With the exception of McDonald’s, Dairy Queen franchisees have quietly amassed the most substantial wealth out of any food franchise that operates at more than 1,000 locations in the United States.
It has been intriguing to study how much Warren Buffett chose to emulate Ray Kroc’s early years at McDonald’s in drafting the incentive systems that exist at Dairy Queen. Instead of opting to build wealth at the expense of franchisees, Buffett chose to build wealth by giving his franchisees a chance to reap significant gains for themselves. In other words, instead of trying to extract as much as he could from a fixed pie, Buffett chose to create a incentives that encourages Dairy Queen franchisees to expand the size of the pie as much as possible.
Since I know my readership is numerically inclined, let’s look at the numbers:
Entering 2018, the average franchise with 1,000 locations required liquid capital of $814,000 prior to becoming eligible for investment. Dairy Queen’s liquid cash requirement is roughly half of that–you only need to have $400,000 in cash on hand to be eligible for your own DQ franchise.
The average net worth requirement for a food franchise in the United States is $1.17 million. Here, again, Dairy Queen offers more favorable entry-level terms, opening the door to those who have a net worth of $750,000.
And critically, and this is the part where Buffett has chosen to imitate Kroc in his early years at McDonald’s, Buffett only charges Dairy Queen franchisees 5% in royalties on gross monthly receipts and only charges an initial franchise fee of $25,000. In the early years at McDonald’s, Ray Kroc refused to earn a profit on the mandated ingredients that he sold to franchisees, concluding that he didn’t want to deal with the resentment from franchisees that this type of conflict of interest would cause.
At Dairy Queen, Buffett has maintained a monthly rate of 5% of gross sales that is below the industry average of 5.4%. In other words, if you the franchisee sells $1,000,000 worth of burgers, fries, and Blizzards in a given month, Buffett’s cut is $50,000 rather than $54,000. Over the course of the year, that is an extra $48,000 in the pockets of Dairy Queen franchisees compared to what would remain if the Dairy Queen franchise royalty rate matched the industry norm.
For owner-operated franchisee locations, the average annual profit is $194,000. For absentee managed franchisee locations, the average profit is $117,000. The average capital investment into the Dairy Queen franchise is $584,000 across all markets. This means that, if you operate and manage the Dairy Queen franchise yourself, you earn a 33% return on your investment (this high return is due to the fact that your labor in operating the location is a component of the total return). If you choose to not operate the franchise, the return is still a very respectable 20% on your investment.
If you are operating a Dairy Queen franchise in a major city or surrounding suburban community, you can earn funds that should put you in the top 10% of the entire country based on annual income. If you are not the daily manager, your income will likely put you in the 25% of the country, which is perhaps even more impressive because of the passive nature of how the money was earnings.
I have a soft spot in my heart for the Dairy Queen franchises that choose to open up shop in rural America and other places throughout the American heartland. In many deindustrialized communities, the owner and operator of the local Dairy Queen is earning $150,000+, putting his family in the top 1% of earnings in his municipality. He single-handedly has the power to make investments that change the community, whether it be making a timely donation around Christmas-time or even for the business purpose of buying a rental property and repairing it for a tenant so that the neighborhood maintains its integrity. A lot of cash is thrown off from those Blizzards!
In fact, the ice cream is Dairy Queen’s secret weapon. McDonald’s secret weapon is the McCafes and Coke, which are essentially all profit (almost literally, we are talking about profit margins of a few thousand percent). At Dairy Queen, the Blizzards earn a 700% profit compared to cost. It can be tacked onto to other menu items to “make a meal”, generating net profit of an additional $1.50 per transaction, and put an additional $75 net-of-profit into the pockets of its owners each day. It may sound trivial, but if it didn’t exist, the operators would earn on average about $30,000 less each year than it does.
In short, the Dairy Queen franchisee has a strong incentive to work hard because he can get a lot for himself and his family if he sticks with it, due to the low franchise royalty fees, the low initial start-up franchise fee, and the profit mechanism of the Blizzard. It would be perfectly expected, rather than hyperbole, for a Dairy Queen operator to find himself earning a million dollars from his Dairy Queen franchise in less than a decade of work.