What is McDonald’s business? Some might say, the fast food business, or more broadly, the restaurant business. But what many people don’t realize is that McDonald’s is really in the real estate business.
Their real estate holdings include land and prime building locations around the world where their Franchisees build restaurants and pay them rent, month-in and month-out. That’s where McDonald’s makes most of their money, more money than selling burgers.
I remember watching, “The Founder,” a 2016 film about McDonald’s history. “You don’t build an empire off a 1.4% cut of a 15 cent hamburger, you build it by owning the land on which that burger is cooked.” Decent flick by the way if you haven’t seen it.
Southwest Airlines flies people around, but they are also adept at buying and selling oil futures. They do it really, really well. What started out as a way to hedge against fluctuations in fuel prices back in 2007, ended up being a major profit center for them. And while other airlines were losing money when oil prices skyrocketed, Southwest made money.
Another good example is Amazon. According to a February 2022 article in Investopedia, while the majority of Amazon’s revenues comes from online and offline retail sales, the majority of its operating income is from AWS or Amazon Web Services. It is the world’s most comprehensive and broadly adopted cloud platform.
Many car companies earn very thin margins selling cars but make up the difference both through financing those cars and inside their service departments. So are they in the car selling or the car servicing/repair business? Are they in the financing business? Of course it depends on the particular car company.
Which begs the question, do you know what business you are really in?
The best way to find out what business you’re in is to give the different departments (or product lines) inside your company their own financial statements. That amounts to extra accounting work, but not that much compared to the benefits that knowledge will give you. Break down each department’s sales, cost of goods sold, and expenses specific to them. You can apportion the time expense of employees who manage and work for different departments. You can also apportion rent, utilities, equipment, and so on.
Then analyze and compare the financials. Which department is making the highest profit margin? Which one is generating the most cash flow? Chances are, that’s your core business.
Why is this important?
This is important because once you figure out what your real business is, you have to protect that and feed it. Spend extra money to make sure it is well staffed and well stocked. Veer marketing and advertising dollars in that direction. Give it the most attention. Doing this will protect your overall business.
When I was a partner in the apparel business, XLARGE Clothing, we had half a dozen retail stores in addition to selling to major retail chains, bougie boutiques, and international licensees. What business were we in?
XLARGE designed an entire collection four times a year: spring, summer, fall/back-to-school and holiday. The collection included everything from graphic tees and sweatshirts to jeans and work pants to accessories (belts, backpacks, etc.), to button down shirts to outerwear and even shoes. We did a lot of collaborations too with artists and other designer brands like, Vans and The Hundreds. Our retail stores were in San Francisco, Orange County, SOHO, and Los Feliz. Licensed XLARGE stores were in London, Germany, Taiwan, China, Hong Kong, Australia, Korea and Japan. The licensed stores had to buy all their clothes from us. We had a girl’s line, X-Girl and later, x’e. And our kid’s line was called, X-Little. And we sold to retailers such as Urban Outfitters, Bloomingdales, Journeys, Hot Topic, Federated Department Stores, PacSun, and many other cool stores like, Colette in Paris.
It was really the best job in the whole wide world. The Beastie Boys were partners and we had a lot of great parties and store openings. Many wonderful artists worked for us and with us. My duties included traveling to Tokyo and New York City. It was hard work but great fun. Work hard. Play hard.
Where do you think we made the most money? Well, it certainly wasn’t our retail stores. Retail is a difficult place to make money even with the vertical integration and resultant hefty gross profit margins that affords. We didn’t make that much money for most of our clothing collection either. Our volume wasn’t quite high enough to get the pricing we needed to be competitive. Most of our licensees had one or a handful of stores so they didn’t really buy enough from us to be a contender for our largest generator of profits.
Diversification is good and we had many different sales channels that helped us achieve that; we didn’t want to throw out the baby with the bath water so we carefully evaluated all our different departments. Our true business, our real business, the thing that made us the most money was two things: graphic t-shirts and sweatshirts, and our Japanese licensees because they had eighteen stores. Nothing else came even close.
Since I was the CFO, I closed most of our stores except SOHO and Los Feliz and wrote off those losses as advertising expenses, because that’s what they were. We also quit selling to most of our wholesale accounts because they weren’t worth the expense of a sales force and the merchandise returns were shameful. There were more things we shuffled around and refocused on. We hired additional, talented graphic designers for more tees and sweatshirts. We transferred the manufacturing of the collection to our different licensees and they had to pay us simply a licensing royalty instead of buying the entire collection. They still had to buy tees and sweats from us. All of these moves made our company immensely more attractive to the point where we were able to sell it to our Japanese licensee for a spectacular return. XLARGE is still around today and still a super cool, niche, streetwear brand.
All of this analysis taught us we were in the business of making t-shirts and sweatshirts and selling them to Japan.
The role of the customer.
Sometimes a less profitable part of your business feeds customers to the more profitable part of your business. It’s similar to a loss leader in a grocery store. Using the car dealer example above, perhaps they make most of their profits in car servicing, but without selling customers the cars in the first place, they wouldn’t have a servicing business. That needs to be taken into account as well and can be established by doing a customer analysis. Think of it like computer analytics which tally where your customers originate. Are they being referred from a blog? Your website? Google searches? Social media posts? You should be able to track that. If most of your customers are coming from outside your website, then don’t invest too much time and money on your website. Or if the bulk of your business is coming from social media, then don’t spend money on Google ads.
The important thing is to know your business. Know where you make the most money, what has the most potential and where your customers originate. Then spend more time nurturing those things. And remember, the truth is always in the numbers.
Originally published at https://www.datadriveninvestor.com on May 12, 2022.