Last week, McDonald's Corporation (NYSE:MCD) CFO Kevin Ozan presented on behalf of the company at the Bank of America Merrill Lynch Consumer and Retail Technology Conference. During his session, Ozan answered several analysts' questions regarding the company's early experiences with the partnership McDonald's has struck with Uber Technologies' UberEATS food delivery service. It's been approximately a year since "McDelivery," as McDonald's delivery service is formally known, first started teaming up with UberEATS.
Ozan relayed that the partnership now delivers to over 5,000 restaurants in the U.S. Roughly 65% to 70% of delivery sales are incremental to McDonald's existing business in participating restaurants. That number has increased from an estimate of 60% when McDonald's first rolled out UberEATS to a smaller sample size of 2,000 restaurants last spring.
Last summer, I expressed concern that as McDonald's experienced a higher uptake in delivery, the new business might cause some issues with throughput -- that is, the rate at which the company can service sales.
Particularly, I worried that delivery orders during peak hours could cause delays in filling orders to walk-in customers. Such lags can be particularly frustrating to in-store customers who can't see the typical visible cues of delay, such as a long line to the cash register.
Yet so far, order patterns as McDonald's expands delivery look much as they did within the initial run last year. A full 60% of orders tend to be placed during off-peak hours. The sales are skewing primarily to younger customers. College students, in particular, whether from intense studying or more freewheeling activities, appear to be working up the munchies in the wee hours. I loved Ozan's tactful explanation of this aspect of a new business driver for McDonald's to a roomful of Wall Street analysts:
Sixty percent of the orders are in the evening -- evening and late nights, which is really helpful for us from a capacity standpoint, because we've got capacity certainly at dinner and overnight hours. Overnight, as you get closer to college campuses, it's a pretty attractive space to be in. I won't surmise why that is or what they're doing prior to ordering McDonald's, but it's become -- so we know it's a younger demographic, we know it's the time of day that's attractive to us.
It should be noted that not only are these orders incremental to McDonald's existing revenue, but to some extent the customers are as well, and they could be converted to core patrons over time. I believe the various initiatives undertaken by CEO Steve Easterbrook to present McDonald's as a legitimate dining option for socially conscious millennials are starting to gain traction. The introduction of fresh, never-frozen beef patties in McDonald's Quarter Pounder and "Signature Crafted" burgers this year represents the latest step in this evolution. Removing a younger generation's objections to the company's menu, while enticing this convenience-driven, app-savvy group with delivery, is a shrewd way to add to McDonald's long-term customer base.
Delivery pleases another important set of stakeholders
Earlier this month, I discussed a strategy used by McDonald's smaller rival Wendy's (NASDAQ:WEN) to keep individual store volumes robust. Wendy's management achieves this by focusing on the economics of its franchisees as much as it does the dynamics of its systemwide profit and loss. Similarly, partnering with UberEATS has proven to be a crisp decision on McDonald's part that benefits U.S. franchisees, a key group of company stakeholders.
The economics of the partnership are straightforward to operators. Franchisees pay a commission fee to UberEATS on each delivery. Thus, these orders carry a lower margin than the typical ticket. But they're still attractive sales to capture, as Ozan explained:
But in terms of additional dollars, the fact that 70% incremental is giving them clearly more dollars and our breakeven, if you will, incrementality is substantially below 50%. So there's a lot of room, let's say before we get anywhere close to breakeven from an incrementality standpoint.
McDonald's CFO is alluding to a type of profitability study known as cost-volume-profit analysis. To wade through jargon and translate the above, franchisees already cover their fixed operating costs (rent, utilities, insurance, etc.) through their existing sales. So the only costs on incremental delivery orders are variable (primarily food and labor). Thus, these sales have a lower breakeven point, giving the franchisee room to cover UberEATS' commission on each sale.
Franchisees love this type of revenue stream because it comes without any additional overhead investment. Between interior and exterior upgrades, investments in kiosk-driven "Experience of the Future" ordering technology, and McCafe beverage equipment, McDonald's operators have been required to invest quite a bit of capital over the last few years to increase their annual cash flows. Adding incremental profits to franchisees' bottom lines -- with zero investment on their part -- is reason enough to label McDonald's expanding delivery business a tangible success.