Understanding McDonald's: Comprehensive company primer and profitability analysis (Part 11 of 21)
McDonald’s management discussed higher commodity inflation in its third quarter earnings call. Management expects U.S. commodity inflation of about 2.5% going forward. As a result, U.S. restaurant margins will probably remain under pressure in the fourth quarter. Similarly, margins remain under pressure in Japan and China, as there’s little room to cut costs and local consumers remain very price-sensitive. In Europe, margins will probably also fall 1% year-over-year despite some sales resiliency in Russia and the United Kingdom.
In the fast-food cost breakdown below, you can see that McDonald’s cost structure is very similar to the industry average, with raw materials (purchases) being the largest component, followed by labor.
Despite recent protests, McDonald’s can’t afford to pay workers $15.00 per hour because labor costs make up about 24% of its total sales. You can read more about McDonald’s labor issues in the following series, Why fast food strikes and proposed wage increases don’t matter, by Market Realist analyst Xun Yao Chen. Since labor costs are such a large percentage of the company’s total costs, McDonald’s has been slowly cutting payroll and employee benefits as a percent of total sales over the past eight years.
In McDonald’s company-operated restaurants, and in collaboration with franchisees, the company develops and refines operating standards, marketing concepts, and product and pricing strategies so that only those it believes are most beneficial are introduced in the restaurants. It continually reviews and appropriately adjusts its mix of company-operated and franchised or licensed (conventional franchised, developmental licensed, and foreign affiliated) restaurants to help optimize overall performance.
Constant currency results exclude the effects of foreign currency translation and are calculated by translating current-year results at prior-year average exchange rates. Management reviews and analyzes business results in constant currencies and bases certain incentive compensation plans on these results. Comparable sales and comparable guest counts are key performance indicators used within the retail industry that indicate acceptance of the company’s initiatives as well as local economic and consumer trends. Increases or decreases in comparable sales and comparable guest counts represent the percent change in sales and transactions, respectively, from the same period in the prior year for all restaurants—whether operated by the company or franchisees—in operation for at least thirteen months, including those temporarily closed.
System-wide sales include sales at all restaurants. While the company doesn’t record franchised sales as revenues, management believes the information is important in understanding the company’s financial performance because these sales are the basis on which the company calculates and records franchised revenues, and they indicate the franchisee base’s financial health.
Browse this series on Market Realist:
- Part 1 - McDonald’s global business model, the “three-legged stool”
- Part 2 - What is a franchise and how do McDonald’s franchise agreements work?
- Part 3 - How important are franchise revenues to McDonald’s?
- Consumer Discretionary