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Franchise Model McDonald's

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Business Studies

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.

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:

  • An annual fee from the franchisee. This fee will depend on the likely profitability of the franchise site or area.

  • Startup and operations fees. The franchisor can sell specified equipment, goods and consumables to the franchisee for a profit.

  • Rentals fee for business venues. If the franchisor owns the property that the franchise operates from then rent will form part of the regular income stream.

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 burgers 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.

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.

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.

Franchise Model McDonald's

According to the latest annual report of McDonald's, the company has a 93% success rate for its franchises.

Having a McDonald's franchise is profitable.

Under the traditional McDonald's franchise arrangement, the company normally owns the land and building for the restaurant or secures a long-term lease for that store location. The franchisee then pays for the equipment, and intellectual property in addition to rent.

According to McDonald's, the average restaurant in the USA has sales of $ 2.7M per year.   

Final Franchise Model McDonald's Quiz

Question

What year was McDonald's founded? 

Show answer

Answer

1940 

Show question

Question

Where was McDonald's founded? 

Show answer

Answer

California in the United States. 

Show question

Question

What year was the “Golden Arch” created? 


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Answer

1953 

Show question

Question

True or False? 

The principles of the modern fast-food restaurant were introduced into McDonalds in 1948 using what they called the "Speedee Service System". 

Show answer

Answer

True 

Show question

Question

True or False? 

Today McDonalds is the largest restaurant chain in the world with over 38,000 restaurants in over 100 different countries.

Show answer

Answer

True

Show question

Question

True or False? 

McDonald's has continued to grow during its history using innovations such as the drive-thru in 2001? 

Show answer

Answer

False

McDonald's introduce the drive-thru in 1961 

Show question

Question

What is a franchised business?

Show answer

Answer

A franchised business is an alternative business model where an independent individual or business becomes a franchisee. 

Show question

Question

True or False? 

The franchisee carries much of the financial risk such as an economic downturn. 

Show answer

Answer

True

Show question

Question

True or False? 

Income streams are not guaranteed whilst the franchisee is still operating. 

Show answer

Answer

False

Show question

Question

True or False? 

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. 

Show answer

Answer

True

Show question

Question

True or False? 

The McDonald's franchise system is designed so that on the one hand it can be highly rewarding to franchisees, whereas on the other hand its financial rules of entry and ongoing obligations are significant. 

Show answer

Answer

True 

Show question

Question

True or False? 

The model focuses on ensuring that a franchisee is able to sustainably run a franchise for 15 years. 

Show answer

Answer

False

It is 10 years 

Show question

Question

How much does a McDonald's franchise owner make a year? 

Show answer

Answer

According to McDonald's, the average restaurant in the USA has sales of $ 2.7M per year.  

Show question

Question

How does McDonald's use franchising? 


Show answer

Answer

Under the traditional McDonald's franchise arrangement, the company normally owns the land and building for the restaurant or secure a long-term lease for that store location. The franchisee then pays for the equipment, signs, and seating areas. 

Show question

Question

 What percent of McDonald's franchises succeed? 


Show answer

Answer

According to the latest annual report of McDonald's, the company has a total of 93% of its franchise success rate. 

Show question

Question

Is McDonald's profitable?


Show answer

Answer

Having a McDonalds franchise is profitable, this could be up to 6% profit margin.

Show question

Question

True or False? 

The franchise has to pay McDonald's between 12.25 per cent and 21 per cent of the restaurant's net sales. This includes a 5% franchise fee, 4.3% contribution to the marketing fund and royalties. 

Show answer

Answer

True

Show question

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