McDonald’s: Polishing the Golden Arches

Overview
In January 2003 McDonald’s, the world’s largest fast food chain, posted its first ever quarterly loss of $343.8 million. The loss was attributed to increased competition, poor management and marketing, and a failure to respond to changing customer needs and to requests from franchisees to alter aspects of McDonald’s menu and operating practices. In the midst of these challenges, CEO Jack Greenberg stepped down and James Cantalupo came out of retirement in January 2003 to take the reigns of the foundering Fortune 500 company. Cantalupo wasted little time in admitting that the company was “in serious need of improvement.” Cantalupo immediately announced an aggressive, broad-ranging turnaround plan (called McDonald’s Plan to Win) designed to refocus McDonald’s on its mission by increasing focus on internal operations, slowing store expansion (opening 640 fewer units than in 2002), enhancing the relevancy of McDonald’s to its customers, and making the consumer the new boss at McDonald’s. McDonald’s has come along way from its beginnings as a 1948 drive-in opened by Dick and Maurice “Mac” McDonald in San Bernardino, California. The initial changes were introduced by Ray Kroc, the pioneering entrepreneurial founder of McDonald’s who conceived and implemented many of the strategic and operating elements that transformed McDonald’s into one of the most successful franchising models in history. By 2002 McDonald’s had a 33% share of U.S. fast food market with 13,491 units in the United States (second behind Subway) and 16,534 outlets in 120 countries. However, sales growth was slowing and franchisees were increasingly unhappy. The company’s problems were due partly to mounting competition (including price wars and other market tactics) initiated by fast-food rivals dissatisfied with their market share and partly to changes in consumer eating preferences. One of McDonald’s strategic responses under CEO Jack Greenberg was to acquire other Quick Service Restaurants (QSRs), including Boston Market, Chipotle, Donato’s Pizzeria, Pret a Manger, and Fazoli’s. Greenberg also attempted to fuel growth in McDonald’s core business by continued store expansion efforts, refurbishing older stores, and introducing new methods to speed service delivery. However, there was accumulating evidence that McDonald’s management was not attuned to fixing the right things. For example, while the company still espoused Kroc’s values of Quality, Service and Value, the company’s customer service rankings were the lowest among all of their competitors and were lower even than the U.S. Internal Revenue Service. By January 2003, it was evident that Greenberg’s plan was not working; he resigned and Cantalupo packaged a number of new initiatives into McDonald’s “Plan to Win” aimed at five key drivers of success: people, products, place, price, and promotion. A year later, January 2004, the company’s stock price had rebounded to $25, up from $12.50 in March 2003, and some analysts were predicting a price of $34.00 by the end of 2004—a price still below the $40.00 per share level the stock was bringing in the late 1990s and the early part of 2000. This case reviews the history of McDonald’s and discusses the strategic changes that occurred under the company’s various leaders, beginning with McDonald’s brothers to Ray Kroc and through Cantalupo. The contribution of each key leader to the evolution of McDonald’s strategy is identified as are the internal and external challenges that led to key

strategic changes. The case continues with an analysis of the Quick Service or Fast Food industry in both the national and international markets. Information is presented that reveals important trends impacting the evolution of the Quick Service industry as well as the key strategies and strategic intent of McDonald’s key competitors. The case concludes with a detailed discussion of McDonald’s “Plan to Win” strategy.

Suggestions for Using the Case
The McDonald’s case should prove to be popular with students, given their firsthand knowledge of the company and the fast-food industry. The comprehensive nature of the case allows it to be used in either the strategy formulation or strategy execution section of your class. However, we suggest that the case be assigned following your coverage of Chapters 3-6, as the material in these chapters provides a solid foundation for students to evaluate McDonald’s current situation and critique its latest strategy. The McDonald’s case contains plenty of information for students to conduct a thorough industry and competitive analysis, understand how and why a company’s strategy evolves in response to environmental changes, and evaluate the soundness of the company’s strategic responses over time. is There is an accompanying video for this case that we recommend showing at the beginning of the class period. It will help set the mood and tone for the discussion and debate that follows. The issues and topics in the case allow students to apply the information in Chapters, 3, 4 and 5 and can give them a chance to:  Apply the concepts and tools of industry and competitive analysis.  Conduct a first rate SWOT analysis.  Develop a detailed financial analysis.  Evaluate a company’s competitive strategy vis-à-vis major competitors. Strategy implementation/execution issues in the case cut broadly across Chapters 11-13 and allow students to:  Examine the evolution of a company’s strategy and recognize the effect strategic leadership can have on the development of a company’s strategy and its core competencies.  Understand how an industry leader can lose focus, have its position eroded by competitors, and develop a strategic plan to regain its competitive position.  Analyze a company’s turnaround plan including the extent to which the company has developed appropriate goals and measurement criteria. The McDonald’s case is a great vehicle for either written case assignments or team presentations. A suggested assignment is as follows: Having heard of your growing prowess in matters of strategic analysis, senior executives at McDonald’s have retained your services to provide analysis and advice to the company’s CEO and Board of Directors regarding circumstances in the fast-food industry in 2004, McDonald’s situation, and its Plan to Win strategy. You have been asked for a full analysis of the company and the industry and for specific, actionable recommendations to improve the company’s strategy and help

sustain the company’s recent growth and business performance. Please support your recommendations with the conceptual and analytical tools presented in Chapters 3 and 4. You are expected to provide McDonald’s with a report that is thorough and thoughtfully prepared, that reflects strong grasp and application of the tools and concepts of industry and competitive analysis and company situation analysis (Chapters 3 and 4). Given the high profile of McDonald’s and the evolving nature of the fast-food industry, there is significant information available for further library/Internet research.

Assignment Questions
1. What are the chief economic and business characteristics of the fast-food industry? 2. What does your 5-forces analysis of the fast-food industry tell you about the competition facing McDonald’s? 3. What forces are driving changes in the fast-food industry, both domestically and globally? 4. What factors do you see as critical to competitive success in the fast-food industry? 5. Is the fast-food industry attractive? What factors make it attractive? Unattractive? 6. Describe how McDonald’s strategy has evolved under each of its CEOs. Did Ray Kroc have the most influence of any CEO on McDonald’s strategy? Do you agree that Greenberg should have resigned in response to McDonald’s loss in 2002? To what extent do you believe McDonald’s current performance is attributable to actions taken by Cantalupo versus those initiated by Greenberg? 7. What is McDonald’s current strategy? Which elements of McDonald’s current strategy can be attributed to Kroc’s influence? 8. How well is McDonald’s current strategy working? Do you like the company’s competitive position vis-à-vis other fast-food chains? 9. What are McDonald’s internal strengths and weaknesses? What are its external opportunities and threats? Do a SWOT analysis in developing your answers. 10. What are the major strategic issues surrounding McDonald’s Plan to Win? What are the specific areas McDonald’s is focusing on to revitalize the company? Is it using the best metrics to measure their goal attainment? 11. Do you believe that the changes McDonald’s is making with its Plan to Win can successfully reposition the company and provide the basis for a sustainable competitive advantage? 12. What specific recommendations would you make to Cantalupo regarding the company’s operations and how McDonald’s can maintain its leadership position?

Teaching Outline and Analysis
1. What are the chief economic and business characteristics of the fast-food industry?
Students should be able to identify the following characteristics of the Quick Service industry:

 Market Size and Growth Rates: 2003 sales for U.S. consumer food service industry totaled approximately $408 billion. Future growth in the sandwich segment is expected to be around 2% for the foreseeable future. The “other sandwich” is growing at 12.8%. Globally, the food service industry is expected to grow by more than $200 billion between 2002 and 2006.  Scope of Rivalry: Competitive scope is mostly national, but major competitors have expanded into international markets as the domestic market becomes rapidly saturated.  Stage of Industry Life Cycle: The domestic market is in a mature stage, while the international market is in the rapid-growth stage.  Number and Size of Competitors: The fast food industry is heavily fragmented, but the ten largest competitors account for 14% of sales. The top 30 chains have U.S system-wide sales of approximately $64 billion. Of this amount, McDonald’s accounts for almost 33% of the sales, the top 5 chains account for 71.70% of sales, and the top 10 chains 88.88%.  Product Differentiation: No evidence of forward or backward integration. Rivals are highly differentiated to accommodate the wide variety of consumer tastes and preferences.  Economies of Scale: Economies of scale are important because they allow competitors to preserve margins in the presence of intense price competition.  Customer Characteristics: The industry is broadening its customer focus to include younger, hipper customers as well as more sophisticated customers.  Entry Barriers: As fast food restaurants are usually franchises, capital requirements are dictated by the franchisor. Typically, a minimum initial payment of $175,000 plus a monthly service fee as a percentage of total monthly sales is made to the franchisor. However, it would be very difficult to enter the market and compete against the national chains given the significant capital requirements it would require and the entrenched position of these chains.  Industry Profitability: Industry profitability is decreasing as the domestic market matures, and international profitability is surpassing the domestic market for the first time.

2. What does your 5-forces analysis of the fast-food industry tell you about the competition facing McDonald’s?
Below is a graphic portrayal of the five-forces model for the fast food industry:

Five Forces Model of Competition: in the discussion below, a (+) indicates a factor acting to intensify competitive pressures and a (–) indicates a factor acting to weaken competitive pressures. Rivalry Among Competing Sellers: Very Strong Competitive rivalry is the strongest of the five forces. The weapons of rivalry are price, quality, convenience, location, promotion and brand name recognition. Specific factors underlying the nature and strength rivalry include:  Large number of competitors, with the industry leaders becoming more equal in size and capability. (+)  Domestic demand is growing slowly(+); although international demand is growing more rapidly, many companies are chasing this growth (+).  Competitors often rely on price cuts to boost volume. (+)  Low switching costs for consumers. (+)  Moderate level of differentiation (–)  Key competitors are dissatisfied with their market share (+) Threat of Entry: Relatively Weak Students should be able to differentiate between entry on a local level and entry as a significant competitor against the largest fast food chains. You can acknowledge that it is relatively easy for a firm to enter the local market. However, local fast-food enterprises are not really important competitors to firms such as McDonald’s and students should be encouraged to focus on entry at the chain level. At this level,

students should spot the following factors affecting the threat of large-scale entry into the fast-food market:  Economies of scale allow preservation of margins during price cuts (-)  Relatively unattractive market with slowing growth (-)  Competitors are working to build brand loyalty through new menus, increased efficiency, and improved service. (-)  Existing competitors have accumulated expertise in marketing and efficiency (-)  Inability of most new firms to match technology and know-how of firms already in the industry (-)  Many potential customers with varied tastes and preferences (+)  High capital requirements to start a nationally competitive chain restaurant from scratch (-)  Rapid demand growth in some international markets (+)  Uncertain economic outlook of some international markets (-)  Threat of restrictive regulatory policies stemming from mad-cow disease (-) Competition from Substitutes: Very Strong This section offers an opportunity to discuss the nature of substitutes based on the need being filled. If students identify the need being filled as simply eating, then they can make a case that the competitive force of substitutes is very strong.  Alternatives to fast food are readily available. Customers can choose other types of restaurants, including buffets, or choose to cook at home (+)  Alternatives are attractively priced (+)  Buyers view the substitutes as satisfactory in terms of quality (+)  Buyers have little or no switching costs in going to substitutes (+) However, it is unlikely that companies in the fast-food industry would view any type of food as their competitors. It is more likely they would perceive the need being filled as convenience, quality, and value. Based on this, competition from substitutes is moderate.  Alternatives to fast food are readily available. Customers can choose other types of restaurants, including buffets, or choose to cook at home (+)  Many alternatives would be less attractively priced, but perhaps more satisfying and nutritious (+)  Buyers are likely to view higher-priced substitutes as unsatisfactory (-)  Buyers have no switching costs when changing substitutes, other than a higher price (+) Bargaining Power of Suppliers: Weak  No evidence of supplier-seller collaboration in the fast-food industry (-)  Fast food supplies are mostly commodities (-)

 Industry leaders are major customers to suppliers (-)  While McDonald’s does own some farms, overall there is relatively little threat of backward vertical integration (+)  The quality of some of the products supplied (e.g., meat) can significantly impact the quality of the products produced by the fast-food companies. Bargaining Power of Buyers: Moderate to weak Students should recognize that there are two types of buyers in this situation: customers who purchase fast-food and franchisees. General customers have some power because:  Buyer’s switching costs are relatively low (+)  Customers purchase in small volumes. (-)  Consumers are well-informed about sellers’ products, prices, and costs (+)  Customers can always choose to eat at home (+)  Customers have discretion whether or not to purchase fast food products (+) However, this power is largely mitigated, resulting in low overall power, because  Customers purchase in small volumes (-)  Large number of customers willing to purchase fast food products (-) Franchisees have more power because:  Franchisees are an important element No evidence of a national chain’s service and can significantly impact the quality of the chain’s offerings (+)  Franchisees also well-informed about the chain’s offerings (+) However:  Franchisees can’t really integrate backwards (-)  Due to seller-buyer collaboration and franchise lock-in, switching costs are high. (–) Overall franchisee power is moderate. Conclusion concerning the overall strength of competitive pressures The competitive environment for fast-food is not particularly attractive overall. The market is crowded with rivals and outlets and growth is slow. Many consumers are looking for healthier alternatives to fast-food. The long run profitability of the fast-food business is moderate and declining. While there is likely to be sustained profitability because of the weak power of consumers, weak power of suppliers and weak threat of entry, overall industry profitability will be kept in check due to strong rivalry and mounting competition from substitutes. The five forces model shows that rivalry among competing sellers is very strong, the threat of potential entry is relatively weak, the threat of substitutes is very strong, suppliers have little bargaining power, and buyers have strong bargaining power. These factors combine to make the QSV food industry extremely competitive. A new entrant faces several firmly entrenched competitors with access to economies of scale, the ability to wage sever price wars, and strong brand image/customer loyalty.

3. What forces are driving changes in the fast-food industry, both domestically and globally?
The following underlying causes of change in the quick service food industry can be identified:  Changes in long-term industry growth rate: Domestic growth in fast food industry is slowing, leading to increased rivalry.  Globalization: Saturation in the domestic market has led to an increase in globalization as large chains look for growth opportunities in foreign markets.  Changes in societal concerns, attitudes, and lifestyles:
   

Customers are increasingly focused on value Customers are increasingly focused on quality and menu selection Increasing number of health-conscious consumers who shy away from fast-food because of the menu options Increasing number of meals being eaten away from home—hence a bigger potential market Differentiation to suit increasingly varied consumer tastes and preferences Broadening customer focus to attract younger, more sophisticated customers Increased offering of premium products both domestically and overseas Broadening customer focus to attract younger, more sophisticated customers

 Increasing product innovation
  

 Changes in who buys the product

The overall impact of the driving forces is mixed—partly positive and partly negative in terms of the effects on industry attractiveness and long-term profitability. Steadily increasing international demand will affect long-term growth rate.

4. What factors do you see as critical to competitive success in the fast-food industry?
Students should be able to identify a number of key success factors based on their own knowledge of the fast-food industry, from experience with the industry, or from information from the case. While students will be able to produce a long list of factors important to competitive success, they should be pushed to narrow it down to 4-6 key factors.  Prime locations – Consumers often choose a restaurant based on the convenience of the location.  Product innovation and improved menu items – Innovative ideas and concepts and keeping the menu relevant are important given rapidly evolving customer tastes and preferences.

 Brand reputation – Brand recognition is key because a favorable image is positively correlated with the probability that a consumer will frequent an establishment. A company with a reputable and favorable image will have an advantage over rivals.  Quality – Food quality is key for obvious reasons but also because it impacts other KSF’s, including brand reputation and customer satisfaction.  Marketing & Customer Service – The main source of consumer satisfaction is the level of over-the-counter service, such as speed of order fulfillment and order accuracy.  Value – Value is a function of quality and price. Fast-food customers are especially value-conscious but are willing to pay higher prices for larger portions and higher quality food, as is evidenced by the recent success of Arby’s and Hardee’s.

5. Is the fast-food industry attractive? What factors make it attractive? Unattractive?
Factors Making the Industry Attractive:  A relatively low threat of entry  McDonald’s is still the industry leader  Little uncertainty in the long term stability of the QSR food industry  Large international growth potential  Increase in meals eaten out of the home Factors Making the Industry Unattractive:  Strong competition prevents excessive profitability  Competitive forces increasing  Mature domestic market  Weaker rivals gaining strength behind changing consumer preferences  Growing trend of customized sandwiches and a more upscale dining experience  Price competition Special Industry Issues/Problems  Consumer preferences shifting to include healthier fast food choices  Large potential for international growth could lead to foreign competition entering industry Profit Outlook:  Competitors McDonald’s can increase profits by differentiating to meet healthier buyer preferences with quality products, while maintaining low prices  Since domestic demand is mature, large sales increases could be realized with international expansion into newly-industrialized markets.

6. Describe how McDonald’s strategy has evolved under each of its CEOs. Did Ray Kroc have the most influence of any CEO on McDonald’s strategy? Do you agree that Greenberg should have resigned in response to McDonald’s loss in 2002? To what extent do you believe McDonald’s current performance is attributable to actions taken by Cantalupo versus those initiated by Greenberg?
This question provides students with an excellent opportunity to understand how a company’s top management impacts the evolution of the company’s strategy. Each top manager has left a clear imprint on the company, most of which are still visible in McDonald’s current strategy. It is important to trace this influence from the McDonald brothers through Cantalupo, as many of them will not have realized prior to the case that there actually was a McDonald behind the company. McDonald brothers:  Created “Speedy Service System” featuring self-service restaurant with a limited menu, a kitchen that utilized an assembly-line layout, and a $.15 hamburger that allowed families to eat out more often  Focus on franchising, although unsuccessful themselves in implementing this  Focus on uniformity of operations and cleanliness Sonneborn & Kroc:  Formed McDonald’s corporation  Implemented real estate holding segment of business model  Took McDonald’s public  Greatly expanded franchising efforts  It is interesting to note that Kroc and Sonneborn had a falling out and Sonneborn dos not appear in any of the official McDonald’s history posted on their website. This is especially interesting given the importance of McDonald’s real estate element to the company’s business model. Fred Turner & Kroc:  First international expansion  1,000th restaurant opened  System-wide introduction of Big Mac  McDonald’s began to serve breakfast  First McDonald’s Playland  Turner was Kroc’s first protégé and was termed his “grill man extraordinaire.” A close personal relationship developed between these two men that positively influenced their ability to work as a team. Michael Quinlan:

 Quinlan was one of the first CEO’s to face the problems that led to McDonald’s decline.  Faced with changing customer preferences due to technological changes and health consciousness  Declining customer base  Increased competition from other quick service restaurants as well as nontraditional outlets like grocery stores and convenience stores  Several menu items were introduced as an attempt to cope with changes, but most ultimately failed  Increased expansion and partnerships to deal with increased competition  Increased expansion caused cannibalization and tension between McDonald’s and franchisees  QSVC store evaluation system discontinued to attempt to ease tensions  Increased focus on international expansion, with focus on more local flavor in many international locations  First ever quarterly decline in earnings in 1987 Jack Greenberg:  Implemented a plan to continue expansion and diversification away from the hamburger segment by acquiring other Quick Service Restaurants in the face of an intense price war, rapid product innovation, falling customer service rankings, and inconsistent quality  Introduced 40 new menu items to combat rivals’ innovation, all of which failed  “Made for You” cooking system implemented and failed  Instituted QSC comprehensive store evaluation system  Streamlined operations, reducing number of regions and laying off employees and closing underperforming overseas outlets  Initiative to refurbish old stores  Posted first quarterly loss since 1965  Greenberg was criticized for taking the company too far from its core business and for starting too many initiatives without focusing on their implementation. Jim Cantalupo:  May use IPO’s in other countries to raise revenue  Tentatively offering retail merchandise for sale in certain stores  Installing computers in restaurants in partnership with Freddie Mac  Implementation of Plan to Win  Divesture of partner brand activities to focus on core business units Did Ray Kroc have the most influence of any CEO on McDonald’s strategy?

As the founder of the modern McDonald’s corporation, Ray Kroc undoubtedly had the most influence on McDonald’s. Under Kroc’s guidance McDonald’s went from a small, local company to an international corporation. He fine-tuned the business model and was responsible for the company’s focus on domestic and international expansion. However the key elements of Quality, Service and Cleanliness are still at the core of McDonald’s values. It may be interesting at this point to ask students if they see any potential negatives to Kroc’s strong influence on the company. It could be argued that Kroc’s influence was so strong that it created corporate inertia and hubris that prohibited the company recognizing significant challenges earlier. Students may also recognize that Kroc may have been difficult to work with given his falling out with Sonneborn and his attack on the McDonald’s brothers in San Bernardino “out of spite.” These characteristics may have created a culture in which lower level managers may not have felt comfortable in questioning upper level management. Do you agree that Greenberg should have resigned in response to McDonald’s loss in 2002? This is an interesting question and you should have split opinions. It may be useful to have students vote on this question and then ask students to support their position. Those who believe Greenberg should have resigned are likely to site his strategy implementation failures and his initiatives that took the company from its core business. They will note that the increased competition and product innovation were a product of the maturation of the quick service restaurant industry, and he led McDonald’s away from the core business segment and into new market niches instead of focusing efforts on first improving the things that were wrong in the company, such as lagging customer service, poor quality, and dated store décor. By introducing the greatly expanded menu, McDonald’s was attempting to cater to a wider variety of consumer tastes and preferences, but the system-wide introduction of 40 new products virtually ensures that none of them will be of high enough quality to succeed. Those who believe Greenberg should not have resigned are likely to recognize that a number of Cantalupo’s efforts have their beginnings in Greenberg’s leadership. These include the focusing more on the customer through the introduction of new menu items, refurbishing older restaurants, and operational changes including streamlining operations and regional restructuring. To what extent do you believe McDonald’s current performance is attributable to actions taken by Cantalupo versus those initiated by Greenberg? A large portion of McDonald’s success is due to Cantalupo, while some success is due to Greenberg’s efforts before his resignation. Greenberg’s streamlined operations, regional restructuring, and international downsizing have made it easier for Cantalupo to implement his changes more efficiently. However, Cantalupo’s Plan to Win and his ability to successfully implement key elements of his plan are largely responsible for the company’s renewed vitality. It should be stressed to the students that this is one of the key differences between Greenberg and Cantalupo. While Greenberg was strong in strategy formulation, Cantalupo was much stronger in strategy implementation.

7. What is McDonald’s current strategy? Which of the five generic competitive strategies is McDonald’s using? Which elements of McDonald’s current strategy can be

attributed to Kroc’s influence?
Some students are likely to see McDonald’s strategy as one of low-cost leadership; others are likely to argue that it is one of being a best-cost provider. In the late 1990’s and early 2000 with the price wars the industry was experiencing, most of the major rivals were striving for low costs so as to keep their prices attractively low. There still are some elements of low-cost leadership in McDonald’s strategy (e.g., the value meal). However, with the revitalization plan McDonald’s seems to be moving a fraction more upscale (which some students might interpret as a shift toward a best-cost provider strategy because of the emphasis on giving customers more for their money). It is worth the time at this juncture to clearly delineate between these strategies, reminding students that the low-cost leadership strategy requires the company to strive to become the overall low-cost provider of the product. A solid case can be made that McDonald’s is now and is likely to remain a very, very economical place to eat a meal (even though it is going upscale somewhat). Whose fast-food meals are lower-priced than McDonald’s? Who in the fast-food industry has more scale economies and lower costs than McDonald’s? Yes, a best-cost strategy is designed to give customers more value for their money by combining an emphasis on low cost with more than minimally acceptable quality, service, features and performance. But is McDonald’s repositioning itself to be more of an upscale place to eat? Is it going to be meaningfully underpriced by rivals? The evidence that McDonald’s is shifting to upscale attributes and abandoning a low-cost strategy is pretty questionable. But some students (and instructors) may see the moves to upscale differentiation with other fast-fast chains as where McDonald’s is headed, thus justifying their claim that McDonald’s is migrating from low-cost leadership (where it has been for decades) to using a best-cost provider strategy. So perhaps there’s room for disagreement here. But unless McDonald’s moves away from its low-price approach and begins to price above rival fast-food chains (to cover the added costs of upscale attributes), we think the case for designating McDonald’s as having a best-cost provider strategy is pretty thin. We think there is plenty of room for McDonald’s to remain the industry’s low-cost leader and still improve its service, quality, cleanliness, and menu offerings because of the volume of business it does allows it to spread such costs out over more units. There’s scant evidence of backing off the longstanding efforts at McDonald’s to control costs. McDonald’s competitive strategy refocuses the company on its mission by doing the following:  Increasing focus on internal operations to help increase quality and control costs  Slowing store expansion to promote quality (640 fewer units than in 2002)  Enhance the relevancy of McDonald’s to customers  Make customers the new boss at McDonald’s Elements attributable to Kroc:  Focus on internal operations (uniformity and cleanliness)  Customer-focused ideas  Quality, Service, Value

8. How well is McDonald’s current strategy working? Do you like the company’s competitive position vis-à-vis

other fast-food chains?
Cantalupo’s strategy does seem to be having positive effects on McDonald’s. The company has experienced significant growth (double-digit growth rate in parts of 2003) and stock price has increased substantially (from $12.50 to $25.28). While it is not stated in the case it is also reasonable to assume that the company has improved its service rankings from the abysmal rankings in 2002. The financial ratios also show improvement in 2003. The financial analysis indicates that McDonald’s position steadily deteriorated during the 1999-2002 period but that recent efforts have improved the company’s financial position (the first three quarters of 2003).  ROA fell from 9.3% in 1999 to 3.7% in 2002, but has recovered nicely in 2003.  ROE rose from 1998 to 2000 but fell from a high of 21.5% in 2000 to 8.7% in 2002; it has bounced upward during 2003 to a respectable 18.8% in Q3 of 2003.  The current ratio is relatively low but improved somewhat between 2000 and 2002, well below the 2.0 level that is traditionally acceptable.  Both the debt to assets and debt to equity ratios increased from 1998 to 2002 further demonstrating McDonald’s weakening position.  Net revenue growth fell off substantially from 1999 through 2002, but has shown some improvement in 2003; the same can be said for operating margins as a percentage of revenues.  Operating expenses as a percentage of revenues increased from 1998-2002, but have dropped significantly in 2003 (numbers that support McDonald’s continuing emphasis on cost control and low-cost leadership). Students should recognize that some of the increased expenses in 1999-2002 were due to Greenberg’s initiatives, while the declines reflect Cantalupo’s turnaround effort. Competitive Position vis-à-vis Other Fast-Food Chains  McDonald’s is still the largest competitor with 7 times the revenue of the closest competitor (Burger King)  McDonald’s is growing more slowly than many rivals  Largest international operations  Many competitors have differentiated to successfully fill market niches left unfilled by McDonald’s, establishing themselves as leaders in their specialties Figure 1 of this teaching note illustrates the market position of the main players in the quick service sandwich chain industry. This strategic group map reveals that McDonald’s closest competitors are Burger King and Wendy’s in terms of the breadth of product line and Pizza Hut and KFC in terms of global coverage. However, no single competitor has developed the product line and international coverage of McDonald’s. It is interesting to ask students to predict future moves of rivals and how their positions may change on this map. This should reveal that several competitors are trying to take aim at McDonald’s but that McDonald’s should maintain its position given the Plan to Win.

Exhibit 1

Financial Analysis
Selected McDonald’s Financial Ratios 1998 2002 2003 ROA 7.8% 3.7% 8.8%* 16.4% 17.3% 16.0%* 0.52 0.71 0.52 0.57 1.09 1.33 N/A 4.40% 12.66% $2,761.9 $2,697.0 $826.2 22.24% 18.14% 19.30% 77.76% 81.86% 80.70% 11.74% 11.18% 10.90% $12,421.4 $14,870.0 $4,280.8 $8,894.9 $11,041.0 $3,189.7 71.61% 74.25% 74.51% $3,526.5 $3,829.0 1999 Q1 2003 9.3% 5.2%* 20.2% 8.7% 18.8%* 0.48 0.79 0.54 0.56 1.18 1.26 6.75% 3.60% 5.23% $3,319.6 $2,113.0 $963.9 25.04% 13.72% 21.40% 74.96% 86.28% 78.60% 11.14% 11.12% 10.13% $13,259.3 $15,406.0 $4,504.6 $9,512.5 $11,500.0 $3,351.2 71.74% 74.65% 74.40% $3,746.8 $3,906.0 2000 2001 Q2 2003 Q3 9.1% 7.3% 7.6%* 21.5% 12.0%* 0.70 0.81 0.78 0.74 0.58 0.58 0.54 0.54 1.36 1.37 1.15 1.17 7.42% N/A $3,330.0 $674.6

ROE

Current Ratio

Debt/Assets

Debt/Equity

Net Revenue Growth

Operating Margin

Operating Margin as a % of Revenue

23.38% 17.75%

Operating Expenses as % of Revenue

76.62% 82.25%

Sales & Marketing expenses as % of Revenue

11.14% 10.43% $14,243.0 $3,799.7

System-wide Sales

Sales at CompanyOwned Stores

$10,467.0 $2,856.1 73.49% 75.17%

% of Total Sales

Sales at Franchised Stores

$3,776.0 $943.6

$1,091.1

$1,153.4

% of Total Sales

28.39% 25.75% 25.49%

28.26% 25.35% 25.60%

26.51% 24.83%

*Annualized.

Figure 1 Serve

Representative Strategic Group Map, for Quick Sandwich Chains

9. What are McDonald’s resource strengths and weaknesses? What are its external opportunities and threats? Do a SWOT analysis in developing your answers.
Resource Strengths and Competitive Assets  Strong financial position as the industry leader  Widely recognized market leader with large customer base  Proven production methods  Excellent supply chain management skills  Strong global distribution capability  Strong alliances with other companies  Strong brand name awareness  Access to economies of scale  Seasoned management  Great bargaining power due to large size of the company  Extensive real estate holdings

Resource Weaknesses and Competitive Liabilities  Lagging in product quality/customer service  Lack of product offerings to meet varied customer tastes and preferences  High employee turnover  Many restaurants are outdated  New restaurants cannibalizing sales in established locations External Market Opportunities  Increasing international demand provides opportunities for increased international expansion  Expansion of menu to meet healthier consumer preferences  Falling global trade barriers in attractive markets  Increase in out of home consumption due to increasing disposable income, decrease in free time, increasing in working mothers  Advances in production technology  The strength of the dollar has help international profits when translated into U.S. dollars External Threats Affecting McDonald’s Well-Being  Loss of sales from substitutes like eating at home and casual dining  Rivals copy McDonald’s innovations fairly quickly, eliminating first-mover advantages  McDonald’s is unable to sustain recovery and rivals use competitive weapons to further erode at market share  Unstable international economic conditions could slow entry into some markets  McDonald’s fails to meet healthier menu preferences of consumers, forcing them to go to competitors  Increasing competition among rivals continues to squeeze profits  Possible litigations and lawsuits  Younger generations may have little connection with the All American image of McDonald’s  Increasing demand for fast casual options Conclusions Concerning McDonald’s Competitive Position McDonald’s is the dominant domestic and global leader in the QSR food industry. It has a knowledgeable management team that is pursuing some fresh strategic initiatives to restore some of the company’s market vitality, luster, and consumer appeal. It has outstanding brand awareness, access to large economies of scale, a proven production system, and a large customer base. However, McDonald’s has been weakened by low customer service/product quality scores. It is also behind the curve in implementing healthier menu offerings to meet changing consumer tastes and preferences. If the company can address

these issues, it ought to be able to defend its position as the market leader in the QSR food industry. McDonald’s executives must be aware that any first-mover advantages are quickly copied, global economic conditions are often unstable, and failing to meet healthier consumer preferences could further erode the company’s leadership position.

10. What are the major strategic issues surrounding McDonald’s Plan to Win? What are the specific areas McDonald’s is focusing on to revitalize the company? Is the company using the best metrics to measure its goal attainment?
Key Challenges  Increasing financial profitability in the presence of a nearly saturated domestic market  Rebuilding the company’s reputation for fast, friendly service and cleanliness  Sustaining the turnaround begun by Cantalupo  Implementing the Plan to Win  Maintaining product and marketing innovation to protect the core market from rivals and from substitutes Recognizing many of these challenges, McDonald’s crafted the Plan to Win, which focuses on five key success drivers:  People  Products  Place  Price  Promotion Specific areas of focus:  Customer Service—Simplifying restaurants, reducing the menu, employee hospitality training, e-learning program to train staff worldwide, and reinstitution of hostesses in Latin America. Measured by reduction of complaints and increased friendliness and speed-of-service scores.  Product Quality—Premium products, wholesome foods, healthier side-items, Premium Salads, and the Salads Plus Menu in Australia. Measured by improvements in hot and fresh food scores.  Restaurant Modernization—Installation of wireless hot-spots, McCafe openings, and restaurant renovations. Measured by return of cleanliness scores to all-time highs.  Productivity/Value—Product offerings at different price points to appeal to pricesensitive customers and those willing to pay more. Measured by improvements in value for money scores and restaurant margins.

 Brand Loyalty—“I’m lovin’ it” campaign, premium salads and better Happy Meals, Ronald McDonald’s return to prominence, relevant advertising targeted at young adults, and renewed leadership in social responsibility. Measured by brand awareness increases and restoration of Happy Meal sales per unit to all-time highs. Is McDonald’s using the best metrics to measure its performance? In the “Plan to Win” McDonald’s clearly defines performance metrics that they intend to use to measure the attainment of their goals. It is a useful exercise to ask students whether they believe the metrics chosen are adequate given McDonald’s goals. In some of the cases the answer is clearly yes, while in others there seems to be a significant disconnect between the metrics and the goals they are supposed to measure.  Customer Service—The measure of a reduction in complaints related to service and increases in friendliness scores and speed-of-service seems appropriate.  Product Quality—The measure of choice is an improvement in their hot and fresh food scores. This seems appropriate but might benefit from a metric that allows benchmarking against competition with similar offerings.  Place—McDonald’s intends to become a customer destination by making its restaurants cleaner, more relevant and more modern. Consistent with this goal the company intends to “make McDonald’s a place customers seek out because it serves the food they want in a contemporary, welcoming environment they want to be in – whether dining alone, with friends or with family.” The primary measure McDonald’s will employ to determine the success in pursuing this driver is restaurants’ cleanliness scores with a goal of returning to their all-time highs. This measure seems inadequate given the breadth of the company’s goals with regard to place as it does not cover the goals of becoming more relevant and more modern.  Productivity/Value—Improving productivity and value. In offering value, McDonald’s concentrates on offering a broad variety of products at a range of price points that will appeal to price sensitive customers, such as McDonald’s dollar menu in the U.S., as well as those willing to pay for premium products. McDonald’s will measure these goals using improvement in value for money scores and restaurant margins. Both of these metrics seem adequate.  Brand Loyalty—The final driver of exceptional customer experiences is building trust and brand loyalty through promotion, including marketing, promotion and trust. Specific metrics in this area include increasing brand awareness and increasing the number of Happy Meals sold per unit to the previous all-time high. It is unclear how the number of Happy Meals sold related to the brand loyalty and trust goals or how they plan to operationalize their brand awareness measure. After reviewing the appropriateness of the metrics, it is useful to ask students why such imperfect measures are being used in some cases. It seems the answer involves issues of cost of measurement, the company’s ability to change operations that allow them to impact specific metrics and the ability to measure the metrics.

11. Do you believe that the changes McDonald’s is making with its Plan to Win can successfully reposition the company and provide the basis for a sustainable competitive advantage?

This question provides an excellent opportunity to reinforce the four characteristics of a sustainable competitive advantage: valuable, rare, not easily imitated, and hard to trump with other resources. The Plan to Win does build valuable competencies that are difficult to imitate due to path dependencies. However, it is not clear whether the capabilities are rare, given the abilities of the other competitors. Further, it is unclear whether the resources can or cannot be overmatched by the resources possessed by rivals. Therefore, although McDonald’s is still the industry leader and it can capitalize on their strong brand awareness and distribution/production capability to implement changes successfully, their competitive advantage is temporary at best. Had it continued their original momentum, path dependency might have assured the company a sustainable competitive advantage. However, its miscues over the last two decades have reestablished parity in the industry. Thus, McDonald’s cannot afford to rest on its prior accomplishments and industry-leading position or there is a potential that competitors could steadily draw customers away with more appealing product offering and close the market share gap.

12. What specific recommendations would you make to Cantalupo regarding the company’s operations and how McDonald’s can maintain its leadership position?
Undoubtedly, the Plan to Win provides an outstanding point of departure for a turnaround in performance at McDonald’s. Specific initiatives that can further McDonald’s recovery include:  Continue to maintain the external focus detailed in the Plan to Win. This focus would include:
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Leverage brand awareness and advertising to ensure that customers respond. Offer healthier menu selections for adults and children, possibly choosing a popular diet program and creating selected items to cater to consumers on the program. Advertise healthy offerings for children. If the kids want to come, the parents will follow. Proactively alter the menu to act as a leader in the fast-food industry and to establish their reputation as a customer responsive company. However, when offering new products, don’t overextend the company. Offer new products only when quality is assured. Also, make the number of new offerings reasonable so the customer isn’t overwhelmed. Ensure they do not underestimate new entrants. In improving their internal operations McDonald’s needs to scan the environment for industry trends and new competitors that reveal changing customer preferences. Benchmark against leaders in niches you’d like to enter. In benchmarking they can find new products and services that can be adopted in McDonald’s business model. Be wary of adopting an imitative strategy that would brand the company as a “me too” player.

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 In facing competitors, McDonald’s needs to

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 Internally, McDonald’s needs to continue focusing on its core business, and streamlining internal processes to ensure focus is on uniform, clean, quality, serviceoriented restaurants. These operations are the core of the business and, as evidenced by the 2002 operating results, failure to pay attention to the internal operations can have a deleterious effect on financial results.  McDonald’s franchise owners are a powerful force in the company. To leverage this force, McDonald’s needs to ensure their “buy-in” to the Plan to Win and to the evaluation system. One way to do this would be to work with franchise owners as the evaluation system evolves and allow them to have input into any changes made to the system. When implementing this system, McDonald’s has to make it a tool for improvement that is valued by the franchisees rather than a punitive tool to ensure compliance. This will increase franchisee ownership of the system. However, McDonald’s must be willing to take corrective action against franchisees that consistently under-perform in the evaluation system. If necessary, McDonald’s must be willing to terminate the franchise relationship with chronically underperforming units.  Internationally, McDonald’s should continue expanding to meet international demand, but do so at a pace that ensures adequate training and preparation. In expanding internationally, McDonald’s should look for learning opportunities that can be transferred throughout the entire organization. McDonald’s should also continue to balance the cost related needs for globalization with the local demands for customization. Successful new products should be evaluated for system wide adoption.  Finally, in implementing the turnaround, perhaps the greatest danger is that McDonald’s will become too internally focused. The potential of this possibility is evident in some of the performance metrics introduced in the Plan to Win. To avoid this myopia, McDonalds should develop a formal mechanism for environmental scanning and a way to introduce important findings into McDonald’s strategy.

Epilogue
In April 2004 McDonald’s CEO Jim Cantalupo died suddenly of a heart attack while attending a large convention of owners and operators of McDonald’s restaurants in Orlando. Less than 6 hours after his death, McDonald’s board of directors at a hastily arranged meeting, named 43year-old Charlie Bell, McDonald’s president and chief operating officer, to replace Cantalupo. Cantalupo had been scheduled to address the convention at 9:30 a.m., but Bell’s quick appointment allowed him to make the opening remarks on schedule as the new CEO. During his 16 months as CEO, Cantalupo had executed the most dramatic turnaround in McDonald’s history. His accomplishments were seen as quite important:  Killing a $1 billion technology program to link all McDonald’s outlets worldwide to McDonald’s HQ  Slowing “runaway” store expansion  Introducing premium entrée salads  Improving the taste of burgers with new seasonings  Speeding drive-thru service  Seeing that surly store employees were disciplined

 Helping blunt attacks that McDonald’s was a purveyor of unhealthy, fat-heavy foods, partly by killing “super size” French fries and soft drinks and partly with some new advertising campaigns emphasizing fitness. During Cantalupo’s tenure, McDonald’s reported 11 consecutive months of same-store sales increases. Bell was already in line to replace Cantalupo, who came out of retirement to lead the turnaround effort at McDonald’s. He was expected to continue Cantalupo’s efforts and had enjoyed considerable success in his previous jobs at McDonald’s. In May 2004, McDonald’s announced that Charlie Bell was undergoing treatment for cancer. He was expected to recover and to continue in his role as CEO. For further updates, please check our periodically updated case epilogues at the passwordprotected Instructor Center (www.mhhe.com/thompson) for the latest information. The online epilogues are updated whenever we become aware of pertinent breaking news about the company and/or developments relating to the specific issues contained in the case.

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