McDonald’s can be defined as a heavy franchised business model company. In fact, as of 2017 of its total restaurants, 92% were franchised. The long-term goal of the company is to achieve 95% of franchised restaurants. This model has allowed McDonald’s to grow its net income from $4.5 billion in 2015 to $5.2 in 2017. The heavy franchised business model enables McDonald’s to have higher gross margins and operating income while rent and royalty income received from franchisees provide a more predictable and stable revenue stream with significantly lower operating costs and risks.
McDonald’s origin story: from the McDonald Brothers to Mr. Ray Kroc
As explained on McDonald’s website “Dick and Mac McDonald moved to California to seek opportunities they felt unavailable in New England.” In 1948 they launched Speedee Service System featuring 15 cent hamburgers. As the restaurants gained traction that led the brothers to begin franchising their concept until they reached nine operating restaurants.
A native Chicagoan, Ray Kroc, in 1939 was the exclusive distributor of a milkshake mixing machine, called Multimixer. In short, he was a salesman.
He visited the McDonald brothers in 1954 and was impressed to their business model which led to him becoming their franchise agent. He opened up the first restaurant for McDonald’s System, Inc., until in 1961 he acquired McDonald’s rights to the brother’s company for $2.7 million.
Ray Kroc, died on January 1,4 1984, all the rest is a legend.
Is McDonald’s a franchising? You bet, and a heavy one!
Of the 37,241 restaurants in 120 countries at year-end 2017, 34,108 were franchised, and the Company operated 3,133 restaurants.
This makes the company 92%.
As specified in its 2017 annual report “McDonald’s is primarily a franchisor and believes franchising is paramount to delivering great-tasting food, locally-relevant customer experiences and driving profitability. Franchising enables an individual to be his or her own employer and maintain control over all employment-related matters, marketing, and pricing decisions, while also benefiting from the financial strength and global experience of McDonald’s. However, directly operating restaurants is important to being a credible franchisor and provides Company personnel with restaurant operations experience.”
McDonald’s goal is to have approximately 95% franchised over the long-term. That makes of McDonald’s a heavy franchised business operation.
How do McDonald’s partnerships work?
As specified in its annual report “under McDonald’s conventional franchise arrangement, franchisees provide a portion of the capital required by initially investing in the equipment, signs, seating, and décor of their restaurant business, and by reinvesting in the business over time. The Company generally owns the land and building or secures long-term leases for both Company-operated and conventional franchised restaurant sites. This maintains long-term occupancy rights, helps control related costs and assists in alignment with franchisees enabling restaurant performance levels that are among the highest in the industry.”
In short, the model is pretty smart. McDonald’s keeps control over the land and or long-term leases to leverage its market position to negotiate deals. At the same time, this kind of deal serves as an alignment between the company and its franchisees.
What are McDonald’s segments?
At the qualitative level the segments can be organized in four main ones:
- The U.S., which as of 2017 represents still the most significant market
- International Lead Markets include Australia, Canada, France, Germany, the U.K. and related markets.
- High Growth Markets which comprise markets with high growth potentials include China, Italy, Korea, the Netherlands, Poland, Russia, Spain, Switzerland and related markets.
- Foundational Markets & Corporate, the remaining markets in the McDonald’s system, most of which operate under a primarily franchised model.
As of 2017, the U.S., International Lead Markets, and High Growth Markets accounted for 35%, 32% and 24% of total revenues, respectively.
Who are McDonald’s key partners?
McDonald’s business model is based on three key players. Franchisees, suppliers, and employees are the piece of the puzzle of McDonald’s successful business model.
- Franchisees are entrepreneurs that at local level allow McDonald’s to expand rapidly while keeping a global focus
- Suppliers across the globe guarantee McDonald’s the ability to operate at a high level
- The continuous training of employees across the over thirty-six thousand restaurants around the world allow McDonald’s to perform at full speed
What management metrics McDonald’s uses to asses its growth?
McDonald’s looks at the following metrics:
- Comparable sales and comparable guest counts: the percent change in sales and transactions, respectively, from the same period in the prior year for all restaurants, whether operated by the Company or franchisees, in operation at least thirteen months, including those temporarily closed
- ROIIC: calculated by dividing the change in operating income plus depreciation and amortization (numerator) by the cash used for investing activities (denominator), primarily capital expenditures
- Free cash flow: defined as cash provided by operations minus the capital expenditures
- Free cash flow conversion rate: defined as free cash flow divided by net income, are measures reviewed by management to evaluate the Company’s ability to convert net profits into cash resources
McDonald’s velocity growth plan in action
McDonald’s has launched and developed a velocity growth plan based on three pillars:
- Retain the customers they have
- Regain the customers lost by improving the taste and quality of food, enhancing convenience and offering strong value
- Convert casual customers to more committed customers with coffee and snacks
They also identified three accelerators, intended to drive growth:
- Digital by re-shaping interactions with customers
- Delivery by bringing the McDonald’s experience in their homes
- Experience of the Future in the U.S. which consist of a set of new technologies within the restaurants to enhance the efficiency and improve the experience
Why is McDonalds’ transitioning to a heavy franchised business model?
The transition to a more heavily franchised business model is part of the long-term company’s strategy. In fact, as the rent and royalty income received from franchisees provides a more predictable and stable revenue stream with significantly lower operating costs and risks.
In a way, it is almost like McDonald’s is introducing a subscription business model, where franchisees pay a fixed amount each month. That makes McDonald’s income more stable over time.
Also, the operating and net income coming from franchising operations makes it easier for the company to grow its profitability.
Key takeaways and summary infographic of McDonald’s heavy franchised business model
Even though revenues have decreased from $28 billion in 2013, compared to $22.8 billion in 2017, the gross margins have increased. Also, the net income increased from $4.5 billion in 2015 to $5.2 in 2017.
Although company-operated restaurants have higher revenues compared to franchised restaurants, they contribute less to the company’s gross margins and net income.
That happens because the net revenues for the franchised restaurants take into account the royalties reported by those, rather than the net sales. In addition, rent and royalty income received from franchisees provide a more predictable and stable revenue stream with significantly lower operating costs and risks.
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