McDonald's – How Golden are its Arches PDF
Preview McDonald's – How Golden are its Arches
McDonald’s – How Golden are its Arches ? This case study has been written exclusively for use on the course Strategic Financial Management FINA 1035 at Greenwich University Business School and its partner institutions. It is to be used exclusively for this purpose. No part may be copied, emailed or reproduced for any other purpose other than stated above. Some of the data in this case study is sourced from material issued by McDonald’s Corporation in its annual and financial reports and on its websites www.mcdonalds.com and www.aboutmcdonalds.com . All other sources are shown. Financial data are all in US $ unless stated. McDonald’s financial year end is 31 December. Author : Scott Duncan, MBA 1 August 2014 1 McDonald’s – How Golden are its Arches ? Introduction The first seven months of 2014 contained a mixture of good and bad news for McDonald’s Chief Executive Officer (CEO), Don Thompson. He was into his second year as CEO after promotion from his previous role as Chief Operating Officer (COO) in October 2012 when McDonald’s CEO since November 2004 – Jim Skinner – retired. On the positive side : - McDonald’s had weathered the world wide recession of the late 2000s in good shape with total revenues up from $22.7 billion in 2009 to $28.1 billion in 2013 and net income up from $4.5 billion in 2009 to $5.5 billion in 2013 - the total number of McDonald’s restaurants worldwide continued to grow year by year from over 32,400 in 2009 to over 35,400 in 2013. In 2013 alone, total restaurant numbers increased by almost 1000 - McDonald’s remained the world’s largest restaurant chain in terms of total sales achieving over $89 billion of system-wide sales across its managed and franchised outlets operating in 119 countries serving almost 70 million customers a day in 2013 - it was one of the world’s most recognised and valuable brands - many of its new product lines added to its menu during the late 2000s had been successful including snack wraps (“McWraps”), smoothies, and the mega-popular “McCafé” beverage line. Further menu items were added in 2013 such as “Fish McBites” and “Mighty Wings” in USA restaurants - the corporation had worked hard to address consumer concerns over the nutritional content of its products . As an example, the McWrap was seen as high-profile attempt to get the attention of customers who have turned to fresher, seemingly healthier offerings from competitors such as Subway – see Annex 1. McDonald’s USA also now published an annual progress report charting progress against its commitment to improve nutritional advice and choice to its customers. On the negative side: - many commentators pointed out that McDonald’s had a string of disappointing sales quarters and had experienced some ups and downs in 2013. A December 2013 article in Quick Service Restaurant (QSR) magazine headed “What’s Going on at McDonald’s” was typical of some of the concerns – see Annex 2. - some analysts said that the number of new items introduced in 2013 to drive customer traffic complicated McDonald’s menu, confused consumers and slowed down service - First Quarter 2014 results disappointed shareholders and financial markets with net income down by 5% versus the same period in 2013 to $1,205 million - Second Quarter 2014 net income fell almost 1 percent versus the same quarter in 2013 to $1,387 million . This result also disappointed most commentators as “established restaurants in McDonald’s struggling U.S. division turned in a third straight quarterly sales decline and results from Europe also logged a surprise drop” according to Reuters – see Annex 3. - in its largest market - U.S.A - First Quarter 2014 same-store sales 1 decreased by 1.7% and Second Quarter same-store sales by 1.5% versus the same quarters in 2013. By the end of June 2014, same-store sales at USA restaurants had fallen every month since November 2013 compared to the same month a year ago – see Annex 4. 1 Same- store sales are sales from outlets opened for 13 months or more and exclude sales from new stores opened within a year 2 - 400 protesters rallied outside McDonald’s headquarters during its Annual General Meeting (AGM) in May calling for a higher minimum wage for fast-food workers. Although McDonald’s barred the media from attending its AGM , reports of McDonald’s response to the questions on wages and other issues raised by shareholders attending the meeting emerged shortly afterwards – for example the article in the Financial Times shown at Annex 5. - for the 20th year in a row, McDonald's ranked last in customer satisfaction in a national survey of patrons of 12 major fast-food chains published in June 2014 by the American Customer Satisfaction Index. The survey results are shown at Annex 6 and commentary in “USA Today” at Annex 7. - at the end of July , a quarter of McDonald's restaurants in China had been hit by a scandal which saw a major supplier allegedly using rotten meat and Russia's main consumer watchdog filed a lawsuit in Moscow against McDonald's urging the restaurant chain to withdraw certain products saying that its inspectors in the city of Novgorod, western Russia, had found violations of food standards by McDonald's. – see Annex 8 . Thompson considered these and other issues that he and his management team faced in mid 2014. He began by recalling the history of McDonald’s and its phenomenal growth. History 2 McDonald's history began in the California town of San Bernardino in 1940 when Richard and Maurice (Dick and Mac) McDonald opened up “McDonald's BBQ Restaurant”. The restaurant had twenty-five menu items, mostly barbeque and was a drive-in with carhops. 3 In October 1948, after the McDonald brothers realised that most of their sales came from a few specific items including hamburgers, they closed down their successful carhop drive-in to establish a streamlined system with a simple menu of just 9 items including hamburgers, cheeseburgers, french fries, milk shakes, soft drinks and apple pie. The carhops were eliminated to make McDonald's a self-service operation. The brothers took great care in setting up their kitchen like an assembly line to ensure maximum efficiency. They followed the pioneering work of the “White Castle” chain who were the first to standardise hamburger production. The restaurant's name was changed to simply "McDonald's" and reopened on 12 December 1948. In 1952 the brothers decided they needed an entirely new building in order to achieve two goals: further efficiency improvements and a more eye-catching appearance. Working with a local architect, they achieved the extra efficiencies needed by, among other things, drawing the actual measurements of every piece of equipment in chalk on a tennis court behind the McDonald house. The design achieved a high level of noticeability thanks to gleaming surfaces of red and white ceramic tile, stainless steel, brightly coloured sheet metal, and glass; pulsing red, white, yellow, and green neon; and two 25-foot yellow sheet-metal separate arches trimmed in neon, called "golden arches" even at the design stage. A third, smaller arch sign at the roadside hosted a pudgy character in a chef's hat, known as Speedee, striding across the top, trimmed in animated neon. The combination of low prices and fast service was soon successful and popular with McDonald’s customers. The service system – now called “Speedee” – also was easy to replicate and resulted in a food or beverage product that was consistent from one location to the next. The brothers began seeking franchisees and the first franchises opened in 1953 in 2 Sources : www.aboutmcdonalds.com , www.articlesbase.com and Wikipedia 3 A carhop is a waiter or waitress who brings fast food to people in their cars at drive-in restaurants. Usually carhops work on foot but sometimes use roller skates 3 Phoenix, Arizona and Downey, California. In 1954, Ray Kroc, a seller of Multimixer milkshake machines, learned that the McDonald brothers were using eight of his machines in San Bernardino and went there to take a look at their restaurant. Believing the McDonalds' formula was a ticket to success, Kroc suggested they franchise their restaurants throughout the USA and offered to take the major responsibility for setting up the new franchises. He returned to his home outside of Chicago as McDonald’s nationwide franchising agent with rights to set up “McDonald's” restaurants throughout the country. The brothers were to receive one-half of one percent of gross sales. Kroc's first McDonald's restaurant opened on 15 April 1955 in Des Plaines, Illinois, near Chicago and incorporated his company as McDonald's Systems, Inc. He later renamed the company McDonald's Corporation in 1960. Once the Des Plaines restaurant had become operational, Kroc sought franchisees for his McDonald's chain. The next few years saw tremendous growth and by 1959 Kroc had opened the 100th franchise in McDonald's history. In 1960, the McDonald's advertising campaign "Look for the Golden Arches" gave sales a big boost. Kroc believed that advertising was an investment that would pay back many times over. A year later, Kroc bought out the shares of the McDonald brothers for $2.7 million. Also in 1961, Kroc launched a training program, later called “Hamburger University”, at a new restaurant in Elk Grove Village, Illinois. There, franchisees and operators were trained in the scientific methods of running a successful McDonald’s. Successful trainees were awarded “Bachelor of Hamburgerology” degrees. Hamburger University also had a research and development laboratory to develop new cooking, freezing, storing and serving methods. Kroc also launched a drive to ensure quality, service, cleanliness and value – “QSCV” – were achieved consistently across the entire chain of franchised restaurants. In 1962, McDonald's modified the design of its separate arches and fused the two together to resemble the letter “M”. The Golden Arches logo that would later become identifiable across the world had been born. The now globally recognized golden arches logo came into existence as an official logo in 1969. McDonald's success in the 1960s was in large part due to the company's skillful marketing and flexible response to customer demand. In 1963, for example, the Filet-O-Fish sandwich was introduced in Cincinnati, Ohio, in a restaurant located in a neighborhood dominated by Roman Catholics who practiced abstinence (the avoidance of meat) on Fridays. It was the first new addition to the original menu and went national the following year. Also in 1963, the company sold its billionth hamburger , opened its 500th restaurant and introduced Ronald McDonald, a red-haired clown designed to appeal to children. In 1965 – its 10th anniversary year – McDonald’s stock was first offered to the public at $22.50 a share . Shares traded at $30 by the end of its first day. Overseas expansion outside the USA started in 1967 when the first McDonald’s opened in Canada and Puerto Rico. A year later in 1968, the Big Mac was developed by franchisee Jim Delligatti of Pittsburgh and added to national menu, the Hot Apple Pie was introduced and the 1000th McDonald's restaurant opened. The early 1970s, McDonald’s first appeared in several overseas markets : - The first Asian McDonald's opened in Tokyo Japan , the first European outlet opened in Zaandam (near Amsterdam) in the Netherlands , and the first McDonald's in Germany (Munich) opened all during 1971 . The Munich restaurant was the first McDonald's to sell alcohol- beer. 4 - The first Australian McDonald's opened in Sydney and the first McDonald's in France opened , both in 1972. By the end of 1972, McDonald’s had opened over 2000 restaurants and achieved $1 billion in sales across its total network. The company pioneered breakfast fast food with the introduction of the Egg McMuffin – first developed by a franchisee - also in 1972 when market research indicated that a quick breakfast would be welcomed by consumers. Five years later, in 1977, McDonald's added a full breakfast line to the menu, and by 1987 one-fourth of all breakfasts eaten out in the United States came from McDonald's restaurants. Other major changes and milestones occurred in the 1970s including : - the Quarter Pounder was added to the menu in 1973 - the UK’s first McDonald’s opened in Woolwich, southeast London in 1974. It was the company's 3000th restaurant. - McDonald's opened its first drive-thru window in Sierra Vista, Arizona in 1975. This service followed an earlier launch of the concept by one of its competitors - Wendy's. The goal was to provide service in 50 seconds or less. Drive-thru (or “McDrive” in some countries) sales eventually accounted for more than half of McDonald's systemwide sales - the first McDonald's opened in Hong Kong in 1975 - the 5000th McDonald's restaurant opened in Kanagawa, Japan and Hamburger University celebrated the graduation of its 15,000th student in 1978 - the Happy Meal, a combination meal for children featuring a toy, was first introduced in the U.S., the first McDonald's in Southeast Asia opened in Singapore and the first McDonald's in South America opened in Brazil all during 1979. In the late 1970s, competition from other hamburger chains such as Burger King and Wendy's began to intensify. Experts believed that the fast-food industry had become as big as it ever would, so the companies began to battle fiercely for market share. A period of aggressive advertising campaigns and price slashing in the early 1980s became known as the "burger wars". Burger King suggested to customers: "have it your way"; Wendy's offered itself as the "fresh alternative" and asked of other restaurants, "Where's the beef?" But McDonald's sales and market share continued to grow. During the 1980s, McDonald's further diversified its menu to suit changing consumer tastes. The company introduced the McChicken in 1980. It proved to be a sales disappointment and was replaced with series of different chicken sandwiches a year later. Chicken McNuggets were invented by McDonald's first Executive Chef Rene Arend in 1979. They were so good that every franchise wanted them. However, there wasn't a system to supply enough chicken products. The supply problem was solved in 1983, when the McNuggets were made available nationwide. By the end of 1983, McDonald's was the second largest retailer of chicken in the world. Ray Kroc died in January 1984. The 1980s were the fastest-paced decade yet. Efficiency, combined with an expanded menu, continued to draw customers. McDonald's, already entrenched in the suburbs, began to focus on urban centers and introduced new architectural styles. Although McDonald's restaurants no longer looked identical, the company made sure food quality and service remained consistent. In 1985, ready-to-eat salads were introduced to lure more health-conscious consumers. 5 Despite further claims by some that the fast-food market was saturated, McDonald's continued to expand. The first generation raised on restaurant food had grown up. Eating out had become a habit rather than a break in the routine, and McDonald's relentless marketing continued to improve sales. McDonald's growth in the United States was mirrored by its stunning growth abroad and by April 1988, the 10,000th unit opened. In the same year McDonald's opened its first restaurant in a communist country, in Belgrade, Yugoslavia (now Serbia) followed by another in Budapest, Hungary. The first Soviet McDonald's opened, in Moscow on 31 January 1990. At the time it was the largest McDonald's in the world. To overcome Soviet supply problems, however, the company created its own supply chain, including farms, within the USSR. The restaurant proved extremely popular, with waiting lines of several hours common in its early days. In the same year, many other McDonald's restaurants also opened in Eastern Europe and the first McDonald's opened in mainland China in the city of Shenzhen, Guangdong province. By the early 1990s the company had established itself in 58 foreign countries and operated more than 3,600 restaurants outside the United States through wholly owned subsidiaries, joint ventures and franchise agreements. Its strongest foreign markets were Japan, Canada, Germany, Great Britain, Australia, and France and by 1991, 37 percent of systemwide sales came from restaurants outside the United States. Much of the growth of the 1990s also came outside the United States, with international units increasing from about 3,600 in 1991 to more than 11,000 by 1998. This expansion included : - the first McDonald's opening in Africa, in Casablanca, Morocco in 1992 - a new region added to the empire when the first McDonald's in the Middle East opened in Tel Aviv, Israel in 1993 and in December 1993 , McDonald's opened its golden arches in Saudi Arabia for the first time. - the first Indian McDonald's opening in 1996 - the first Pakistani McDonald's opening in Lahore immediately followed by a branch in Karachi in 1998 As the company entered new markets, it showed increasing flexibility with respect to local food preferences and customs. In Israel, for example, the first kosher McDonald's opened in a Jerusalem suburb in 1995. In Arab countries the restaurant chain used "Halal" menus, which complied with Islamic laws for food preparation and in India it offered a Big Mac made with lamb called the Maharaja Mac. It also introduced some new menu items and services in the 1990s primarily : - the fried apple pie was replaced with a baked apple pie in 1992 - a coffee house style stand-alone outlet called McCafé was launched in Melbourne, Australia by McDonald’s licensee Ann Brown in 1993. By 2002 the McCafé chain had spread to 13 countries worldwide. The first one in America was launched in 2001. By 2003 it was the largest coffee shop brand in Australia and New Zealand. - a soft serve ice cream base dessert called the McFlurry was invented by a Canadian franchisee in 1997. The company reached the 20,000-restaurant mark in mid-1996 and the number of countries with McDonald's outlets nearly doubled from 59 in 1991 to 114 in late 1998. In February 1998 the company took a stake in another fast-food chain for the first time when it purchased a minority interest in the 16-unit, Colorado-based Chipotle Mexican Grill chain. 6 McDonald's followed up this investment with several more moves beyond the burger business. In March 1999 the company bought Aroma Café, a UK chain of 23 upscale coffee and sandwich shops. In July of that year McDonald's added Donatos Pizza, a midwestern USA chain of 143 pizzerias based in Columbus, Ohio. In May 2000, McDonald's completed its largest acquisition yet, buying the bankrupt Boston Market chain for $173.5 million in cash and debt. At the time, there were more than 850 Boston Market outlets which specialised in home-style meals with rotisserie chicken the lead menu item. McDonald's rounded out its acquisition spree in early 2001 by buying a 33 percent stake in Pret A Manger, an upscale urban-based chain specialising in ready-to-eat sandwiches made on the premises. There were more than 110 Pret shops in the United Kingdom and several more in New York City. Also during 2001, McDonald's sold off Aroma Café and took its McDonald's Japan affiliate public, selling a minority stake through an initial public offering. During the late 1990s, McDonald's had to contest its public image as a purveyor of fatty, unhealthy food. Consumers began filing lawsuits contending that years of eating at McDonald's had made them overweight. McDonald's responded by introducing low-calorie menu items and switching to a more healthy cooking oil for its french fries. McDonald's franchises overseas also became a favourite target of people and groups expressing anti- American and/or anti-globalisation. For example, in August 1999 a group of protesters destroyed a half-built McDonald's restaurant in Millau, France. They claimed the attack was in protest against U.S. trade protectionism. McDonald's was also one of three multinational corporations (along with Starbucks Corporation and Nike, Inc.) whose outlets in Seattle were attacked in late 1999 by some of the more aggressive protesters against a World Trade Organisation meeting taking place there. In the early 2000s, McDonald's pulled out of several countries, including Bolivia and two Middle Eastern nations in part because of the negative regard with which the brand was held there. In November 2004, Jim Skinner who had been McDonald’s COO was appointed as CEO and established the “Plan to Win” initiative. This involved renovating existing stores and adding new healthier items to the menu such as salads, the snack wrap and the rollout of the McCafé brand of gourmet coffee. The strategy set out to deliver “faster, friendlier service, tastier food, a more appealing ambiance, better value and sharper marketing.” The chain also expanded in new emerging markets like China. McDonald’s announced in 2007 that it would focus on its core brand and began divesting itself of other chains it had acquired during the 1990s and early 2000s. It had already sold Donatos Pizza in December 2003. The company sold its majority stake and fully divested from Chipotle Mexican Grill in October 2006 and recorded net proceeds of over $800 million as a result. On 27 August 2007, McDonald's sold Boston Market to Sun Capital Partners and received proceeds of approximately $250 million . In 2008, McDonald’s 33% shareholding in Pret a Manger was acquired by Private equity firm Bridgepoint when they bought a majority stake in the sandwich bar chain. McDonald’s received cash proceeds of $229 million as a result. In 2008, McDonald’s launched its new design for its packaging – the most comprehensive in the brand’s history – and in 2010 introduced the McCafé range of fruit smoothies and frappes. 7 The Fast Food Industry Fast food is the term given to food that is prepared and served very quickly. Typically, the term refers to food that is ready-made, on display and available for immediate consumption and sold in a restaurant or store in a pre-packaged form to be eaten on the premises or for take-out/take-away. The customer normally selects the food at the counter or brings the pre- prepared food on display to the counter, pays there and eats the product as finger food without using traditional cutlery. Common menu items at fast food outlets include fish and chips, sandwiches, pitas, hamburgers, fried chicken, french fries, onion rings, chicken nuggets, tacos, pizza, hot dogs and ice cream. Many fast food restaurants also offer "slower" foods like chilli, mashed potatoes and salads. Outlets may be fast food restaurants (also known as “quick service” restaurants), stands or kiosks which may provide no shelter or seating. Fast food restaurant chains have standardised foodstuffs shipped to each restaurant from central locations. Although fast food is often considered to have been first popularised in the 1950s in the United States - the term "fast food" was recognized in Webster’s dictionary by in 1951- its origins go back further in time. 4 The concept of ready-cooked food for sale is closely connected with urban development. In the Roman empire around the Mediterranean, cities had street stands that sold bread, sausages and wine and much of the empire’s urban population living in apartment blocks depended on food vendors for most of their meals. In the Middle Ages, large towns and major urban areas such as London and Paris supported numerous vendors that sold dishes such as pies, pasties, flans, waffles, wafers, pancakes and cooked meats. As in earlier Roman cities, many of these establishments catered to those who did not have the means or kitchen facilities to cook their own food including travellers. In post World War 2 USA, modern day fast food outlets became popular with consumers for several reasons: - they delivered food to consumers at a very low cost through economies of scale in purchasing and producing food - fast food was attractive to someone in a hurry or away from home - they provided a break from the routine of home cooking - chains like McDonald's rapidly gained a reputation for their cleanliness and a child- friendly atmosphere for families - they were more attractive than previous generation “greasy spoon” diners where the quality of the food was often questionable and service lacking and full service restaurants that were expensive and impractical for families with children. In other parts of the world, American and American-style fast food outlets have proved to be popular for their quality, customer service and novelty, even though they are often the targets of anger towards American foreign policy or globalization more generally. Many consumers nonetheless see them as symbols of the wealth, progress, and well-ordered openness of Western society and therefore become trendy attractions in many cities around the world, particularly among younger people with more varied tastes. McDonald’s is a major competitor in the modern fast food market. Rather than only focussing on global fast food demand, however, McDonald’s defines its primary competition as all those companies in the “Informal Eating Out” segment of the food service market including : 5 - fast food (or quick-service) eating establishments • 4 Source : Wikipedia 5 Source : McDonald’s 2013 annual return to US Security and Exchange Commission (SEC) 8 - street stalls or kiosks • - cafés • - 100% home delivery/takeaway providers • - specialist coffee shops • - self-service cafeterias • - juice/smoothie bars • + casual dining full-service restaurants that serve moderately-priced food at a table in a casual atmosphere ( for example TGI Friday’s). Note : * = This group of 7 outlet types is often called “Limited service” restaurants . They do not offer a waiter/waitress service from a table. The Informal Eating Out segment excludes establishments that primarily serve alcohol and full-service restaurants other than casual dining. McDonald’s annual report adds that its restaurants compete with international, national, regional and local retailers of food products on the basis of price, convenience, service, menu variety and product quality in a highly fragmented global restaurant industry. The broader “food service” or “catering” industry defines those businesses, institutions, and companies responsible for any meal prepared outside the home. This industry includes fast food restaurants, “full service” restaurants (which offer waiter/waitress service whilst seated at a table), school and hospital cafeterias, catering operations, hotel restaurants , motorway and railway eating places and pubs/bars that sell food. Food service to consumers excluding non institutional consumers such as those in schools or hospitals can be summarized as follows : Consumer Foodservice 100% Home Self- Street Cafés/ Full-Service Fast Food Delivery/ Service Stalls/ Bars Restaurants Takeaway Cafeterias Kiosks The global “Informal Eating Out” and restaurant industry market sizes and McDonald’s shares from 2008 to 2012 is estimated to have been as follows : 6 6 Source : McDonald’s annual returns to US SEC from 2009 to 2013 based on data from Euromonitor International 9 Informal Eating Out and Total Restaurant Industry - Global Market 2008 2009 2010 2011 2012 Informal Eating Out: a) No. of Outlets - 5.9 6.3 6.5 7.0 8.0 million b) Annual Sales – 875 868 933 1050 1200 $ billion Memo: McDonald’s 70.7 72.4 77.4 85.9 88.3 Systemwide Sales – $ billion 7 McDonald’s 8.1% 8.3% 8.3% 8.2% 7.7% 8 Systemwide Sales as Share of IEO market Total No. of 31,967 32,478 32,737 33,510 34,480 McDonald’s Restaurants 9 Total Restaurant Industry: 10 a) No. of Outlets - 12.6 13.1 13.7 14.8 16.0 million b) Annual Sales – 1850 1790 1860 2110 2300 $ billion Memo: McDonald’s 3.8% 4.0% 4.2% 4.1% 3.8% Systemwide Sales as Share of Total Restaurant Industry 7 McDonald’s “systemwide sales” are its global sales to consumers from all McDonald’s restaurants including from franchise restaurants . 8 McDonald’s 7.7% share of IEO market in 2012 assumes market size of $1150 billion - rounded up by Euromonitor to $1200 billion 9 McDonald’s restaurant numbers are at year end 10 The “Total Restaurant industry” includes full service restaurants 10
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