MainBanner JavaFiller
quote.fool.comToday's FeaturesQuotes, News, Charts, Data


Poker is a game of chance, but not the way I play it. -- W.C. Fields

Hamburger Struggles
by Jim Surowiecki (Surowiecki)

It has one of the world's greatest franchises. Over the last five years, it has expanded rapidly both at home and abroad, moving strongly into new foreign markets while ensuring that in the United States it's hard to go more than two exits on an interstate highway without seeing the familiar golden arches rising over the horizon. Yet almost everyone, it seems, is convinced that McDONALD'S (NYSE: MCD) is badly in need of an overhaul.

In recent weeks, the management of McDonald's has taken flak from rebellious franchisees concerned about the company's aggressive growth strategy, from analysts unconvinced that the corporation has a real plan to stem the decline in domestic sales, and from shareholders annoyed at the company's seeming inability to translate its ambitious "Campaign 55" promotional gimmick into a successful sales campaign. The company itself, meanwhile, while dismissing much of the criticism as the sniping of a few disgruntled franchise owners and an overly aggressive press corps, has apparently embraced on a restructuring scheme designed to encourage flexibility and eliminate layers of bureaucracy.

Ironically, the wave of public discontent that has hit the company in the last month arrives after the first quarter in more than a year when same-store sales improved. In 1996, same-store sales were down 6.4%, while in 1995 they declined 2.5%. The first quarter of this year, though, saw same-store sales rise sharply, and expectations are that the same will be true of the quarter ending next month. On the other hand, McDonald's has benefited in both quarters from elaborate promotional tie-ins, including a Monopoly game promotion in the first quarter and, more importantly, a tie-in with the already legendary Beanie Babies in the second quarter.

Neither promotion, needless to say, engenders much confidence in the long-term health of the company (although McDonald's ability to sign promotional deals seems unlimited, since the summer will feature an elaborate Disney tie-in). One shareholder put it bluntly at the company's annual meeting last Thursday: "Taste is your No. 1 factor. People were saying 'keep the food.' All they wanted was the Beanie Babies.''

Company chairman Michael Quinlan did his best at the meeting to reassure shareholders that management was focused on the fundamentals. "Taste, service, and value are the three big hitters," he said. He also hinted at a forthcoming unveiling of a new chicken sandwich -- which would make it McDonald's third -- and emphasized that the company understood what it had to do to win back regular customers. "We are hard at work on the ingredients, on the method of preparation," he said. More telling than Quinlan's somewhat platitudinous remarks on taste, though, was his evident frustration with the company's many critics. He tried to redirect the public discussion away from "Campaign 55" and the problems with franchisees toward the company's rapid growth overseas, and exhibited a certain impatience with shareholders' desire to focus on McDonald's relatively stagnant domestic business.

The company's problems with some of its franchisees was the focus of an article in Business Week last week, which spotlighted the tensions created by McDonald's continued rapid expansion. According to Jack Greenberg, chairman of McDonald's USA, the company plans to add 600 stores this year to its already existing 12,094 U.S. restaurants. That number, meanwhile, is up 40% since 1991, when there were just 8,764 domestic McDonald's. (The company has almost 9,000 restaurants abroad.) And that growth has necessarily meant that some franchisees have watched business be taken away, not by BURGER KING or WENDY'S (NYSE: WEN), but by new McDonald's. In response, franchisees have formed an activist group called Consortium Members Inc., which has taken to lobbying Congress for new legislation to protect franchisee rights and lobbying the press for attention to their plight. At a press conference the day before the annual meeting, a half-dozen franchise owners complained about new franchises "encroaching" on their business and attacked McDonald's management from caring only about "the stock market and their personal wealth."

The franchisees' complaints might be seen as a curious turn in the debate over stakeholder interests, since their argument seems to rest on some notion of corporate responsibility to the franchisees over corporate responsibility to shareholders. Nonetheless, given the fact that most franchisees take home well over $100,000 a year, and that the legal basis for restricting expansion seems dubious at best (each of the current franchisees, after all, owns his or her franchise(s) because of expansion), Consortium's efforts seem guaranteed mainly to annoy McDonald's management.

The organization certainly has done that, though.

After the annual meeting, in fact, Greenberg dismissed the group as "eight people and a guy with a fax," and argued that while profits for individual stores were not as robust as in the early years, they were still far better than those offered by any of McDonald's competitors. "The only people who don't want to see more McDonald's," he said, "are our competitors and the handful of people who don't want to be fair and give the people the service that our customers demand."

Still, given the fact that 85% of the company's U.S. sales come from franchise operations, and that McDonald's depends on the cooperation of its franchisees for the success of its promotional campaigns, any public squabble with the franchisees is guaranteed to make shareholders anxious, as in fact it has. The stock currently trades at about where it was at the beginning of last year.

More intriguing, though, and perhaps more telling, has been the disappointing denouement of "Campaign 55," which McDonald's announced months ago to much fanfare -- and much criticism from franchisees. The plan called for a cut in the price of different sandwiches to 55 cents when purchased with an order of fries and a drink. At the time, restaurant owners complained that there was no way a rise in sales could make up for the impact of the price cut. But what really appears to have happened is that consumers have ended up more confused than ardent.

Initially, Campaign 55 appeared to offer the prospect of a 55-cent Big Mac, no strings attached. Burger King, in fact, responded to the promotion by slashing the price of a Whopper to 99 cents, sparking fears of a burger price war. By tying the Big Mac to fries and a soda, though, McDonald's essentially just duplicated its Extra Value Meal strategy, albeit with a minor price cut. Customer confusion seems to have outweighed whatever benefits the simplicity of "55" offered. And now that the company has shifted the 55-cent sandwich from the Big Mac to the Quarter Pounder with Cheese, it'll be no surprise if consumers end up gazing quizzically at the menu in search of that 55-cent Big Mac. The one place where the 55-cent campaign has helped is in the breakfast business, but some analysts have questioned how much that helps business as a whole, since people who eat at McDonald's in the morning may not want to return for lunch. In any case, at the annual meeting Quinlan had little of substance to say about Campaign 55, though the company has described itself as "fine-tuning" the promotion. The last week has seen a much-stepped-up ad campaign devoted to explaining exactly how the plan works, which some might take as a less-than-hopeful sign.

More generally, McDonald's increased reliance on promotional gimmicks of this kind speaks to the paradoxical spot the company finds itself in. No fast-food corporation is better positioned to take advantage of the opportunities offered by the new global economy, and the company is expanding abroad without hesitation. In the last week, for instance, McDonald's opened its first two restaurants in Kiev, Ukraine, and the global market clearly has decades to go before approaching the saturation level the fast-food business may have reached in the United States.

Domestically, though, it's difficult to see how McDonald's can improve its position without dramatic improvements in taste and service, improvements that will be difficult to effect without major revisions in the company's structure. What was the last new product the company introduced that became a major hit, after all? The Arch Deluxe, for which management had high hopes, was a major flop, as was the McLean. The company's rapid addition of new stores, in that sense, might be seen as a substitute for its failure to add successful new products.

The limits against which the company appears to be bumping domestically, though, may very well be limits inherent in the fast-food business. What isn't clear, to be sure, is how susceptible consumers are to be lured away from the burger chains by restaurants like Boston Market, which purportedly offer better-tasting and healthier food. What does seem clear is that McDonald's can't solve its problems by playing games with prices, and that short-term solutions like the Beanie Babies won't ameliorate the company's long-term concerns.

(c) Copyright 1997, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool.

© Copyright 1995-2000, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool. The Motley Fool is a registered trademark and the "Fool" logo is a trademark of The Motley Fool, Inc. Contact Us