Franchise Model McDonalds

McDonald's has continued to grow during its history using innovations such as the drive-thru in 1961 and, more recently, teaming up with partners to offer a delivery service. Innovations have also included improved efficiencies such as the use of AI in their drive-thru ordering system and kiosks for in-restaurant order placement.

Today McDonald's is the largest restaurant chain in the world with over 38,000 restaurants in over 100 different countries. It is ranked as the world's 9th most valuable brand.

McDonald's contracted its first franchise agent in 1955. Today, the company has a presence in over 38,000 locations in more than 100 countries. Around 93% of all McDonald's locations are operated by franchisees (independent owners). Since the franchise model constitutes such a large part of the McDonald's business, their franchise operations will be discussed in the sections below.

Fig. 1 - A McDonald's Franchise in Belgium

Advantages of the franchise model to the franchisor:

The main advantage of this type of model to the franchisor is a reduction in the capital required for business growth. The income streams are guaranteed as long as the franchisees are still operating. While there are risks of running the business such as severe economic downturn, local competition, most of these risks and costs are transferred to the franchisee. The franchisor also retains significant control over the corporate branding and image.

A franchisor can enjoy multiple revenue streams, including:

• An annual fee from the franchisee. This fee will depend on the likely profitability of the franchise site or area.

• Startup and operations fees. The franchisor can sell specified equipment, goods and consumables to the franchisee for a profit.

• Rentals fee for business venues. If the franchisor owns the property that the franchise operates from then rent will form part of the regular income stream.

Disadvantages of the franchise model to the franchisor:

While calculating the franchise fee, the franchisor needs to estimate the ongoing value of the business within the area. If this is underestimated then the franchise fee will be too low and the franchisor will not have maximized the available profit from that geographic trading area.

Furthermore, the franchisor takes on some risk whereby the behaviour of the franchisee might degrade the company's corporate image.

The franchisor has to ensure that the franchising opportunity is both financially attractive and financially sustainable otherwise it won't attract franchisees and/or franchisees could go out of business quickly. If this is not done then the burden of attracting and onboarding new franchisees will outweigh the advantages of the franchise model.

The main advantage to the franchisee is that whilst not being a complete and readymade business opportunity much of the hard work will have already been done. Generally, the franchisee would expect to be buying into part of a business that already has an established product (this might include physical products and/or services) and a good reputation generated by an established business with corporate branding and advertising.

The franchisee will often be leasing premises from the franchisor and most likely have all materials and equipment sourced for them which in turn makes the franchise operation quick to set up and start trading. The franchisor will often provide access to finance together with guidance and advice. The franchisor has a vested interest in making the business a success.

Often franchising provides a natural route to expansion for the franchisee as if their first franchise is successful then taking over or expanding to other locations is relatively easy.

The disadvantages and risks of the franchise model to the franchisee:

While there's room for innovation, most franchisees don't have a chance to innovate individually.

In addition, a significant part of the franchisee's hard work will be returned back to the franchisor financially (with royalty fees, etc) as the franchisee is dependent on the franchisor's corporate presence, reputation, and brand value.

Finally, the franchisee will carry much of the financial risk, for instance in the case of an economic downturn.

The McDonald's franchise system is designed so that it can be highly rewarding to franchisees, whereas on the other hand its financial rules of entry and ongoing obligations are significant.

McDonald's franchisees can take over a previous franchisee or build a new one, though most choose to purchase existing restaurants. This gives some level of certainty for new franchisees and lowers the risk of business failure since customer footfall and sales revenues are understood for that site. An additional advantage is that an existing restaurant will come with equipment and trained staff.

New franchisees are normally only allowed to take on an existing venture that has been trading for more than 10 years.

To take on a franchise, the cost is between £350k and £1.85M in the UK. This covers franchise rights, equipment and inventory. In the USA this is far higher and it has been reported that the minimum is $1M. McDonald's insists that a maximum of 75% of this can be funded through loans so the franchisee must put in 25% of its initial cost as cash. This ensures that the franchisee is motivated towards success.

The vast majority of McDonald's locations in the UK used to be owned by McDonald's itself. However, the situation has changed. Out of the 1300 operating venues within the UK, roughly 1100 are franchised.

Once operating, the franchisee has to pay McDonald's between 12.25% and 21% of the restaurant's net sales. There's also a monthly service fee of 5% for using the McDonald's system. Since McDonald's owns the vast majority of the property that its restaurants sit on, another part of this fee is rent.

In addition, the franchisee has to pay for internal and external upgrades to the restaurant, and for replacement and upgrades to equipment. These are typically expensive.

In return, according to McDonald's, the average restaurant in the USA has sales of $ 2.7M per year.⁵ After food costs, supplies, staff payroll, and about a dozen other costs handed down by McDonald's, it is estimated by independent analysts that the typical profit is $ 150k. This equates to a 6% profit margin.

We have seen how McDonald's have effectively used the franchise model to build the most successful restaurant chain in the world. Integrated within their franchise business strategy are multiple processes to ensure that each franchise is sustainable, and whilst absolute returns from each restaurant are relatively small, the sustainability makes the franchise business an attractive proposition for most, but not all geographies.

At the same time, McDonald's ensures that it receives multiple revenue streams from each restaurant, ensuring corporate profitability is maximized from its franchise model.