The asset light model is a business strategy, where an organisation focus on growth with relatively low capital investment. This results in capital efficiency by focusing capital on core assets and result in the best return for investors. This is achieved through a reduction in spending on owning a network, infrastructure and manpower by outsourcing, licensing or asset sharing, etc. While an organisation or organisations may invest their resources and time in more value-added work such as product innovation, forming strategic alliances for products, etc. The asset light model helps in easy scalability as there is low fixed capital investment requirement for expansion.
The restaurant industry (where the competition is high and companies are struggling to control costs) frequently uses the asset light model through a franchise system. Moreover, under this model, the company (franchisor) provides a franchise, ownership of its brand and trademarks for operations, while also providing training, access to corporate strategies, advertising, etc. All this is offered in return for an initial licensing fee and monthly royalty payments (typically a percentage of revenue). This has proven to be one of the most efficient methods for expansion since franchises are not responsible for any operating or development costs, once the franchise restaurant begins their operations. Thus, franchises are required to commit less capital to operate under the model. Although, revenue growth potential is limited (as they receive only a fixed percentage of revenue as a royalty), but operational efficiencies achieved outweigh this limitation.
Further, in the restaurant industry, the model is more prevalent in the fast food restaurant segment, where the menu and quality of service are more standardised and can be easily replicable in a franchise setting. However, casual full-service restaurant operators have not been able to accept this model readily as the menu and the quality of services cannot be standardised and vary significantly from restaurant to restaurant. Therefore, while fast food restaurants have been readily investing in this model, the casual full-service restaurants have either reduced their exposure in franchise restaurants or maintained it at a level beneath 50% of the total restaurants over the past two decades.
Additionally, in the last two decades, the fast food industry began refranchising thousands of company-owned restaurants by selling these to franchise owners. This was spearheaded by the industry leaders like McDonald’s, Domino’s Pizza, etc. The industry trimmed a number of company-owned restaurants, while simultaneously increasing the franchise ownership.
The franchise model helped companies in the industry to rapidly enhance their geographical penetration and resulted in a steady cash flow stream from fee-based income from franchises. The franchise, on the other hand, was able to focus on the core risks and opportunities to unearth maximum value in the business by spending productive time on enhancing the distribution network, partnerships and geographic reach.
While the scaling up of operations through franchises allowed wider geographical reach and customer base, the revenue took a hit owing to earning only a percentage of revenue of the franchises vis-à-vis the complete revenue in case of company-owned restaurants.
*McDonald’s Corp Revenue are taken in secondary axis
The revenue for casual full-service restaurants increased owing to opening up of a higher proportion of company-owned restaurants compared with franchise restaurants.
The franchise model has led to “operational efficiency through cost savings” by reducing operating costs as a percentage of revenue. As mentioned earlier, under the franchise model, the franchise owner is responsible for running the restaurant and managing entire operations. The company that grants a franchise has no role to play in the day to day operations and earn an agreed upon share of the franchise‘s total revenue. Consequently, even though total revenues declined for the fast food restaurant operators (who follow the franchise model), direct costs which majorly include food & beverage and labour expenses saw a decline as a percentage of revenue for all companies leading to an improved operating profitability.
In the past 4-5 years, the fast food EBITDA margins improved for all the operators analysed. Domino’s continued to enjoy higher EBITDA margins than the rest of the companies due to the backward integration of their supply chain, which enabled to save on direct expenses on food & beverage. Although McDonald’s negotiated a lower cost with its labour owing to a bigger brand name. On the other hand, Wendy’s and Jack in the Box had lowest margins owing to higher food, labour and rental costs, this improved in the last few years due to system optimisation through refranchising company owned restaurants.
In contrast, casual full service’s EBITDA margin remained on the lower side as compared to that of the fast food restaurant operators. This is attributed to a higher direct cost as a percentage of revenue, which is required for day to day operations in company-owned restaurants.
At the same time, the franchise model has led to “higher return on assets” for fast food companies as compared to casual full-service restaurant operators on the back of higher profitability and lower asset weight.
Although fast food restaurant operators majorly follow asset light model, they remain comparatively highly leveraged from casual restaurant operators. A high indebtedness of fast food restaurant operators is mainly due to a large amount of long-term debt taken in order to finance their stock buyback program as well as to fund their cash dividend payments. However, despite high leverage almost all fast food restaurant operators have high debt servicing capability in-line with casual full-service restaurant operators due to low short-term debt repayment obligations as repayments of long-term debt raised for stock repurchase will start from 2017 onwards.
In spite of the asset light model, the return on capital employed for fast food restaurant operators remained in-line with that of the casual full-service operators because the fast food operators undertook large debts to finance stock repurchases, this increased the capital employed in-line with that of the casual full-service operators.
Thus, it can be concluded that while the asset-light model is prevalent in the restaurant industry, it is readily accepted in the fast food industry vis-à-vis the casual full-service industry because the menu and the quality of service for fast food operators are highly standardised and easily replicable in the franchise settings. It is due to the model’s strategy, the fast food operators enjoy a wider base of customers and geographic reach, besides higher operating margins on account of operational efficiencies achieved through a reduction in direct expenses as compared with their casual full-service counterparts. Although the revenue growth potential was higher for casual full-service operators. Fast food operators on an average enjoy a higher return on their assets owing to lower assets on their books while receiving steady cash flow stream from fee-based income from franchises.