By Anant Gupta
When you think of McDonalds, the first word that comes to your mind is burger, fries & real estate, right? Well, if the answer is no, you might be surprised to know that the real estate market is where the fast food giant earns the bulk of its revenue.
We are not technically in the food business. We are in the real estate business, said McDonalds Chief Financial Officer Harry Sonneborn. He emphasized the core of McDonalds money-spinning machine – not the assembly-line stylized burgers, but McDonalds burgeoning real estate empire. Born as a brainchild of Dick and Mac McDonalds, it was eventual owner Ray Kroc whose vision gave wings to the fast-food behemoth.
About Kroc
The three attributes that sum up Roy Kroc would be ruthless, tireless and relentless. Known for his aggressive business dealings, Krocs singular focus at that time was to open 1,000 McDonalds all over the world. When the McDonalds brothers posed a challenge to his ambition, Kroc decided to buy them out and gain full control of the burger-flipping juggernaut.
Krocs habit of pushing the envelope stemmed from his early days when at the age of 15, he lied about his age to get a job as an ambulance driver. While navigating through various odd jobs as a pianist, musical director & a real estate salesman, he chanced upon McDonalds when working as a multimixer salesman. It was in this job that he encountered the McDonalds brothers. Impressed by their work ethics, the quality of food and its preparation efficiency, Frank asked for a job as the restaurants franchise agent.
Kroc eventually decided to become a franchise owner and expand McDonald’s across multiple geographies. After seizing control from the McDonalds brothers, he remained in firm command of the company till the very end. A nearly six-decade-old career is an ode to his tireless spirit and passion for work. His perseverance is embodied in his famous quote, “Press on. Nothing in the world can take the place of persistence”.
How the burger came to be
Krocs business structure is best resembled by the hamburger. With bun holding it all together, the patty giving the crunch, and the sauce giving a unique flavour, McDonalds business model also seems to follow on the same lines.
The bun McDonalds standardized menu in times of changing tastes
McDonalds proverbial bun has always been its standardized menu go anywhere in the country and youre bound to find the same consistency in flavour and ingredients. Kroc was very particular about consistency, as he felt the global brand name could only work if the quality at one restaurant could be replicated at any other, in any corner of the world. Although now McDonalds has customized menus to cater to local cuisines, the standard burger-fries-shakes template has still managed to retain its original taste.
The meat the single store franchise model
Sonneborns aforementioned dialogue sums it up neatly for McDonalds real estate is revenue. By the end of 2016, McDonalds owned $30 billion worth of real estate all around the world. Moreover, they had leased most of the land to franchisees, who sold burgers under the McDonalds brand name and shared profits.
Although many similar companies have a similar system, the reason McDonald’s enjoyed overnight success is due to Krocs single store franchise model. Initially introduced to avoid diluting his majority ownership, Kroc leased out land for franchisees to set up a single restaurant. This was unlike the common model in place, where a company usually operated around the world by diluting its stake for a majority of restaurants to a single franchise. This gave that particular franchise leverage over the majority owner, which could spell doom in case things went awry.
Wherever he saw fit, Kroc bought land to set up a McDonalds store. Next, he listed potential buyers for that franchise. After careful vetting, he awarded one company the right to sell under the McDonalds brand. The franchise paid rent for the land leased and a share of the profits earned from the burger business. In reality, Kroc was now earning on real estate even when sleeping, and earning more when the fast-food business picked up in the morning. His ingenious model allowed aggressive expansion and strict enforcement of standards non-conformers could be swiftly replaced through a new round of bidding.
This is what McDonalds revenue for FY 2017-18 looks like.
Figure 1: McDonald’s consolidated statement of income source: McDonalds Annual Report 2017McDonalds operates most of its restaurants through the franchisee-based model. Very few stores are actually owned and operated by the company itself. Yet, McDonald’s earns higher revenue through its company-operated restaurants, though they are significantly lesser in number. So shouldnt it just take full control of most of their restaurants? McDonalds data on operating margins for the same fiscal year tells us why that is not a good idea.
McDonald’s operating margins – source: McDonald’s Annual Report 2017.We see that McDonalds retains a huge portion of franchisee-generated revenues as margins. This is because they are not paying rent for land and all operating expenses are borne by the franchise owner themselves. On the flip side, the revenue earned from company-operated restaurants shrinks significantly, after paying off land rents and operating expenses. These expenses also include branding, marketing, equipment and furniture overhaul on a periodic basis. The strong margins from the franchised based model is the reason McDonalds is targeting to achieve 95% enfranchisement, up from the current 92%.
The sauce what worked so wonderfully well
The familial feeling when you step into a McDonalds store is no strange coincidence. Kroc has spent plenty of effort and time to create such an atmosphere. The staff was instructed to be professional and courteous, especially to children. In fact, Kroc went as far as ensuring all men working the frontline had to be clean shaven (this was later relaxed to well-groomed facial hair). Additionally, cigarette machines, pinball machines and alcohol were all strictly prohibited.
This culminated into an atmosphere congenial for family gatherings relaxed, clean and fresh. Now one of the worlds most recognizable brand names, and with over 300 billion burgers served, you can bet Ray Kroc is simply lovin it.
Anant Gupta is a writing analyst at Qrius