Why McDonald's Stabilization Plan Will Boost Sales

McDonald's reported another lackluster quarter this week. But management's current approach may gain traction later this year.

Apr 24, 2014 at 7:00PM

Images

McDonald's in Cairns, Australia. Image courtesy mateoutah under Creative Commons license.

Earlier this year, McDonald's (NYSE:MCD) named four "priority markets": United States, Japan, Australia, and Germany. Each of these is considered a major market for the company, and each has underperformed recently within the McDonald's system. McDonald's global sales in the first quarter of 2014 increased a mere 0.5%, and the four priority markets were responsible for dragging the entire system into a negative guest traffic comparison.

During the company's earnings conference call this week, CEO Don Thompson mentioned that in visiting each of the four priority markets during the first quarter, he and other members of the management team noted four "opportunities" common to each of the markets. The gist of each opportunity (or more candidly, each area of improvement) is as follows:

  • Use data more effectively in the planning process to create action plans centered around the customer, within internal financial constraints.
  • Strengthen marketing to increase awareness and better resonate with customers.
  • Enhance value offers: improve their consistency and ensure they are clearly communicated.
  • Focus on the core menu: items such as the Big Mac, Egg McMuffin, and fries.

<pThis prescription is being administered to "stabilize" sales and guest count trends in the four mammoth developed economies mentioned above. But the tactics laid out to some extent will affect the total McDonald's system. Let's review these opportunities for a closer look at how "stabilization" may set the stage for revenue growth.

Take care of the customer and the P&L will fall into place
On the earnings call, CEO Thompson and CFO Pete Bensen both stressed the importance of not overly optimizing profitability, despite pressures on the profit and loss statement. Virtually flat comparable sales threaten McDonald's margins, as food costs alone will rise between 2.5% and 3.5% this year. An easy solution would be to initiate significant cost-cutting, which would hold margins steady in the absence of increased sales.

Yet as management pointed out repeatedly during the call, McDonald's wants to focus on the customer experience, addressing such issues as menu selection, decor, and efficient service. The belief is that if negatives in the customer experience are addressed, sales will increase, and margin pressure will be resolved.

This is not a novel approach to earnings rejuvenation, but it seems rarer these days among Fortune 500 companies, where a fear of displeasing investors often leads management teams to boost earnings through cost-cutting and ramped-up share repurchases. Give McDonald's management credit for choosing to manage for the customer rather than opting for a quick and easy boost via operational trimming.

Use marketing to reconnect with customers
This year, McDonald's wants to use advertising and marketing to create a "greater emotional connection between customers and [our] core products." We can infer that some of this spend will attempt to reinforce the base of the company's customer spectrum, which tends to be slightly older. Last year, an internal McDonald's document pointed to the company's poor showing among millennials: according to the memo, McDonald's fails to rank among this demographic's top 10 restaurant chains. In response, the company has recently begun testing a mobile app across 1,000 stores that sends promotional menu offers to customers based on their preferences.

While making the mobile leap is clearly a necessary step, especially given Starbucks' mobile and digital domination , this year it appears that the company is also going to communicate with the slightly graying partners who've brought the company to the dance, those pre-millennials who have long-standing emotional connections to the chain's core products. Focusing on both groups together will achieve much toward the company's goal of stabilizing guest count.

Enhance value offers
On the earnings call, analysts asked management about the initial results of the "Dollar Menu and More" format, in which McDonald's value offerings have been extended to include price points of between $2 and $5. Management disclosed that the the new format has met expectations so far. But Thompson stressed the need for value offerings to be "clearly messaged." This may seem counterintuitive at first. Doesn't the low price of a value item provide all the messaging and incentive needed for a customer to make a purchase? McDonald's may be thinking of how to better present visually the concept of value items. Here's a simple, beautiful graphic created by the advertising firm DDB Sydney for the clever McDonald's Australia value offering known as the "Loose Change Menu:"

Mcdonalds Loose Change

DDB Sydney graphic for McDonald's "Loose Change Menu" campaign by Colorbis.

Sometimes, simplicity helps to spur sales. In practice, value menu boards in the U.S. have tended to be crowded and difficult to parse, especially at the drive-through. Strong visual communication as in the graphic above may provide the "clearly messaged" value proposition behind McDonald's "Dollar Menu and More" the company seeks to put out.

Show the core menu some love
In 2014, McDonald's will keep the core menu of items, such as Big Macs, Egg McMuffins, and fries, at the top of customers' minds. The company mentioned during this week's call that 40% of all sales dollars come from core items. Such items make an efficient contribution to McDonald's margins. They don't have significant R&D costs associated with them, don't need test marketing, and they won't challenge restaurant staff with their assembly during rush hours as new menu items and limited-time offers do. In the same vein as remembering the older demographic that provides a customer base, management sees the value in promoting beloved standards as a way to enhance revenue. So, in essence, get ready to see media targeting older customers in which strong emotional appeals to the core menu are made.

A good tactical maneuver at present
While the idea of stabilization was presented as mostly endemic to the four big markets, in practice, McDonald's entire system's sales will benefit from a bit of stabilization. As discussed above, a repeated theme on the earnings call was the need to run operational and marketing changes through the filter of the customer in order to drive sales and margin. This is a practical and effective tactic, making McDonald's earnings report very much a "stay the course" result for current investors. Moreover, this plan may well be setting the company up for a bit of revenue growth in the back half of fiscal 2014, so investors on the sidelines, stay tuned.

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Asit Sharma has no position in any stocks mentioned. The Motley Fool recommends and owns shares of McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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