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McDonald's Discovers Employees Get in the Way of Profits

Jamal Carnette, CFA, The Motley Fool

McDonald's (NYSE: MCD) has experienced a mini-renaissance under new CEO Steve Easterbrook. Since he took over from Don Thompson, shares of the restaurant franchisor have soared 72% as new initiatives like All Day Breakfast have grown same-restaurant sales. Last year the company set a six-year record in the heavily watched stat, growing 5.3%.

Although Easterbrook has been lauded as a growth-focused executive, there's another part of his plans that doesn't get enough discussion. Easterbrook has been consistent in his push to cut employees to boost profits. One leg of the "three-legged stool" -- employees, franchisees, and suppliers -- that defined pioneering fast-food visionary Ray Kroc's leadership philosophy early in McDonald's history has been notably hobbled in the Easterbrook era.

A Big Mac and fries

Image source: Getty Images.

First, company-owned restaurant employees

Soon after taking the reins, Easterbrook initiated an aggressive refranchising plan. At the time approximately 80% of total restaurants were franchises, with the company being the owner-operator of the remainder. The plan was to increase franchise mix to 90% by 2018.

As of the last quarter that goal has been met and exceeded, with 92% of the company's total 37,286 restaurants being franchised; a new goal was set, of 95% of all restaurants being franchised. Refranchising boosts the company's bottom line -- as employees are shifted from McDonald's to franchise rolls, McDonald's no longer has to deal with the resulting labor expenses.

For comparison purposes, here's a margin profile comparison from the first quarter of 2015 -- right before Easterbrook's refranchising announcement -- and the most recent quarter, also ended in March:

Metric Q1 2015 Q1 2018 Growth
Company-owned sales $3,914 million $2,536 million (35%)
Company-owned expenses $3,354 million $2,131 million (37%)
Company-owned operating margin 14.3% 16%  
Franchise revenue $2,045 million $2,603 million 27%
Franchise expenses $404 million $480 million 19%
Franchise operating margin 80.3% 81.6%  
Consolidated revenue $5,959 million $5,139 million (14%)
Consolidated expenses $3,758 million $2,611 million (31%)
Consolidated restaurant margin 36.9% 49.2%  

Data source: McDonald's.

As you can see, although McDonald's consolidated revenue dropped 14%, expenses dropped a much sharper 31%. That's a result of the employee shift at restaurant locations.

Then, corporate HQ employees

The second phase of personnel cuts is at corporate headquarters. The company has a plan to slash $500 million in selling, general, and administrative expenses by the end of 2019. According to The Wall Street Journal, McDonald's sent an email message confirming a recent round of layoffs to employees, suppliers, and franchises but declined to give a specific number.

This isn't the first layoff for the burger maker; the WSJ notes McDonald's cut an undisclosed number of jobs prior to the announcement. Although the company notes it plans to invest in technology (more on this later) with the cost savings, it also has an ambitious plan to return $22 billion to $24 billion in dividends and buybacks to investors over the three years ending in 2019.

And finally, all restaurant-level employees, both franchisees and corporate

The final way McDonald's is looking to cut personnel is to invest in technology to increase productivity. Recently the company announced plans to add self-order kiosks to 1,000 stores every quarter for the next two years, with Easterbrook noting that kiosks lead to an increase in the average ticket order.

The downside: This will likely lead to job loss and a slower pace of hiring. Even at minimum wage, the ongoing cost of an employee will be higher than that of a machine. Ironically, new U.S. tax law incentivizes businesses to spend money on capital equipment like kiosks and other technology via immediate expensing, which will most likely lead to more entry-level job losses.

Easterbrook's version of McDonald's is one with fewer employees on its rolls. To date, Wall Street's given the CEO enthusiastic support, but it's likely employees have differing opinions.

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Jamal Carnette, CFA has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.