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Better Buy: McDonald's vs. Coca-Cola

By James Brumley - Jan 16, 2021 at 8:22AM

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Only one of these companies seems to be working with its most important partners, while the other appears to be working against them.

The two companies clearly sport similarities. McDonald's (MCD 2.14%) is a fast-food giant, while Coca-Cola (KO 1.63%) is a beverage powerhouse. But both outfits continually cater to retail consumers in an effort to make them repeat customers. McDonald's restaurants even offer Coca-Cola products to their patrons.

But the similarities of these two organizations goes well beyond what one can see on the surface. Neither Coca-Cola nor McDonald's is heavily involved in the businesses they seem to be in. Rather, both companies are major franchisers, licensing the right to sell their products to third parties, who in turn pay royalties to the parent organization. Both Coca-Cola and McDonald's, in fact, have spent the last few years selling bottling and restaurant management operations (respectively) back to bottlers and restaurant franchisees. As it turns out, there's more profit to be made in licensing popular brand names than there is in dealing directly with the public.

One thumbs up, and one thumbs down.

Image source: Getty Images.

Ergo, the question of which name is the better buy is ultimately a question of which of these two companies is the better franchiser.

Right now -- and for the foreseeable future -- that's Coca-Cola. McDonald's franchisee partners are growing increasingly frustrated with the parent company's heavy demands. An outright revolt may be on the horizon.

Dissension in the ranks

For perspective, as of the end of September, only 2,658 of the world's 39,096 McDonald's were actually owned by the parent company. The other 36,438 were franchisee-owned. That's a relatively big change from the shape of things five years ago, when only 29,851 of the 36,405 McDonald's stores open at the time were owned by franchisees. McDonald's has been steering away from the restaurant ownership game, offloading a few thousand of its once-owned units in search of more profits even if it meant less revenue.

In retrospect, one can't help but wonder if the company knew it would be raising the fiscal bar for its franchisees soon thereafter. The first of what would be several new or raised costs, after all, materialized in early 2015, which was right around the time McDonald's began the refranchising effort. Namely, the parent upped its minimum hourly pay at company-owned stores to $10, leaving many franchisees fearful they would eventually have to follow suit (which many did).

However, the ever-increasing costs of running a franchised store aren't limited to employee pay. Although the parent company helps pay some of the costs, many of the store remodels customers may have seen in recent years were compulsory, meaning the restaurant owner was forced to cough up the cash to finance their end of the upgrade.

Also largely overlooked is the fact that franchisees don't actually own their building. That's real estate owned by the parent company, and rented by the operator at a price established by -- you guessed it -- the McDonald's company.

The seemingly unchecked cost increases for franchisees ultimately led to the creation of a National Owners Association in 2018, which unofficially lets restaurant owners work together to prevent McDonald's itself from making unreasonable demands. Think of it as an employee union that has enough collective clout to push back on an employer.

The fact that McDonald's franchisees saw the need to organize is in and of itself an indication of their frustration, though it arguably understates just how contentious the franchiser/franchisee relationship has become in just the past few years.

Now fast-forward to last month. That's when the parent company informed franchisees of changes that would collectively cost them an additional $170 million in 2021, according to a report from Restaurant Business. In protest, 95% of the franchisees surveyed indicated they would refrain from any and all "non-essential communication with the home company until a more palatable agreement could be found." Some franchisees say they've never seen anything quite like this standoff within the McDonald's system.

It may all end amicably. But, franchisee/franchiser tensions have been building for years -- if they were going to fade, they should have done so by now. If anything, this dissension among McDonald's store operators seems to be worsening rather than abating, growing into a liability that not even investors can afford to overlook. As fellow Motley Fool writer Brett Schafer put it in December, "Optimizing for short-term profits and angering the people who interact with its customers millions of times a day during a pandemic is playing with fire, and the company is almost asking for franchisees to revolt." He adds, "It also may cause McDonald's to lose quality owners to competitors."

Bottom line

You don't necessarily have to jump to an extreme conclusion on the call. McDonald's still does plenty of things right, and Coca-Cola can still stumble. The fast-food giant has mastered the art of marketing and branding, while the beverage brand is grappling with changing consumer tastes. Sugary soda is losing its appeal, and people are trying out more niche drinks. Coke's big fountain/syrup business has also proven vulnerable to COVID-related shutdowns of sporting events, concerts, and the like.

Still, Coca-Cola and its bottlers are maintaining a healthy symbiosis. For instance, Coca-Cola CEO James Quincey commented during the company's third-quarter earnings call that some drinks are being dropped from the portfolio, but added, "We have begun the work with our bottlers to quickly sunset or thoughtfully transition them to one of the growth brands over the next year." This sort of relationship is in contrast with the one McDonald's currently has with its franchisees.

Only time will tell how it all shakes out for the king of the fast-food scene. For investors, this sheer uncertainty makes McDonald's the tougher of the two names to own right now.

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Stocks Mentioned

The Coca-Cola Company Stock Quote
The Coca-Cola Company
KO
$60.98 (1.63%) $0.98
McDonald's Corporation Stock Quote
McDonald's Corporation
MCD
$233.91 (2.14%) $4.91

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