As the world’s largest restaurant chain by revenue, McDonald’s is an American fast-food company channeled through an efficient franchise business model worldwide.
Today, McDonald’s has 38,000 restaurants serving close to 68 million customers – about 1% of the world’s population – every day, all of whom want a burger, fries, or chicken nuggets as quickly as possible.
This restaurant has evolved into the most popular family restaurant that appeals to children and adults alike and has emerged as the market leader in the “Quick Service Restaurant (QSR)” end of the market.
Franchises in the QSR category include McDonald’s Corp. (MCD), KFC, Taco Bell, and Wendy’s (WEN). As of 2021, McDonald’s will be the most valuable QSR (i.e., fast-food) chain with a brand value close to 130.36 billion USD and assets worth $53.8 billion USD.
McDonald’s (MCD) has consistently led this market segment in terms of sales and restaurants worldwide, followed by Starbucks (SBUX) and Subway.
In this post, we will explore the business model of McDonald’s and examine how it has grown to become the second-largest employer in the world with 1.7 million employees (behind Walmart with 2.3 million employees).
Franchise Business Model of McDonald’s
McDonald’s operates under a three-tiered franchise system.
The following are popular franchises, developmental licensees, and affiliates. Its franchisees are bound by a shared agreement. McDonald’s is the world’s second-largest food brand because it focuses on quality and innovation, customer relationships, and franchise relationships.
Honestly, McDonald’s is mostly known as a franchisor.
Most of its restaurants are run by franchisees, who own and operate them. In addition to supporting the franchisees, the company also acts as the employer and has significant control over the pricing, the sale, and the operation of the restaurants.
Independent franchisees reap the benefits of the company’s global brand name.
On the other hand, the company helps its franchisees succeed with their businesses. One of its most important features is that it tests franchisees’ innovation.
As a result of good results, it also implements them across all of its operating restaurants. Franchisees benefit from both independence and support from their parent company.
How Does McDonald’s Make Money Through Franchising?
McDonald’s makes money by leasing properties, often at large markups, that are owned by McDonald’s, to its franchisees for resale. McDonald’s operates 2,636 of the 38,695 restaurants, of which 36,059 were franchised.
There are approximately 93% of franchises in total.
With this model, the revenue stream (rent and royalty income received from franchisees) is much more predictable and stable, while the operating costs are reduced, making it easier to achieve profitability.
McDonald’s can leverage its market position because it owns the land and has long-term leases. Analysts have noted that this is similar to a subscription, in which a fixed amount is paid by the franchisee each month.
Analysts estimate McDonald’s keeps about 82% of franchise-generated revenue, but only about 16% of revenue generated by company-operated locations, which are further trimmed by operating costs.
Three types of franchises are offered by the company.
1. Conventional Franchising
The company obtains a lease on the land and owns the building where the restaurant is located. Franchisees pay for decor, equipment, and signage. The best type of agreement of its kind in the QSR industry achieves the highest levels of operational performance.
Over time, franchisees reinvest their capital. The company supports them to make sure they are successful. From implementing innovative ideas to providing operational support. In this way, the company increases its overall value as its functional restaurants generate more revenue.
The franchise agreement has a 20-year term. The franchisee is required to pay the company a minimum rent during this period, with royalties constituting a specific percentage of its sales.
During the signing of the franchise agreement and the opening of the restaurant, the franchisee is also required to deposit a certain amount. This allows the company to increase its cash flow dramatically.
2. Developmental License
When it comes to developmental licenses, the company does not make any investment, unlike conventional franchising. Franchisees invest the entire capital. In addition, they are also responsible for the operating costs and real estate charges.
As a result, the company receives a percentage of sales as royalty. A certain amount is also paid to the company for each new franchise it provides.
McDonald’s employs this structure in more than 80 countries. Around 6,900 restaurants use it.
Equity investment agreements are of this type. McDonald’s receives a royalty on its sales.
McDonald’s has 2,600 and 2,900 affiliated restaurants in China and Japan, respectively, which are the largest affiliated markets. McDonald’s has 5,800 affiliates worldwide!
McDonald’s currently operates in four global business segments: U.S., International Operated Markets, International Developmental Licensed Markets, and Corporate. The three sectors contributed 37.2%, 54%, and 8.7% of revenues, respectively.
- U.S.: With revenues of $7.843 billion in 2019, this is the segment with the highest revenue.
- International Operated Markets: Includes Australia, Canada, France, Germany, Italy, the Netherlands, Russia, Spain, and the United Kingdom. In 2019, this segment generated $11.398 billion in revenues.
- Developmental Licensee and Affiliate Markets & Corporate: Contains development licensee and affiliate markets, along with corporate activities. The segment had revenues of $1.836 billion in 2019.
Burger King, Wendy’s, Kentucky Fried Chicken, etc., have all managed to keep up with McDonald’s in the fast food arena, but its biggest challenge might be the demand for healthier, organic options coupled with fast food convenience.
There has been a resurgence in recent years of another restaurant model, one that offers consumers higher-quality, freshly prepared food in an informal setting, with efficient counter service. This model is seeking to attract consumers, or more specifically, their palates.
Known as fast-casual restaurants, these entities – Chipotle (CMG) and Shake Shack (SHAK), among others – have begun to take on the QSRs like McDonald’s.
An industry as stable as fast food should exist. They want their food fresh and fast without spending too much money. The industry does, however, face challenges due to a shift in consumer demand towards healthier eating habits.
A restaurant chain that sells familiarity and consistency needs to recognize that those qualities themselves are enormous assets. Even when McDonald’s has an under-performing year, it’s still profitable. When operating at its peak, it’s a must-have stock in any comprehensive portfolio, especially since it has similarities with REITs as well.