The real business model of McDonalds
Plus speculation on hidden secrets in various other industries
I recently watched this brilliant movie on the history of McDonalds called ‘The Founder’. (I encourage you to watch it if you haven’t seen it already).
Here is the most interesting part if you aren’t interested in watching the full movie: (ALERT: spoilers in video below)
You see the ground-breaking moment in McDonald’s history is the founder realizing that the money isn’t actually in flipping burgers. No, the real money is in owning land, leasing it to franchisees and collecting rent from these captive customers. I did some digging and apparently this insight is common knowledge in the fast food and retail coffee industry. This got me wondering whether there might be other industry secrets which ordinary folks or non-industry professionals do not get at first sight. I decided to do an exercise where I would try and write this out. (Disclaimer: this is based on my personal knowledge which is relatively choppy; I am happy to receive feedback/comments). So here are my thoughts on ten different industries:
1. Fast food:
What ordinary folks think the business is primarily about:
Making tasty food, standardizing the food preparation workflow.
What they didn’t tell you it’s about:
Real estate arbitrage by leasing to franchisees (see discussion above).
2. Personal Lines Insurance:
What ordinary folks think the business is primarily about:
Underwriting/pricing risk successfully.
What they didn’t tell you it’s about:
Running a successful and efficient call center.
See the proportion of staff that work in a call center/customer service role at any major insurer - you’ll be genuinely surprised.
3. Apparel:
What ordinary folks think the business is primarily about:
Creating a strong brand and keeping up with fashion trends.
What they didn’t tell you it’s about:
Managing inventory turns; preventing stock at department stores from being sold at heavy discounts.
Most brands sell a majority of their stock at 50-75% discount once a season has passed. Consider Zara - the fast fashion success story - of the past two decades. It became successful by shunning discounts in favor of releasing lot more designs in limited quantities.
4. Retail Banking (checking/savings accounts)
What ordinary folks think the business is primarily about:
Offering competitive rates and working on the 3-6-3 model.
What they didn’t tell you it’s about:
Cheap customer acquisition.
High customer acquisition costs is why most high-street banks try and bundle a bunch of lending and insurance products. CPA for a retail bank can range from $500-1000 and can often edge higher for the most attractive customers. Fintechs that have witnessed explosive growth (i.e. Monzo, Revolut, Venmo et al.) have done so cleverly by foregoing margin entirely on a core product line (e.g. exchange rates) instead of competing in an already crowded field
5. Pharmaceuticals:
What ordinary folks think the business is primarily about:
Hiring a kick-ass team of doctors and medical professionals who research drugs and help them pass through the various stages of clinical trials.
What they didn’t tell you it’s about:
Lobbying lawmakers/FDA to protect and extend existing patents.
The probability of actually producing a blockbuster drug and/or getting approval for a large pharmaceutical company over a given year is actually less than 1%. For small research labs, these figure is even smaller. In many cases, you have just as good a chance of winning the national lottery.
6. Higher Education (Universities):
What ordinary folks think the business is primarily about:
Charging students tuitions and using that money to cover the costs of running the university (almost all major universities in the United States are non-profit).
What they didn’t tell you it’s about:
Building a large endowment (primarily via alumni donations) and investing it aggressively (8-10% p.a.) to watch it grow.
The actual cost of ‘supporting’ a student at most major private universities in the United States has now ballooned to $200K. (anecdotal as I worked in admissions during my college years) University tuition at large private schools is now around $70K so there’s still a large gap. The gap is largely filled by the returns generated on a university’s endowment. This is also why an endowment fund manager at a major university can generally out-earn a university provost/chancellor.
7. Utilities (Energy/Gas):
What ordinary folks think the business is primarily about:
Charging individuals and businesses different tariffs based on zones/usage.
What they didn’t tell you it’s about:
Taking on a load of debt, consolidation (via merging/buying up competition).
Recent deregulation has helped the emergence of bunch of ‘online-only’ energy suppliers. However, most of these are unlikely to survive in the long-run as the core product is generally offered at the same wholesale price to every supplier. Most large players remain competitive by buying up competition, often taking on tonnes of debt on their balance sheets.
8. Auto manufacturing:
What ordinary folks think the business is primarily about:
Having tremendous scale/volume to justify the high fixed costs associated with building and manufacturing a car.
What they didn’t tell you it’s about:
Getting subsidies from the government for at least the first decade
Read the history of Toyota, Hyundai, Kia or Tesla. While the stories are impressive, you will come out convinced that it is impossible to build a successful car manufacturer without relying on tremendous government help and support. In the case of Asian manufacturers, these took the shape of cheap government loans in the 1960s and 1970s combined with significant tariffs to protect the incumbents from competition.
9. Marketplace (ala Uber/Airbnb)
What ordinary folks think the business is primarily about:
Building a cool app in an unexplored niche, matching demand and supply and taking a cut from gross merchandise value that passes via the platform.
What they didn’t tell you it’s about:
Solving the chicken and egg problem and convincing early investors that the underlying unit economics are healthy.
Which came first - The chicken or the egg? This existential question has plagued humanity since the dawn of time. And yet it is also a question that almost all ‘marketplace platforms’ face in their early years. Since marketplaces generally pick a niche (e.g. Uber for dog-walking) and then expand operations city-by-city, the chicken-and-egg problem never really gets solved for the first decade of any such startup. What happens in effect is that while certain markets hit scale/positive unit economics, the cost of expanding to new markets and subsidizing new riders/drivers makes the overall financials appear bad. Thus, the challenge remains to raise successive rounds of private financing at increased valuations while pursuing the dual objectives of growth and profitability.
10. Airlines
What ordinary folks think the business is primarily about:
Forecasting demand accurately and filling up plane seats on every flight; managing fuel costs; working with labor unions to prevent strikes.
What they didn’t tell you it’s about:
For long-haul flights, creating a strong value proposition for price-inelastic business and first-class customers. For short-haul flights, minimizing turnaround time of plane at airport.
For long-distance flights, business and first-class customers quite often subsidize most economy customers. That is why airlines focus so much on premium customers and so many airline loyalty programs are really focused around repeat business-type customers.
For short-haul flights, having a fleet of small planes coupled with operational processes that minimize wait times is a key source of competitive advantage. This is an area where short-distance specialists like Ryanair, easyJet and Southwest airlines really excel relative to peers.
To receive more posts like this, sign up for our newsletter!