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February 25, 2014
U.S. Fast Food Industry Analysis
Executive Summary
Fast food industry in the United States has always been a lucrative playground for prevalent and
potential new players. However, owing to the rising cost of food further plagued by recession,
changing paradigm in food and lifestyle changes the industry has not been as attractive and easy
as before. However, despite the health and increasing cost issues surrounding this industry there
is always demand for quick fix , fast food. Also, fast food places, also, seem to be rising up to the
occasion and have started offering healthier food choices.
With low to medium attractiveness as demonstrated by Porter’s model, fast food industry seems
to be a difficult arena for players. It is becoming increasingly important for companies to
introduce healthier options while retaining their fast food image. This becomes difficult when
customers have many options to choose from and the switching costs are low. Substitute
products also pose a threat here with at-home options whilst delivering a comparable product.
The Industry is dominated by four major players. Although investors view companies such as
Wendy’s as having greater growth potential, such companies lag behind in terms of profitability
and putting a cap on fixed costs. McDonald’s remains as the market leader both in terms of
market share and profitability indices.
Changing customer food preferences serves as an alarming indicator of the emergence of a new
segment who would remain undeterred by typical fast food choices. Firms need to cater to such
customers or risk losing market share. Number of franchises or company owned locations also
play an important role. For this reason, bigger and financially healthy competitors show greater
profitability indicators.
Overall, the attractiveness of the industry is not very alluring. There already seem to be prevalent
competition with established brand names and strong holding of the market share. Product
differentiation is difficult especially when major fast food joints have started tapping on the
health conscious consumer. Unless there is strong financial backing, it seems unlikely that a new
entrant would significantly have success in such a high competition industry.
Analysis of Macro Environment
U.S. fast food companies are now franchised in over 100 countries. In the U.S. alone there are
over 200,000 restaurant locations. As of last year, revenues have grown to a staggering $160
billion from $60 billion in 1970; an 8.6% annualized rate.
Fast food franchises are primarily focused on low cost and high speed product with mass
production. The precooked and preheated food is normally consumed on site and/or the take
away option is utilized. The food is also standardized. Despite the straightforward approach of
the fast food there have been challenges faced by the industry which seem to be putting a
downward thrust on profit margins.
The most important factor that this industry is facing is market saturation. For every fast food
restaurant in the street, there is a representative of each of its competitors. In fact, the new face of
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fast food called quick service restaurants which utilize the attractiveness of quick meals whilst
upholding the integrity of providing healthy, organic food choices seem to be quickly gaining
popularity among aware customers.
Since early 2000s the typical fast food customer in the U.S. has been greatly affected by the
concerns that question the health effects of fast food. This gamut ranges from the high fat content
in almost all the food resulting in the alarming obesity rates. According to (Centers for Disease
Control and Prevention), one third of U.S. adults are obese. It is also important to note that the
negative press hype around fast food restaurants, for instance Super Size, a documentary, and
books such as Fast Food Nation have increased public awareness about the debilitating effects of
food choices. This has resulted in the typical fast food losing customers to healthier food
competitors such as Subway. (Sena)
Food and beverages make up more than one third of the costs of fast food companies; rising
prices of life stock, grounded grains and fast food drinks have decreased industry margins by
10% (Sena). However it is important to note that this industry has proven to be recession proof in
terms of consumer spending. In fact given the increase in prices of traditional restaurants, this
sector has seen an increase in consumer spending.
Fast food had been thought to be largely recession proof, and indeed the industry did not suffer
nearly as much as other discretionary spending sectors. In fact, there was some increase in
consumer visits as people choose cheaper fast food options over fast casual or traditional
restaurant choices. But overall, the recession hurt spending, and consumers overall purchased
less with each trip. (The changes facing fast food)
Porter’s Five Forces
Supplier chain of fast food industry is inundated with plenty of suppliers. The companies have
options to choose their supplies. This typically consists of meat/vegetable options from the
typical butcher/farm or from a more specialized packaged supplier. Also, if the fast food
companies unlike Chipotle, Panera, Qdoba and Moe’s SouthWest Grill (Shaw), are not looking
at specialized suppliers then there are plethora of suppliers to choose from with little to no
bargaining power.
With the pitch to the bottom, bargaining power of customer is high in the fast food industry.
Companies such as McDonalds, KFC and YUM cannot afford to raise the prices and should
make do with a decrease in profitability. Since higher prices would put off a customer who only
compromised on food quality on the premise of lower price. Consequently this would also result
in customers switching to healthier brands such as Chipotle.
There are few, if any, barriers to entry in this industry. Due to saturation it is extremely difficult
to maintain a profitable position in the fast food industry but on the other hand it is fairly cheap
to start up a restaurant to begin with.
There is always a high threat of substitute products. These begin with food provided by organic
food offered by expensive restaurants and the new trend of fast casual restaurants. Also, it is
important to note that indirect packaged food substitutes including choices such as Betty Crocker
or full service restaurants and caterers and also pose a challenge.
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The industry is highly saturated with fast food companies and the new hybrid companies that
offer fast but healthy food. It is also interesting to note that some companies have focused
fighting for the fast food customer who has converted to health focused consumer. Fast food
chains such as McDonalds have started exploring new options such as breakfast and brunch
offers to increase their offer base for customers and create new demand. Industry rivalry remains
very strong and fast food chains and franchises who ignore the upcoming new trends and new
offers by their competitors continue to suffer.
Financial Analysis
McDonald’s is the market leader of this industry followed by Starbucks, Wendy’s and Burger
King. As of 2012, McDonalds reported sales of $35,000M, followed by Subway ($12,100M),
Starbucks ($10,600M), Wendy’s ($8,600) and Burger King ($8,587M).
As of 2013, With respect to P/E ratio McDonalds has the lowest (17.3) followed by Starbucks
(32.98) and Burger King (31.52) while Wendy’s (61.88) dominates which means that investors
are finding Wendy’s to have higher earnings growth in the future.
Industry reported (2012) ROE and ROA of 15.41% and 6.38%. Starbucks ROE deteriorated from
2011 to 2012 (27.09%) falling to an all low of 0.19% in 2013 with ROA of 16.84% by Dec 2012.
McDonald’s ROE is the highest in 3 years standing at 35.73% with ROA of 15.44% . While
Wendy’s (ROE 0.36% and ROA 0.16%) lags behind and Burger King (10.6%) and ROA 2.13%
falls in the middle (Y Charts).ROE and ROA show profitability and growth potential. It seems
that McDonald’s is the most profitable firm among its competitors and has high growth potential
. While Wendy’s even while viewed as lucrative by investors is the least profitable among its
competition.
Operating Profit Margin of the industry was 15.02% as of 2012. McDonald’s (32.21%) followed
by Burger King (19.5%) , Starbucks (15.02%) and Wendy’s (4.19%). This shows that
McDonald’s is in the most sound health being able to pay its fixed costs while earning the most
on every dollar earned on cash. Even here, Wendy’s demonstrates least financial health.
Industry Net Profit margin as of 2012 is 5.1%. McDonald’s (19.82%) again dominates followed
by Starbucks (10.4%), Burger King (5.99%) and lastly Wendy’s (0.32%). This shows that cost of
Wendy’s have increased greater than sales while McDonald’s maintains a cap on its costs whilst
increasing sales followed by a commendable performance by Starbucks.
Since toughening of competition from 1990s , McDonald’s has been experimenting with
diversification by investments in quick service restaurants such as Chipotle, Donatos Pizza,
Boston Market restaurants and Aroma café stores. Also, McDonald’s has been named a Top 25
Socially Responsible Dividend Stock by Dividend Channel. It signifies a stock with aboveaverage ''DividendRank'' statistics including a strong 3.1% yield (Forbes). Adapting to latest
trends and focusing on social responsibility initiatives has made a positive influence on its
financial health and it remains the industry leader as well.
Wendy’s lacks behind in terms of profitability because it has less presence in the market. As
major holding major chunk of the market, competitors such as McDonalds have greater say on
prices o raw materials affecting profitability of smaller competitors such as Wendy’s.
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Burger King and McDonald’s have often gone hand in hand for both financial health and market
share. Offering by one firm is always followed by a similar offering from the other. Both have
inundated the market with their presence on virtually every location and due to greater size both
the firms are most profitable.
However, since 2008 sales of Burger King continue to decline. From conspicuous marketing
blunders to losing its second place to Wendy’ s. This coupled with recession and aggressive
competition has made Burger King lose its former glory. But with the new acquisition of Burger
King the company seems to increase profitability with a decrease in its costs. As reported,
“Burger King reported $275.1 million in third quarter revenue, a 40% decrease over this time last
year but beating analyst predictions of $267 million. Despite this decrease, profit increased
32.7% to $81.1 million, or 23 cents per share, beating the Street consensus of 21 cents per share.
A sharp drop in operating expenses, which fell over 64% due to cost management and a global
refranchising effort, the company said.”
Also, after its dip in sales Burger King shares seem to be enjoying a 2.7% increase in pre-market
trading; year-to-date, the stock is up 16.5%. On the other hand, McDonald’s share was up 0.12%.
Also, Wendy’s and Yum! remained non-commendable.
Key Success
One of the major key success factors affecting this industry includes shifting customer focus.
Consumers are getting more health conscious by the day. So the only factor stopping a customer
from going to a healthier choice is product price. This is the reason that McDonald’s and Burger
King have been able to stay the most profitable because they offer products at cheap prices. But
these firms are not viewed as attractive by investors who think that Wendy’s is a more optimal
option since it caters to a potential future market of health conscious customers. While Burger
King and McDonald’s current profitability and market share looks fleeting, considering the
projected exponential growth in the size of health conscious consumers these companies will
have to look for more product choices for this segment.
Also inundation of a firm’s franchises is also very important since a typical fast food customer is
looking for a quick meal. He would go to a restaurant which semis in proximity compared to one
that is far off. This shows why Wendy’s profitability lags behind while bigger competitors
exploit location opportunity.
Over the years, fast food chains such as McDonald’s have been looking at changing customer
tastes and preferences. These fast food joints remain quite profitable as they offer a hybrid of
products catering to both health conscious customer and customers who are price conscious and
would settle for a less organic alternative.
Companies such as Burger King are offering healthier fast food by offering choices such as low
fat French fries (Stirfries).Innovation seems to be a driving force is this industry. Where product
offerings such as stirfries can increase sales up to tens of thousands of dollars, firms need to
focus revamping their existing offers.
Industry Attractiveness
An analysis of Profitability of fast food sector in the United States suggests that the
attractiveness of the industry remains low. Bigger firms and established names such as
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McDonald’s remain highly profitable due to a commendable franchising system, smart real
estate decisions, brand value and Debt/Equity choice. Attractiveness of this industry is high for
brands who already have established a market presence.
Since price penetration is the norm so the firms cannot afford to offer products at increased
prices. To solve this problem both existing companies need to either outsource labor and employ
international cheaper alternatives or utilize economies of scale and operate on as many locations
as optimal. Potential entrants need hefty cash to step into this industry because significant
spending would have to be allowed for marketing purposes to establish a brand name. Next, cost
is an important factor which needs to be minimized, so proper due diligence would have to be
carried out to put a cap on costs.
Existing competitors need to learn from the mistakes of Burger King and should try to improve
profitability by capping their costs. This especially holds true for Wendy’s which cannot utilize
economies of scale and struggles with higher costs and questionable profit indices.
Also, it has become virtually impossible to operate in the fast food sector without the menu
catering to health conscious customers. It seems a matter of putting a limit to the fixed costs,
essentially the cost of raw materials and an organized road map to be successful in the fast food
industry. Potential entrants who are low on budget might need to rethink their decision to enter
the playground.
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Works Cited
Business Week. 2014. February 2014
<http://investing.businessweek.com/research/stocks/earnings/earnings.asp?ticker=MCD>.
Centers for Disease Control and Prevention. 2012. February 2013
<http://www.cdc.gov/obesity/data/adult.html>.
Forbes. 2014. 2014 <http://www.forbes.com/sites/dividendchannel/2012/12/17/why-mcdonalds-is-atop-25-socially-responsible-dividend-stock/>.
Sena, Matt. Franchise Help. 2014. February 2014 <https://www.franchisehelp.com/industryreports/fast-food-industry-report/>.
Shaw, Brian. "Risks for Chipotle Shareholders in 2014 and Beyond." Janurary 2014. Daily Finance.
Febuary 2014 <http://www.dailyfinance.com/2014/01/18/risks-for-chipotle-shareholders-in2014-and-beyond/>.
"The changes facing fast food." 2010. The Economist. 2014
<http://www.economist.com/node/16380043>.
Y Charts. 2014. February 2014 <http://ycharts.com/companies/BKW/return_on_equity>.
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