Defense Management: Better Guidance Needed in Selecting Operating Methods for Name-Brand, Fast-Food Restaurants

A letter report issued by the General Accounting Office with an abstract that begins "The military exchange services operate a wide range of retail activities, such as department stores, florist shops, barber and beauty shops, gas stations, and restaurants. Hamburger restaurants represent a major segment of the exchange services' name-brand, fast-food sales. The exchange services use either a direct or an indirect method to operate these restaurants. Under the direct method, the exchange service enters into a franchise agreement with a name-brand company to sell its product on a military installation. As the franchisee, the exchange service builds and operates the restaurant and directly employs and trains the personnel. In turn, the exchange service receives all of the revenues and profits and usually pays the company a licensing fee plus a percentage of the restaurant's sales. Under the indirect method, the exchange service contracts with a name-brand company that, in turn, builds the restaurant and either operates it as a company restaurant or provides a licensed operator. The company or its licensed operator hires, trains, and pays the restaurant personnel and usually pays annual fees and commissions to the exchange service on the basis of restaurant's sales. Under this agreement, the exchange service receives a percentage of the restaurant's annual sales; annual licensing fees; and, in some cases, a signing bonus or minimum guaranteed commissions. GAO's analysis of fiscal year 1998 and 1999 financial data from the Army and Air Force Exchange Service and the Navy Exchange Service Command showed that the indirect method of operating name-brand hamburger restaurants was more profitable than the direct method, regardless of the restaurants' sales volume, restaurant type (free-standing or part of a food court), or location. GAO's investment analysis projected that if new name-brand, hamburger restaurants were to be built, the indirect method would provide a greater return on investment over a 20-year period. Other factors important in choosing between direct and indirect methods include financial and operating risks, customer service issues, employment opportunities for military dependents, and management control of a restaurant's operations. Although the Department of Defense's (DOD) policy on name-brand, fast-food restaurants establishes preferences for when the direct and indirect methods should be used, it does not provide enough guidance or criteria to determine which method to use or when it is appropriate to deviate from the policy. Also, DOD has not been actively involved in monitoring compliance with the policy. As a result, the exchanges have, over time, adopted operating philosophies and business models they believe best suit their particular circumstances.