McDonald's is a fast-food chain that was founded in 1940 in California, United States. The principles of the modern fast-food restaurant were introduced into McDonald's in 1948 using what they called the "Speedee Service System".
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.
What is a franchise business?
A franchised business is an alternative business model where an independent individual or business becomes a franchisee. This means that they enter into an agreement with the primary business (the franchisor) to operate the franchisor's business within an agreed area. Part of that agreement involves the franchisee paying a franchise fee to the franchisor and this is one of the ways in which the franchisor makes a profit.
To learn more about how this form of business operates, check out our explanation on Franchising.
Fig. 1 - A McDonald's Franchise in Belgium
Advantages and disadvantages to the franchisor
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:
McDonald's restaurants will always use coffee cups with a McDonald's corporate logo and these are sold to the franchisee at a profit on the basis that the corporate logo is valuable intellectual property.
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.
If a McDonald's franchisee did not cook food correctly and this resulted in an outbreak of food poisoning then the entire corporate image could be tarnished as customers may associate the McDonald's brand with failure.
The franchisee might commit fraud or stray away from company policy in order to boost profits.
The franchisee could purchase their beef patties from a cheaper source than those of the franchisor. If this were to happen the franchisor would lose part of their revenue stream and would lose some control of their corporate quality.
Fig. 2 - A McDonald's Beef Burger and Fries
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.
Advantages and disadvantages to the franchisee
The advantages of the franchise model to the franchisee:
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.
By franchising as a McDonald's owner, you can buy into the official McDonald's name, their famous logo, etc, without having to develop a new brand from scratch. There's also a chance to bring your unique ideas to the world. Many successful sectors of McDonald's such as Big Mac, Filet-O-Fish, Egg McMuffin have been developed by franchisees.
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.
McDonald's provides the necessary training, support, and tools to help you get off on the right foot and build a local presence. In addition, you can benefit from a well-established operating system including advertising, marketing, human resources, purchasing procedures, which contributes to faster growth.
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.
A franchisee might want to create a Tikka Burger to satisfy demand from a local community. However, without the franchisor's consent, the franchisee cannot add a new item to the menu.
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.
McDonald's, for a while, suffered from bad press due to the perceived unhealthiness of their menu. McDonald's reacted to this criticism by introducing healthier options, such as salad into their menu.
The McDonald's franchise model
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.
McDonald's does have agreements with banks that can offer favourable interest rates to franchisees for the remaining business funding.
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 the US, a McCafe espresso machine might cost $12,000.
Fig. 3 - McDonald's Coffee
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.
Conclusions
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.
Franchise Model McDonalds - Key takeaways
The principles of the modern fast-food restaurant were introduced into McDonald's in 1948 using what they called the "Speedee Service System".
A franchised business is an alternative business model where an independent individual or business becomes a franchisee.
McDonald's model focuses on ensuring that a franchisee is able to sustainably run a franchise for 10 years.
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.
McDonald's ensures that it receives multiple revenue streams from each restaurant ensuring corporate profitability is maximized from its franchise model.
Sources
Advantages of Franchising, McDonald's US, 2022.
Adrian Zorzut, BUYING IN How much does a McDonald’s franchise cost, The Sun UK, 2021.
Chris Fuhrmeister, McDonald’s Takes Aim at Starbucks With Pricey Espresso Machines, Eater, 2016.
Marissa Laliberte, How Much Money Does the Average U.S. McDonald’s Make Every Year, RD, 2020.
How many McDonald's restaurants are there in the UK and the world, McDonald's, 2022.
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