The McDonald's Origin Story: A Systems-Based Approach in Building an Empire
In 1948, brothers Maurice—also known as “Mac”—and Richard McDonald opened the first McDonald’s in San Bernadino, California. Revolutionary in their approach, the brothers had expanded their once small food stand that they opened eight years earlier in 1940. The two had a vision for a more effortless approach to dining out by using a more efficient and ultimately faster way to get your burger and fries.
“Our concept was based on speed, lower prices, and volume,” Dick McDonald had explained. “We were going after big, big volumes by lowering prices and by have the customer serve himself.”
At the time, the menu consisted of only a hamburger, cheeseburger, potato chips, pie, and milk, coffee, or soda to drink. Hamburgers were 15 cents only, which was half of what you’d pay at a sit-down restaurant. It wasn’t until a year after their first storefront that french fries were even introduced to the menu.
By turning their kitchen into a literal assembly line—where each step of the cooking process was built to maintain efficiency and speed—the McDonalds brothers’ system was one that was built to not only last but more importantly, duplicate. Gone were the days of carhops or indoor seating, blasting into the future went the brothers with their new format: ordering directly through a service window where the magic of their assembly line style would distribute their vision of speed and efficiency. No need to tip the waitress or wait thirty minutes for a burger and fries, just order through the window and in a few short moments, your food was in your lap, ready to enjoy.
Unfortunately for the McDonalds brothers, by 1954, they had only ten licensed drive-ins with the McDonald’s name. On top of that, aside from the original McDonalds, the others were either poorly managed or lacked the revenue needed to stay afloat. The McDonalds concept was sound, yet these franchises offered little to no value to the brand that was (and of course, still is), McDonalds.
The problem? There was no system.
Enter Ray Kroc, a salesman from Illinois who had a vision for McDonald’s that Mac and Dick couldn’t yet see. Although Kroc was struggling as a salesman of Prince Castle Multi-Mixer ice cream machines, Dick and Mac McDonald quickly became Kroc’s favorite customer-- the McDonald’s purchased a number of Multi-Mixer machines to expand their albeit small menu.
Kroc soon came to realize that the concept the McDonald brothers had was smart—fast service at low prices with the idea of volume being the key to a scalable business model. He decided to offer his sales experience as a way to help the McDonald’s Corporation grow by implementing a franchise model. In other words, Kroc deemed himself the first McDonald’s national agent and opened up a McDonald’s near his home in Des Plaines, Illinois.
With Kroc’s grand vision and franchising model, McDonald’s soon became a household name in the fast-food industry. It was only six years later that Kroc bought out the founding brothers for a mere $2.7 million and by 1965, there were 700 McDonald’s across the United States.
Perhaps what Kroc was most known for wasn’t necessarily his franchising model, but rather his standardized operations of all the franchises under the McDonald’s Corporation. From portion sizes to food preparation, packaging and ingredients, even down to customer service standards and price (regardless of economic demographics), what Kroc established and essentially scaled the McDonald’s Corporation with was his system.
A system so powerful that by 2019-- long after Kroc’s death in 1984-- had over 38,000 restaurant store fronts in over 119 countries, serving roughly 68 million people every day and bringing a revenue, on average, of $57,745,205 daily—or $2,406,050.21 per hour, $40,100.84 per minute, and $668.35 per second… every day.
You could say McDonald’s paved the way for the fast-food industry by developing a model of fast, efficient, and good—but certainly not nutritionally dense-- food. It’s no surprise that fast-food chains like: Burger King (1953), Dairy Queen (1940—38 days after McDonald’s opening), Dunkin Donuts (1948), In-N-Out (1948), Jack in the Box (1951), and even Sonic (1951), originated shortly after the birth of McDonald’s. Sure, restaurants like KFC and White Castle already existed, but they didn’t offer the speed and efficiency of delivery that a drive through window restaurant like McDonald’s.
There are a number of reasons why the McDonald’s Corporation scaled and thrived during a boom of fast-food franchise conceptions. They had strong leadership from Kroc and other executives in the company. There was a cost benefit to what McDonald’s had to offer, even if quality was always meant to be “good,” not “great,” according to Kroc himself. You could even point to the fact that because they were willing to adopt a new model and risk their reputation, quality, and service by expanding that this was obviously why they were massive. But no, none of these reasons were more important than the most important secret ingredient:
They have a system.
But perhaps the most impressive aspect of all when examining the McDonald’s business model isn’t the burgers, fries, efficient methods of distribution, or even their lack of service to their seemingly always broken ice cream machine. It’s a piece of their business franchising model that happens to be close to 30% of its net worth today.
The amount of real estate they own.
Ray Kroc was no doubt one of the main reasons McDonald’s had massive success. However, although the original model of franchising was great, it only allowed the room to scale to a certain level. Simply put: the only form of income McDonald’s really had was the sheer volume of food they were selling. In fact, it’s actually because Kroc was solely focused on only franchise sales to scale and expand McDonald’s that it nearly led to the demise of McDonald’s as a household name. After all, it’s easy math—if you don’t have a reasonable amount of cash flow, it’s difficult to justify expanding.
Enter Harry Sonneborn.
If you’ve seen the movie, “The Founder,” you know that Ray Kroc-- played by Michael Keaton—is in the bank asking for a larger line of credit in order to continue the never-ending expansion of more and more McDonald’s. Now, whether or not the portrayal of how Harry Sonneborn—played by B.J. Novak—is accurate, it sure makes the movie better.
If you haven’t seen it, Kroc is in the bank, up to his ears in debt, and asking the bank for money to expand. Kroc, getting nowhere with the bank’s loan officer eventually realizes that he won’t be able to get more funding and thus, will likely be looking at a company restructure as a whole. In the cubicle right next to Kroc, Harry Sonneborn hears Kroc’s cry for help and follows a stressed and emotionally beaten down Kroc out of bank.
What happens next would change the McDonald’s franchise model for generations to come.
Sonneborn, a clean-cut businessman gets the attention of Kroc on the sidewalk outside of the bank. Harry praises Ray’s McDonald’s restaurants and intrigues Kroc by saying, “Mr. Kroc, if you’re not making money hand over fist, something is terribly wrong.”
The scene then shifts to Kroc inviting Sonneborn into his office to take a look at McDonald’s financial statements and books.
“So, to summarize, you have a minuscule revenue stream. No cash reserves. And an albatross of a contract that requires you to go through a slow approval process to enact changes—if they’re approved at all… which they never are,” says Sonneborn. “Am I missing anything?”
“That about sums it up,” a defeated Kroc replies.
“Tell me about the land,” Sonneborn says.
“The… land?” Ray says.
“The land. The buildings, how that whole aspect of it works,” Sonneborn questions.
“Oh, that’s pretty simple, really. The franchisee finds a piece of land he like. Gets a lease, usually 20 years. Takes on a construction loan, throws up a building and off he goes,” Kroc casually says.
“So, the operator… selects the site,” Harry says. “He picks the property?”
“Right, yep,” Ray says, clearly missing the angle.
“You provide the training, the system, the operational know-how, and he’s… responsible… for the rest,” Harry mockingly asks.
Ray grumbles a little, sensing a bit of arrogance from Harry, “mmmm… is there a problem?”
“Yes, you don’t seem to realize what business you’re in,” Harry confidently replies.
Ray, still looking a bit confused scoffs slightly and stares back at Harry, awaiting an answer.
“You’re not in the burger business,” says Harry, “you’re in the real estate business. You don’t build an empire off of a 1.4% cut of a .15 cent burger. You build it, by owning the land on which that burger… is cooked.”
Kroc, now visibly interested and finally hearing Sonneborn, sits up in his seat, eager to hear more.
Harry continues, “what you ought to be doing, is buying up plots of land. Then turning around and leasing said plots of land to franchisees who, as a condition of their deal, should be permitted to lease from you… and you alone.”
Flexing his business-minded spirit, Sonneborn goes on, “This will provide you with two things.
1. A steady, up-front revenue stream—money flows in before the first stake is in the ground.
2. Greater capital for expansion. Which in turn, fuels further land acquisition. Which in turn fuels further expansion, and so on… and so on…”
Kroc, understandably fidgety in his seat from the brilliant idea, starts to visualize the
genius of Sonneborn’s proposition.
Not quite done with his pitch, Harry confidently states, “Land. That’s where the money is. And more than that, control. Control over the franchisee. Fail to uphold quality standards, you cancel their lease. Control-- over Dick and Mac (McDonald’s brothers)-- and you’ll have the banks and the franchisees in the palm of your hand.”
What’s also mentioned before this climactic scene of the movie—and is important to the story—is that Kroc was effectively trying to wear the McDonald’s brothers out, so they’d give up and hand over the rights to McDonald’s as a whole. Kroc wasn’t necessarily the cleanest businessman, that’s far clearer in the movie. That being said, he was a true visionary. A visionary that, with the help of Sonneborn, promptly adopted the real estate business concept to future franchises and the same model is used today.
So, how did it work out for McDonald’s?
With a current market cap of $163 billion (as I write this in September of 2021), close to 25% of the McDonald’s portfolio is real estate holdings. On top of that, 8.5-10.5% of franchise revenue is paid to the McDonald’s corporation, monthly. Talk about sitting back and collecting rent checks and royalties!