Article Critique! Burger King Lawsuit

In case you haven't heard, Burger King franchise owners are suing Burger King corporate for forcing them to launch a $1 double cheeseburger promotion. Franchise owners claim that selling the cheeseburgers at $1 makes them take a $0.10 loss.

I am sure (or I hope, at least) that the lawsuit will dig deep in to the balance sheets of how this promotion affects the business. But the problem I have with articles like this is that they only tell part of the story. This particular story might lead you to feel sorry for the poor franchise owners who have to lose money at the demand of the guys in suits. Surprise! News stories don't always give you the entire story.

Some observations on this lawsuit:

1. There is always a bit of tension between the field (stores/franchises) and the corporate headquarters, with the field believing that corporate lives in its ivory tower and doesn't care about the needs of the field, and with corporate believing that the field doesn't appreciate the research done behind the scenes for decisions and is lazy about implementation. Bickering like this is bound to happen if communication between the two is lacking in the slightest. Burger King corporate claims that this promotion was tested before launch, but did it share the details of the test with the franchisees, and the forecasted results?


2. In the article, the NFA generalizes the franchisees' cost structure by saying that $0.55 goes toward ingredients and $0.45 goes toward overhead. However, overhead costs are spread out over all incoming revenue (not just the double cheeseburger), so the "loss" would be less than $0.10.


3. This promotion is clearly meant to be a loss leader, a tactic employed by a lot of companies, and virtually all fast-food companies. You sell an item at a loss to encourage more traffic and hope that more people will buy other things that give you more profit. This often works, and the article mentions that an analyst predicted traffic would increase by 20% with this promotion. This additional revenue should in theory make up for the loss from the double cheeseburger.

So, I thought I'd try to work out some "back of the napkin math" to see if I can find out just how much "loss" this is causing the franchises to take. I had to make a few assumptions to work this out, but I think you can see that the fight is far from easy to call.

According to Burger King's financial statement, their 3-month revenue total ending 9/30/09 is $636.9M, which would average out to $212.3M per month. If we assume that the average visit brings $5 in revenue, then that would mean the chain sees about 45 million visits per month. With the promotion, the analyst predicts an increase in visits by 20%, bringing it to about 55 million visits per month.

Here's where it gets a little tricky because there is a lot of information I don't know. I don't know what the double cheeseburger was selling for before the $1 promotion, and I don't know what proportion of sales the double cheeseburger makes up, or how that proportion might have shifted after the promotion (the promotion might mean the proportion of double cheeseburgers sold compared to other things may have increased). Lets say the double cheeseburger was selling for $3 before the promotion (and the promo reduced the double cheeseburger transaction totals by $2, to $3). And lets say that (generously) half of the visits take advantage of the promotion with relatively no other change in their other purchases (they still buy a coke or whatever else they would normally get). I made this so generous because there might also be some people who come just for the double cheeseburger and nothing else, which is also a number I couldn't guess. That would mean the revenue brought in would look like this:

($5*27.5M visits)+($3*27.5M visits) = $137.5M+$82.5 = $220M/month

$220M-$212.3M = +$7.7M/month

This works out to be an increase in revenue by almost $8M/month. An increase! Now, if the traffic is increasing by 20%, total costs are likely to increase as well, although not likely at the full 20% rate because economies of scale can be enjoyed through purchasing and cooking in bulk, and fixed costs like rent will stay the same.

Obviously, with so many unknown variables, this math is not reliable. But the point that I put forth is that there is more going on in this promotion and in the lawsuit than just what appears in the news, and that this fight might be much closer than it would appear. The lesson here is to take news stories like this with a grain of salt and not rush to the same conclusion that the article may lead you to believe.