Case 40 McDonalds

On January 24, 2007, McDonalds CEO Jim Skinner stated that the total revenue for the fast food chain • had risen by 11 percent during 2006 to $21.6 billion Net profits had climbed by 36 percent to $3.6 billion. These results indicated that the firm had managed to make significant improvements to its performance since announcing its first quarterly loss ever in early 2003. The stock for McDonalds had risen to almost $45, representing a threefold increase in value since pulling out of a nosedive three years ago. “To state the obvious, McDonald’s is on a bit of a roll,” the firm’s chief financial officer Matthew Paull told analysts1 (see Exhibits 1 and 2 for income statements and balance sheets).

Skinner was the second person to take over the company since James R. Cantalupo had died unexpectedly of a heart attack in 2004. Cantalupo had been replaced by Charlie Bell, who also resigned a few months later in order to fight his recently discovered cancer. In spite of these changes in leadership, the fIrm has continued to push on the turnaround strategy Thailand been initiated by Cantalupo in order to ad- dress McDonald’s lackluster performance. The strategy, commonly referred to as the “Plan to Win” tried to target various critical areas that needed to be addressed.

In fact, Skinner attributed the firm’s consistent growth in sales and profits to the successful development of Cantalupo’s early turnaround efforts. As a result of these, McDonald’s has managed to achieve 4 4 straight months of higher same-store sales. Much of the momentum has been generated in the United States, the firm’s single largest market, where new menu items, refurbished outlets, late-night hours and cashless payments have boosted sales. The firm has also shown some1mpiment in its sales in Europe, where it had failed to show much growth for several years.

But Skinner was acutely aware that the problems at McDonald’s went way beyond cleaning up restaurants arid revamping the menu. The chain has been squeezed by long-term trends that are threatening to leave it marginalized. McDonald’s is facing a rapidly fragmenting market, where changes in the tastes of consumers have made once- exotic foods like sushi and burritos everyday options. Many of its fast food customers are also looking for food that is healthier and better tasting. Furthermore, competition has been coming from quick meals of all sorts that can be found in supermarkets, convenience stores, and even vending machines.

Many analysts believe that McDonald’s must continue to work on its turnaround strategy in order to meet these challenges. But they acknowledge that the firm has pushed hard to transform itself, and they are encouraged by the results that it has achieved over the last three years. “They have experienced a comeback the likes of which has been pretty unprecedented,” said Bob Golden, executive vice-president of Technomic, a food service consultancy. “When restaurants start to slide, it really takes alot to turn them around.”

Experiencing a Downward Spiral Since it was founded more than 50 years ago, McDonald’s has been defining the fast food business. It provided mill ions of Americans their first jobs even as it changed their eating habits. It rose from a single outlet in a nondescript Chicago suburb to become one of the largest chains of outlets spread around the globe. But it had been stumbling over the past decade (see Exhibit 3).

The decline in McDonald’s once-vaunted service and quality can be traced to its expansion of the 1990s, when headquarters stopped grading franchises for cleanliness, speed, and service. By the end of the decade, the chain ran into more problems because of the tighter labor market. McDonald’s began to cut back on training as it struggled hard to find new recruits, leading to a dramatic falloff in the skills of its employees. According to a 2002 survey by market researcher Global Growth Group, McDonald’s came in third in average service time behind Wendy’s and sandwich shop Chick-fl-A Inc.

McDonald’s also began to fail consistently with its new product introductions, such as the low-fat McLean Deluxe and Arch Deluxe burgers, both of which were meant to appeal to adults. It did no better with its attempts to diversify beyond burgers, often because of problems with the product development process. Consultant Michael Seid, who manages a franchise consulting firm in West Hartford, pointed out that McDonald’s offered a pizza that didn’t fit through the drive-through window and salad shakers that were packed so tightly that dressing couldn’t flow through them.

In 1998, after McDonald’s posted it’s first-ever decline in annual earnings, CEO Michael R. Quinlan was forced out and replaced by Jack M. Greenberg, a 16-year veteran of the firm. Greenberg did try to cutback on McDonald’s expansion as he tried to deal with some of the growing problems. But his efforts to deal with the decline of McDonald’s were slowed down by his acquisition of other fast food chains such as Chipotle Mexican Grill and Boston Market.

On December 5, 2002, after watching McDonald’s stock slide 60 percent in three years, the board ousted Greenberg. He had lasted little more than two years. His short tenure had been marked by the introduction of 40 new menu items, none of which caught on big, and the purchase of a handful of nonburger chains, none of which helped the firm to sell more burgers. Indeed, his critics say that by trying so many different things and executing them poorly, Greenberg allowed the burger business to continue with its dec1ine. According to Los Angeles franchisee Reggie Webb, “We would have been better off trying fewer things and making them work.”

Pinning Hopes on a New Leader

By the beginning of2003, consumer surveys were indicating that McDonald’s was headed for serious trouble. Measures for the service and quality of the chain were continuing to fall, dropping far behind those of its rivals. In order deal with its deteriorating performance, the firm decided to bring back retired Vice-Chairman James R. Cantalupo, 59, who had overseen McDonald’s successful international expansion in the 1980s and 1990s. Cantalupo, who had

retired only a year earlier, was perceived to be the only candidate with the necessary qualifications, despite shareholder sentiment for an outsider. The board had felt that it needed someone who knew the company well and could move quickly to turn things around.

Cantalupo realized that McDonald’s often tended to miss the mark on delivering the critical aspects of consistent, fast, and friendly service and an all-around enjoyable experience for the whole family. He understood that its franchisees and employees alike needed to be inspired as well as retrained on their role of putting the smile back into McDonald’s experience. When Cantalupo and his team laid out their plan for McDonald’s in the spring of 2003, they stressed getting the basics of service and quality right, in part by reinstituting a tough “up or out” grading system that would kick out underperforming franchisees. “We have to rebuild the foundation. It’s fruitless to add growth if the foundation is weak,” said Cantalupo.

To begin with, Cantalupo cut back on the opening of new outlets, focusing instead on generating more sales from its existing outlets. In fact, he shifted his emphasis to obtaining most of the growth in revenues to come from an increase in sales in the over 30,000 outlets that are already operating around the world (see Exhibits 4 through 7).

In part, McDonalds tried to draw more customers through the introduction of new products. The chain has had a positive response to its increased emphasis on healthier foods, lead by a revamped line of fancier salads. The revamped menu was promoted through a new worldwide ad slogan, “I’m loving it,” which was delivered by pop idol Justin Timber- lake through a set of MTV-style commercials.

But the biggest success for the firm came in the form of McGriddles breakfast sandwich which was launched nationwide in June 2003. The popular new offering consisted of a couple of syrup-drenched pancakes, stamped with the Golden Arches, which acted as the top and bottom of the sandwich to hold eggs, cheese, sausage and bacon in three different combinations. McDonald’s has estimated that the new breakfast addition has been bringing in about 1 million new customers every day. In 2006 the firm also launched its Premium Roast Coffee with considerable fanfare to enhance its breakfast offerings.

With his efforts largely directed at a turnaround strategy for McDonald’s, Cantalupo was thinking of divesting the nonburger chains that his predecessor had acquired. Collectively lumped under the Partner Brands, these have consisted of Chipotle Mexican Grill and Boston Market. The purpose of these acquisitions had been to find new growth and to offer the best franchises new expansion opportunities. But these acquired businesses had not fueled much growth and had actually posted considerable losses in recent years. Skinner was finally able to dispose of the firm’s investment in Chipotle Mexican Grill in 2006.

Striving for Healthier Offerings

As Skinner took over the reins of McDonald’s in late 2004, he expressed his commitment to Cantalupo’s plans to pursue various avenues for growth. But Skinner felt that one of his top priorities was to deal with the growing concerns about the unhealthy image of McDonald’s, given the rise of obesity in the United States. These concerns had recently been highlighted by the release of a popular documentary, Super Size Me, made by Morgan Spurlock. Spurlock vividly displayed the health risks that were posed by a steady diet of food from the fast-food chain. With a rise in awareness of the high fat content of most of the products offered by McDonald’s, the firm was also beginning to face lawsuits from some of its loyal customers.

In response to the growing health concerns, one of the first steps McDonald’s took was to phase out supersizing by the end of 2004. The supersizing option allowed customers to get a larger order of French fries and a bigger soft drink by paying a little extra. McDonald’s has also announced that it intends to start providing nutrition information on the packaging of its products. The information will be easy to read and will tell customers about the calories, fat, protein, carbohydrates, and sodium that are in each product. Finally, McDonald’s has also been pledging to gradually remove the artery-clogging trans fatty acids from the oil that it uses to make its french fries.

But Skinner must also try to push out more offerings that are likely to be perceived by customers to be healthier. McDonalds has continued to build upon its chicken offerings, using white meat with products such as Chicken Selects. It has also placed a great deal of emphasis upon its new salad offerings. The firm’s latest addition, an Asian style salad with chicken, was added in 2006. Although the firm had failed to attract many customers in the past with its salads, McDonald’s carried out extensive experiments and tests with its new premium version. It chose higher quality ingredients, from a variety of lettuces and tasty cherry tomatoes to sharper cheeses and better cuts of meat. It offered a choice of Newman’s Own dressings, a well known higher-end brand.

McDonald’s has also been trying to include more fruits and vegetables in its well known and popular Happy Meals. It has been testing Happy Meals for grownups with items such as an entrée salad, a bottle of Dasani water, and a “stepometer.” And in many locations, the firm is offering apple slices or carrot sticks in place of French fries in the children’s Happy Meal. The addition of fruits and vegetables has raised the firm’s operating costs, because these are more expensive to ship and store because of their more perishable nature.

But Skinner believes that the firm had to push more heavily on fruits and salads. “Salads have changed the way people think of our brand,” said Wade Thomas, vice president for menu development in the United States “It tells people that we are very serious about offering things people feel comfortable eating.” The addition of items that are perceived to be healthier makes it easier for people to continue to eat at McDonald’s, even though the vast majority of them still order a hamburger and fries.

Revamping the Outlets

Skinner is also aware that most of McDonald’s outlets are beginning to look and feel outdated. About a quarter of its 1,400 outlets in the United States are, in fact, more than 25 years old. Without any changes to their decor, the firm is likely to be left behind by other more savvy fast-food and drink retailers. Under Skinner, McDonald’s is pushing harder to refurbish, or re-image, all of its outlets around the world. “This is all part of becoming more relevant to our consumers,” said company spokesman Walt Riker. “When a customer enters our restaurant, they enter our brand.”

The re-imaging concept was first tried in France in 1996, and has been gradually expanded to other European countries. Dennis Hennequin, president of McDonald’s Europe, felt that the effort was essential to revive the firm’s sagging sales. “We were hip 1 5 years ago, but I think we lost that,” he said.7 McDonald’s is now applying the reimaging concept to its outlets around the world, with a budget of more than half of its total annual capital expenditures. In the United States, the changes cost an average of $ 150,000 per restaurant, a cost that is shared with the franchisees when the outlet is not company owned.

One of the prototype interiors being tested out by McDonald’s has curved counters with surfaces painted in bright colors. In one corner, a touch-activated screen allows customers to punch in orders without queuing. The interiors can feature armchairs and sofas, modern lighting, large television screens, and even wireless Internet access. The firm is also trying to develop new features for its drive- through customers, which account for 65 percent of all transactions in the United States. They include music aimed at queuing vehicles and a wall of windows on the drive-through side of the restaurant allowing customers to see meals being prepared from their cars.

Beyond these ideas, Skinner is also looking for new ideas from some of the better performing franchisees. He insists that its franchisees must feel free to respond to their own markets, although they must adhere to specific parameters that are set by corporate headquarters. One of its more innovative franchisees, Irwin Kruger recently opened a 1 7,000-square-foot showcase unit in New York’s Times Square with video monitors showing movie trailers, brick walls, and theatrical lighting. Similarly, Bob and Julie Dobski have been remodeling their outlets around Illinois, trying to create a different atmosphere in each of them. One of their outlets even has a fireplace in the front lobby.

The chain has even been developing McCafes in- side its outlets next to the usual fast food counter. The McCafe concept originated in Australia in 1 993 and has been rolled out in many restaurants around the world. McDonald’s has just begun to introduce the concept to the United States as it refurbishes many of its existing outlets. McCafe offers espresso-based coffee, gourmet coffee blends, chicken wraps, fresh baked muffins, and high-end desserts. Customers can consume these while they relax in soft leather chairs listening to jazz, big band, or blues music. Commenting on these types of changes, Marty Brochstein, executive editor of The Licensing Letter said, “McDonald’s wants to be seen as a lifestyle brand, not just a place to go to have a burger.”8

A New and Improved McDonald’s?

Even though Skinner’s efforts to transform McDonald’s have led to improvements in its sales and profits, there are questions about the future of the fast-food chain. The firm is trying out a variety of strategies in order to increase its appeal to different segments of the market. Through the adoption of a mix of outlet decor and menu items, McDonald’s is trying to target young adults, teenagers, children, and families. In so doing, it must ensure that it does not alienate any one of these groups in its efforts to reach out to the other. Its new marketing campaign, anchored around the catchy phase “I’m loving it,” takes on different forms in order to target each of the groups that it is seeking to attract.

Larry Light, the head of global marketing at McDonald’s since 2002, insists that the firm has to exploit its brand through pushing it in many different directions. The brand can be

positioned differently in different locations, at different times of the day and to target different customer segments. In large urban centers, McDonald’s can target young adults for breakfast with its gourmet coffee, egg sandwiches, and fat-free muffins. Light explains the adoption of such as multi-format strategy, “The days of mass-media marketing are over.”

As McDonald’s expands upon its concept of fast food, it is moving beyond its staple of burgers and fries to a wider variety of offerings. It is also trying to find a balance between the reliably cheap food for which it has be- come known and the newer items for which it can charge a premium. Many analysts are wondering just how far McDonald’s can stretch its brand while keeping all of its outlets under the traditional symbol of its golden arches. Filmmaker Spurlock insisted, “People go to McDonald’s to eat burgers.”°

Chief financial officer Paull acknowledged that burgers continued to be the main draw for McDonald’s. “There is no question that we make more money from selling ham- burgers and cheeseburgers,” he recently stated.” The chain must make sure that it keeps its established customer base from bolting to the growing number of competitors such as the California-based In-N-Out chain. The long-term success of the firm may well depend on its ability to compete with rival burger chains. “The burger category has great strength,” added David C. Novak, chairman and CEO of Yum! Brands, parent of KFC and Taco Bell. “That’s America’s food. People love hamburgers.”

Above all, Skinner is aware that McDonald’s may not have many shots at trying to get its strategy working. The recent improvement in performance has taken some of the pressure off to turn things around. It has allowed Skinner to respond to disgruntled shareholders, some of whom have suggested that the firm should spin or sell off its company-owned restaurants in order to raise its stock price. But the firm must figure out what steps it needs to take in order to ensure that it does not encounter another meltdown like the one that it faced a few short years ago. “They are at a critical juncture and what they do today will shape whether they just fade away or recapture some of the magic and greatness again,” said Robert S. Goldin, executive vice-president at food consultant Technomic Incorporated.

Endnotes Carpenter, D. 2006. McDonald’s stock soars on 4Q earnings. Associated Press, January 24. Buckley, N. 2004. McDonald’s shares survive resignation. November 24: 18. Gogoi P., & Michael Arndt, M. 2003. Hamburger hell. Business Week, March 3 : 106. BusinessWeek, March 3, 2003: 105. Warner, M. 2005. You want any fruit with that Big Mac? New York Times, February 20: p. 8. Horovitz, B. 2003. You want ambiance with that? USA Today, October 30: 3B. Grant, J. 2006. McDonald’s to revamp UK outlets. Financial Times, February 2: 14 Horovitz, B. 2003. McDonald’s ventures beyond burgers to duds, toys. USA Today, November 14: 6B. Big Mac’s makeover. Economist, October 16, 2004: 65.

Economist, October 16, 2004: 65. Economist, October 1 6, 2004: 64. BusinessWeek, March 3, 2003: 108. BusinessWeek, March 3, 2003: 108.