Business Model of McDonald’s : Advantages and Risks of Franchising
McDonald’s is the largest fast food brand of the world. Run mainly by its franchisees, it has seen a lot of success worldwide. Apart from strong brand equity, it has an impressive presence globally. McDonald’s is expanding and adding new markets as well as new stores every year. It is known for its great quality food, taste and customer service. However, at the core of its successful business is a strong business model which is enjoying continuously faster growth. Last year, it re-franchised several of the company owned restaurants. In the longer term it aims to manage more than 95% of its restaurants through the franchisees. McDonald’s global chain of restaurants has grown to more than 36,000 restaurants and recently it opened one in Kazakhstan. To stay its customers’ favourite McDonald’s has kept experimenting and innovating.
While a system nearly fully operated by franchisees can run quickly into operational issues, the case of McDonald’s is different. It has managed a largely uniform system and its success with managing its franchisee system shows high level of synchronisation. The core focus of the system is still customers’ preferences and their convenience. McDonald’s has also continued to play with the menu and improve it to suit changing preferences of the customers. The company has come a long way since the McDonald’s system, Inc purchased the rights from the McDonald brothers for $2.7 million in 1961. The business is enjoying immense popularity worldwide and plans to achieve faster growth. Its business model and business strategy are distinct and very different from the rivals like Burger King. Despite being a large chain of 36,000 Quick service restaurants run mainly by franchisees, McDonald’s is bound by a common thread. Apart from seeing high level of financial and operational success the QSR brand is working to drive meaningful progress through collaboration between systemwide partners.
Company Franchisee Relationship :
The company operates and franchises restaurants that serve fast food and beverages across more than 100 countries at several price points. McDonald’s system is made up of both company operated and franchised restaurants. There are three kinds of structures under which it operates its franchised restaurant. These three structures are conventional franchise, developmental license and affiliate. There are several actors that affect optimal ownership structure for a restaurant, trading area or a country. They include entrepreneurial experience of individuals, financial resources as well as the legal and regulatory environment locally in several areas including property ownership and franchising. McDonald’s one term goal is to run 95% of its system through franchisees (McDonald’s Annual Report, 2017). For this purpose and for continuous optimization, it regularly reviews its mix of company owned and franchised restaurants. The relationship between the McDonald’s brand and its franchisees is of utmost importance to the company. The franchisees are bound by agreement which requires them to adhere to certain essential standards and policies.
McDonald’s can be seen as mainly a franchisor because independent franchisees run more than 90% of its restaurants. These independent franchisees own and operate the McDonald’s restaurants. These are some major advantages of being a McDonald’s franchisee. The company and the brand act as a core support while the independent franchisees can be their own employers and exercise major control over employment, marketing and pricing related matters. McDonald’s is a renowned brand and its global fame is highly beneficial for the franchisees. The company utilises the expertise it has gained by operating company owned restaurants to support and improve franchisee operations and help them be successful. Moreover, it can test the innovations made by franchisees and if possible implement them across relevant restaurants. The biggest advantage for a franchisee is that he enjoys all the necessary freedom to successfully operate his business. At the same time, he has all the support he needs to be successful in terms of marketing, branding and operational knowhow. However, McDonald’s own operations are also of special significance since they help it be a credible franchiser. The company personnel can gain training experience for restaurant operations at the company operated restaurants. These restaurants also act as platforms for innovation where the company tests new operation standards as well as innovative ideas as well as marketing concepts. These things benefit the franchisees down the line.
Three Franchising models:
As already discussed the company uses three types of franchising models for its restaurants.
1. Conventional franchising:
The first type is the conventional franchising model. Generally in this kind of agreement, the company either owns the land and the building or obtains a long term lease for the restaurant location. The franchisee has to pay for equipment, signs, seating and decor. This type of arrangement where the company holds the ownership of the real estate and where the franchisee and the franchisor invest together helps ensure the highest standards of operational performance in the entire QSR industry. The franchisees should also reinvest capital into their business over time. However, the company also converts with the at times in order to help them improve their restaurant and operations as well as for implementation of special initiatives. In this way, the company is able to increase its own brand value by developing more attractive and modern restaurants that generate higher revenue. Typically, the term of a franchise remains 20 years. Franchisees should meet the rigorous standards developed by the company. McDonald’s has designed the business relationship between the brand and the franchisees in a manner as to ensure high quality and consistency across all restaurants. The conventional franchisees pay rents and royalties to the company. Company has specified minimum rent payments and the royalties are a percentage of sales. Apart from that there are also some initial fees which are to be paid at the time of the opening of a new restaurant or when a new franchise is granted. This is a profitable structure allowing the company to generate significant levels of cashflow (McDonald’s Annual Report, 2017).
2. Developmental license:
This is the second type of franchisee agreement which is referred to as developmental license arrangement. The company does not make any investment in this type of arrangement. Instead the entire capital is invested by he licensee himself. Apart from the costs of operations, the charges of real estate are also paid by the licensee. However, McDonald’s does receive a royalty which is a percentage of the sales. It also receives initial fees when a new restaurant is opened or when a new license is granted. the developmental license franchise structure is used by McDonald’s in more than 80 countries. There are around 6900 restaurants which operate under this structure. the largest of such developmental licensees operates around 2200 restaurants in 19 countries of the Latin America and the Caribbean (McDonald’s Annual Report, 2017).
McDonald’s has an equity investment in a limited number of affiliated markets which are referred to as affiliates. In these markets too the company receives a net percentage of the sales as royalty. McDonald’s completed the sales of its Hong Kong and China based businesses in 2017. However, it retained a 20% ownership in the entity that now holds the ownership of those businesses. Japan and China are the largest affiliated markets of McDonald’s with around 2,900 and 2,600 restaurants respectively. In total, there are around 5,800 McDonald’s restaurants in the foreign affiliated markets (McDonald’s Annual Report, 2017).
Risks in the Franchisee Model:
These were the three models that McDonald’s has used to run its system operations around the world. while it has brought the brand immense success, this business model is not without risks. McDonald’s system has more than 90% of its operations being carried out with the help of franchisees. This leaves the company heavily dependent on the franchisees. Moreover, the level of control and participation that the franchisees enjoy is very high. This leaves the company with limited control and influence over franchisee operations. Giving the franchisees enough scope to run their own operations and make their own decisions is a good practice with its own benefits but since the company’s influence gets limited, it also presents certain kind of risks. Now, the company’s success depends heavily on cooperation of the franchisees including the conventional franchisees, development licensees and the affiliates. Their financial success is also important for the success of the company (McDonald’s Annual Report, 2017).
The two main sources of income for McDonald’s are the fees including the rents as well as the royalties which are a percentage of total sales and second the sales from its own restaurants. Sales from the company operated restaurants generate less revenue than the company receives in the form of fees from its franchised restaurants. The franchisees manage their business independently and the day to day operations of their restaurants are the responsibility of the company. So, the revenue that the company collects from the franchised restaurants depend on the ability of the franchises to grow their sales. Otherwise, if the franchises are not able to generate significant revenue then it would affect the company’s revenue as well. Moreover, if the sales trends for the franchisees grow worse then it could lead to restaurant closures as well as financial loss in the form of lower revenue. As McDonald’s continues to refranchise its restaurants its dependence on franchisees and the potential effect of these factors which can affect revenue. Gaining the cooperation of franchisees is also very crucial to the success of the system. The system depends on the franchisees for several major things like implementation of key initiatives several of which my require financial investment. It requires the franchisees to remain closely aligned with the brand for the successful implementation of such initiatives. There are several kinds of critical decisions related to effective selection of franchisees, licensees and affiliates which affect the success of the system. Selecting the right franchisees helps at achieving the financial and other objectives of the brand.
Supply Chain Management at McDonald’s:
A large and global chain cannot be operated just through franchisees. You also need to have a strong network of suppliers to ensure the availability of quality raw materials. Apart from that while supply chain management is a source of competitive advantage, it is also a very challenging area. QSR industry is facing new challenges in terms of SCM including a need for higher transparency as well as consistent global standards. These challenges are not as easy as they look. You have to innovate continuously to find the right balance. Moreover, short term solutions do not always produce the right results. Consumer trends have changed fast in the 21st century. McDonald’s has also faced its fair share of challenges related to transparency and food quality and safety practices. Even if your supply chain is not your customers’ priority, how you are managing it is an important concern. There are challenges related to reputation that can emerge from not managing a healthy supply chain. The QSR industry has grow highly competitive. Increased competition demands that you do not just adopt best supply chain management practices but continuously revisit them and your standards to make improvements. Sustainability is also an important concern affecting both suppliers and companies. How you source your food and how you keep it till it is consumed, all these questions have become an important priority for QSR brands. Growing need for supply chain transparency and a generation of heath conscious foodies require your QSR brand to follow the best practices in terms of sourcing and storage.
McDonald’s has maintained a strong and global supply chain to source good quality food and other raw materials from. Neither the company, its franchisees, subsidiaries and nor the affiliates provide the food, paper, equipment or packaging. The entire supply chain is outsourced. There are several independent suppliers from whom the company and its franchisees food, packaging, equipment and other goods. However, having outsourced the supply chain the company enjoys greater flexibility which allows it to focus on operations management and innovation. The company does not own or operate warehouses or distribution centres either. Instead there are company approved and independently owned and operated distribution centres. These centres distribute food and supplies to the restaurants. To manage the storage and handling part, the company has trained its personnel properly. McDonald’s has managed long term relationships with its suppliers and distribution partners. Martin Brower is an important logistics partner for McDonald’s. The partnership started long back when Ray Kroc had founded his first restaurant. Stock inventory control at McDonald’s is a collaborative process between the company and Martin Brower. It takes place once at the end of the business day on a daily, weekly or monthly basis. The central ordering team forecasts future demand on the basis of stock levels. It generates orders to ensure every restaurant has the correct stock levels.
The company also ensures that its quality standards are consistently met. It has established quality centres all around the globe for the purpose of quality review. As a part of its supply chain management, McDonald’s conducts ongoing product reviews as well as on site supplier visits. Apart from that, there is a Food Safety Advisory council to manage the food safety aspect of McDonald’s supply chain. This council is made of technical and safety experts as well as supply chain specialists. Suppliers and outside academia are also a part of this council who advise on food safety practices. This helps the company manage all the aspects of food safety. Another area where the company has partnered with its suppliers is innovation. It works in tandem with its suppliers to encourage innovation and to ensure that the correct standards are closely followed. It also helps assure that the best practices are being followed and the system continuously improves on them. The goal of McDonald’s is to achieve a competitive and strong supply chain which helps it manage costs more efficiently. In this regard the company collaborates with suppliers and leverages its scale, infrastructure and risk management strategies to derive the best results. Over the longer term this will help the management keep the costs of raw material, paper and equipment under control.
Global Restaurant Chain:
McDonald’s is a global chain of restaurants. By the end of 2017, the number of company operated restaurants was 3,133 whereas that of the franchised restaurants was 34,108. Total number of restaurants in the McDonald’s system at year end 2017 was 37,241 in 120 countries. U.S. is the leading market for McDonald’s which accounted for around 35% of the company’s revenue in 2017. The number of restaurants in U.S. by the end of 2017 was 14,036 (McDonald’s Annual Report, 2017). McDonald’s has divided its market into four types of markets. Apart from US, there are International lead markets, high growth markets as well as foundational markets. UK and Canada are the international lead markets whereas China and HongKong are high growth markets. A large global network of restaurants serves millions of customers every month. McDonald’s extensive global presence is also an important pillar of its business model. the number of total restaurants grew by around 340 in 2017 compared to 2016. Apart from re-franchising company owned restaurants, McDonald’s is also opening new restaurants to grow its presence and revenue.
McDonald’s has kept growing popular over years. However, there are a large number of challenges it is facing related to food quality as well as transparency and management of its franchisee system. Apart from the high level competition in the QSR industry, the demand for transparency has also grown high. McDonald’s is working to tackle the challenge. It makes information related to sourcing and the suppliers from whom it sources raw material available on its website. Its franchisees enjoy a lot of freedom in terms of decision making and control over the operations of their restaurants. They also receive a lot of support from the brand. However, the success of the company also depends on how much the franchisees cooperate with it and are willing to reinvest for growth. There are several inherent risks of a franchisee based business model. Apart from higher dependence on the franchisees for revenue, sometimes their is fear of failure at implementing key initiatives. As McDonald’s continues to re-franchise its restaurants, the company’s dependence on the franchisees will grow higher. However, despite these risks McDonald’s has remained popular. Despite being full of risks, its business model has worked and is generating a nice revenue every year.