Brothers Richard and Maurice McDonald opened the first restaurant bearing their names in San Bernardino, California, 1940. Their early innovation was the application of assembly lines in fast food production, which enabled them to reduce variability and increase consistency in the food they produced. This in turn reduced costs and time for preparation. But the transformation of McDonald’s into a franchise corporation did not happen until Ray Croc came in 1955 (as chronicled in the movie, The Founder).
Currently, McDonald’s offers similar menus in more than 122 countries: the same Big Mac, milkshakes, and golden fries cooked to perfection (with a little help from chemical agents). McDonald’s is so ubiquitous that its burger is used as a measure of purchasing power parity between different countries (see the Big Mac Index).
But we are not here to discuss McDonald’s food, we are here to talk about how the company makes money.
You can’t build an empire off a 1.4% cut of a 15-cent hamburger – you build it by becoming a real estate empire
The modern-day McDonald’s generates its revenue primarily from two sources: (1) sales from its own restaurants and (2) revenues from restaurants owned and operated by its franchisees. See Figure 1 for the quarterly trend from the past 15 quarters. As of the last quarter, the company generated 42% revenue from its own restaurants and 57% from franchised restaurants (not owned by the company).
Figure 1: Restaurant revenue of McDonalds by segment. Source
By the end of 2020, there were more than 40,000 McDonald’s globally, of which, 93% were not owned by the company (although the company does not own those restaurants, it owns most of the land the restaurants are built on). There are two reasons why the vast majority of restaurants are not owned by the company:
The first reason is that although the revenue per store is much smaller for franchised restaurants, these restaurants are far more profitable. See Figure 2 for the quarterly trend of operating margins. Franchised restaurants generate ~82% operating margins vs. ~19% for company-operated restaurants.
McDonald’s charges its franchisees ~15% of gross sales for services and rent. The rent is the largest component of the high margin revenue. As a global company, with more than $40 billion in real estate portfolio, McDonald’s can acquire highly sought after locations and negotiate low-cost long term leases on behalf of its franchisees. It then charges franchisees rent in the form of a cut of gross sales. In other words, McDonald’s converts fixed investments into variable revenue. The whole purpose of the food it sells is to generate rent on land it owns. It’s a REIT wrapped as a restaurant business.
Figure 2: McDonald’s operating margin by segment. Source
Read more about Domino’s and other factors affecting McDonald’s at our Vested blog.