Understanding McDonald's: Comprehensive company primer and profitability analysis

Understanding McDonald's: Comprehensive company primer and profitability analysis (Part 1 of 21)

McDonald’s global business model, the “three-legged stool”

Brief history and overview

McDonald’s, the world’s largest fast food chain, has over 34,000 restaurants across 119 countries. The company was founded in 1940 in the United States as a standalone barbecue restaurant. It was started by Richard and Maurice McDonald, who later revolutionized the company’s business model using production line principles to set up hamburger stands. In 1955, businessman Ray Kroc joined the team and started franchising restaurants and improving company return on capital. Today, McDonald’s serves nearly 70 million global customers daily.

three pillarsEnlarge Graph

The franchise’s most common menu items include hamburgers, cheeseburgers, French fries, chicken, soft drinks, milkshakes, breakfast items, and desserts. Recently, the company has broadened its menu to include salads, fruits, wraps, and smoothies.

Most McDonald’s restaurants are operated by the holding company, its franchisees, or its affiliates. Revenues consist of owned-restaurant revenues, royalties, rent, and franchisee fees. In 2012, the company had approximately $27.5 billion in sales and $5.5 billion in earnings.

Three-legged stool

McDonald’s business model—depicted by the “three-legged stool” of owner/operators, suppliers, and company employees—is its foundation. The balance of interests among the three groups is essential to the company’s success. The company currently has over 1.8 million employees and 5,000 franchisees. Recently, the third leg of this stool has been a source of consternation for both McDonald’s management and investors, as many of the company’s employees have been aggressively demanding increases in wages. For more information on recent minimum wage conflicts at fast food chains, please view this recent series, Why fast food strikes and proposed wage increases don’t matter, by Market Realist analyst Xun Yao Chen.

The strength of the alignment among the company, its franchisees and suppliers, and employees has been key to McDonald’s success. This business model enables McDonald’s to consistently deliver locally relevant restaurant experiences to customers and be an integral part of the communities it serves. Plus, it facilitates McDonald’s ability to identify, implement, and scale innovative ideas that meet customers’ changing needs and preferences.

McDonald’s has a successful franchise business model wherein all restaurants are operated either by the company or by franchisees, including conventional franchisees under franchise arrangements and developmental licensees and foreign affiliated markets under license agreements. The company’s operations are designed to assure consistency and high quality at every restaurant. When granting franchises or licenses, the company is selective and generally does not franchise to passive investors.

Overall, McDonald’s combination of owned and franchised restaurants has been very profitable for its investors over the past view years. Explore this series to get a better understanding of the fundamental drivers of the company’s profitability and stock price.

McDonald's Return on Assets and Equity 2013-12-24Enlarge Graph

The Realist Discussions

  • Tom

    One way to add a leg to the stool would be to lower the labor rate. I know this is a hotly debated topic, but doing something as bold as proposing lower wages through a barter system would be great for revenue building.

  • Eric Hertha

    Over the past several years McDonalds gross margin on Owned Stores has continued to decline. In other words the hamburger business is not doing well. The only reason that profit has increased is due to Franchise Fees – IE rents. McDonalds is no longer a hamburger chain it is a REIT. That is the way it needs to be looked at

  • burgerman

    Automated ordering via a kiosk in the lobby would speed up the process, cut cost and result in fewer errors in ordering. I strongly suggest that Fast Food Operators consider automation at least in the ordering process. I could work through the drive-through by using a smart phone app.