Earlier this week, we told you that McDonald’s franchisees were frustrated after their cash flow declined $100,000 per location in 2022, enough that the National Owners Association wants limits on the amount of discounts given through the company’s mobile app.
The decline is indicative of the industry in 2022. Many operators watched sales and profitability soar in 2021. But when inflation hit in 2022, much of that was lost.
Let’s look at the numbers. McDonald’s same-store sales for the full year in the U.S. rose 5.9%. The number suggests that operators’ average unit volumes approached $3.5 million.
On balance, a brand that generates an increase like that off already high volumes should have at least maintained profitability. McDonald’s operators generated record cash flow in 2021 and, even with the decline in 2022, it remains up 35% since 2018.
But customer shifts and high costs ate into that profitability last year, even with unfathomably high menu price inflation.
McDonald’s customers in the back half of 2022 shifted more of their sales back into the restaurant, or toward mobile order and delivery, and away from the drive-thru. The group occasions that dominated the pandemic had slowed. Customers were on average reducing the number of items per visit.
The smaller order size, and shift toward value, enabled McDonald’s to generate traffic growth even with menu price increases of 10% in the last three months of the year.
CEO Chris Kempczinski said last week that there was some trade down to McDonald’s in the fourth quarter. But everything was “probably on the margin.”
The biggest issue, for McDonald’s and the bulk of the restaurant industry’s operators, was food costs. Wholesale food costs rose more than 14% in December. Wage rates, meanwhile, were up in the double digits for most of the year. Energy costs also increased.
The inflation has been bad enough in Europe, in fact, that McDonald’s is planning to spend up to $150 million this year to keep operators afloat. It’s indicative of just how bad the inflation problem is that the company has to spend that kind of money to protect franchisees at a time of otherwise strong sales.
In the U.S., the inflation problem for McDonald’s is so bad that it’s intensifying operator frustration at a time of remarkably strong sales. Weakening cash flow is playing a clear role in the difficult relationship between operators and the company.
To be sure, much of the industry is fine. Profitability was remarkably strong throughout the business in 2021, thanks to a combination of strong sales, government assistance and pandemic cost cuts. To some degree, inflation normalized that profitability.
At the same time, weakening cash flow is still a concern. Imagine, for instance, if McDonald’s sales weren’t so strong. We can, in fact: Look at Burger King, where heavily indebted franchisees are working to avoid bankruptcy. The bankruptcy filing of the 90-unit operator Toms King was a big warning sign for any brand that didn’t quite keep pace on the sales side.
The concern, both for McDonald’s and other chains, is whether consumers shift further toward value. At the moment, that doesn’t appear to be the case. As we wrote about yesterday, Kempczinski noted that consumers are “actually holding up better than what we would have probably expected” just a few months ago.
That might not happen. There seems to be an easing of concern that the economy is headed for a recession, meaning that the consumer might navigate through these challenges with a relatively modest impact on their spending. Yet if the economy does worsen, then brands are basically out of pricing power.
What’s more, the lower cash flow could pressure franchises to avoid any real discounts. McDonald’s franchisees are already pushing back on discounts given through the company’s mobile app, at least by calling for those discounts to be limited to certain percentages. That is the kind of pressure that takes place when cash flow takes a hit.