McDonalds (Photo credit: Sean MacEntee)
Franchise chains, a form of "collective entrepreneurship" that allows its members to share the risks and rewards associated with the discovery and exploitation of new business opportunities, has been a popular investment concept in Wall Street. And for a good reason: They've delivered superior returns to investors.
McDonald's, Yum Brands, Dunkin Brands (NASDAQ:DNKN), Wendy's and Burger King (NYSE:BKW) are a good case in point—they all beat the S&P 500.
But as is the case with other investments, not every franchise is successful. And even among successful franchise chains, some fare better than others. McDonald's and Yum Brands, for instance, have fared much better (in terms of equity performance) than Wendy's.
What makes the difference? Four factors:
1.The Right Business Concept—the way a chain enhances customer value vis-à-vis the competition. Franchise pioneer McDonald's, for instance, delivers a quicker, more convenient and less expensive meal, compared to traditional restaurants–Wendy's is doing something similar. KFC offers the same meal attributes, but with a different menu—focusing on chicken rather than hamburgers—though both chains broadened their menu portfolio overtime, adjusting it to the local tastes.
Dunkin' Donuts offers coffee and a variety of breakfast items (and in recent years ice-cream) to go at convenient locations.
2. Scale– Cost savings associated with a larger production scale of a standardized menu – the bigger the production scale, the lower the cost per menu. With 33,510 units around the world, for instance, McDonald's has a scale advantage over Wendy's, which has 9,792 stores; and so is Yum Brands with over 30,000 stores when KFC and Pizza Hut are combined.
| Company | Rank | Worldwide Sales ($M) | Domestic Units | International Units | Total Units |
| McDonald's | 1 | 85,941 | 14,098 | 19,412 | 33,510 |
| KFC (Yum Brands) | 3 | 21,300 | 4,780 | 12,621 | 17,401 |
| Burger King | 5 | 14,975 | 7,500 | 5,012 | 12,512 |
| Pizza Hut (Yum Brands) | 6 | 12,626 | 7,600 | 6,147 | 13,747 |
| Wendy's | 18 | 6,004 | 6,772 | 3,020 | 9,792 |
| Panera Bread | 33 | 3,421 | 1,538 | 3 | 1,541 |
| Dunkin' Donuts (Dunkin Brands) | 18 | 6,004 | 6,792 | 3,020 | 9,792 |
Source: 2012 Franchise Times: Top 200 Franchise Systems
The scale advantage is reflected in the operating margins of the two companies. McDonald's and Yum Brands enjoy 30.12 percent and 15.05 percent operating margins, versus 7.38 percent of Wendy's.
| Company | OperatingMargins (%) | Return on Assets (%) | Qtrly Revenue Growth (yoy) | Qtrly Earnings Growth (yoy) |
| McDonald's | 30.13 | 15.42 | 0.90 | 0.30 |
| Burger King | 31.95 | 6.17 | -42.50 | 150.3 |
| Wendy's | 7.38 | 2.72 | 1.80 | -82.7 |
| Dunkin' Brands | 39.23 | 5.22 | 6.20 | -8.30 |
| Panera Bread | 8.22 | 15.64 | 12.70 | 16.80 |
| Yum Brands | 15.05 | 13.80 | -8.30 | -15.10 |
Source: Yahoo.Finance.com
3. Scope— The cost savings associated with offering different products by a single corporation rather than by different corporations. McDonald's and Panera Bread, for instance, offer a variety of products for sale (McDonald's has added Mccafe in many locations), vis-a-vis Wendy's and Dunkin' Brands. That can explain the higher return on assets.
4. Location—The benefits associated with occupying primary location sites for franchise stores. In fact, location can support and reinforce all these advantages. As an older franchise McDonald's, for instance, had the opportunity to pick best locations with favorable leases. This further explains both its hefty operating margins and the high return on assets.
The bottom line: Concept, scale, scope, and location make a big difference in the franchise world.
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