McDonald’s Business Model: How A Food Franchise Company Can Be Turned Into A Real Estate Company

 

Franchising is a model by which fast food chains can expand quickly and efficiently by using the money of small investors. McDonald’s perfected new franchising techniques, increasing the corporation’s size while maintaining strict control of its products.

Instead of making money by selling supplies to franchisees or demanding huge royalties…the McDonald’s Corporation became the landlord to its franchisees. They bought the properties and then leased them out – at large markups. In addition to that regular income, the corporation would take a percentage of each shop’s gross sales.

Today McDonald’s makes its money on real estate through two methods. Its real estate subsidiary will buy and sell hot properties while also collecting rents on each of its franchised locations. McDonald’s restaurants are in over 100 countries and have probably served over 100 billion hamburgers. There are over 36,000 locations worldwide, of which only 15% are owned and operated by the McDonald’s corporation directly. The rest are franchisee-operated.

Contrary to common belief, McDonald's primary business is not about selling fast food, but real estate. The company owns the land and buildings of most of its franchised locations. Franchisees pay McDonald's for the right to operate a McDonald's restaurant, and these fees include a percentage of sales as well as rent. This strategy provides McDonald's with a steady stream of revenue, regardless of restaurant sales, making it one of the world's biggest commercial real estate operators.

During the 2008 recession, McDonald’s leaned heavily on this facet of their business as they capitalized on an anemic property market – buying up more of the land and buildings where it operates. How much land does McDonald’s own? The company owns about 45% of the land and 70% of the buildings at their 36,000+ locations (the rest is leased).

The reason of high profitability is that it owns the land and buildings at most of its locations – and its franchisees pay McDonald’s rent. They started by leasing out to franchisees, charging a 20% markup but increased it to 40%. They were minting a lot of money. The brand also made an arrangement in the lease agreement that if the outlet was doing well, then the markup would go up. The franchisee paid the lease markup or 5% of sales, whichever was higher making McDonald’s invincible.

In 2014, the McDonald’s corporation made $27.4 billion in revenues, of which fully $9.2 billion came from franchised locations and the rest ($18.2 billion) was from company-operated restaurants. Although the majority of their revenue came from company-operated restaurants, it costs way more money to run your own store than it does to sit back and collect cash. McDonald’s keeps close to 82% of all their franchise-generated revenue versus only 16% of its company-operated restaurant revenue. Of that $18.2 billion generated by company-operated stores in 2014, the corporation keeps just $2.9 billion. Of the $9.2 billion coming from franchisees, the corporation keeps $7.6 billion.

McDonald's commitment to consistency and efficiency, both in terms of the quality of food and service, is a critical aspect of its business model. The company's standardization of products and processes, coupled with its innovative "Speedee Service System," ensures that a Big Mac or fries ordered in Tokyo tastes the same as in New York. This consistency builds customer trust and loyalty.

Finally, even if people stop eating burgers tomorrow, McDonald’s is not going down, supported by its massive real estate empire. And even in the worst-case scenario, the liquidation value of McDonald’s is still quite high because the asset base is still composed by real estate properties (whose value grows with inflation in the long-term). Therefore, you must consider this liquidation value in case you buy the stock.

3 major lessons from this new business model:

As an entrepreneur, it’s important you create an alternate source of income if your original business goes down

Focus on building real assets that can provide strength if things do not work in your favor.

Try to find a growth model with minimum liabilities. In this case McDonald’s did not have the liability to pay rent yet it became one of the largest fast-food chain.