The fast food industry provides around $570 billion in revenue each year. With more than 850,000 establishments worldwide and has a 2.5% annual estimated growth. This can be an attractive industry for many investors. As with any investments. it is important to understand the industry and risks involved.
The average margin profit per fast food establishment is between 6-9%. Therefore, when considering entering the business of fast food restaurants owning several restaurants, in some cases, may be the only way to make a large profit. A practical way to own more than one establishments is by purchasing several franchise establishments.
A franchise as described in Investopedia is “proprietary knowledge, processes and trademarks to allow the party to sell a product or provide a service under the business’s name. In exchange for gaining the franchise, the franchisee usually pays the franchisor initial start-up and annual licensing fees”.
As you evaluate if purchasing a fast food restaurant is the best decision for your interest, it is important to understand that franchisors make profit by implementing different strategies that have a direct impact to you as a franchise owner. For example, McDonalds makes most of its profit by buying the restaurant property and then renting the property to the franchisee at a very high price. Other ways in which fast food franchisers can earn their revenue is by:
- A floor payment
- Technology and email fee
- One time flat fee
- Royalty fee
A floor payment would probably be the fee you want to avoid the most when starting in the fast food franchise industry. Since the profit margin are low in this industry, having to pay a floor payment even if you are not generating a profit is a quick way to go out of business.
When choosing what type of fast food franchise to own it is important to pay attention to the trends. For example, in recent years the Chipotle restaurant model has proven to be successful because customers like the “build your own” concept. Another example of this new tendency is Pizza Studio.
It is important to analyze the five forces framework to understand the level of competition within the fast food franchise industry:
Threat of new entrants
When owning a fast food franchise oversees the government policies may impact what can and cannot be sold to a customer. For example, in the United States, different states have different levels of alcohol that can be given at a fast food restaurant. This is a state policy. Selling alcohol could be one of the ways the restaurants makes most of its profit but now is limited. In places like India, Burger King does not sell beef because many people are against the slaughter of cattle because of their religious beliefs. Burger King needs to find a substitute for beef and evaluate the costs.
The threat of substitutes
In each country there is a traditional dish people love and are used to eating. Not having that dish or an equivalent could turn away customers. To solve this the franchise in consultation with the franchisor can adapt items to their menu for a specific country. An example of this is McDonalds in Venezuela offering arepas.
The bargain power of buyers
Franchisors establish the minimum price that a food item can be sold for. The bargaining power of buyers can play a role here due to buyer’s price sensibility. As you expand with a franchise to a different country keep in mind the limitations you have as a franchise owner to adapt or change prices. This can only be done through approval of the franchisor.
The bargain of the provider
Your franchisor may require you to purchase products from a specific provider. This is not flexible and as a franchise owner you are subject to purchasing the product at the price the franchisor has established with the provider. Although you could probably find a better deal, you fall under the bargain of the provider and the price they set.
Fast food Industry rivalry
As a fast food franchise owner the industry rivalry is something you cannot always control. For example, the franchisor may charge you a fee for marketing purposes. The competition could have a better marketing strategy and as a franchise owner you are paying for a marketing fee that might not be producing results.
Like in all things, there are some pros and cons that need to be considered before owning your own fast food franchise. Due to the low profit margin in the fast food industry, to make medium to large profits, owning more than one establishment would probably be required.
Purchasing a fast food establishment that has a record of being profitable would be the safest investment but would probably be the a more expensive investment. The new fast food franchises that are not so well known, are less expensive to own and could be the next McDonalds but they are a riskier investment when you take into consideration that per a study of Ohio State University 60% of new restaurants do not make it past the first year and 80% do not make it past 5 years.
In the last years there has been a great marketing push on having “healthy options”. Subway growth is an example of this. Subway is seen as the “healthy option”. In 2010 Subway became the largest fast food franchise in the world, with more than 33 thousand restaurants and presence in 112 countries. Currently there are more than 44 thousand Subway restaurants. On the other hand McDonalds has been seen as the “not healthy option”.
In 2015 McDonalds saw a historic 11 straight quarter loss. In 2016 McDonalds is projected to close 500 restaurants. McDonalds has been portrayed in movies like “Super Size Me” as unhealthy and tends to always be portrayed as the unhealthy option.
Most fast food franchises have adapted their menu items to include salads to attract the current customer who want to eat healthier, however, restaurants who offer hamburgers continue to be the fast food restaurants in which people eat the most. According to Franchise Help, in the United States, the franchise with more profits includes:
30+ % Hamburgers
15% Pizza parlors
12% Sandwich shops
8% Chicken restaurants
7% Mexican restaurants
One advantage for the franchisor is that he can learn from his franchisees. A clear example of this is the “happy meal” of McDonalds. The idea of serving kid size meals came from Yolanda Fernandez a franchise owner who came up with the idea of serving kid size meals. This was in 1979. After this, McDonalds started the Happy Meal for kids.
The fast food industry has revolutionized to try to satisfy the healthy and fast options. Two of the challenges the fast food franchise industry faces has to do with Millennials. According to Forbes “The internet has revolutionized countless industries…Now it’s starting to revolutionize the food industry. The demand seems to be healthy, fast and delivered food. This symbolizes higher cost for the restaurants. In an industry were margins are low, restaurants may be forced to hike the prices to keep with the demand while making large profits. Menus will need to be changed to compete with the new restaurants startups that offer a “better more fresh and healthy option”. A sign of this is that according to Forbes is that in 2013 venture capitalist invested $2.8 billion into food related startups.