Must-know: An overview of McDonald's (Part 2 of 15)
McDonalds’ business segments
McDonalds (MCD) and its competition, Yum! Brands (YUM) and Burger King (BKW), use the franchise model as well as the company-operated model—the two most common models in a restaurant industry, the PowerShares Dynamic Leisure and Entertainment ETF (PEJ) and the PowerShares Dynamic Food & Beverage ETF (PBJ )— to operate their restaurants across the world. McDonalds categorizes its markets in four segments—U.S., Europe, Asia or Pacific, Middle East, and Africa (or APMEA), and other countries and corporate (or OCC).
About 81% of McDonalds’ restaurants are franchised and only 19% are company owned restaurants. Under the franchising umbrella, McDonalds has a conventional franchise and license agreement. Under the conventional franchise agreement, McDonalds provides capital for location, which it then owns. Each franchise provides portions of capital for seating, equipment, decor, signs, and re-investments in the business. Under the license agreement, the licensees provide capital for the location.
Revenue breakdown
McDonalds divides its revenues into company-operated and franchised. In the previous chart, McDonalds earned 67% of its revenues from company owned restaurants at the end of December, 2013. McDonalds earned only 33% of revenues from franchise. Revenue contribution was highest from Europe, at 43%, under the company owned model and highest from in the U.S., at 47%, under the franchise model. Let’s look at why franchises contribute to only one third of the revenues and whether it’s better than company-owned.
Franchise margins
With the franchise model, McDonalds earns revenues from rents and royalties based on the percent of sales and initial fees from new restaurants. McDonalds also earns revenues from a new franchised term, which could last for as much as 20 years. With the licensing model, McDonalds doesn’t earn revenues from rent, although it takes its share of revenues on a percentage basis. Due to low commodity and operating costs, franchises have higher operating profit margins. As of fiscal year 2013, franchised margins,calculated as revenues from franchise less the company’s occupancy cost—rent and depreciation over revenues from franchise, were 82.4% compared to company operated margins, which were 17.5%.
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