Every ads ends with her asking where is there a DQ near us? Simply, No where. I am an experienced Food Service Manager. I am current working for a Taco Bell franchisee. My inner desire is to have my own restaurant/franchise.

    I have been toying with the idea of finding a way to get a DQ opened again in our area. I like the idea of the DQ Grill and Chill restaurant. So in this respect what could you send me that may help direct me in a manner that would assist me along the best course of action.

    Thank you.

    Joseph

    • Joshua Kennon

      1. Go to this site and read everything you can.

      2. If you think it is a fit, fill out a request for more information. They may or may not require a lot of stuff, including your income and balance sheet figures.

      3. Once they are satisfied you are legit, they will send you something known as the Uniform Franchise Offering Circular (UFOC). That is the document that tells you what you need to know by providing the terms of the franchise, general sales estimates, and a host of other vital data. Until you have THAT document in your hands, you can’t really know whether it is something you should consider or not.

      Get that document, and then send me any questions you have and I’ll do my best to try and point you in the right direction.

  • TheDairyKing

    Wow. I know this article is old, but, hilariously, the city of Des Moines is seeing this in an extreme sense right now. There’s 3 old-time, walk-up treat stores in a mile or so radius that are all blighted and canibalizing each other and all the owners moan and complain about how hard it is ‘in this economy’. Conversely, there’s probably 5 or 6 full run, Grill & Chills in the suburbs all making huge money and setting record sales. I should know, I run one of them. You’ll see even more as DQ pushes the Orange Julius concept in the coming months. Great article.

  • BeingHealthyandFit

    Hey man , I’m all about improving systems. My aunt owns a few of the DQs but in Canada, and I have a question about marketing on the local level. I’m not sure, but are franchisees allowed to do their own direct marketing initiatives ? For example, currently my aunt does not collect any leads or customer information, is it against DQ headquarters policy to do your own direct mail? I was thinking of at least just collecting information Address and name information when people order cakes, so that in the future you can send them a postcard reminding them of up and coming birthday, and if they order because of the coupon, you would give them %15 percent off, this would then give the business more revenue.

  • Jeremy Lohrke

    Those “old stores” have old franchise agreements with Dairy Queen & in many cases would have to renew their franchise agreement to “change concepts”. Until DQ allows its Franchisees to keep their old agreements & royalty rates nobody with more than 2 brain cells would voluntarily increase their royalties from $0.32 per gallon to a flat 9%…