The Impact of McDonald's Real Estate Strategy on its Success

In the wake of Russia's aggressive incursion into Ukraine, McDonald's made a significant move by exiting the Russian market. The renowned burger chain sold its 850 restaurants to a local franchisee, resulting in a $1.4...

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In the wake of Russia's aggressive incursion into Ukraine, McDonald's made a significant move by exiting the Russian market. The renowned burger chain sold its 850 restaurants to a local franchisee, resulting in a $1.4 billion charge against its earnings. The new name of the Russian branch is "Tasty and That's It," reflecting the straightforward nature of its offerings. This decision marks the end of an era for McDonald's in Russia, a country that played a vital role in the company's expansion into new markets.

The Moscow Arrival and Lessons Learned

On January 31st, 1990, McDonald's made its grand entrance into Moscow, marking a historic moment in fast-food history. This event symbolized Russia's opening to the Western world, with over 30,000 visitors flocking to the restaurant on its first day. McDonald's encountered unique challenges in Russia, which eventually shaped its successful business model.

Control of Franchisees

When McDonald's first entered Russia, it faced the task of establishing a supply chain for its 300 distinct ingredients. With the absence of private businesses to meet its requirements, McDonald's built a $50 million factory, aptly named The McComplex, just outside Moscow. This factory supplied everything from buns and lettuce to frozen fries and beef. Not until 2010 did McDonald's fully outsource its supply chain in Russia, which facilitated the smooth transition to the current franchisee.

Real Estate Deals

In a remarkable display of eagerness, Russia agreed to an extraordinary deal to entice McDonald's into the country. After 14 years of negotiations, McDonald's secured the first Moscow location for the equivalent of just 1 ruble per square meter per year, with a lease term of 49 years. Even attempts to renegotiate this deal over the years failed. This exceptional agreement proved to be incredibly beneficial for McDonald's, as it eventually led to lucrative real estate ventures that continue to generate substantial revenue.

McDonald's Real Estate Holdings

Today, McDonald's holds a vast and valuable portfolio of real estate assets. Approximately 55% of the land under its locations is owned, with long-term leases encompassing the remainder. Furthermore, the company owns 80% of its buildings. In total, these real estate holdings account for nearly 80% of McDonald's total assets. This makes the fast-food chain resemble an apartment building landlord, collecting rent from its franchisees.

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The Lucrative Real Estate Model

While Ray Croc is often associated with McDonald's success, it was Harry J. Sonneborn, the company's president from 1955 to 1967, who devised the highly profitable real estate model. Croc's initial approach involved extracting money from franchisees through various means such as franchise fees, escalating royalty payments, and selling marked-up supplies. However, Sonneborn proposed a more substantial level of control by transforming McDonald's into a landlord.

In 1956, Croc and Sonneborn launched McDonald's Franchise Realty Corp and began acquiring real estate to lease to franchisees with a 40% markup. This new arrangement allowed McDonald's to maintain control over its franchisees. If franchisees failed to comply with the company's guidelines, they risked breaching their lease agreements and facing eviction.

From the perspective of Wall Street investors, Sonneborn famously stated, "We are not...in the food business. We are in the real estate business. The only reason we sell $0.15 burgers is because they are the greatest producer of revenue from which our tenants can pay us rent." This bold statement captured the essence of McDonald's successful real estate model.

In 2021, McDonald's generated $13.1 billion in revenue from franchisees, with rent accounting for 64% ($8.4 billion) and royalties making up the remaining 36% ($4.6 billion). At the individual level, franchisee sales contribute 8-15% toward rent. Overall, rent represents a significant portion of McDonald's total revenue, making up 35% of its overall earnings.

The Franchise Model's Advantages

The franchise model has proven to be immensely profitable for McDonald's. The company boasts an impressive 82% operating margin for its franchisee-run stores, compared to just 18% for its company-owned locations. As a result, McDonald's has strategically prioritized franchisees, who account for a staggering 93% of its 40,000+ locations worldwide.

Company-owned stores serve as testing grounds for new ideas and products before they are rolled out to franchisees. Franchise agreements typically span 20 years, allowing McDonald's to establish stable and long-lasting partnerships. The company meticulously selects prime real estate locations based on traffic analysis, walking patterns, and census data.

An ideal McDonald's location encompasses over 50,000 square feet, occupies a corner or corner wrap with signage on two major streets, features a signalized intersection, has a build height of 23 feet, and has the potential for a parking lot.

The Secret Sauce of McDonald's Real Estate Strategy

McDonald's unique real estate strategy hinges on the interplay between fixed rate property financing and variable income from franchisees. With royalties accounting for 4% of sales, coupled with advertising fees, McDonald's capitalizes on rising sales and prices to capture revenue growth. As a result, the company benefits from sales upside while keeping its largest financial outlay fixed.

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The Unyielding Success of McDonald's Real Estate Business

In the early 2010s, there were calls for McDonald's to spin off its real estate business into a real estate investment trust (REIT). However, the company ultimately decided against this move due to the complexity of the deal and changes to the tax code that made such a spin-off less advantageous. Yet, the real reason behind this decision likely lies in the fact that Sonneborn's real estate model remains an incredibly successful and highly profitable business strategy.

McDonald's has built an empire, relying not only on its delicious burgers and fries but also on the strategic management of its extensive real estate holdings. As the company continues to thrive in the global fast-food industry, its success story serves as a testament to the power of innovative business models and the long-lasting impact of well-executed real estate strategies.

Additional Sources: McDonald's 2021 annual report, Strategy Story

For related content, check out this viral fast food thread: A former Wendy's pricing manager breaks down the economics of a single fast food store. Among the highlights from the Twitter thread, the "30/30/30 rule" reveals the balanced cost breakdown for successful stores, with 30% dedicated to wages, 30% to site costs (utilities, rent, maintenance), and 30% to food costs. The remaining 10% accounts for profits and franchise fees. The thread also explains the profitability of drinks and fries, the pricing dynamics of ground beef, and uncovers intriguing advertising hacks employed by fast-food chains.

And here are some light-hearted memes for your enjoyment:

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