Welcome back to The Business Of! I hope you all had a lovely week. So, before the break, we explored The Business Of Semiconductors. And broke down the business models of Nvidia, TSMC and ASML.
This week we start a new 3-week series and I’m super excited for it. We’re going to be diving into The Business Of Fast Food!
And we’ve got 3 cracking business models to dive into…
McDonald’s: The world’s most famous fast food restaurant. And the 46th biggest company in the world.
PepsiCo: The world’s #2 fizzy drink. And the 34th biggest company in the world.
Huel: A different meaning to the phrase ‘fast food’! The UK-based company is eyeing an IPO. And I’m a die-hard fan of their products!
Now, unlike the previous series, you’ll all have heard of these 3 companies - well, definitely the first 2! But, I can guarantee that there’s so much about their business models that you won’t be aware of. So, without further ado, let’s take a look at what McDonald’s actually does. And we’ll be learning about a new business model…!
Okay so, I don’t think there’s any need for me to talk about what McDonald’s does. I’m pretty certain everyone’s aware of what the company does. Even the cleanest eaters out there…
However, something I’m not so sure everyone will be aware of. Is HOW McDonald’s does what it does. The US fast food giant has ~40,000 restaurants, ~3,000 more than the #2 fast food chain, Subway. And the table below shows which countries love their Maccy D’s the most.
But I was shocked to learn that McDonald’s only own and operate 5% of these restaurants! The other 95% are franchised. And this is what I want to focus on today - the franchise business model.
So, how does franchising actually work? And why do companies like McDonald’s use franchising? Well, franchising is used for growth. Like any company, McDonald’s need to grow their revenues and profits. And what’s the most obvious way for a restaurant chain to grow? Open more restaurants!
However, the issue with opening more restaurants is the huge costs involved! You need seats, tables, cooking equipment, signs, employees, food, etc. And this would cost McDonald’s an awful lot of money and time. So, what’s the solution?
Well, the solution is franchising! Instead of owning and operating the restaurants themselves. McDonald’s find individuals to take on the costs and run the restaurants for them! These individuals are called franchisees. Up till last year, the UK’s largest McDonald’s franchisee was a chap called Atul Pathak - who had 43 McDonald’s restaurants to his name!
Okay, so hopefully that’s clear. Franchising allows McDonald’s to open new restaurants without spending lots of money. Because franchisees take on the costs. But then, if franchisees are running the restaurants, how do McDonald’s Corporation make money from these franchised restaurants? Good question, and we’ll dive into this in much more detail tomorrow. But McDonald’s takes a royalty fee from franchisees. This means that a certain percentage (usually ~6%) of a franchised restaurant’s sales is taken by McDonald’s Corporation.
Now, some of you may be wondering why on Earth McDonald’s prefer franchising? Because sure, they don’t have all the costs when they franchise. But they only take a tiny 6% of the sales! Compared to when they run their own stores and take all 100% of the sales! Well, it’s a super interesting discussion. And trust me, we’ll uncover all of this in Tuesday’s and Wednesday’s newsletters!
Okay, so we know that 95% of the McDonald’s restaurants we drive past aren’t actually run by McDonald’s. They’re run by normal business people, who get permission from McDonald’s to use their brand. Also known as licensing!
But then some on you may be wondering - if all these restaurants are run by different people. How does my McDonald’s order always taste the same, whichever McDonald’s I’m at?! Surely if each of the restaurants are managed by different people, the food would have a different taste no?
Well, the reason for this consistency across restaurants is because McDonald’s has a select list of suppliers they work with. And all franchisees have to buy their beef, chicken, and all other ingredients from these suppliers! For instance, Lopez Foods is one of McDonald’s suppliers of beef in the US. And Lakes Free Range Egg Company is one of McDonald’s longest standing suppliers of free range eggs in the UK. And because McDonald’s have strict standards for their suppliers, it means the food from all their various suppliers is similar!
And it’s not just the purchasing of ingredients that McDonald’s are strict on. To provide control in-store, the company has several techniques like secret shoppers and corporate visits. Now, combine these techniques with the strict control of suppliers. And voila - you’ve got a restaurant chain that is one of the most consistent across the world!
Okay, so just before we wrap up. There’s one more important question to answer. And that’s - what’s in it for the franchisee? Because if there wasn’t any reward for the individual, they wouldn’t become a franchisee. And then McDonald’s franchise business model wouldn’t work!
Well, the first thing to say is that not everyone can become a McDonald’s franchisee. You need to be fairly well-off! On the company’s website (extract below), it says that on average, a franchisee will have to invest between £400k-1.9m for a new restaurant! And the individual must have at least £100k of that in cash! The remainder can be taken out as a loan. To read about the investments franchisees need to make before they can open a McDonald’s - check out this article.
Okay, so quite a bit of cost just to get up and running. But what’s the upside to all of this? Well, the upside is the brand - McDonald’s. The average McDonald’s restaurant makes annual sales of ~£3m. If you set up your own fast food restaurant, I doubt you’d be making £3m in sales a year! And so that’s the benefit!
Now, of course, the profits for the franchisee are much less than £3m. And after you take away the cost of buying the food ingredients, rent, marketing, employees, etc. The profit margin is only ~6-10%. The table below illustrates this using a 10% margin.
So, what does this all mean for the franchisee? They invest £2m before their McDonald’s restaurant even opens. And then once it’s opened, the restaurant makes £3m in sales, £300k in profits every year. This means that the franchisee makes back their initial £2m investment after ~7 years!
Is this a good return? Well, that’s subjective. Some individuals may feel like that return is too low. Others may feel that return is great! But what we can say is that this return has been enough. More and more people have been opening up their own McDonald’s franchised restaurants over the years. And as we’ll see tomorrow, this has been a huge part of the McDonald’s story!
Yup, that’s right! This Friday we have another Career Talk, and it’s a special one! We’ll be hearing from my friend, Rishabh Shah, Senior Associate @ TA Associates (https://www.linkedin.com/in/rishabh-shah-08396580/).
After graduating from the University of Durham in 2013, Rish spent 6 years in the Debt & Capital Advisory team at Deloitte. Before joining the Capital Markets team at TA Associates, the Private Equity firm. This Friday he’ll be talking about…
how he made the move from consulting to private equity (PE),
advice he’d give to students who are interested in consulting/PE,
what skills are more important to develop for his roles, and,
how a capital markets team would work with a company like McDonald’s.
Anyway, that’s a wrap for today. We’re back tomorrow where we’ll be diving into how McDonald’s makes money! I can assure you, it’s a cracker!
Have a great day!
The Business Of Team