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McDonalds: What am I lovin next?

mcdonaldsBy Shawn Duncan, Srikant Akula, Zarmineh Rab, Roman Yasinsky, Isabella Delboni and Philippe Richard

McDonalds is the world’s biggest food service retailer serving more than 60 million customers each day in over 30,000 retail locations in 118 countries. McDonalds is growing at an annual rate of 3-8% worldwide. Annual revenues are in excess $24 B with a net income of $4.9 B. Earnings per share $4.59 with a dividend yield at nearly 3%. McDonalds has over 385,000 employees in its various stores around the world.

In early 2002, after posting a fist quarterly loss McDonalds began a major restructuring of its operations. Over 700 restaurants worldwide were closed and many employees were laid off. McDonalds exited from several countries where brand had a negative perception.

It also shifted away from the company’s traditional reliance on growth through the opening of new units to a focus on gaining more sales from existing units. Several new menu items were successfully launched, including entrée salads, McGriddles breakfast sandwiches, and white-meat Chicken McNuggets. Fruits and Vegetable alternatives were tested as Happy Meal options in several outlets. Coffee sales for McDonalds has increased from 2% in 2004 to over 6% in 2009 with the introduction of the McCafe coffee line. In 2009, this new product line represented nearly $1.85 billion in coffee sales.

A new global advertizing campaign “ I’m lovin’it” was successfully launched and subsequently used in advertising in more than 100 countries. After making improvements in service and helped by successful global ad campaign, McDonald’s is not only profitable again, but also better positioned to continue expansion.

McDonald’s History

In 1954 Ray Kroc delivered 8 milk shake mixing units to a restaurant in San Bernardino, California. At this restaurant they had a sharp focus on quality and for consistency only served burgers, fries and beverages. Ray was so impressed with the simplicity and effectiveness that it inspired his vision to establish a nationwide restaurant business and expand the small store’s success. His focus was to provide high quality food at affordable prices. Within just 5 years Ray bought the exclusive rights to the McDonald’s name and in 1955 the McDonalds Corporation was born. The first McDonald’s opened in Des Plaines, Illinois on April 15, 1955. Within 10 years it expanded to 700 stores throughout the US. First international stores opened in Canada and Puerto Rico in 1967. By 1983 McDonalds was located in 32 countries around the world with nearly 8,000 locations.

Ray Kroc wanted to build a restaurant system that would be famous for its consistent high quality and uniform methods of preparation. In the words of Ray Crock, “If I had a brick for every time I’ve repeated the phrase Quality, Service, Cleanliness and Value, I think I’d probably be able to bridge the Atlantic Ocean with them.” This strategic focus would enable McDonalds to have a consistent experience at all stores whether it was in Oklahoma or in Russia.

Business Model

McDonalds continues to open stores in preferred traffic areas of malls, business centers, and in major communities. New entrants seeking high traffic locations to support their value offering often find themselves unable to afford the high priced prime real-estate locations and achieve competitive market parity with McDonalds. McDonalds leads the industry in ownership of prime real estate property and in many cases moves ahead of the market to identify new opportunities and buy land for future development.

McDonalds has a well established supplier network and benefits from scale economies.  This coupled with a sophisticated change management and product integration process allows them speed to market advantages in response to any new competitive products. They can open stores and move quickly on new product lines because of their extensive credit worthiness and their access to large amounts of capital: currently having a credit line in excess of $1.3B (see exact quote from 2009 Annual report). Successful restaurant franchising options have made it easy to open franchise stores and this process is streamlined allowing them to be first to market. Over 80% of McDonalds worldwide are independently owned and operated. McDonalds has strong brand recognition and is one of McDonalds most valuable assets.

McDonalds’ views its suppliers as a crucial part of the overalls company’s success. There are no contracts signed with their vendors and commitments are made out of mutual respect. The suppliers who commit resources to new technology and product development are rewarded through the financial gain associated with fast moving product lines. McDonalds has unique and distinct suppliers in each of the countries it has a presence. McDonalds enjoys a significant leverage over suppliers because of national presence in each country and the high volume nature of their business. McDonalds’ credit worthiness, reputation of having the fastest invoice payment time in the industry, and a strong brand make them attractive to local domestic suppliers. A potential threat from the “Supplier” force does exist in some countries with underdeveloped infrastructure where only select few can offer consistency and quality of supplies. In such countries cost of supplies are slightly higher. Examples are Russia, Ukraine, and Central Asia. In those cases McDonalds enters into special relationships where suppliers develop the necessary infrastructure by using McDonalds funds (e.g. in Russia McDonalds planted Idaho potato, lettuce, etc to maintain the brands consistency).

Competition

The most significant of the external factors McDonalds needs to consider are new entrants, buyers, and rivalries due to the hypercompetitive nature of the food service industry. New entrants into this industry have a hard time competing with the current players due to massive established infrastructure and scale economies. However, existing rivals continue to enter new business lines which do pose a threat to McDonalds. McDonalds has a solid supplier strategy and due to the sheer volume and purchasing power, McDonalds maintains a controlling position. McDonald’s rivalries include Burger King, Jack-in-the-box, Subway, Carl’s Jr., Mom and Pop shops, Starbucks and many more worldwide.

There are not many new entrants from a “ground-up” chain perspective however there are many new entrants from the local markets fueled by financial crisis and demand for low cost food alternatives. There is a particular fast expanding market of so-called “NeoBurgers” that offer a “build-it-yourself” variety of burger alternatives ( i.e. turkey burger, veggie burger, tofu burger, etc.) For example, a fast growing chain Five Guys Burgers & Fries in Washington DC has grown to 600 outlets, most of them franchises, serving only fresh (not frozen) patties and kosher-style hot dogs. FGBF sales grew 50% in 2009, to $453 million.

Competitors have expanded product lines to compete directly with McDonalds’ McCafe product offering. Seattle’s Best Coffee (SBC is owned by Starbucks) has partnered with Burger King and Subway to increase market share. This also helps Starbucks regain share of the profits in the industry giving Starbucks an extended reach into over 16,000 more locations via these fast food giants. This activity threatens the growing coffee market that McDonalds will need to address if it chooses to expand and gain market share with this product.

Marketing and Activities

By incorporating and combining sound operational practices with innovative marketing strategies, McDonald’s from its very inception laid the foundation for its global success in the fast food industry. As a result, McDonald’s today is well known brand because its offerings and service are consistent globally – thus its value transcend borders and cultures.

The strategic positioning of the company, based on family values and shared experiences is a competitive advantage. Over time, its marketing approach has been built around this central theme and message positioning.  Family values are well understood globally – irrespective of type of culture, nationalities and religions. McDonald’s therefore message comes across as universal and is well understood in diverse markets. Their entire offering is built around the concept of welcoming the family and makes it enjoyable for both children and adults (playground for children, happy meal, larger menu for adults and friendly environment).

The consistency of McDonald’s message in line with its menu offering at any of the McDonald restaurant provides a clear message, and includes: easy and predefined menus, value for money, friendly and quick service, cleanliness and kids’ environment friendly. The company’s aggressive investment in marketing and communication has created strong brand awareness around the globe which makes it difficult for new entrants and rivals to compete with and capture market share within this niche market (family).

The magic of McDonald’s marketing approach is that they managed to have a simple, across the globe, communication on its company and product offering and, in the meantime, communicate on a local basis through a specific marketing campaign. As a result, millions of consumers worldwide recognize McDonald’s by its brand symbols such as the Golden Arches, and Ronald McDonald.  The company throughout has effectively used advertising, and cross promotionally platforms to gain global brand recognition while smartly communicate on a local basis, using local events and cultural differences in order to integrate itself within a given country. For instance, in the Middle East, and in India, McDonald’s has very effectively marketed and promoted the Mc Arabia sandwich and vegetarian burger respectively. In Switzerland, the Mc Swiss with its local cheese was promoted. This “local spirit” doesn’t just stop at the promotional level. Their franchise strategy not only allows them to expand rapidly but also help them to have local market intelligence and credibility in each country. From the selection of its suppliers to the selection of the hospitals they will help through the foundation, McDonald’s is fully integrated in the cultural life of each country where they decided to go. The message is clear: No, we are not an American company, which is trying to expand around the world… we are a global company in the fast food industry and each country is our home country!

This marketing strategy would not be feasible if McDonald’s had not organized its entire operational chain towards this goal. As a result, McDonald’s product integration process is second to none in the industry. Using their strong local supplier base and an efficient operational change management process McDonalds maintains competitive advantage through rapid integration of new products. They have extensive access to local raw materials with significant economy of scales. Their product tailored to specific markets, cultures, and unique preferences compared to other international brands that offer standardized products. McDonalds has acquired an important market share due to their cultural adaptation.

As Porter would argue in his article “What is Strategy”, a well-defined and sustainable strategy is when there is the creation of a unique and valuable position, involving a different set of activities. McDonald’s is a clear example of this concept as the whole set of activities they operate is organized toward the same goal and the combinations of all these activities is what makes this strategy credible and sustainable.

Opportunities and Recommendations

Even though McDonalds is the global leader within the fast-food industry, this market is experiencing major shifts in trends, due to press criticism and health awareness. The fast food industry is perceived negatively for its unhealthy and high calorie foods. McDonalds has a lawsuit pending which alleges deceptive advertising practices aimed at luring children to its restaurants. Other equally daring attempts by media and pro-health consumer advocate groups were aimed at linking McDonalds directly with the contribution to obesity in children, already taking epidemic proportion in the US and other developed nations. Whether fair or not, such strong affiliation with junk food and obesity is not in McDonald’s best interests and won’t help it to maintain their competitive edge for years to come. For McDonalds to be successful and continue to grow in the coming years, it will need to continue developing an expanded healthy product line and put more emphasis on nutritional meals. It will be equally critical to market these changes to change the perception of the fast food industry from being unhealthy and greasy to an industry that can also offer different products and keep the same philosophy of being a family environment with quick, affordable, and friendly products.

Although growth remains consistent, most of this growth is coming from the opening new stores rather than improving revenues of the existing ones. With that at hand, the only clear direction for McDonalds is to create a “Blue Ocean” opportunity that will allow the company to maintain its leadership position for years to come. Clearly, healthy or healthier alternatives are driving trends in consumers dining choices today. McDonalds’s fruit smoothie, already very profitable is a small step in tapping into more beverage product offerings. Fruit smoothie, although much healthier than a calorie packed milkshake, however, still loaded with sugar and some artificial flavors and is not enough to influence change in consumer’s perception. McDonalds should go further with offering freshly squeezed juices, similar to Jamba Juice or the like.  That seems like a win-win combination for McDonalds, as it will bring millions of health-minded customers, dieters and athletes to its doors.

By experimenting with a new more sophisticated ambiance, such as the one available at a test unit in Oakbrook, Illinois where customer see stylish furniture with an attractive granite countertops illuminated with hip track lights.  Perhaps a creation of McDonalds Bistro that will be more conducive to modern consumer preferences may become the next breakthrough for the food giant. It is obvious that in order for McDonalds to continue dominate McDonalds should embrace the new idea and by building on existing strengths, and by leveraging its brand to transform the company into a leader of this new potential market.

Additional items to consider:

  • There are many options for affordable luxury coffee as several different industries have entered this market. Consumers want more affordable options which McDonalds responded too with its initial McCafe line. Consumers are price sensitive and will continue to seek even cheaper alternatives. This will drive prices down over the next few years as supply catches up to the demand. This force may continue to influence McDonald’s offerings in the future. To make even stronger value proposition McDonalds could consider improving its other offering, such as improving quality of coffee to tap into a luxury coffee market dominated by Starbuck’s and instead of partnering, build on its own brand and quality image for this market segment.
  • To fully capitalize on that market’s potential McDonalds should offer a better quality food with low fat and sodium content. Zero trans-fat oil can be used for frying and some frying can be replaced with baking. Mayonnaise can be replaced with soy-based or other alternative sauces without changing the original taste. Lean meat can be offered as an option and buns can be baked with whole grains. These and other healthy ideas may point McDonalds in the right direction.
  • In terms of its international markets, McDonalds will need to continue to evolve its menu to the various regions and consumer preferences, and capitalize on their competitive advantage of speed to market without sacrificing the quality and consistency, which is a key competency. This approach will enable them to further saturate the market and increase profitability domestically and internationally.
  • By remolding the existing outlets and make them into more cozy and comfortable, not only this industry will be service and food focused but it will also provide a better customer experience.

The world’s economic challenges will have consumers looking for quick and affordable meal options. Future substitutes to consider are farmer’s markets and stores like Fresh & Easy that provide healthy alternatives and prepared foods to take home. Frozen food producers continue to make advancements in their “meal in a bag technology” which provide quick, healthy, and convenient meal options. McDonalds will need to remain competitive on price and continue to expand its healthy food line to grow market share.

Conclusion

McDonalds has enjoyed an unsurpassed growth and a deep appreciation as the fast food leader in this industry. However since their humble beginnings many changes have taken place and the fast food market has become, arguably, the most hyper-competitive market in the restaurant industry. Competitive pressures come from many directions: new entrants, existing rivals, suppliers, customer and availability of many substitutes. Alas, those are not the only ones that threaten the hegemony that McDonalds enjoyed for many years.

There are many substitutes for the fast-food industry including restaurants, grocery stores, coffee houses, convenience stores, affordable home coffee systems, bookstores and others. The high demand for gourmet coffees is being made available to consumers by increasing number of “do-it-yourself” home espresso makers, coffee machines, availability of gourmet coffee products. Bad publicity about unhealthy aspects of fast food, expanding availability of fast healthy alternatives, and the increase in consumer’s general health food awareness will require McDonald’s to continuously evolve their product offerings and adapt to their various customer segments.

In the fast paced society we live in today consumers will continue to demand food on the go. There are many options for fast and affordable dining. The restaurant industry is getting more aggressive to regain market share and it will be necessary for McDonalds to compete on price. Consumers have also become more health conscious about their food choices. McDonalds needs to respond to the demand for healthy food by implementing healthier menu items.. As the leader in this industry McDonald’s biggest challenge will be to change the negative perception of the fast food restaurant industry and align its competitive strategy for the future.

This report was a group project for the Global Strategy class of Thunderbird School of Global Management Professor Nathan Washburn, Ph.D.