by Jim 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
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
(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.