What Makes These Arches Golden?
Ted is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
McDonald's (NYSE: MCD) is the largest fast-food chain by sales in the world. It has the 7th-best global brand according to Interbrand, and Entrepreneur Magazine ranks it third on its list of top 100 franchises; no other quick-service burger chain made Entrepreneur's list. But a great brand and popular franchises are not what make this chain the best in its industry. Instead, McDonald's secret to success lies in a much less visible aspect of its corporate system.
Best Economics in Industry
McDonald's has more sales per restaurant and earns a higher profit per dollar of sales than its competitors. Each of its restaurants brings in about $2.6 million in sales each year, compared to $1.4 million for Wendy's (NASDAQ: WEN) and $750,000 for Jack in the Box (NASDAQ: JACK). In addition, McDonald's EBIT margins are much higher than its competitors. McDonald's averaged a 23.6% EBIT margin from 1990-2011, while Wendy's, Jack in the Box, and Burger King earned low-teens EBIT margins.
But, despite earning higher EBIT margins, McDonald's does not earn higher restaurant margins. Its restaurants average 17.3% margins compared to 16% for Jack in the Box and Wendy's, though Burger King is closer to 12%. This suggests that McDonald's operating structure is more efficient than its competitors and is the source of its higher profitability.
Three Keys to Success
There are three key reasons that McDonald's is the most profitable quick-service burger chain in the world.
(1) Consistent Offering. When you walk into a McDonald's in Thailand, you can expect to get the same burger that would have been served had you been in the United States. The company has more or less boiled restaurant operations down to a formula that results in the same offerings made to the same specifications in all of its restaurants across the globe. Since each restaurant operates according to the same instruction book, each restaurant's cost structure should be roughly the same. This allows McDonald's to quickly implement cost-improvements across the entire system.
(2) Real Estate. McDonald's requires franchisees to undertake a rigorous location analysis before granting approval. As a result, other fast-food chains often locate their restaurants near McDonald's. But, in addition to strong customer demand in a location, McDonald's requires its restaurants to leverage points of distribution in a cost-effective manner. This has resulted in a matrix of restaurants spanning the globe that are all quickly and easily served by distribution centers.
(3) Training Programs. The key to offering consistent quality across the globe is to give employees the training they need to replicate the McDonald's system in each restaurant. As part of the company's training program, employees simulate extreme scenarios that might occur on any given day, such as a busload of people unexpectedly arriving at the restaurant. This type of training allows restaurant operators to quickly share and implement optimization strategies.
McDonald's moat is not impenetrable; competitors will eventually implement each of the foregoing keys to success. In order to maintain market dominance, McDonald's must continuously focus on being the best in the world at quickly serving hamburgers. The company lost focus in the early part of last decade; it wanted to branch out into as many customer meals as possible, with investments in Chipotle, Boston Market, Donatos Pizzeria, and Pret A Manger. Not only did these investments turn out poorly for the company, but the company also lost focus on the hamburger business and profit margins suffered as a result. However, McDonald's has produced outstanding results for many decades, and will continue doing so for decades in the future.
titans8904 has no positions in the stocks mentioned above. The Motley Fool owns shares of McDonald's. Motley Fool newsletter services recommend Burger King Worldwide and McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!