It’s undeniable McDonald’s ( MCD 0.11% ) is a leader in the fast-food sector. The company has not only perfected the operation of quick-service restaurants but, with over 42,000 locations each generating approximately $3 million in annual sales, it stands as the most prominent brand in the industry. Additionally, it has proven to be a profitable long-term investment.
Even the most successful companies aren’t assured of perpetual success. In fact, the strengths that initially propelled a company to greatness can, over time, become disadvantages.
That’s arguably the situation McDonald’s finds itself in currently. For many years, it outpaced its competitors by being the leading name in restaurant franchises. However, its previously successful relationships with franchisees are now under significant strain, leading to potential issues. Two particular tensions highlight the company’s more profound challenges, even if the risks aren’t immediately obvious.
Owning McDonald’s stock might be challenging until these obstacles are clearly overcome.
Frustration is mounting among McDonald’s franchise owners.
Most McDonald’s locations aren’t directly owned by the company. By June, 95% were run by franchisees who, in addition to paying an initial fee to operate a McDonald’s outlet, also give the corporation a portion of their restaurants’ earnings as ongoing royalties. franchisor McDonald’s mandates that its franchise owners buy supplies directly from the company and take part in specific marketing initiatives. One of the most significant distinctions between McDonald’s and other franchises is that McDonald’s owns the real estate where its franchises are located. Franchisees must pay increasing rent based on market rates to use the company’s property and buildings.
Regardless of the setup, the restaurant The business landscape is growing more competitive, placing greater strain on various aspects of McDonald’s operations. This heightened pressure is causing friction between franchisees and franchisors, both of whom are primarily focused on boosting their profits. It’s not uncommon to hear about franchisees feeling exasperated by unforeseen expenses and stringent demands.
In fact, these issues have become so widespread that the U.S. Federal Trade Commission has stepped in. Only last month, the FTC released a formal warning to U.S. franchisors, reminding them that “using contract terms, such as non-disparagement clauses that block franchisees from communicating with the government, is against the law.” The agency also reminded franchisors that they “cannot legally impose and collect fees from franchisees that were not disclosed beforehand.”
The Commission did not specifically identify McDonald’s or any other fast-food chain as breaking these standards. Nonetheless, these comments echo the intense criticisms expressed by McDonald’s franchisees in recent years. The FTC’s decision to release a public statement on the issue suggests that the tension between McDonald’s and its franchisees may have reached a critical point, potentially hindering future expansion. Franchisees are unlikely to accept higher-than-normal risks if they are receiving lower-than-average returns on their investments.
What’s the second obstacle? Inflation, although the complex relationship between franchisee and franchisor also contributes to this issue.
Anyone reading this is likely aware that rising prices are significantly reducing your purchasing power these days. McDonald’s and its patrons aren’t immune Until recently, the cost of a Big Mac meal was approaching $20 in certain areas, with other combo meals experiencing similar price hikes. This led some customers to skip visits to the fast-food chain.
In late June, the company responded by launching several combo meals available for just $5. This strategy was successful, attracting customers back to the restaurants. The promotion was so effective that the restaurant chain decided to continue it at most locations, extending beyond its initial short-term plan into this month.
However, the generous promotion is having an impact. Many franchise owners have expressed their concerns about the high expenses involved in producing and selling these $5 meals without support from the main corporation, which seems unlikely to arrive. Since many pricing and menu choices across the chain are mandatory, it seems unlikely that there will be any relief in sight if these $5 value meals are extended or become a permanent offering.
Once more, it’s more a symptom than the actual problem. However, it represents another possible source of tension arising from a business arrangement that shifts a significant portion of the cost burden — and consequently much of the risk — onto franchisees.
The potential risk is too significant to overlook.
These issues are clearly as much philosophical as they are practical, which makes them more difficult to resolve. However, they can be resolved. And even if they aren’t, McDonald’s still holds a position that encourages franchisees to overlook their frustrations and keep following the rules for a long time to come.
These apparently minor philosophical issues can gradually erode a business without drawing attention until it’s too late. Consider once-thriving companies such as GE (General Electric) , IBM and Blockbuster (which once had the chance to purchase Netflix for almost no cost). These companies didn’t face an abrupt and unforeseen collapse. Instead, they gradually declined by neglecting the minor issues that were eroding their revenues and profits until those issues turned into major problems.
It’s unlikely that McDonald’s will experience the same downfall as Blockbuster, or face the challenges that GE or IBM have encountered, and its appealing dividend doesn’t seem to be at risk anytime soon.
Red flags are The company’s approach to managing franchisees and the expectations it sets for how they should interact with customers is becoming a growing concern for investors. Shareholders should pay close attention to this part of the business. At the moment, the stock might not be the most promising investment option.
Before investing in McDonald’s stock, take this into account:
The Motley Fool is a financial services company that provides investment advice and stock market analysis. Stock Advisor The analyst team has recently pinpointed what they consider to be the 10 best stocks for investors to consider purchasing at this time… and McDonald’s was not included. The 10 stocks that were selected have the potential to generate significant returns in the future.
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