Expect More Experimentation From McDonald's in 2014

McDonald's (NYSE: MCD  ) is set to close the books on a rather painful year. Beset by declining same-store sales, and a stock price that has returned only one-third of the S&P 500's performance on a total return basis year-to-date, management and investors are mutually concerned. The sense of lost value creation is even keener if you run the tape back to 2012: The S&P 500 Total Return Index shows a gain of 49.50% for the two-year period to date, versus McDonald's paltry total return of 3.85%. While 2014 may not look any more promising at this juncture, investors can take some comfort in the fast food giant's propensity for experimentation and innovation. The following are two major areas in which McDonald's restless spirit for change may provide a breakthrough in the near future.

The evolving "Plan to Win"
McDonald's "Plan to Win" has been a foundational strategy for the company for nearly 11 years. In its latest iteration, the plan encompasses the three following global growth priorities: optimizing the McDonald's menu, modernization of the customer experience, and broadening customer accessibility to the McDonald's brand. Of the these three priorities, McDonald's will expend a tremendous amount of energy and resources to optimize its menu. What might this look like in 2014?

To begin with, management may decide that it makes sense to continue to move away from its "barbell" strategy of value menu items counterbalanced with premium items. This may cause current pain. As Fool contributor John Maxfield points out, the evolution away from McDonald's "Dollar Menu" to the new "Dollar Menu & More" may already be hurting same store sales. But if management can compartmentalize the pressure from Wall Street and investors who hungrily await each month's same-store sales figures, it may be worth it to cede some value menu traffic to attract a larger average ticket.

The company is avidly experimenting with ways to attract a higher margin customer under its rather fatigued arches. While this fall's "Mighty Wings" promotion was a failure, resulting in 20% of wings inventory still frozen as you read this article and awaiting another marketing push, the company is at least following an appropriate strategy. I've argued here for a logical approach to menu differentiation. Ultimately, we should expect more menu R&D in 2014, with a bias toward premium items that will satisfy both new customers and franchisees worried about their current profitability.

McDonald's will entertain new revenue streams
In late October, McDonald's announced that it will partner with Kraft Foods (NASDAQ: KRFT  ) to test-market packaged McCafe coffee in grocery stores in 2014. Dunkin Brands (NASDAQ: DNKN  ) and Starbucks (NASDAQ: SBUX  ) have already demonstrated that a popular in-house coffee brand can enjoy success in the grocery aisles. Selling coffee in grocery stores under its premium McCafe label should similarly reward McDonald's.

Working with a partner such as Kraft to market and distribute coffee is native to the way McDonald's conducts business. The company operates under a licensing mind-set to a more extreme degree than almost any other large franchisor. Though it has operations in 119 countries around the world, the company has almost no investment in its own supply chain, preferring that its suppliers make infrastructural investments in distribution. Thus, the idea of using its own purchasing power to drive cost efficiencies on premium beans, but utilizing a mammoth partner like Kraft to handle the rest of the operation must appeal greatly to McDonald's management team.

Is there another space in which McDonald's can enhance its revenues as it tries to shore up its core quick-service business? At $27.9 billion of trailing-12-month revenue, there are not many more large levers left for McDonald's to pull. However, here's an outlandish thought: It's possible that in 2014 we may see McDonald's take an equity investment in one or more boutique food chains. A host of smaller quick-service chains with relatively low price points and higher perceptions of quality such as Jimmy John's, Potbelly Sandwich Works  (NASDAQ: PBPB  ) , and the Shake Shack (on the East Coast) are tugging at the very higher-margin customers that McDonald's wants to attract. Plunking down some pocket change for a stake in one or two of these types of private (or public) chains would assist McDonald's in getting up to speed with the contemporary customer's palate. And a shrewd investment could perhaps provide an incremental boost to the company's fortunes, as Chipotle Mexican Grill would have undoubtedly provided, had the company held on to its one-time investment.

2014 may be a choppy year for MCD
Investors who are in McDonald's for the short term may want to brace themselves: The type of experimentation the company needs to adapt to a changed quick-service world will have unpredictable effects on both revenue and profit margins. Long-term investors may also want to prepare for a very good possibility that 2014 may look quite a bit like 2012 and 2013. However, the company has the resources and innovative muscle to acclimate itself to the challenge. It now needs to exhibit the patience and determination to keep experimenting with its menu and alternative revenue streams to preserve its vaunted, decades-long success.

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  • Report this Comment On December 24, 2013, at 6:16 AM, fegroup wrote:

    "Plunking down some pocket change for a stake in one or two of these types of private (or public) chains would assist McDonald's in getting up to speed with the contemporary customer's palate."

    That was exactly the logic in the late 1990s when McDonald's bought, or bought interests in, a string of sandwich shops and a pizza chain. It turned out to be nothing but a distraction and key to kick starting things in 2002 was to get rid of most of those ventures. Keep in mind, McDonald's is not run by restaurateurs or entrepreneurs. These folks are corporate bureaucrats and should not be pushed too far out of their safety zone.

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