Nanalyze

Why McDonald’s May Never Use Robots to Flip Burgers

We spend the vast majority of our waking hours trying to figure out the best way to invest in disruptive technologies, but that’s not where we actually allocate the lion’s share of our investments. Instead, our hard-earned dollars can be found in boring industries like insurance or consumer goods which are more likely to provide predictable cash flows in the form of dividends that grow slowly over time. It’s probably the “safest” way we’ve seen to invest in equities, provided that you diversify across industries and hold a large enough number of stocks for diversification. Additionally, we like to invest in large multinational firms to avoid being over-reliant on those crazy Yanks.

Speaking of which, one thing you’ll see in Yankee land is a whole lot of overweight people. At least that’s what one of our Danish MBAs remarked as he experienced a McDonald’s (MCD) drive-through for the very first time in his life. In Denmark, they don’t have drive-throughs, and they’re also crazy enough to believe that big isn’t beautiful, it’s unhealthy. Denmark has a total of 88 McDonald’s outlets, less than 0.02% of the 37,404 total Mickey D’s restaurants that can be found occupying some of the most prime real estate in 120 countries around the world. All those restaurants have collectively helped McDonald’s pay dividends every single year for 42 years, each year more than the last. So how can McDonald’s continue to grow those payments moving forward? Well, they can increase sales or decrease costs.

Increasing Sales or Decreasing Costs?

When it comes to increasing sales, that might come from entering new markets like Kenya, being more clever with advertising spend, or developing new food products to increase sales (think all day breakfasts). When it comes to decreasing costs, the biggest bang for the buck appears to be reducing labor costs. At least that’s the case for franchised McDonald’s restaurants where labor is the biggest expense at 24% of net sales:

McDonald’s Franchise Income Statement

The above numbers were taken from a firm called Janney Capital markets, and we can’t confirm the accuracy of the data nor the date it was published. Still, let’s assume employing humans amounts to 24% of costs. Then, add to that the whole minimum wage debate about paying workers $15 an hour, something that a previous McDonald’s executive said would result in “a job loss like you can’t believe“. This, of course, led to some rumors that McDonald’s may decrease costs by adopting the type of robotics technology we talked about before in our article on A High-Tech Burger Joint of the Future:

Flippy from Miso Robotics – Is this the McRobot of the future?

Astute readers may pick up on the fact that the McDonalds franchise model charges restaurant operators (in the majority of cases) a fee based on revenues, not profits. Why would McDonald’s care about developing robots to flip hamburgers if the franchisees were the only ones to benefit? Well, it could be because not all McDonald’s restaurants are franchises.

One look at revenues from the last quarterly earnings report shows us that McDonald’s receives about half their revenues from franchises and half their revenues from company-owned stores. Then, consider the following:

Of the 37,406 restaurants in 120 countries at June 30, 2018, 34,521 were licensed to franchisees

That means that only 2,885 restaurants (7.7% of total) generate half the revenues for corporate McDonald’s. That number is slowly declining over time, with McDonald’s aiming to have around just 5% of company-owned stores:

McDonald's Franchises Over Time vs. Company-owned Stores

McDonald’s Franchises Over Time vs. Company-owned Stores – Source: Quartz

For the majority of their franchises, McDonald’s makes money on the “franchise fees” they charge franchisee restaurant operators (up-front fees and 4% of sales). Again, if McDonald’s invests in robots to lower labor costs, how will they stand to benefit if their franchise model is to charge a fee based on revenues? One look at their long-term strategy shows that they seem more interested in driving revenues, not decreasing costs for restaurant operators.

The McDonald’s Growth Strategy

Introduced as recently as March 2017, it’s called “The Velocity Growth Plan” and the company says it’s “designed to drive sustainable guest count growth, a reliable long-term measure of the Company’s strength that is vital to growing sales and shareholder value.” Here are the three pillars of the plan:

  • Experience of the Future (“EOTF”). Focuses on restaurant modernization and technology – drive incremental customer visits and higher average check.
  • Digital. Strengthens its relationships with customers through technology (global mobile app, self-order kiosks, curbside pick-up).
  • Delivery. Delivery transactions tend to realize a higher average check and a high customer satisfaction rating.

Looks like it’s all about getting the customer to spend more dollars, something that supports our thesis so far. McDonald’s may not have any incentives to automate the food production aspects of their restaurants, but they do need to increase revenues which have been falling since 2013:

Mickey D's Revenues Over Time

Mickey D’s Revenues Over Time – Source: Statista

That’s something they may be able to rectify simply by expanding into new international markets.

McDonald’s and International Expansion

One metric we can use for measuring McDonalds’ market penetration is “number of stores per capita”. This simply means you divide a particular country’s population by the number of McDonald’s restaurants in said country. If we use the United States as a benchmark of “optimal penetration”, then that number would be around 22,842 (323.13 million people / 14,146 stores = 22,842). That number is incredibly high for other countries out there like China (higher number means lower penetration in this case). China has 577,164 people per McDonald’s restaurant.  That means you would need to open 58,042 McDonalds restaurants in China in order to have the same number of outlets per capita as the United States.

The growth potential in China hasn’t gone unnoticed by McDonald’s who last year announced a partnership with the Chinese which has received regulatory approval. From the McDonald’s press release:

 Termed “Vision 2022,” this strategy aims to drive double-digit sales growth in each of the next five years by increasing the number of restaurants from 2,500 to 4,500, including delivery hub coverage of over 75% of restaurants, by the end of 2022, bringing unparalleled convenience to Chinese customers.

While that may just be the tip of the iceberg for growth potential in China, there are other countries with low penetration just in case the Yanks should piss off the Chinese for some reason. Here are the number of McDonald’s to be found in some large population centers around the world:

  • Vietnam – 92.7 million people – Only 17 McDonald’s restaurants
  • Pakistan – 193 million people – Only 60 McDonald’s restaurants
  • Indonesia – 261 million people – Only 170 McDonald’s restaurants
  • Egypt – 96 million people – Only 100 McDonald’s restaurants
  • Kenya – 48.6 million – Exactly 0 McDonald’s restaurants

Any one of these markets could provide some great international expansion opportunities. There’s also the India chestnut to crack open – over a billion people with only 270 McDonald’s restaurants to serve them veggie burgers. Of course, there are some who say McDonald’s isn’t even in the business of selling burgers, veggie or otherwise. Maybe McDonald’s isn’t a restaurant chain, maybe it’s a real estate company.

Is McDonald’s a Real Estate Company?

Operating research teams can be expensive, especially when you give away your research to everyone for free. That’s why we were glad to see someone else had already performed the heavy lifting on this one. An article by Chase Purdy over at Quartz talks about how McDonald’s is actually a “brilliant $30 billion real-estate company.” In order to understand that statement, we need to understand their franchise model a bit better. For the majority of franchises, McDonald’s uses a “conventional franchise model” which involves buying or leasing property in some of the best locations in the world and then renting it to their franchisees. This means that McDonald’s is receiving a whole lot more than 4% from their conventional franchises. Consequently, they’re more of a commercial landlord than a restaurant operator. They still get paid regardless of how many burgers are sold, and they can always raise the rent for those locations where lots of burgers are being sold.

Conclusions

When it comes to our core investment portfolio, Sleep-Well-At-Night (SWAN) companies like McDonald’s need to be adopting technology to simply just compete. For example, just imagine how much big data they can collect from all those franchises that could be used to gain additional insights on how to increase sales. Just last year, McDonald’s CEO Steve Easterbrook talked about how the company might consider a technology acquisition. In order to keep growing those dividend streams every year, they need to reverse the sliding revenue trend, and technology may provide an answer to the problem. We’re fairly confident that they’ll be able to sort that out, but we’re not sure the answer is robots that flip hamburgers. At least not anytime soon.

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