Here's How McDonald's Plans to Get Itself Back on Track

With new initiatives in place to right McDonald's U.S. ship, disappointing earnings numbers were softened by optimistic views from company executives. Is this turnaround on track?

John-Erik Koslosky
John-Erik Koslosky
Jul 26, 2014 at 8:30AM
Consumer Goods

McDonald's (NYSE:MCD) struggles continue, with the company reporting disappointing second-quarter numbers Tuesday. The Golden Arches have had a tough time finding traction in the U.S., with yet another quarter that lacked any growth in same-store sales. Monthly same-store declines in the U.S. now stretch back to the fall of 2013.

Even worse, the disappointing numbers arrived just a day after key competitor Chipotle Mexican Grill (NYSE:CMG) knocked it out of the park, delivering same-store sales growth of better than 17%. Ouch.

Yet McDonald's executives continued to say they remain optimistic about the future.

There are a few areas that investors should be paying close attention to, and management touched on some of those Tuesday. We'll have more on that in a moment. But first, let's take a quick look at how McDonald's ended up in this pickle in the first place.

Th shrinking burger patty inside the competitive bun
The company at this stage has been getting squeezed. It's feeling competitive pressure from below, with fast-food competitors like Burger King competing on price. It's also getting pressure from above. Starbucks (NASDAQ:SBUX) has moved into breakfast, extended lunch and dinner offerings, and made the drive-through window a key part of its expansion plans. Chipotle(NYSE:CMG), meanwhile, continues chipping away at the monument of traditional fast-food with its faster-than-fast-food service, competitive prices, and its underlying message of "food with integrity."

Lines at McDonald's drive-throughs haven't been as long over the past several months. (Source: WikiMedia Commons)

To deal with all this, it was time for McDonald's to step back and chart a new strategy. Over the past three quarters, it's had a few key areas of focus to better compete with those challenges both from above and below.

Getting back to basics
Earlier this year, McDonald's CEO Don Thompson laid out two important components of the company's plan to right the ship in the U.S. Those included a new focus – on the old, time-tested menu items like the Big Mac, Egg McMuffin, Quarter Pounder, Filet-o-Fish, and french fries.

They also included a look into the future of kitchen operations. McDonald's has been rolling out new prep stations at all of its U.S. restaurants that will make way for a wide assortment of fresh toppings and condiments. This design sounded a lot like like McDonald's was trying to incorporate a little of what Chipotle offers customers – build-your-own ordering that is fast and lets diners customize to their own tastes.

On the first part of the plan, McDonald's seems to realize it's strayed too far from what built its empire. On Tuesday, Thompson said The company is refocusing its marketing efforts around its core menu items and "creating stronger messages to reinforce our place in customers' lives."

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"... We are also strengthening our creative messages by placing greater emphasis on the quality of our food and again reestablishing the emotional connection that our customers associate with the McDonald's experience," Thompson said.

Focusing on these core products -- which represent about 40% of total sales -- and looking to capitalize on the emotional connections customers have with these items makes sense.

And a look toward the future
But McDonald's knows it can't rely on the Big Mac and Quarter Pounder alone. Not with players like Chipotle snatching away customers from fast-food restaurants at the rate it is. While McDonald's – fast-food's standard bearer – saw same-store sales flat last quarter, Chipotle saw comps up a staggering 17%. With the average Chipotle bill up by just 5%, that growth was driven mostly by more customers coming into each store.

Some of McDonald's traditional rivals, like Wendy's, have been making adjustments. Wendy's is more than a year into changes to upgrade its menu with more premium offerings and to begin building stores that are more like modern, fast-casual restaurants.

McDonald's new kitchen stations appear to be the chain's latest answer to this troublesome trend for traditional fast food. 

"... The high-density kitchen was intended to give us more flexibility and allow refrigeration on the prep table, which gives us a little bit stronger capability relative to products," Thompson said on Tuesday. 

Without going into many details, Thompson told analysts they "will be seeing more products," that put those new kitchen stations to use.

The Foolish bottom line
Management has been careful to point out that these efforts are neither a "silver bullet" nor a recipe for a quick, thorough, turnaround for the company in the States. With these efforts just getting under way, they probably didn't have much of an impact yet on quarterly earnings. But Thompson remains optimistic. With shares trading at a forward P/E of 17, McDonald's turnaround plan will need to start showing signs of success soon, or it may start testing investors' patience.