[The Two Faces of McDonald's]② No Taxes Paid, 'Eat and Run'... Concerns Over Price Hike Backfiring

Direct Store Conversion and Price Increase... Last Year's First '1 Trillion Club'
Sales and Royalties Linked to Perpetual Deficit... Corporate Tax '0 Won'
New Owner of Hankook McDonald's Faces Profitability Improvement Challenge

As Korea McDonald's was transferred to a Qatari company, controversy over 'Muk-twi' (running away after eating) has arisen. Last year, Korea McDonald's became the first hamburger franchise in the industry to achieve sales of 1 trillion won, but it has been criticized for inflating its size by converting prime franchise stores into directly operated stores and raising prices for the sale.

In this process, Korea McDonald's reportedly recorded annual losses linked to sales scale and royalties paid to the U.S. headquarters, thereby avoiding corporate tax in Korea by funneling massive royalty profits to the headquarters.

Korea McDonald's signed a strategic partnership with Kamal Al Mana in Qatar on the 30th of last month. (From left) Kamal Al Mana, strategic partner of Korea McDonald's, CEO Kim Ki-won, Stan Haytons, President of McDonald's Asia Global Business Division.

According to the industry on the 6th, Korea McDonald's recently signed a 'strategic partner (master franchise)' contract with the Middle Eastern Qatari company 'Kamal Al Mana (Al Mana)'. Al Mana took over the operation rights of Korea McDonald's from McDonald's Asia-Pacific, Middle East, and Africa regional headquarters (McDonald's APMEA) and is now responsible for operating about 400 stores domestically.

The Al Mana Group is a Qatari company operating 55 companies in 8 countries worldwide, engaging in various businesses such as food, distribution, and real estate, and also holds the operating rights for McDonald's in T?rkiye. Joe Sampels, Global McDonald's IDL (International Developmental Licensed Markets) division president, said, "Through the partnership between Al Mana and Korea McDonald's, we expect the number of stores in Korea to increase to 500 by 2030, along with growth in the brand and business."

First 1 Trillion Won Sales by Converting Franchise Stores to Directly Operated Stores

Last year, Korea McDonald's recorded direct sales of 1.1181 trillion won, a 12.4% increase from the previous year (994.6 billion won). This is the highest sales since entering Korea and the first time exceeding 1 trillion won. Since disclosing performance from 2019, Korea McDonald's sales, which were about 724.8 billion won that year, have increased annually by 54.3% over four years.

Like the case of Mr. Yeo, who operated the Daegu Jincheon Drive-Thru (DT) store (link), sales were significantly boosted by converting franchise stores into directly operated stores. Typically, franchise stores generate revenue from royalties (franchise fees), store rent, and ingredient costs collected from franchisees. Korea McDonald's has been reducing the number of franchise stores annually, causing royalty revenue to shrink from 12.5 billion won in 2019 to 11 billion won last year.

On the other hand, for directly operated stores, the entire sales amount is reflected as revenue. Korea McDonald's food segment sales rose from 673.8 billion won in 2019 to 1.059 trillion won last year. The number of McDonald's directly operated stores increased from 301 in 2020, when the number was disclosed, to 327 last year. Considering that the total number of stores decreased slightly from 407 to 399 during this period, the effect of increasing directly operated stores was significant.

This supports the claims of franchisees currently in litigation over the invalidity of refusal to renew franchise contracts, who argue that "franchise contract renewals were refused to convert franchise stores into directly operated stores ahead of the sale."

Raising Hamburger Prices to Defend Profitability

However, converting to directly operated stores led to deteriorating profitability. Directly operated stores inevitably incur costs such as ingredient expenses, labor costs from direct employment, and real estate rent. Therefore, Korea McDonald's resorted to the 'price increase' card. Typically, price increases can boost sales volume and improve profit margins.

Kim Gi-won, CEO of Korea McDonald's, focused on price increases and expanding stores such as drive-thrus (DT) to improve profitability. Since Kim's appointment in April 2022, Korea McDonald's raised prices four times. In February last year, prices of major menu items like the Big Mac were increased by an average of 5.4%, followed by an average 3.7% increase on 13 menu items in November, and in May this year, prices of 22% of the entire menu were raised by an average of 2.8%. Most price hikes occurred every six months, the shortest and most frequent among major hamburger franchises. The company stated, "The increase was inevitable due to rising costs of raw materials, logistics, and labor."

As a result, operating losses, which had nearly increased by 50 billion won in 2020, were reduced to 20 billion won last year. Although net losses also decreased last year, the company remains unprofitable. This is due to the linkage between Korea McDonald's sales and royalties paid to the headquarters.

As Sales Increase, Headquarters Royalties Approach 70 Billion Won Annually... Corporate Tax '0 Won'

Korea McDonald's signed a master license contract in 1996, agreeing to pay 5% of net sales as royalties for 30 consecutive years. Additionally, it pays a fixed technical fee of $45,000 (about 62 million won) per new store to the headquarters. As sales and the number of stores increase, Korea McDonald's royalty expenses grow, and the headquarters' royalty income increases accordingly. Consequently, McDonald's headquarters' royalties surged annually from about 46.2 billion won in 2019 to 68.5 billion won last year.

In this process, Korea McDonald's also avoided paying corporate tax. According to data submitted by the National Tax Service to Rep. Cheon Ha-ram of the Reform Party last month, Korea McDonald's corporate tax burden was zero in 2022, when sales reached 994.6 billion won. Under current corporate tax law, the National Tax Service can impose corporate tax on foreign companies only on income (net profit) earned in Korea according to tax treaties with each country. If a company has no income or incurs carryforward losses, it can receive tax reductions under the Restriction of Special Taxation Act.

If a foreign company transfers a significant portion of profits earned by its Korean subsidiary to the headquarters as royalties, the taxable base decreases, reducing corporate tax payable domestically. In fact, Korea McDonald's has recorded net losses for five consecutive years since 2019. The accumulated losses during this period amount to 250.3 billion won, while royalties paid to the headquarters total 271.4 billion won. The company has accumulated net losses every year, increasing the deficit. The company's deficit, which was about 189.4 billion won in 2019, grew to 358.6 billion won by the end of last year.

Through this partnership contract, McDonald's can secure additional royalty income over the next two years. Since the partnership agreement announced plans to increase domestic stores to 500, Korea McDonald's royalty expenses are expected to rise.

New Owner of McDonald's... Concerns Over Price Increases to Improve Profitability

[Image source=Yonhap News]

The problem is that Al Mana, which took over Korea McDonald's operating rights, must find a way to make profits despite paying royalties to the headquarters that exceed twice the amount of last year's losses.

Moreover, since it must comply with McDonald's global franchise operation management standards and fulfill investment plans presented during the acquisition process, domestic business operations are expected to be challenging. There are concerns that Korea McDonald's profitability improvement efforts may ultimately backfire on domestic consumers through price increases.

However, a Korea McDonald's official said, "Rather than escaping short-term losses, McDonald's is continuously conducting customer-centered activities and various investments for long-term growth and healthy profit generation. We believe that generous investments in the Korean market, such as local sourcing, eco-friendly policies, and job creation, are the way to gain greater trust from customers. We will continue to prioritize customer-centric values and strive for growth from a long-term perspective."