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Berkshire Hathaway
The Turnaround Game-MCD

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By Goofyhoofy
March 20, 2002

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Note: This is pretty long. It's about McDonald's, executive compensation, and later on, K-Mart, for those who might want to just skip the whole thing. The original post was here; I wouldn't know where else to put it.

The game is the Turnaround Game. It's really simple. Pick a company that is doing poorly and come up with the best possible ideas to fix it. Currently, ... But I have done McD's even though I sold that sucker back in February. I know why Buffett sold. His initials are JG.

This is an entertaining, but superficial read on McDonald's. (Of course it's on a message board and not a doctoral thesis, so perhaps that's excessively harsh.)

1. PUT THE FAST BACK IN FAST FOOD.
Everybody complains about McD's sorry tasting food. But people don't buy it because it is good. They buy it because it is fast.


The problem is, people stopped buying it, period. As Greenberg came into the big chair, same store sales were actually declining (masked by increased gross sales due to expansion). The reason for the SSS declines is that McDonald's doesn't exist in a vacuum. They had the playfield - and the image - to themselves for several decades, but other competitors appeared and changed the landscape. Wendy's had notably better food. Burger King, by that time, had significantly increased the number of outlets. Pizza joints were driving their product to your driveway. And all of the big guys had gotten into the promotional toys and contest game, reducing a big advantage which McDonald's had once enjoyed.

Your analysis assumes that "if everything just went back the way it was" everything would be fine. It's not true. Once upon a time people accepted "lousy food fast"; they no longer do.

The #1 reason in McDonald's research for their declining sales was "bad food quality". They attempted a fix with "other selections" and it didn't work, so they tried "better preparation method."

2. SACK JACK.
He tried to fix what was not broken. Dumb.


Actually, it was broken. He may have picked the wrong solution, but saying there wasn't a problem is a misreading of history.

This reminds me of the "If it ain't broke don't fix it" theory of business, the corollary of which is "Wait 'til it's broke, by which time it may be too late to fix it." Jack may be the wrong guy, or he may be the right guy who picked the wrong solutions, but just yelling "Dump Jack" without a deeper understanding of what's going on surely isn't right. It took another Jack, this one named Welch, over five years to have a significant impact on GE. (Luckily, most of his early moves were the right ones, it just took time to have the desired effect on the corporation.)

That said, Greenberg took the big chair in '96 or '97, so his five years are close to "up." I'd give him another year to see a payoff, and if there isn't one, it's probably time to move if for no other reason than "it's time."

3. IMPROVE RELATIONS WITH FRANCHISEES.
This goes back to Mr. Greenberg. This is also a consequence of McD's saturation campaign where a new McDonald's was put three blocks away from an existing franchise. A franchise is a partnership. McD's has forgotten this.


There is no question there has been cannibalization. This is an unhappy artifact of "adding stores" in any business; it is exacerbated in the franchise system, where the corporation has a high incentive for "more gross sales" while the franchisee has an incentive to "maximize sales in his location."

From McDonald's corporate point of view, it's better to site a location halfway between two others, even if they will each lose 10% of sales, so long as the new one generates 80% of new sales. The franchisees, of course, hate this. Generally they don't even want to own the one in between, because they are trying to maximize their ROC on the location they already own.

It's a tough balance, and I'll admit McDonald's hasn't always handled it well. OTOH, every franchise system has some unhappy franchisees, so I don't have my knickers in a knot over this.

5. GET RID OF BOSTON MARKET.
This is part of Mr. Greenberg's ego enlargement. He turned around BM while deep sixing a stellar company.


Maybe. But with McDonald's approaching world-wide saturation, it seems logical to explore new areas for growth. Wal-Mart is doing it with Neighborhood Markets, Home Depot is doing it with Contractor only stores, and, of course, Berkshire Hathaway does it every time they buy a new something-or-other company. (Different case, I know.)

6. PAY EMPLOYEES A LIVING WAGE.

More a decision for the franchisees, who own 2/3 of the locations (domestically, at least.) Or do you think the franchisees would be happier if McDonald's sent down a corporate edict telling them to raise wages?

7. DUMP OPTIONS AS COMPENSATION.

Yeah, well. I'm thinking of a whole different way of handling "options" for execs, which in theory are good to align interests, but in practice give them a huge potential reward with virtually no risk.

My game would be to make options available for purchase at ~75% of face anytime during the succeeding 12 months. (Some corporations offer an employee discount of 10%; this would be the same sort of thing), but would require investment by the executive. They're only available for 12 months to encourage lumpy-but-truthful results (sad, I know) and to discourage the banking of such a perk for years-and-years and windfall profits as a result. A new set would be available each succeeding year under some formula set by the compensation committee.

Then we would get to see "who has cash in the game", which would be a more telling sign, it would certainly "align interests", and it would give executives a chance to profit from appreciation of the business (presumably followed by share price appreciation).

Oh. They would also be required to hold these shares for a minimum of five years (to incent "long term thinking") but divest any of these shares (although they could certainly also buy "regular shares" and buy-and-hold-forever) within 24 months of leaving the company.

Might sound a bit complicated, but if you've ever been part of one of these programs, it's actually simpler than the way many of them operate now.

Currently, I am working on Kmart, and I'm not doing too well

I have one for K-Mart.

Take down the signs. The K-Mart image is forever tarnished, and not just by the bankruptcy. Stores with a bad image almost never recover. Caldor, Service Merchandise, WT Grant, Almy's, Kresge, Ben Franklin, Zayre, the list is endless.

Close the bad locations and jump out of the leases as allowed by the bankruptcy court. Make a deal with Martha and put up new signs that say "Martha Stewart Home Center". Shoot the gap between cheesy Wal-Mart and Home Depot selection and high-end department stores. The target, you should pardon the pun, is where Target and Kohl's are, and where there is still room for a national player, which Kohl's isn't yet.

Fire Fleming. Dump the so-called grocery section, which is not good enough to be anyone's grocery store, and is too big, and the lines too long to be a convenience store.

Raise prices a little. In the urban stores there is no Wal-Mart competition, so it doesn't matter. In the suburban areas, you're now playing to a different image, although you will still get some traffic just because of location-convenience. Work desperately on ironing out the supply chain.

Give Martha her due, ride on her perceived ability to have taste, hold your nose when dealing with her, and make a comeback. She's about the only thing they've got, and if she leaves, they're not just toast, they're dead, burned, stale toast.

Or, to bring the post full circle, they're the Arch DeLuxe, verging on an overdone McLean sandwich.


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