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McDonald's Restaurants

The route to fast food franchising


Introduction
When the McDonald brothers, Dick and Mac opened their first restaurant
in 1940 in San Bernardino, California, they could never have imagined
the phenomenal growth that their company would enjoy. From extremely
modest beginnings, they hit on a winning formula selling a high quality
product cheaply and quickly. However, it was not until Ray Kroc, a
Chicago based salesman with a flair for marketing, became involved that
the business really started to grow. He realised that the same successful
McDonalds formula could be exploited throughout the United States and
beyond.
There are now more than 28,000 McDonalds Restaurants in over 120
countries. In 2000, they served over 16 billion customers, equivalent to a
lunch and dinner for every man, woman and child in the world!
McDonalds global sales were over $40bn, making it by far the largest
food service company in the world.
In 1955, Ray Kroc realised that the key to success was rapid expansion.
The best way to achieve this was through offering franchises. Today, over
70 per cent of McDonalds restaurants are run on this basis. In the UK,
the first franchised restaurant opened in 1986 - there are now over 1,150
restaurants, employing more than 49,000 people,of which 34 per cent
are operated by franchisees.
This case study examines the success of franchising and investigates the
special three way relationship that exists between the franchisee, the
franchisor and the suppliers.

What is franchising?
McDonalds is an example of brand franchising. McDonalds, the
franchisor grants the right to sell McDonalds branded goods to someone
wishing to set up their own business, the franchisee. The licence
agreement allows McDonalds to insist on manufacturing or operating
methods and the quality of the product. This is an arrangement that can
suit both parties very well.
Under a McDonalds franchise, McDonalds owns or leases the site and
the restaurant building. The franchisee buys the fittings, the equipment
and the right to operate the franchise for twenty years. To ensure
uniformity throughout the world, all franchisees must use standardised
McDonalds branding, menus, design layouts and administration systems.

Advantages to the franchisee


1.

Being their own boss

The Franchise Agreement grants the right to the franchisee to run a


specific McDonalds Restaurant for a set period of time, usually twenty
years. These rights include the use of the McDonalds trademarks,
restaurant decor and designs, signage and equipment layout, the formula
and specifications of the menu items, as well as McDonalds methods of
operating, stock control, bookkeeping, accounting and marketing.
In return, the franchisee agrees to operate the restaurant in accordance
with McDonalds standards of quality, service, cleanliness and value.
McDonalds regularly checks the quality of the franchises output and
failure to maintain standards could threaten the licence. The franchisee
is also expected to become involved in local events and charities. Ray
Kroc believed strongly that a business must be prepared to put
something back into the community in which it operates.
The franchisee, for all the training and support McDonalds offers, is
running his or her own business. They fund the franchise themselves and
therefore have much to lose as well as gain. This makes them highly
motivated and determined to succeed.
2.

Selling a well established, high quality product

In this case, the product is recognised all over the world. A large
proportion of new businesses and new products fail, often due to costs of
the research and development needed. The McDonalds formula,
however, has been successfully tried and tested. Ray Krocs insistence
that all McDonalds outlets sold the same products and achieved the
same quality has led to a standardisation of the process and great
attention to detail.
The cooking processes in McDonalds restaurants are broken down into
small, repetitive tasks, enabling the staff to become highly efficient and
adept in all tasks.
This division of labour and the high volume turnover of a limited menu
allows for considerable economies of scale. For the franchisee, this can
considerably reduce the risk of setting up their own business. There is no
need to develop the product or do expensive market research. Nor will
they have sleepless nights wondering if the product will appeal to the
consumer. McDonalds carries out regular market research.
3.

Intensive initial training

Every franchisee has to complete a full-time training programme, lasting


about nine months, which they have to fund themselves. This training is
absolutely essential. It begins with working in a restaurant, wearing the
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staff uniform and learning everything from cooking and preparing food to
serving customers and cleaning.
Further training at regional training centres focuses on areas such as
business management, leadership skills, team building and handling
customer enquiries. The franchisee will have to recruit, train and
motivate their own workforce, so they must learn all the skills of human
resource management. During the final period, the trainee learns about
stock control and ordering, profit and loss accounts and the legal side of
hiring and employing staff. Consequently, no McDonalds franchisee
would have to ask a member of his or her staff to do something that they
couldnt do themselves. Knowing this, can also be a powerful motivator
for the staff.
4.

Continuous support

McDonalds commitment to its franchisees does not end with the


training. It recognises that the success and profitability of McDonalds is
inextricably linked to the success of the franchises. A highly qualified
team of professional consultants offer continuous support on everything
from human resources to accounting and computers. The field consultant
can become a valued business partner and a sounding board for ideas

5.

Benefit from national marketing carried out by McDonalds

A brand is a name, term, sign, symbol or design, (or a combination of


these) which identifies one organisations products from those of its
competitors. The phenomenal growth of McDonalds is largely attributed
to the creation of its strong brand identity. McDonalds trademark, the
Golden Arches, and its brand name has become amongst the most
instantly recognised symbols in the world.
In the UK, McDonalds recognised the need for a co-ordinated marketing
policy. In order to be successful, an organisation must find out what the
customers want, develop products to satisfy them, charge them the right
price and make the existence of the products known through promotion.
Cinema and television advertising have played a major part in
McDonalds marketing mix. McDonalds is now the biggest single brand
advertiser on British television.
Radio and press advertisements are used to get specific messages across
emphasising the quality of product ingredients. Promotional activities,
especially within the restaurant, have a tactical role to play in getting
people to return to the restaurants regularly. All franchisees benefit from
any national marketing and contribute to its cost, currently a fee of 4.5
per cent of sales.
The franchisees additionally benefit from the extensive national market
research programmes that assess consumer attitudes and perceptions.
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What products do they want to buy and at what price? How are they
performing compared to their competitors?
Any new products are given rigorous market testing so that the
franchisee will have a reasonable idea of its potential before it is added
to the menu. The introduction of new products, which have already been
researched and tested, considerably reduces the risk for the franchisee.
Massive investment in sponsorship is also a central part of the image
building process. Sponsorship of the 1998 football World Cup, the
Premier League and the European Championships increases awareness
of McDonalds brand. However, McDonalds still
follows Ray Krocs community beliefs today, supporting the Tidy Britain
Group and the Groundwork Trust, as well as local community activities.
6.

Forecasting

Another major problem for a new business is predicting how much


business it might enjoy, running the risk of either cashflow problems or
the difficulties associated with overtrading. The turnover and profit from
any outlet will vary, depending on a wide range of internal and external
variables. Each franchisee is expected to take a positive approach to
building up sales, although an average rate of return of over 20 per cent
is generally expected over the lifetime of the franchise.

The advantages for the franchisor


McDonalds recognises the benefits of a franchised operation. Franchises
bring entrepreneurs, full of determination and ideas, into the
organisation. Franchising enables McDonalds to enjoy considerably
faster growth and the creation of a truly global brand identity. The more
restaurants there are, the more McDonalds can benefit from economies
of scale.
On the financial side, McDonalds receives a monthly rent, which is
calculated on a sliding scale based on the restaurants sales, i.e. the
higher the sales, the higher the percentage and visa versa. There is also
a service fee of 5 per cent of sales in addition to the contribution to
marketing. The purchase price of a restaurant is based on cashflow and
is generally about 150,000 upwards. The new franchisee is expected to
fund a minimum of 25 per cent of this from their own unencumbered
funds.

Dynamic innovation
Whilst the franchisees have to agree to operate their restaurants in the
McDonalds way, there still remains some scope for innovation. Many
ideas for new items on the menu come from the franchisees responding
to customer demand. Developing new products is crucial to any business,
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even one which has successfully relied on a limited menu for many years.
Consumer tastes change over time and a company needs to respond to
these changes. Innovation injects dynamism and allows the firm to
exploit markets previously overlooked or ignored. The introduction of the
Egg McMuffin in 1971, for example, enabled McDonalds to cater initially
for the breakfast trade. Filet-o-Fish, Drive-thrus and Playlands were all
products or concepts developed by franchisees.

The three-legged stool - the suppliers


A third group of stakeholders, critical to the success of the franchise
operation, is the suppliers. As McDonalds considers the quality of its
products to be of absolute importance, it sets standards for suppliers
that are amongst the highest in the food industry. McDonalds believes in
developing close relationships with suppliers - everything is done on an
open accounting, handshake trust basis.
The suppliers work closely with McDonalds to develop and improve
products and production techniques. This close interdependency is
described as a three-legged stool principle, and involves McDonalds, the
franchisees and the suppliers. Suppliers that are able to meet the quality
standards set down by McDonalds have been able to share in the growth
and success of McDonalds.

Conclusion
McDonalds views the relationship between franchisor, franchisee and
supplier to be of paramount importance to the success of the business.
Ray Kroc recognised the need very early on for franchisees that would
dedicate themselves to their restaurants. He wanted people who had to
give up another job to take on the franchise venture, relying on their
franchise as their sole source of income and would therefore be highly
motivated and dedicated. Consequently, McDonalds will not offer
franchises to partnerships, consortia or absentee investors. The initial
capital has to come from the franchisee as a guarantee of their
commitment. The selection process is rigorous to ensure that McDonalds
only recruits the right people.

Questions

1. What do you understand by the term economies of scale? How will


economies of scale affect McDonalds?
2. You have been hired as advisor on the Pakistani market by
McDonalds. Based on your observations of the Pakistani market,
prepare three instructions you would issue to the franchisee on
behalf of McDonalds, and explain why you think they are
important.
3. Why do you think that over 70 per cent of new businesses fail but
90 per cent of franchises succeed?
4. Evaluate why a business might choose a corporate objective of
growth maximization over profit maximization?

America's caloric crisis


By Irfan Husain
In a brilliant new animated film "Belleville Rendezvous", director Sylvain Chomet shows the
audience a New York-like city populated by grotesquely fat people who waddle around,
their fat quivering as they move.
This sardonic observation is not far off the mark: currently 61 per cent of all Americans are
overweight, with one in five being clinically obese, and five million qualifying for a surgical
procedure that restricts the digestive function of the stomach. According to doctors, there is
a long waiting list for this operation.
A long-retired director general of the Food and Agriculture Organization (FAO) once
remarked: "In a world where there is so much hunger, there are too many fat people". If he
is still alive today, he would be shocked by the expansion in waistlines that has taken place
since he made that remark.
And yet it was not always so: for decades up till the early seventies, the number of
overweight Americans was stable at 25 per cent. Over the last three decades, this number
exploded to its current proportion of six in ten people. To investigate the reasons behind
this epidemic, Greg Crister has written a bestselling book called (what else?) "Fat Nation".
Crister traces the origins of the current caloric crisis to two factors: the development in
Japan of a sweetening agent called High Fructose Corn Syrup (HFCS), and the decision to
allow the import of palm oil for the manufacture of cooking oil in the United States. The
former allowed the processed food industry (including cold drink manufacturers) to take
advantage of the huge over-production of corn in America, and free it from the vagaries of
sugarcane harvests which were the mainstay of many Third World economies. Also, HFCS
was six times cheaper than ordinary sugar. The downside is that fructose is much harder for
the liver to break down than sucrose.
As for palm oil, this was developed by the British in the late nineteenth century as a cash
crop in Malaysia which today exports it across the world. The problem with this oil is that
although it sounds as innocuous as vegetable oil, in reality it is highly saturated, thereby
clogging the arteries more effectively than even animal fat.
The parallel mushroom growth of fast-food chains like McDonald's and KFC put more and

more HFCS and palm oil into more and more people. As this was a very competitive field
and profit margins were low, McDonald's looked for ways to raise sales, but ran into the
deeply ingrained inhibition against gluttony: people who would lick their plates clean were
reluctant to order a second helping. But in the mid-seventies, a group of McDonald's
franchises in Chicago discovered that if they offered customers a mix of items at what
seemed like bargain prices, sales shot up. Welcome to the world of "value meals": suddenly
people were eating more, not because they were hungry, but because they thought they
were getting a good deal.
All these developments have lessons for countries like Pakistan. Although poverty has
limited the sale and consumption of fast food and aerated sweet drinks, palm oil is widely
used in kitchens across the country. Indeed, the Ghee Corporation of Pakistan imports
huge amounts of palm oil for use in the many manufacturing units making cooking oil. In
the cities among the middle class, heart disease and high blood pressure are rampant
killers.
When I experienced a heart problem a few years ago, doctors did advise me to use as little
fat as possible; however, they did not mention how much worse palm oil is than any other
cooking medium, even butter. And while quantifying the caloric contents of various sweet
drinks, books do not tell us that fructose is actually bad for the system.
In poor countries, the rich tend to be overweight, while the poor are skinny; in rich countries
it is generally the other way around. The professional middle classes are more healthconscious; eat less fats and carbohydrates and more proteins; and exercise more. Studies
have shown that there is a positive correlation between the amount of TV children watch
and their weight. In America, black children living in ghettoes are often not allowed to play
outside because their parents are concerned about security. And when both parents are
working, it is much easier (and often cheaper) to buy a burger or a pizza than it is to cook a
healthy balanced meal.
These concerns might seem remote in poor countries where the vast majority can only
dream of a Big Mac, but sedentary lifestyles and rapid urbanization are putting a bigger
proportion of the population at risk. Pakistani cuisine is high in fat and salt, both important
factors in the growing numbers of patients suffering from high blood pressure that the
Pakistan Hypertension Society regularly warns us about.
Dr Azhar Farooqi, executive director of Karachi's cardiac hospital and an indefatigable
crusader for better heart care, has worked tirelessly to raise consciousness about the
dangers of poor diet and no exercise. And yet the incidence of heart disease continues to
rise remorselessly.
Mercifully, the trend is showing signs of reversing itself in the West. McDonald's has seen
share prices and the number of its customers falling. When an American sued the firm for
his weight-related health problems, he was the butt of ridicule in the media. However, the
case caused tremors in the fast-food industry and many fast-food outlets have shut down in
western cities. The 'slow food' movement which started in Italy a few years ago is gaining
popularity, and governments concerned about the high social and economic cost of obesity
are doing their best to encourage children to eat better and exercise more.
But ultimately, good health is about class: the well-off take better care of their bodies than
the poor who are more concerned about survival than the quality of life. Those at the
bottom of the socio-economic ladder have virtually no recourse to medical advice. The food
industry, meanwhile, is more interested in profits than social welfare. Until their activities are
more closely regulated by governments, they will continue making fat nations fatter.