How McDonald's Really Makes Money

Summary

This video explores how McDonald's thrives during economic recessions due to its unique business model. While known for fast food, McDonald's is primarily a real estate company, earning most of its profits through renting properties to franchisees. This strategy, combined with its strict franchise requirements, ensures stable revenue even during downturns. The video highlights how this real estate focus helps McDonald's stay 'recession-proof' and why its franchisees consider it a safe investment. Viewers are encouraged to learn more with Skillshare courses, including lessons on investing and building a YouTube business.

Takeaways

• 🎓 McDonald's is a real estate company at its core, making most of its profits from rent rather than food sales.
• 🏠 McDonald's owns $39 billion worth of property, making it one of the world's largest real estate holders.
• 📈 During economic downturns, McDonald's performs exceptionally well due to its real estate model and consistent consumer demand for cheaper food options.
• 🍔 Despite being a fast-food chain, 64% of McDonald's franchise revenue in 2019 came from rent.
• 🤝 Franchisees must lease McDonald's locations and follow strict operational guidelines, making it a low-risk, high-cost investment.
• 💼 McDonald's scouts prime real estate locations, ensuring its franchises are placed in high-traffic areas for maximum profitability.
• 📊 The company benefits from tax breaks on property depreciation, despite increasing property values over time.
• 💡 McDonald's has been suggested to split its real estate business into a separate company, but it declined, valuing the synergy between real estate and fast food.
• 🏦 McDonald's franchisees typically pay 8.5-15% of their sales in rent, which is higher than other fast-food chains.
• 🎓 Skillshare sponsors the video, offering a free trial to the first 1000 viewers to access a wide range of educational courses.

Q & A

What is the main sponsor of the video and what offer is presented?

The main sponsor of the video is Skillshare. The first 1000 people to use the link in the description can watch the creator's course and thousands of others with a free trial of Skillshare Premium.

How do recessions typically affect consumer behavior?

During recessions, consumers tend to prioritize essential goods and services, opting for cheaper alternatives. Industries like travel, tourism, leisure, and hospitality are hardest hit, while others like fast food may benefit as consumers look for more affordable options.

How did fast food chains like Subway and KFC perform during the 2008 recession?

From 2008 to 2010, Subway added nearly 6,000 new locations, while KFC added around 300. These fast food chains performed well because they provided cheaper food options during the economic downturn.

Why is McDonald’s considered ‘recession-proof’?

McDonald’s is considered ‘recession-proof’ due to its unique business model, which prioritizes real estate over food sales. It owns a vast amount of property and makes a significant portion of its revenue from rent paid by franchisees.

How does McDonald’s make most of its franchise revenue?

Unlike other fast food giants, McDonald’s earns the majority of its franchise revenue from rents, not food sales. In 2019, 64% of its $11.6 billion franchise revenue came in the form of rent.

What role does real estate play in McDonald’s business model?

Real estate plays a central role in McDonald’s business model. The company buys valuable properties and leases them to franchisees at above-market rates, ensuring a steady revenue stream from rents even during economic downturns.

Why do McDonald’s franchisees agree to pay higher rents than other franchises?

McDonald’s franchisees agree to pay higher rents because it is seen as a safe investment. McDonald’s stringent requirements reduce risk, ensuring franchisees have good locations, high standards, and strong business support, which results in more stable returns.

What training does McDonald’s provide to its franchisees?

McDonald’s provides its franchisees with comprehensive training at its ‘Hamburger University,’ where they learn all the necessary business skills and operational knowledge to run a McDonald’s franchise.

Why hasn’t McDonald’s split off its real estate holdings into a separate company?

In 2015, some investors suggested McDonald’s split its real estate holdings into a separate company. However, McDonald’s decided not to, believing that the efficiency of its business model comes from managing both real estate and food services together.

How does McDonald’s benefit from real estate during economic downturns?

During economic downturns, McDonald’s benefits from owning real estate as property prices tend to remain stable, and franchisees are still contractually obligated to pay rent regardless of their sales, ensuring continued income for McDonald’s.

Outlines

00:00

💼 McDonald's: A Recession-Proof Business Model

The video begins by explaining how McDonald’s thrived during the 2008 recession while many industries such as travel, leisure, and manufacturing suffered. Fast food chains like Subway, KFC, and especially McDonald's benefited from consumers opting for cheaper alternatives. McDonald's, in particular, had impressive financial results, continuing its growth and outperforming competitors. One key reason for its success is its business model, which focuses on real estate rather than just fast food. In 2019, McDonald's held $39 billion in property, making it one of the largest real estate holders globally. This strategy enables McDonald’s to profit from rents paid by franchisees.

05:00

🏢 McDonald's Franchise Model: Rent over Burgers

McDonald’s operates primarily as a real estate company. Unlike other fast food giants, most of its franchise revenue comes from rent rather than food sales. McDonald’s expertly selects prime locations and purchases properties at favorable terms due to its size. Franchisees sign long-term contracts, ensuring McDonald's has tenants paying above-market rents. This model gives McDonald’s leverage over its franchisees, who must comply with strict operational guidelines but benefit from a reliable and safe investment. The franchisees' success is largely guaranteed due to McDonald's demanding standards and proven business model.

📈 McDonald's Success: Safe Investment and Franchise Stability

The video explains how McDonald’s franchise model is an attractive and stable investment. The average McDonald’s location earns $2.7 million annually, with franchisees making $154,000 in take-home profit. The strict control McDonald’s maintains over its franchisees and locations reduces risk and ensures consistent performance. Franchisees are rigorously trained at ‘Hamburger University,’ ensuring they meet the company’s high standards. This training and oversight create a secure investment environment, making McDonald’s franchises less risky compared to other fast food chains.

🏠 Real Estate Advantage: Tax Breaks and Long-Term Value

Owning property is more lucrative for McDonald’s than selling burgers. The company benefits from U.S. tax laws that provide breaks for property depreciation, even as those properties often increase in value over time. This strategy has made McDonald’s one of the few companies to grow during the 2008 recession and a member of the ‘Dividend Aristocrats’ — companies that have raised their dividends for 25 consecutive years. Even during crises, like the COVID-19 pandemic, McDonald’s shifts the financial risk to franchisees, who are still obligated to pay rent, ensuring McDonald’s revenue stability.

🔀 McDonald's Real Estate Strategy: A Unique Business Model

McDonald’s business model focuses on owning real estate, which provides long-term financial stability. While some investors suggested splitting the company into a separate real estate business, McDonald’s rejected the idea, citing the synergy between its property holdings and franchise operations. This dual approach — fast food and real estate — allows McDonald’s to remain efficient and highly profitable. The video concludes by encouraging viewers to explore Skillshare courses on investing and business, with the first 1,000 people able to get a free trial.

Keywords

💡Recession

A recession refers to a period of economic decline, often characterized by reduced consumer spending, high unemployment, and business closures. In the video, the speaker explains how recessions lead to predictable changes in consumer behavior, with people opting for cheaper alternatives such as fast food, which can actually benefit chains like McDonald's. The video uses the 2008 financial crisis as an example, highlighting how McDonald's thrived during this period.

💡Franchising

Franchising is a business model where independent owners operate stores or locations under a brand’s name, paying fees and adhering to certain rules set by the brand owner. McDonald’s uses this model to expand globally, with 85% of its locations owned by franchisees. The video emphasizes that McDonald’s profits from its franchisees primarily through rent, making franchising a crucial part of its business strategy.

💡Real estate

Real estate, in the context of McDonald's, refers to the company’s practice of owning land and property where its restaurants operate. McDonald’s is described as more of a real estate company than a fast food chain, profiting primarily from rents paid by franchisees. The video highlights that McDonald’s owns billions of dollars in real estate, giving it financial stability and making it ‘recession-proof’.

💡Franchise Agreement

A franchise agreement is a contract between McDonald's and the franchisee, outlining the terms of operating a McDonald’s location. This agreement includes details such as rent, royalties, and business operations, ensuring that franchisees adhere to strict company standards. The video mentions that these agreements are highly beneficial to McDonald's, ensuring a steady income stream through rent, regardless of a restaurant’s performance.

💡Depreciation

Depreciation refers to the reduction in the value of an asset over time, especially due to wear and tear. The video explains that McDonald’s benefits from tax breaks on depreciation, even though the value of its real estate holdings may actually increase. This tax advantage is part of what makes the company’s real estate strategy so profitable.

💡Hamburger University

Hamburger University is McDonald’s internal training program for franchisees, teaching them the skills and knowledge necessary to operate a McDonald's restaurant. The video emphasizes that this rigorous training helps ensure consistency across locations and reduces risk for franchisees, making McDonald’s a safe investment.

💡Recession-proof

The term 'recession-proof' describes businesses that are resilient during economic downturns. McDonald’s is described as recession-proof in the video because of its ability to thrive during tough economic times, largely due to its real estate model and the steady income it generates from rent, rather than relying solely on food sales.

💡Dividend Aristocrats

The Dividend Aristocrats are a group of companies that have consistently increased their dividends for 25 consecutive years. McDonald's is part of this prestigious group, which is highlighted in the video as evidence of the company's financial stability and its ability to provide returns to shareholders, even during recessions.

💡Return on Equity (ROE)

Return on Equity (ROE) is a financial metric that measures a company's profitability in relation to shareholders’ equity. The video mentions that McDonald's had a 29% ROE in 2008, showcasing its ability to generate significant profits for investors despite the economic downturn. This highlights the strength of McDonald's business model.

💡Fast Food Industry

The fast food industry consists of businesses that provide quick, affordable meals to consumers. While many industries suffer during recessions, fast food chains like McDonald's tend to benefit, as people turn to cheaper meal options. The video uses this context to explain how McDonald's profits not just from food sales, but primarily from its real estate and franchising model.

Highlights

Skillshare offers a free trial of its Premium membership for the first 1000 people who use the link in the video description.

During recessions, consumer behavior changes predictably, and businesses in unnecessary industries like travel, tourism, and manufacturing are hardest hit.

Fast food chains like Burger King and Wendy’s often perform better during recessions because consumers opt for cheaper alternatives.

Between 2008 and 2010, Subway added nearly 6,000 locations, while KFC added around 300 during the same period.

McDonald's was the standout fast food performer during the 2008 recession, opening 600 new locations and achieving a 29% return on equity.

McDonald's is not just a fast food company but primarily a real estate company, owning $39 billion in property and equipment in 2019.

McDonald's makes most of its franchise revenue from rent, not food sales, with 64% of its $11.6 billion franchise revenue in 2019 coming from rents.

The company strategically buys properties at high-traffic intersections to ensure success for franchise locations.

Franchisees must pay above-market rates for rent, often between 8.5% and 15% of sales, making McDonald's a profitable landlord.

McDonald's success is partly due to its strict franchise model, which reduces risk for franchisees while ensuring they meet high standards.

McDonald’s trains its franchisees at 'Hamburger University,' ensuring they have the necessary skills and knowledge for success.

McDonald’s real estate model provides long-term stability and tax advantages, making it a safer business compared to the fast food industry.

Despite suggestions to split its real estate and fast food businesses, McDonald’s believes its efficiency comes from managing both simultaneously.

McDonald’s is part of the 'Dividend Aristocrats,' companies that have increased their dividends for 25 consecutive years.

Skillshare offers courses on investing, YouTube marketing, and logo design, which can help viewers apply the business concepts discussed in the video.

Transcripts

Thanks to Skillshare for sponsoring this video.

The first 1000 people to use the link in the description can watch my course and thousands

of others with a free trial of Skillshare Premium.

During recessions, consumer behavior tends to change in fairly predictable ways.

The hardest-hit businesses are, of course, the most unnecessary.

Travel and tourism, leisure and hospitality, and manufacturing.

Other companies actually stand to benefit.

Like, fast food.

Stomachs don’t respond to economic downturns, but smaller bank accounts do opt for cheaper

alternatives, which is why chains like Burger King and Wendy’s often perform better than

average during recessions.

From 2008 to 2010, for example, while other businesses closed or downsized, Subway, added

nearly 6,000 new locations.

KFC added around 300 in roughly the same period.

One company, however, stands out as the clear fast food winner of 2008: McDonald’s.

That year, it continued its 55-month long streak of same-store sales increases with

even better performance than before the recession, while opening 600 new locations, and with

an impressive 29% return on equity.

Some of this is for obvious reasons: During that time, consumers were simply eating cheaper

food.

But there’s also another reason McDonald’s is what some analysts call “recession-proof”:

McDonald’s is, first and foremost, a real estate company.

Glancing at its 2019 balance sheet, one number, in particular, should grab your attention:

$39 billion.

That’s the current value of all its property and equipment before it reports depreciation.

That would technically make it the fifth-largest real estate holder in the world, measured

by total assets.

Cover the name ‘McDonald’s’, and this might look like the financial statement of

any other boring big-name real estate developer.

Like Burger King and Subway, the company was able to grow so fast and reach so many countries

around the world through franchising.

85% of its restaurants are owned by someone who essentially ‘leases’ the McDonald’s

name and brand, in exchange for a considerable fee.

What makes the company so unique is that, unlike other similar fast-food giants, McDonald’s

makes the majority of those franchise revenue from rents, not burgers.

To be more precise, in 2019, 7.5, or 64%, of its 11.6 billion dollars in franchise fees

came in the form of rent.

Here’s how it works:

Because McDonald’s has decades of experience buying and selling properties, it knows the

precise ingredients of a successful location.

It shops around usually for intersections between two high-traffic roads and buys space

in whichever corner has the most parking.

The ideal space is around 50,000 square feet, 4 and a half thousand for building space.

The intersection should also have traffic lights.

It then buys the property with long-term fixed interest rates.

Its huge existing property holdings provide it with the most favorable deals.

Then, when someone applies to operate their own McDonald’s location, they sign with

the company a Franchise Agreement — stipulating nearly every detail of how the business will

operate — from how the burgers are cooked, to the hours of operation.

For example, they can only purchase from an approved supplier, who may or may not be the

best or cheapest option.

The franchisee — that is, the local owner — generally makes a total upfront investment

of $1-2 million for a single location, including an initial down payment paid in cash, one-time

franchise fee of $45,000, and a percent royalty of every month’s revenues.

These, usually 20-year contracts, also have the unusual but highly consequential stipulation

that the restaurant be located at that specific address — the one McDonald’s, the corporation,

just bought.

In other words, McDonald’s instantly has a tenant, and one who will always pay above-market

rates.

Depending on the value you attribute to good location scouting, you might characterize

this as a valuable service, or, a ruthless business tactic.

Indeed, one franchise union found that the average franchise tends to pay an average

of 6-10% of its sales in rent, while McDonald’s franchisees pay 8.5-15%.

And if a location fails to perform as expected, McDonald’s can simply find a new franchisee

for that location after the contract has expired, or sell the land to someone else entirely,

likely at a significant profit.

So, why do franchisees agree to these stringent requirements?

Simply put: because it’s seen as an incredibly safe investment.

The advantage of this model is that while the absolute numbers are abnormally large

— the fees, the initial startup costs, and even the annual revenues — the odds of success

are relatively high.

For example, the average location makes $2.7 million in sales every year, with a respectable

but not incredible, all-things-considered, $154,000 in final take-home profit.

But precisely because McDonald’s is so demanding, can it be such a solid investment.

Sure, applicants have to meet high standards to become franchisees and once they do, they

have little control over their own business, but all these factors also reduce their risk.

While other franchises may have fewer requirements, they also come with greater risk.

The owner of a McDonald’s can be pretty sure they’re qualified for the job, have

a good location, and are meeting customer’s standards, because otherwise, they wouldn’t

be allowed in the first place.

McDonald’s trains its franchisees in what it calls “Hamburger University” — the

company’s internal system of teaching business owners all the skills and knowledge they need.

For McDonald’s, the benefits of owning property are far greater than just an additional source

of revenue.

It’s no exaggeration to call it an entirely different business model: It understands that

real estate is a far better business than hamburgers.

The first reason is just a function of American tax law — which offers heavy tax breaks

for depreciation, even while that same property may increase in value over time.

The biggest advantage is the long-term stability of property prices.

Along with Walmart, McDonald’s was one of the only two stocks in the Dow Jones Industrial

Average to increase in value in 2008.

It’s also one of the 60 or so members of the so-called “Dividend Aristocrats” — stocks

that have increased their dividends annually for 25 consecutive years.

Recessions are only a welcome opportunity to buy up discounted properties.

When things are truly catastrophic — like during a pandemic — the real estate model

outsources risk to franchisees — who are contractually obligated to pay a minimum amount

of rent regardless of sales.

All of this is reflected in the upward trend of franchised McDonald’s locations and downward

trend of the few remaining company-operated locations.

If anything, McDonald’s is actively trying to remove itself from the fast food industry.

But this naturally raises a question: If McDonald’s makes a huge portion of its profits in the

form of rent, and managing real estate is a fairly separate skill from creating new

McThings, why not split-off the real estate holdings into a new company?

Do that, and you have a very stable, active, and profitable real estate investment trust

— one immune from the variability of fast food and/ changing consumer appetites.

A group of investors suggested this very idea in 2015.

The company, however, decided not to, believing that its property model is what makes it unique,

and that its remarkable efficiency is a function of doing both.

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