Why McDonald's Can't Follow Walmart in Raising Workers' Pay

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Fast Food Protests Arizona
Ross D. Franklin/APA protester, dressed as the McDonald's Hamburglar character, stands on a wall at a rally against low wages for fast-food workers, in front of an Arizona McDonald's in 2013.
Walmart (WMT) made waves last week, announcing that it's raising its entry-level wages. The world's largest retailer will be paying its hires at least $9 an hour in April, bumping that to at least $10 an hour by next February.

It's a bold move by Walmart, and now it's only natural to ask if McDonald's (MCD) will follow suit. After all, activists have made the two consumer-facing giants the focal point of getting companies to improve their pay. The ultimate goal is to bump starting wages to $15, but Walmart taking a baby step in that direction has provided some degree of success for activists.

It's unlikely that McDonald's will be next. There are a few factors that separate the two companies, and they will probably get in the way of activists crying for better pay at Mickey D's.

1. There's a Big Difference in Operating Models

Walmart owns and operates all of its 4,516 U.S. stores. That's important. Walmart is the one on the hook for all of its employees, and it's the only one that's accountable for deciding and implementing corporate decisions.

McDonald's, on the other hand, relies primarily on franchisees. More than 80 percent of its domestic locations are owned by franchisees. These are independent and often small entrepreneurs. McDonald's can push new menu items and national marketing campaigns, but it would be hard-pressed to dictate or have authority on pay. Even if it were to somehow force all of its franchisees to pay more -- above and beyond local and state minimums -- it wouldn't be a surprise if that made it that much harder to woo future franchisees to open more restaurants under the McDonald's banner.

2. The Margins May Not Be There

A popular argument in suggesting that McDonald's can pay employees more is that the company is so profitable. That's certainly true. McDonald's has scored an annual profit between $4.7 billion and $5.8 billion in each of the past five years. Some have even suggested that McDonald's could offset wage hikes by redirecting the money that it's using for dividends and buybacks to the pockets of its front line.

However, as we've already discussed, McDonald's doesn't pay the vast majority of the people assembling Big Macs and handing over Quarter Pounders. The grim truth is that the actual franchisees are nowhere near as profitable as McDonald's.

Profit margins at McDonald's have hovered near 20 percent in recent years, meaning that 20 cents is left over as the profit after taxes for every dollar it records as revenue. Margins are high because McDonald's is sitting back and collecting royalties on the vast majority of franchised locations. It's a different story at the franchisee level. There is no publicly traded stateside franchisee of McDonald's, but we do have Arcos Dorados (ARCO): Argentina's largest McDonald's franchisee was reporting net margins of just a little more than 3 percent for years before profitability deteriorated in 2013 and turned negative in 2014. In other words, there isn't a lot of wiggle room for franchisees to pay more and still turn a profit.

3. McDonald's Is in a More Challenging Competitive Position

Walmart is investing $1 billion in employee-friendly compensation, hiring, training, and scheduling improvements, but it's also the undisputed champ of retail. Walmart's image isn't perfect, but shoppers ultimately know that it's hard to beat the chain when it comes to the lowest prices.

McDonald's is in a more precarious situation. Franchisees that are already working on lean margins would be hard pressed to implement higher wages without increasing prices, and this would come at a time when fast-casual chains are growing at the expense of fast-food chains, and even within the burger-flipping niche we find smaller rivals doing a better job of attracting store-level growth. There will come a time when McDonald's can pave the way for better pay for its employees, but competitively speaking, this isn't the ideal operating climate.

Motley Fool contributor Rick Munarriz has no position in any stocks mentioned. The Motley Fool recommends McDonald's. The Motley Fool owns shares of Arcos Dorados. Try any of our Foolish newsletter services free for 30 days. Looking for a winner for your portfolio? Check out The Motley Fool's one great stock to buy for 2015 and beyond.
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