MCDONALD’S EXODUS:
McDonald’s operators have had enough. For decades, they’ve put up with McDonald’s anti franchisee
policies and agressive corporate politics just to have a chance at growing a thriving restaurant.
But, the more time they put in, the more they realize that this deal is far more favorable
for McDonalds. The average franchisee owner pulls in $150,000 per year from each restaurant which
sounds great until you realize that you have to invest $1 to $2.2 million to get your hands on a
location. In other words, operators are running a full restaurant business just to earn a 10% return
on their investment. Instead of putting in all this effort into running a restaurant, operators
could just invest their money into the S&P 500 and earn comparable returns with absolutely no
effort. This is only made worse by the fact that as a franchisee, you’re not even building up your
own brand, you’re building up McDonald’s brand which is doing better than ever. You know how
there’s all this fear about recessions, layoffs, bank failures, interest rates, and what not? Well,
despite all that turmoil, McDonald’s is doing better than ever. They’re one of the
only companies’ who stock is at near all time high levels giving them a valuation of just under $200
billion. A similar story can be seen with their net income as well. In the last 12 month period,
McDonald’s profited just over $6 billion. If we divide that amongst their 38,000 locations,
we get an average income per store of $162,000 or even more than the average franchisee. Given
McDonald’s brand image, it’s not surprising that their able to charge such a premium, but
more franchisees than ever are starting question whether all of this is even worth it, and for many
of them, the answer is no. In 2021, a record 13% of franchise owned locations changed hands. For
perspective, only 6% of Burger King franchise locations changed hands during the same time
period. If we zoom out a little, it just looks even worse for McDonalds. Between 2019 and 2022,
28% of McDonald’s locations have either been closed or sold off. And according to operators,
it’s only getting worse. There’s apparently a line to get out the door. So, here’s why
McDonald’s operators are leaving in droves and the frightening implications for McDonald’s.
EXPENSIVE REMODELS: McDonald’s likes to write off the
exodus as simply pent up demand from the pandemic, but in reality, there was a pivotal event 2018:
remodels. This marked the biggest remodel in the company’s history in decades and it was
required. McDonald’s wanted new furniture, new decor, remodeled counters, exterior redesigns,
digital kiosks, and reimagined drive thru lanes. Even if you only go to McDonald’s on an occasional
basis, I’m sure you’ve noticed these changes. And honestly, they’re pretty nice, but they were also
quite a burden for franchise owners. McDonald’s offered to pay 55% of the renovation expenses
for the affected 14,000 US restaurants which came out to a total of $6 billion.
This means that the average cost to renovate each store was a whopping $779,000, out of
which operators were responsible for $350,000, and that’s just the average. For older more outdated
stores, the renovation expenses were probably closer to a million dollars if not over which
pushes up the operator contribution to nearly $500,000. This is made even worse by the fact that
the stores that are most likely to be outdated and run down are ones that aren’t performing as well.
In other words, the stores that are performing the worst would likely have to pay the highest
bill. For 40% of operators, this was completely unfeasible as the remodel expense would put them
in danger of not having their leases renewed based on McDonald’s own financial requirements,
though McDonald’s does dispute this number. For obvious reasons, operators were triggered.
In fact, when asked to rate their relationship with McDonald’s from a scale of 1-5, the average
operator gave a rating of 1.19, and that was in April of 2022. This was the 3rd worst rating in
the survey’s history and the 2 times that it was worse were both during the height of the
remodels. All of this tension would lead to the creation of basically a franchisee union named
the National Owners Asociation in 2018 which was the first of its kind in the company’s history.
The association has been trying to advocate on behalf of operators, but it doesn’t seem like
they’ve been able to make much tangible progress. In fact, McDonald’s has not only not backed off,
but they tried to offload even more of the remodel expenses onto operators. The most notable example
of this was a new technology fee that McDonald’s implemented in late 2020. Apparently, McDonald’s
was racking up too much debt, so they decided to charge operators a $70 million technology fee.
Operators would end up suing McDonald’s, but even this didn’t eliminate the fee, though it
did reduce by 60%. It seems that McDonald’s has gotten into a habit of prioritizing end consumers
and shareholders over everything else which isn’t a bad thing in itself. The reason that
it’s bad in McDonald’s case is that they’re doing it at the cost of operators which is not exactly
a very smart move long term given that 93% of their locations are operated by independent
business owners. But, expensive remodels and annoying technology fees are just the tip of the
iceberg. The truth is that the entire partnership between operators and McDonald’s is just a facade.
FACADE OF A PARTNERSHIP:
When you think McDonald’s, we all think of burgers, fries, creepy clowns, and big golden
arches, but what if I told you that McDonald’s doesn’t actually make money from any of this?
While these are what us consumers associate with McDonald’s, the reality is that we’re not even
the real end consumer of McDonald’s. The real end consumer is actually operators, and if you don’t
believe me, just take it from McDonald’s former CFO himself. “We are not technically in the food
business. We are in the real estate business. The only reason we sell fifteen-cent hamburgers is
because they are the greatest producer of revenue, from which our tenants can pay us our rent.” This
might be confusing because it’s been engrained in all of our minds that McDonalds is a fast food
company. But in reality, McDonald’s figured that that wasn’t all that lucrative decades ago. I mean
just think about it. Even if you sell billions of burgers every year, if you’re only make 10 or 20
cents on each burger, it’s not gonna be that much money on a company scale. If you own the land of
tens of thousands of the most desirable locations in the world and charge your operators massive
leases though, well, now you’re talking. This is magnitudes more profitable than selling burgers
and it’s evident in McDonald’s market cap. They’re worth over 4 times more than the 2nd largest
restaurant chain, Chipotle, and they’re worth almost 20 times more than Domino’s. This isn’t to
say that McDonald’s is 20 times more popular than Domino’s or that they sell 20 times more food,
but it does mean that their business is 20 times more attractive for investors. While this model is
brilliant for investors, it hasn’t been all that friendly for operators especially over
the past few years because of the real estate boom. Right at the beginning of the pandemic,
the Fed cut interest rates to 0% which led to real estate across the country going absolutely
wild. And given that McDonald’s is a real estate business, I don’t think you’d be surprised to see
that McDonald’s total assets also went wild. But, this didn’t exactly sit well with operators. Here
they were struggling to pay cashiers and burger flippers minimum wage during one of the worst
hospitality crises ever while McDonald’s was doing better than ever. Of course,
you can argue that all of this is in the fine print and operators should look into
all aspects of the franchise before signing and all of that’s true. But with that being said,
it’s also natural for people to get mad in such a situation. When you sign up for a franchise, you
expect to be partners with the company. You expect to share in the good times and the bad times. But,
in McDonald’s case it seems like the partnership is cleverly structured such that all of the risk
of running a low margin fast food business lies on the operator. And for many operators,
the pandemic was the eye opener they needed to see the partnership for what it really
was. And now that things have finally stabilized on their side as well, they want out.
UGLY BREAKUP:
If these one sided policies weren’t a good enough reason to leave, yet another reason to leave is
that modern generations aren’t as eager to get into the fast food business. Traditionally, many
McDonald’s locations are run almost like a family business. A family might own a few locations in
their home town that they’ve pass down generation after generation, but for the first time,
the new generation doesn’t want in. It’s not just that McDonald’s franchisee policies aren’t that
great but also that there’s way more opportunities out there thanks to the internet. If you’re gonna
go down the partner with a big company approach, why partner with a fast food company when you can
partner with a tech company. You can become a Google AdWords partner or a YouTube partner or
an Amazon Affiliate marketer or an FBA seller. The options are basically endless online. Also,
you don’t even need to go down the entrepreneurial route. In the western world, you don’t have to run
a business to make a $150,000 per year. There’s plenty of jobs that pay the same or more without
the stress of running a full on restaurant. So, naturally, despite putting in decades
into the business, many families want out. These families would of course prefer an amicable split,
but McDonald’s is making this rather difficult as well. First of all, they don’t even question about
why you’re leaving which is quite surprising. I mean, if you’re trying to cancel a simple cell
phone plan, you’ll run into 4 sales reps asking you why you’re leaving and trying to convince you
to stay. But, at McDonalds, not a single persons asks operators why they’re leaving which simply
strengthens the idea that they don’t really care about their operators. That’s quite a shame but
the bigger disappointment for many operators is that they don’t even get to choose who they hand
off their location to. If you spend 30, 40, 50 years building up a location, it would make sense
that you would want to hand off the location to someone you know and trust, but McDonald’s
is often blocking outright. You see, on paper they have the right to first refusal meaning.
Traditionally, this wasn’t enforced very strictly, but given that many operators are starting to
take a stand against McDonald’s, McDonald’s has resorted to leveraging this right more
aggressively. This way, they can route the stores to more passive investor operators but that just
makes the situation worse for all of remaining everyday operators. All of this is leading to
operators not even missing the business that they worked on for decades. And as more and more
operators start feeling this way, the McDonald’s operator exodus is only gonna get worse.
THE FUTURE OF MCDONALD’S:
For franchises, it’s usually the operators that can make or break the business. McDonald’s has
cleverly structured their business to minimize impacts from unhappy operators, but even this
will only shield them so much. At the end of the day, if operators drop the ball on running these
stores, people will have a worse experience at McDonald’s and they will come less often.
Eventually, this would lead to locations becoming unprofitable meaning that operators won’t be able
to pay McDonald’s their cash cow lease payments. And if a location is already performing poorly,
it’s just gonna be even harder to bring in another operator and try to turn things around especially
if that operator isn’t all that happy to be there either. McDonald’s isn’t quite at that point,
but given that 28% of stores were sold off or shutdown within past couple of years,
it won’t take long for things to get that bad if McDonald’s doesn’t take any action. So, I think
it’s in McDonald’s best interest to get on the good side of their operators as soon as possible
unless they want to continue facing this mass exodus and ruin their business in record time,
but that’s just what I think. Do you like McDonald’s? Comment that down below. Also,
drop a like if you think that McDonald’s operator policies are brilliant but also
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