TIP753: The Relentless Vision That Made McDonald’s a Global Giant w/ Kyle Grieve

22:35Preston Pysh:But Ray did not allow for any of that. because he believed it tarnished the fine brand of being a family restaurant that McDonald's had cultivated over the years. McDonald's had been a uniform operation. There was simply just no room for people who wanted to operate under the McDonald's brand, but take a different direction. He didn't want it to be a name used by various people haphazardly. Now, Ray needed to create a restaurant system known for consistently high quality food and uniform methods of preparation. He needed to focus on repeat business driven by the system's reputation rather than relying on a single store or operator.

23:09Preston Pysh:They also had to maintain a continuous program to educate and support operators, as well as to review their performance on a regular basis. To continue improving McDonald's, they needed a full-time research and development program as well. Now, while developing this program, Ray Kroc and his colleague Harry Sonneborn began to understand the bigger picture for McDonald's. Instead of just building out the locations on behalf of the franchisee, they would decide to have a slightly different model where they would find the location, develop it themselves, then lease the area back to the franchisee.

23:40Preston Pysh:It was a brilliant business plan that had massive success. To get this all started, Ray and Harry began at the Franchise Realty Corporation. It was seeded only with$1 ,000 and its success came from some pretty savvy financial engineering. So you could basically break it down to four parts. The first part, find a landowner. Second part, convince that landowner to lease the land back to them and agree to take a second mortgage, meaning they'd only get paid back after the bank. Third, use that agreement to get a first mortgage from a bank to build the restaurant on the land. And fourth, the landowner's rights to the land would be subordinated.

24:15Preston Pysh:The bank would have first claim before the landowner. Croc didn't think the landlords would go for this deal at all, but he decided to let Harry try it anyways. Ray's management style reminds me a lot of Reed Hastings style at Netflix. If you hire a superstar, you give them responsibility and you let them take ownership of it. If you hire them for their expertise, you let them cook and see what kind of innovations they can do to help move your company forward. Harry Sonneborn was Croc's first superstar inside of McDonald's. And the system worked incredibly well. It allowed franchise realty to scale up.

24:47Preston Pysh:And since there wasn't as much competition for real estate as there is today, they could secure their locations at much better prices than they could probably get today. Now, speaking of systems, the next curveball thrown at Ray was related to having a key person who could visit the newly set up franchisees to help them getting run properly. The man he found for this job was Fred Turner. In 1957, Kroc opened 25 franchises and Fred Turner worked inside every single one of them. Fred bought other innovations to McDonald's just like Harry Sonneborn. For instance, as McDonald's scaled up, the scale created numerous problems regarding uniformity.

25:24Preston Pysh:The hamburger buns are a good example. So any McDonald's you go to is going to have the exact same buns. However, the problem was that as McDonald's scaled, they needed more and more buns and making them prove to be very, very challenging. As a result, Fred came up with the idea to have buns made in significant quantities by several suppliers, with McDonald's being their primary customer, and I think in some cases being their only customer. And as McDonald's expanded, so did its suppliers. So I mentioned earlier that Ray was very good at helping his customers when he was at Lily Tulip. He brought that same attitude to McDonald's.

25:57Preston Pysh:For instance, at the time, McDonald's was creating just nine products and required only 40 items to make those nine products. But Kroc wasn't selling these inputs to his franchisees. Each franchisee was sourcing them directly from the supplier. Where McDonald's had the advantage was in making it cheaper for their suppliers to get their product to the franchisees. They did things like improving packaging, which could make the supplier more efficient, allowing them to charge McDonald's less than other customers. Many of these relationships with suppliers came about because the suppliers were also inside of the business as franchisees.

26:31Preston Pysh:This alignment of incentives worked very well between McDonald's, its franchisees, and its suppliers. For instance, in California, there was actually a massive discrepancy in sourcing buns and meat. So in California in the late 1950s, buns and meats were going for nearly 100 % premium compared to the stores in Illinois. Ray resolved this issue by leveraging his entrepreneurial skills and connections. He basically just found a baker who had helped solve McDonald's buns problems elsewhere, who retired and got him to come out of retirement to help McDonald's in California. Now for the patty problem, he had to take a different approach.

27:05Preston Pysh:One supplier of meat for McDonald's named Bill Moore was actually experiencing cashflow problems and needed about a million dollars to avoid bankruptcy. Him and his partner asked if McDonald's would buy the company, but Ray said no, because he just didn't want to be part of the supply chain business. But what Ray did was basically just told him to hang in there and that he'd be okay because they were partners with McDonald's. And as McDonald's grew, the supplier would grow with them. And it all ended up working out for Bill. So Bill ended up building multiple McDonald's franchisees with his partner.

27:34Preston Pysh:Bill then ended up selling his shares in the franchises to fund a new meat processing plant that Ray said processes over 300 million patties per year for McDonald's. The plant also made things like syrup for soft drinks and manufactured milkshake mix. Additionally, Bill then went on to create even more plants around the US, including locations in Atlanta, San Jose, North Carolina, and Hawaii. Now, like most small businesses, McDonald's had numerous cash flow problems as it scaled up. One such problem occurred when a McDonald's franchisee named Clem Boer, who was responsible for scouting and leasing new sites for McDonald's, failed to secure a clear legal title to the properties.

28:11Preston Pysh:This oversight resulted in a mechanic's liens totaling around$400 ,000 against the company. This was a significant financial setback for the very early franchise operation. Ray's net worth at this time was only$90 ,000. So he just wasn't able to come up with that money himself. So they basically were forced to borrow money from a consortium of insurance companies and an acquaintance. This opened the door to McDonald's borrowing more money in the future, which helped further expedite their growth. Another way that McDonald's systematized was through its speedy service system. So this system required a standardized store blueprint.

28:47Preston Pysh:This meant that every McDonald's location had nearly identical floor pans for the kitchen and the front counter. Additionally, equipment such as things like grills, fryers, shake machines, and prep tables were placed in the exact same position in every store. This allowed staff to be trained to move more consistently regardless of their location. Next came the workflow system, which was based on an assembly line system. An example of this while cooking a hamburger might be, you know, the patty start on the grill, the cooked patties move directly to the dressing station. Burgers were then wrapped and placed in warming bins for pickup.

29:19Preston Pysh:Each step was located just one to two steps away from the next, which reduced any wasted movement. Kitchens were laid out so that everything a worker needed was within an arm's reach. Additionally, equipment was placed to minimize traffic jams or collisions, which could slow down production. Quality control was also a massive part of McDonald's brand and success. Food had to be served while still hot, so grills were positioned near holding bins, allowing burgers to be served quickly while still warm. Now, when thinking of fries, the fryers were placed close to the salt station and holding area to ensure crispiness and speed.

29:53Preston Pysh:Shaken soda machines were near the front counter to minimize any delays in serving drinks. To add further uniformity, all major kitchen equipment was supplied or authorized by McDonald's, which ensured uniform cooking times, temperatures, and quality. This level of control made it easier to train crew members because every store operated in the same way. Kroc was basically just transforming the restaurant industry into an assembly line model. The best aspects of an assembly line are that it builds speed and consistency, lowers training time, reduces labor costs, improves the efficiency of space, and is more easily scalable.

30:27Preston Pysh:Without this assembly line systems, McDonald's would have never been able to expand much further outside of California. Additionally, the assembly line system ensured a consistent product wherever it was eaten. This was vital in building McDonald's brand. When you visit McDonald's today, you expect a very, very specific product. And if you are wildly disappointed with that product in one location, the brand's reputation is going to be tarnished in all locations to that one customer. Now, another key theme that I really appreciated from Ray Kroc was his ability to generate wealth for those around him.

30:56Preston Pysh:Many investors like myself are huge fans of individuals such as Mark Leonard, the CEO of Constellation Software. He has helped over 100 Constellation Software employees become millionaires through the system that he created for Constellation. His ultimate goal is to create 500 CSU millionaires, which demonstrate how much runway he still thinks he has left. Now, the similarity that I see between the two of them is that Ray also created several millionaires within McDonald's. However, instead of being purely employees of McDonald's becoming millionaires, they were also from the franchisees that he partnered with.

31:29Preston Pysh:One person close to the McDonald's organization told Ray, he was certain research would show that Ray Kroc had made millionaires of more men in history than any other person. But Ray seemed like a modest person. In the book, he discusses that he didn't feel like he'd made millionaires out of his employees and franchisees. Instead, they made it themselves. But Kroc saw himself as someone who could just provide the means to the right person to attain wealth if they were willing to put in the work. I admire this humbleness and I think it's a very powerful trait in leaders that I'd like to invest in.

31:59Preston Pysh:Now let's focus here a little more on just how important it is to be aligned with the people that you do business with. Kroc made a point in his book as he helped scale McDonald's that he just wasn't aligned with the McDonald's brothers. He writes, the McDonald's brothers were simply not on my wavelength at all. I was obsessed with the idea of making McDonald's the biggest and best. They were content with what they had, and they just didn't want to be bothered with more risks and more demands. But there wasn't much I could do about it. At one point, Kroc sent Fred Turner to the California area to observe the practices at the 10 locations that the McDonald's brothers had franchised before the deal with Kroc.

32:35Preston Pysh:stock. Ray was absolutely appalled by what they were allowing at these locations. The locations outside of the original just weren't following the brand closely enough, and Ray felt they were tarnishing the brand that he'd fought so hard to build. So they were doing things such as adding non-core items to the menu, such as pizza, burritos, and enchiladas. They were lowering the quality of the burgers by adding ground hearts to their ground beef mix, which changed the fat composition of the burger, making it greasier. The operators refused to cooperate in volume purchasing, so they couldn't charge the same amounts.

33:07Preston Pysh:And they just wouldn't pony up additional revenue dollars to spend on advertising campaigns that were supposed to help all of McDonald's's franchises. So Ray was infuriated by this because he was just running a tight ship and he felt contempt for the McDonald's brothers for allowing these franchises to operate differently. But since they weren't his stores, there was nothing he could do. And that upset him because like I mentioned before, when you go to McDonald's in one place, you expect the exact same experience in any location. And he could see that these other locations just weren't suitable for the brand as a whole.

33:39Preston Pysh:There are many parallels between Kroc and other high performing founders, such as Steve Jobs, Howard Schultz, and Elon Musk. All three of these guys wanted to concentrate a lot of their decision-making early on to help solidify their brand and product. Kroc did the same thing, just decades ahead of these guys. So in Steve Jobs' case, he was utterly obsessed with product design and the user experience. While Jobs was much more prickly than Kroc was, neither was afraid to clash with partners or internal executives who disagreed with their uncompromising standards. An example was when Jobs insisted on removing disk drives from the iMac in the late 1990s, which was an initiative that many other insiders first resisted.

34:19Preston Pysh:But Jobs' clarity of design helped protect Apple's brand identity, which was based on the principle of simplicity. Other rigid requirements that Jobs wanted included things such as having no fans on his computers. This made computers much quieter and less distracting to use. However, it also required a completely different method to keep the laptop cool, which necessitated considerable innovation. While Kroc was nowhere near the innovator that Jobs ever was, they were both keen on shaping their companies in their own mold, and they knew they had the best vision for providing the best product to customers based on the brands that they built.

34:52Preston Pysh:Starbucks' Howard Schultz was another pioneer who came after Kroc and understood the power of the interplay of experience with the consumption of a beverage or food. In Schultz's case, Starbucks wasn't just a location to get coffee. He envisioned it as a third place to go between home and work. Schultz is an interesting case study because he stepped down as CEO, saw his brand and results deteriorate as a result, and then returned to right the ship. The corrections he made helped save the brand and are significant reasons that Starbucks remains the behemoth that it is today. Now, part of the strategy that Schultz used to bring Starbucks back to its rightful place was to ensure that operators were aligned.

35:31Preston Pysh:Small changes in a store were not part of Starbucks' core and were not to be tolerated as they altered the customer's core experience. When Schultz left, Starbucks initiated cost-cutting measures that led to a departure from his original vision. For instance, they started using ground beans instead of grinding them in-house and sold food that overpowered the coffee smell for which Starbucks had been known. When Schultz came back, he was willing to go the extra mile to ensure that employees and customers knew that he was earnest about getting back to its roots. He famously shut down every US Starbucks location for three hours to retrain baristas on how to make coffee the way that he thought it should be made.

36:07Preston Pysh:This clearly demonstrated to Starbucks employees and customers that they were very serious about improving the product and service. Then you look at the enigma that is Elon Musk. So where Musk and Kroc met was in the concept of risk. Elon pushed for Tesla to be vertically integrated. He wanted control of everything from battery production to the sales process. This was a pretty novel concept because the legacy automotive industry operates in a significantly different manner. They outsource heavily for manufacturing parts and they use dealerships to sell their products. However, Musk chose not to take this route because he knew that the traditional way of thinking didn't align with the concepts of first principles thinking.

36:47Preston Pysh:He understood that the best way to make a good product was just to do it all in-house, but it was a rocky road to get Tesla to where it is now. The Gigafactory, for instance, was incredibly costly, and Tesla operated a loss for most of its existence. So while some people inside Tesla might have wanted to hit the brakes and maybe slow down growth or take fewer risks, Elon decided to push forward with his ambitious projects because he had the vision to see what could be possible. This vision and the ability to take risks are two similarities between these two exceptional value creators. The next topic that I would like to address is competition.

37:20Preston Pysh:McDonald's is not, never was, and never will be a monopoly. While its revenues are second only to those of Starbucks today, I would be hard pressed to admit that they have any sort of monopoly. Are they positioned well? Yes. But they must continue to improve. Otherwise, they very well risk losing market share. So how have they managed to stay near the top for multiple decades? Let's examine some of the concepts that Ray adopted, which are still prevalent today. So Ray specifically demanded to express the strengths of McDonald's through four things, quality, service, cleanliness, and value. This is one of those situations where I actually don't really think McDonald's had some sort of inherent competitive advantage that isn't available to basically any other well-scaled competitor.

38:04Preston Pysh:Where they differentiate themselves though, is in execution. So Kroc points out that many former franchisees and copycats have tried to replicate what they learned from working inside of a McDonald's franchise, but none of them really ever had that special sauce to make it big. This reminds me actually a lot of Evolution AB, a business that we've discussed quite often on TIP and which I used to be an investor in. Evolution, upon analysis, doesn't really seem to have a significant moat versus competitors. And similar to McDonald's, it operates in a very, very competitive industry. They have separated themselves and their ability to execute at a higher level than many of its competitors.

38:38Preston Pysh:Now, what exactly does this mean for a business? It means you must continue innovating and executing at an exceptionally high level. Even a minor mistake can allow competitors to steal market share and erode your business. For this reason, it's not the best competitive advantage to have, but it can still be powerful when wielded by the bright leaders in business. Now, Kroc mentions that many of his competitors have attempted to clone the McDonald's system, but have been unsuccessful. Many competitors will even clone McDonald's real estate locations. Now, this is an interesting point because actually in the book, Ray doesn't discuss the rationale at all behind choosing locations.

39:16Preston Pysh:I assumed that he probably did this purposely for competitive reasons to prevent competitors from gaining any knowledge that could harm McDonald's. But in reality, competitors can really just open shops on this exact same street as McDonald's and rely on McDonald's own research to find areas that have very, very high volumes of foot traffic to support a given restaurant. It's really just no coincidence that you'll see McDonald's next to several other fast food restaurants. There was a very good example from the book about a franchise in Knoxville, Tennessee. So a competing burger restaurant a few doors away was offering five burgers for 30 cents.

39:51Preston Pysh:And this was a price that the McDonald's franchisee just could not compete with. But he was actually still turning a profit because while customers were going next door to buy hamburgers, they would actually end up going back to McDonald's for their fries and beverages. But then the competitor turned up the heat. They were offering burgers, fries, and milkshakes all for 10 cents each. So the franchisee visited Ray to inform him of his troubles and that he was thinking of taking legal action against the competitor as he found it to be anti-competitive behavior. But Ray let him know that he believed in entrepreneurship and didn't think that people should rely on the government to fight their own battles.

40:24Preston Pysh:He felt that if a competitor could put a McDonald's franchise out of business using this strategy, the McDonald's didn't deserve to be in business and should shut down. Instead, Instead, he suggested things like being a better merchandiser, providing a better service, and a cleaner place. The franchisee took this to heart and became a much larger franchisee. So apparently, this speech lit a real fire under him. Let's take a quick break and hear from today's sponsors. One part of being an investor that I don't think gets enough attention is how hard it can be to continue to improve as an investment researcher.

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43:57Preston Pysh:Now, we've spoken a lot here about how critical alignment is in business. So let's now look at Ray's dissolution of his partnership with the McDonald's brothers, as it's a key story to Ray Kroc. He decided that he no longer wanted to be in business with Mac and Dick because they were playing just too many games and just getting on his nerves. From the sound of it, the feeling was actually mutual. So Ray gave an example of one of the suppliers that he shared with Mac and Dick, who they used and they would visit. And when they would visit, it was actually near McDonald's headquarters. But whenever they visited, they didn't bother calling Ray or visiting the HQ, which was a behavior that Kroc found very irritating.

44:35Preston Pysh:Now, the McDonald's brothers were interested in retiring and their price was set at about$2.7 million. This was a figure that Ray felt was unfair. Now, it's pretty challenging to really evaluate this deal as I couldn't find any reliable statistics for that time, but we're going to revisit this shortly. So I'm not sure if Ray felt the agreement was unfair or was just upset that he'd have to find the money from someplace. He eventually found a lender and purchased a McDonald's brother's stake at the agreed upon price. Now, the original deal was for all locations, including the San Bernardino location, which was the cash cow.

45:08Preston Pysh:However, at the last minute before the deal was completed, the McDonald's brothers demanded that they retain the San Bernardino location for themselves and allow their employees to run it. This angered Ray as he felt that they had gone back on their word and changed the deal. But the McDonald's brothers were happy. His quote here shows what he thought of the agreement and how cutthroat he was as a businessman. So I was happy too, except for one part of the deal that stuck in my throat like a fishbone. That was the McDonald's brothers' last minute insistence on retaining their original restaurant in San Bernardino.

45:39Preston Pysh:They were going to have their employees run it for them. What a goddamn rotten trick. I needed the income from that store. There wasn't a better location in the entire state. I screamed like hell about it, but no way. They decided they wanted to keep it and they were willing to pull the plug on the whole arrangement if they didn't get it. Eventually, I opened up a McDonald's across from that store, which they had renamed The Big M and ran it out of business. But that episode is why I can't feel charitable or forgiving towards the McDonald's brothers. They went back on their promise, made on a handshake, and forced me into grinding it out, grunting and sweating like a slave for every inch of progress in California.

46:16Preston Pysh:Here's some figures from the book that may provide insights to the economics of McDonald's in its early days. So in 1958, a news column mentioned that Kroc had built a$25 million business. He said that a successful store had an average net profit of about$40 ,000 on an annual gross of$200 ,000. The average customer's payment was about$0.66, and not a single franchise had failed at that time. He also mentioned that if a franchise were to fail, McDonald's would just come in and take it over anyways. What Ray didn't disclose was that McDonald's business was actually showing a paper profit, but nothing in terms of cash flow.

46:51He

46:51Preston Pysh:noted that out of the 160 stores they had, they were only receiving income from 60 locations that had been internally developed. The remaining 100 were owned, developed, and operated by the operators themselves. At this time, they collected about a 1.9 % service fee, which I assume is just a franchise fee. The 60 they were receiving income from had significant development-related costs. However, by 1963, they had resolved the cash flow issue and were generating sufficient profits to address it. This was done through scale efficiencies. Now, another way that McDonald's developed itself was in the culture that it created for its franchisees.

47:25Preston Pysh:Much of this culture was created at HamburgerU. Now, I mentioned earlier that Ray placed a massive emphasis on standardization. HamburgerU was created specifically to help people get trained to adopt Ray's mindset when it came to consistency. But credit goes to Fred Turner, who actually founded HamburgerU. Now, instead of focusing purely on how to cook hamburgers and fries, HamburgerU looked more broadly at a multitude of different things, such as operations, service, and leadership. It was at HamburgerU that managers were taught about the speedy service system, quality control and cleanliness, customer service, and employee management.

48:00Preston Pysh:The course was a six-week intensive. Now let's fast forward here to 1959. Ray had made Harry Sonneborn president and CEO of McDonald's, but a rift was beginning to form between the two. These rifts can mean a lot of bad news as, you know, they generally indicate that the chairman, who I would assume would be Ray at this time, is misaligned with the CEO. As we've discussed, alignment within a corporation is key to its success. Part of the rift was due to perception. So Ray had actually moved to California to help develop stores in that specific state. But this was far away from McDonald's HQ and Harry felt Ray was just wasting his time in California.

48:39Preston Pysh:The rift began to widen and McDonald's executives were informally categorized as either croc people or sauna born people. However, the rift seemed to be put on the back burner as Ray's efforts in California ultimately proved to be successful. And McDonald's was now flirting with the notion of going public. The reason that McDonald's went public is this pretty much the exact same reason that most businesses go public, which was to reward the hard work of a lot of the insiders inside of the corporation. We'll get back to going public shortly, but I want to tackle another key concept of McDonald's, innovation.

49:11Preston Pysh:While it might not be the same innovation as a tech business, such as an Apple or Tesla, McDonald's had its own version of innovation that it utilized to help grow its business. The first significant innovation in terms of product was the Filet-O-Fish. Now, the idea for the Filet-O-Fish was quite novel. One of the McDonald's franchisees named Lou Groen was noticing that business was very slow on Fridays. And that was because the franchise was in Cincinnati, which had a large Catholic population where meat wasn't supposed to be consumed on Friday. Another chain called Big Boys had a sandwich called the Big Boy Sandwich that became a big seller on Fridays.

49:45Preston Pysh:So Lou was losing significant amount of business to Big Boy and wanted to innovate to find a way to keep up or even beat them. And the Filet-O-Fish was his innovation. The reason that he was allowed to have the Filet-O-Fish was that he owned the territorial licensing rights to that area. At first, Ray was hell-bent against the idea. But Lou convinced a few other key executives that he'd either have to sell fishburgers or sell the store. They decided to proceed with the idea and began rolling it out on a very limited basis initially on just Fridays. However, the burgers were so successful that it became a mainstay product where it still is today.

50:19Preston Pysh:But in any successful business, it's evident that you won't be rolling in wins all the time. You're going to have to get through a number of roadblocks on the way to success. And that was no different in innovation. So Ray talks about a burger that was around a long time ago called the Hula Burger. It was a slice of grilled pineapple surrounded by two slices of cheese. Ray actually thought that it would contend with the Filet-O-Fish, but it was just a major flop and was removed nearly immediately. Now back to going public here. So going public for a business is often kind of a circus because many companies that go public have little to no experience in capital markets.

50:55Preston Pysh:So navigating that potential minefield can be an absolute headache. Luckily, McDonald's had really good connections and found suitable partners to work with. Now, the first issue they had with going public came from their auditors. They had been using what they call the development accounting, which was not certifiable by their accountant. Now, the book doesn't mention what exactly development accounting is, but from my research, I would actually completely agree with the accountants. So development accounting enabled McDonald's to recognize revenue basically before it was even earned. For instance, if they knew they were adding 50 new franchises, they would include the revenue from those franchises in their numbers to give an idea of where revenues would be in the near future.

51:34Preston Pysh:They also recorded income from franchise fees and property leases as assets prior to that restaurant's commencement of operations. So they did this not for nefarious reasons, but just because it made the business look better rather than relying on trailing numbers. I see the rationale for doing this, as you know, it would have helped potential investors understand the business's growth potential. But this is not a system that I ever really be that comfortable with. So I can see how the accountants require them to do away with it. Now, the issue was that McDonald's only had two weeks to rewrite their financials to meet their deadline, which they achieved by working nearly 24-7.

52:08Preston Pysh:The next annoyance with going public related to the question of what the shares would be priced at. The underwriters suggested 17 times earnings, but Ray thought that anything less than 20 times earnings was just ridiculous. But you know, when you go public, it doesn't really matter what you think. It matters what the market thinks. And the market actually agreed with Ray here. So shares opened at about$22.50 and closed the same day at$30. And in the first month, shares actually climbed to$50. McDonald's chose a very, very good time to go public as it was right at the beginning of the go-go years.

52:42Preston Pysh:Euphoric markets are the best possible time to IPO as investor sentiment is at its absolute highest and you can increase your chances of having a successful IPO, which McDonald's did. Now, after McDonald's IPO, there were new forces at play that would help it grow. For instance, McDonald's had no indoor seating until 1966 when it was introduced to a few locations. The stores were also in need of a facelift, which meant some pretty significant capex was going to be needed. With indoor seating, increased square footage and new buildings, McDonald's would increase its revenue it generated per restaurant, and the market would welcome any news on that front.

53:15Preston Pysh:Now, as I've learned from researching the franchise business model, restaurants key into one specific sales figure, which is called system sales. So why not just sales? Because system sales represents the total revenue generated by the franchise and its franchisees, as opposed to just a franchisor. As I mentioned earlier, franchise fees for McDonald's at inception were just 1.9%. So that means if there were$100 million in system sales, McDonald's revenue was just 1.9 million. Now, if you're looking to attract investors, would you be more likely to use 100 million in systems revenue or 1.9 million in franchise revenue.

53:49Preston Pysh:Probably the former. But all franchises will show both. Let's get back to the rift here between Harry Sonneborn and Ray Kroc. So there are a few forces at play, and the first was a personal issue for Harry. So his health, unfortunately, just wasn't very good in 1966, which forced him to spend more and more time away from the business. More related to the corporation was the fact that Harry and Ray would butt heads over things such as who to appoint as the next vice president. Then they had other issues with more minor things such as compensation and a proposal for the removal of McDonald's golden arches.

54:23Preston Pysh:However, the most significant sticking point between Ray and Harry had to do with real estate. So Ray felt that Harry had been overly conservative because Harry was listening too closely to bankers who were telling him that the US was headed into a recession in 1967. So Harry concluded that if that were true, McDonald's should slow down their growth and hoard cash. It culminated in Harry putting a moratorium on any new store openings. But their man in charge of locations complained to Ray because he already had 33 really good locations lined up to go. So Ray promised him that he'd go and try to talk to Harry and see what he could do.

54:56Preston Pysh:And they ended up arguing about it, resulting in Harry actually stepping down. Ray eventually got Harry to come back for a short time, but Harry just didn't have it in him anymore and he left for good. Ray noted that Harry thought McDonald's shares would plummet after he left because the aggressive growth plan that Ray backed would backfire. And that was a massive error, but you know, Harry was very well taken care of. He just didn't have as much money as he would have if he'd kept his shares. There was an interesting quote from the book that really highlighted how skilled an operator Ray was.

55:25Preston Pysh:This was after Harry stepped down and Ray took over as president. I really had my work cut out for me now. I took the title of president and chairman of the board, and I removed the misguided moratorium on building new stores. In reviewing our real estate picture, I discovered all kinds of locations we had purchased and sort of stockpiled for future development. When I was told that we were waiting for the local economy to improve in those areas, I hit the ceiling. Hell's bells, when times are bad is when you want to build, I screamed. Why wait for things to pick up so everything will cost you more?

55:55Preston Pysh:If a location is good enough to buy, we want to build it right away and be there before the competition. Pump some money and activity into a town and they'll remember you for it. This is just good stuff. And I think it shows that Ray was thinking independently rather than succumbing to the institutional imperative that just so many executives fall for. So if Harry Sonnenborn had followed the banker's advice, which may have been standard practice for the industry, he would have ended up just waiting for the recession risk to subside and then resumed investing in new stores afterwards. But this just shows short-term thinking.

56:26Preston Pysh:I completely side with Ray on this. I prefer to have operators who act counter-cyclically. When times are bad, they are the best possible times to invest. This applies both to individual businesses and to just investing in general. poor sentiment offers the best upside and the highest margin of safety, but most investors and executives are just too afraid to take advantage of that. Ray then told Fred Turner that once he had finished a few things inside of McDonald's, he would turn over the presidency role to Fred, which he gladly accepted. Now, what were the changes that Ray wanted to make? So the first one here was that he wanted to recapture some of the territory that he knew would help with the expansion of the business.

57:03Preston Pysh:So there were two partners that owned a company that had licensing rights for the entire District of Columbia, as well as a few counties in Maryland and Virginia. So since they had these exclusive rights, McDonald's couldn't expand into these territories. So Ray wanted to just buy them out. McDonald's ended up buying them out for$16.5 million in cash, but ended up doubling their stores from 43 to 90 over a very short period of time, as well as adding significant talent to McDonald's from the people that were already involved in those stores. So Ray felt like that purchase was very, very well justified.

57:35Preston Pysh:The next one was price increases. So Ray wanted to increase the price of some of the items that McDonald's sold, and he wasn't sure, unfortunately, how customers would react. So the example that he gives is a 15 % hamburger that he wanted to increase to just 18 cents. But it actually sounds like this price increase was more of a result of compressing margins. So Ray writes, we were in the midst of Lyndon Johnson's muddled guns and butter economy with the war in Vietnam. And even our increasingly sophisticated purchasing operations could not cope with inflation. So Ray had conducted some internal modeling to see what he could expect from these price increases.

58:09Preston Pysh:So the theory was that volume would initially surge as regular customers came in and paid the increased pricing. But once they were accustomed to the increased pricing, they would look elsewhere. Then competitors would follow suit, increasing their own pricing, and customers would eventually return. And this is exactly what happened when they did the price increase. It took about a year for things to stabilize. And this was part of the reason that Ray didn't want to hand the company over to Fred Turner during that weak point. Now, the last part here was to roll out a national advertising and marketing plan.

58:38Preston Pysh:So McDonald's was developing a program to support all of its franchisees. The spending would be supported by the franchisees who would contribute 1 % of their revenue to support the program. Ray liked this, but I've spoken to some franchisees and they don't always like it because it obviously eats into their margins. Some locations also just don't believe that an advertising plan will necessarily benefit them at their exact location and at that price. So by 1968, the business was thriving under Fred Turner's leadership as president and CEO, who did a superb job. I find this story interesting because generally when a CEO steps down from a business, it's a red flag at worst and typically a yellow flag at best.

59:16Preston Pysh:But in this case, it was a blessing. Now, it's hard to have an intimate understanding of what is going on inside of a business when you're just an investor. The problems that Ray and Harry had would have probably been surprising to investors during this time. But to McDonald's insiders, it was probably very evident to everyone that there was a growing rift and that there was some sort of event that was likely to happen that would cause an explosive change to either towards the direction of Ray Kroc or to Harry Sonneborn. This is why, you know, scuttlebutt is so essential. When you can talk with competitors or former employees, you can learn these types of hidden dynamics that are going on that just aren't shared with the general public.

59:53Preston Pysh:You unfortunately need a network and connections to talk with the right people to get this kind of information. Now, Ray shared a quote at the end of the book that I thought was powerful. Press on. Nothing in the world can take place of persistence. Talent will not. Nothing is more common than unsuccessful men with talent. Genius will not. Unrewarded genius is almost a proverb. Education will not. The world is full of educated derelicts. Persistence and determination alone are omnipotent. Now, I'd like to conclude this episode by discussing my seven primary takeaways from Ray Kroc and his business experience.

1:00:27Preston Pysh:The first one is just vision over product. So while Ray cared a lot about the end product, without his vision where he felt McDonald's could eventually go, the story would have never unfolded as it did. Kroc could have gone into the business of just selling hamburgers and fries, but he knew the big picture was the real estate. He created the franchise model, systematized it, and made it highly scalable. This allowed him to focus more on expanding McDonald's while leaving many of the product innovations to those within the company who were highly customer-facing and understood customer needs at a deep level.

1:00:59Preston Pysh:Second, having relentless standards can create a wide moat. If McDonald's were a disconnected franchise with various franchisees selling different products, it's unlikely the brand would have ever achieved a critical mass. Ray's ability to get all franchisees to follow the system that he supported was tremendous for the success of the McDonald's brand. Kroc was obsessed with uniformity and consistency, and while there is a place for innovation, it had to be rolled out conservatively before being released to all franchise locations. Third is the power of real estate. Even though things didn't work out with Harry Sonneborn, Harry was massively important for providing Kroc with this insight.

1:01:35Preston Pysh:Gaining funding to open a new restaurant wasn't easy, but using financial engineering to own a property a franchise sat on was much easier. This system allowed McDonald's to focus on collecting royalty fees rather than being the sole operator of the franchise. So even though McDonald's is seen as a fast food chain, it's really a real estate business disguised as a fast food chain. I'd like to add that I've studied many quick service restaurants. And one thing I find interesting is that franchises with a high number of corporate owned stores often, not always, but often struggle to achieve profitability.

1:02:06Preston Pysh:A couple of really notable examples would be something like Cava or Sweet Greens, which have just nosebleed evaluations. However, when you look at their margins, they're incredibly subpar, despite the fact that they have hundreds of locations. Now I've concluded that the franchise model is just better than operating with all locations centrally owned. The margins on franchise revenue are fat and you don't have to deal with the number of headaches and expenses involved with operating the restaurant. The fourth here is that people and culture often trump strategy. Kroc knew that surrounding himself with the right people would be the key to long-term success of McDonald's.

1:02:39Preston Pysh:This is how he found hungry young franchisees and corporate people like Harry Sonneborn and Fred Turner. Ray also understood that he could help motivate his franchisees to success by following many of the systems that he had implemented. While Kroc was very demanding of his people, he also inspired them to continue performing at a high level, which often resulted in a win-win situation. And fifth is that expansion requires ruthless amounts of focus. It would have been easy for Ray to adopt too many innovations that were thrown at him, which would have taken him off the course of his grand vision for McDonald's, which was to continue growing its store count and system sales.

1:03:13Preston Pysh:When McDonald's first began expanding, its menu was incredibly simple, you know, burgers, fries, and beverages. He could have diversified the menu more, but that would have taken focus away from his vision. This speaks to Buffett's exceptional ability to just, you know, say no to everything. This helps Buffett keep his schedule clear so he can read and learn things that he needs to educate himself on to be the best possible investor that he can be. Kroc also said no to several things. He didn't want to diversify. Six is the power of systems. I already mentioned how much focus Ray put on things like uniformity and consistency.

1:03:46Preston Pysh:If you scale a brand up significantly, you have to have systems in place. Otherwise, you risk drifting away from what truly works. McDonald's initiatives such as Hamburger U and how they set up and design stores were a tool to accentuate consistency. If you're building a brand, you should closely examine what your people are doing to move you towards or away from your vision. Buffett has said, I try to invest in businesses that are so wonderful that an idiot can run them because sooner or later one will. Now, I'm not saying McDonald's has any idiots who have run the show in the present or the past, but they've gone through 11 CEOs and remain still a great business today.

1:04:20Preston Pysh:I think this is a testament to the power of systems in building a resilient business. While Kroc understood that the business required different leaders at different times, he established many guardrails to ensure that regardless of whoever was in control, the company would succeed. And lastly, is that just contrarian thinking pays off? I love contrarians because no matter where you look, most outperformers in businesses and investing are just natural contrarians. And Kroc was just a different person. While he spent much of his career trying to find that edge that would allow him to truly take off, he didn't see it until he was 52 years old.

1:04:53Preston Pysh:While many business people flock to young guns who have built these enormous tech empires today, many lessons can be learned from contrarians like Kroc, who took a few more decades than Zuckerberg or Musk to find his footing. Now, before Kroc, nobody thought a quick service restaurant would reach nearly every corner of earth. Heck, I don't think anyone thought a fast food restaurant would even be in every US state. But Kroc thought this was a possibility and did everything in his power to make this vision a reality. And even though he didn't have the support from those closest to him, you know, his wife, for instance, thought he was crazy for getting into McDonald's at his age, he had the inner fire to help motivate himself.

1:05:28Preston Pysh:The original McDonald's brothers initiated the idea for McDonald's. But without Ray's understanding and frankly, backbreaking work, the business would have never probably left the state of California. The example I gave earlier in this episode about Croc's ability to think counter-cyclically is a potent example of that contrarian mindset. I love seeing businesses and founders participate in initiatives like this. One great example in my portfolio was Dino Polska, which invested heavily in its distribution centers. Despite Poland being in a state of deflation with a war next door in Ukraine, the GDP growth having stalled, the company just continued to expand.

1:06:03Preston Pysh:They could have sat on their hands and waited, but they invested heavily in the company's future development. So far, it's proven to be a very successful investment, which should allow the business to continue expanding its new store development for many years to come. Now, when I take a step back and look at Ray Kroc's story, it's clear that McDonald's was never just about burgers and fries. It was about vision, discipline, and building systems that could outlast one person. Kroc didn't invent fast food. He just saw the potential to scale it in a way that no one else was willing to do. And that's a big lesson for us as investors and business builders.

1:06:35Preston Pysh:Execution and scale often matter more than the original idea. For entrepreneurs, the lesson is straightforward. Systems often outperform individual genius. For investors, it serves as a reminder to look beneath the surface. Sometimes the real money isn't made where you expect, like the real estate model at McDonald's. And for anyone chasing success, Ray's story is proof that there's no such thing as an overnight success. His overnight took more than 30 years of grinding it out, risking everything, and betting on himself. So when you see the golden arches, don't just think about a fast food joint.

1:07:06Preston Pysh:Think about what happens when someone refuses to compromise on standards, builds alignment across stakeholders, and focuses on execution day in and day out. That's the real engine behind McDonald's, and it's a blueprint I think we can all take on our own investing and business journeys. That's all I have for you today on Ray Kroc and the building of McDonald's. Want to keep the conversation going? Follow me on Twitter at IrrationalMRKTS or connect with me on LinkedIn. Just search for Kyle Grieve. I'm always open to feedback, so feel free to share how I can make the podcast even better for you.

1:07:37Preston Pysh:Thanks for listening and see you next time.

1:07:39Kyle Grieve:Thank you for listening to TIP. Make sure to follow We Study Billionaires on your favorite podcast app and never miss out on episodes. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only before making any decision consult a professional. This show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.