August 7, 2017    6 minute read

McDonald’s: Staying Competitive in a Millennial Age

Food for Thought    August 7, 2017    6 minute read

McDonald’s: Staying Competitive in a Millennial Age

Since 2012, McDonald’s has lost over 500m customer visits in the US – its largest market –  and their fast food restaurant market share fell from 17.5% in 2012 to 15.1% last year. A Goliath with 37,000 restaurants in 120 countries, McDonald’s had begun to embody the worst of a mature company – a hampering bureaucracy, sluggish to changing trends at the top of its cycle.

Yet under Steve Easterbrook, CEO, the company has undergone an impressive turnaround since he took the C-Suite helm in March 2015. The share price is up 60% since his appointment and the company’s recent earnings report global same-store sales growth at 6.6% – a 5 year high – and net income up 36% year-on-year.

The British executive has achieved a great deal in a short time and analysts are not willing to bet against him or his impressive resume as former Wagamama and Pizza Express CEO. But as the millennial demographic eclipses baby boomers in spending power and population, ensuring McDonald’s recent success catalyses into sustainable growth with a changing demographic remains Easterbrook’s biggest challenge.

Source: McDonald’s

Millennial Preferences

Companies need to innovate to a certain degree to stay competitive: too little innovation and you get left behind, too much and operations may spread too thinly. Over the years, the McDonald’s menu became increasingly bloated with 100+ items as it tried to compete with healthier rivals such as Chipotle and Panera Bread. This campaign was ineffective from a marketing and operations perspective.

The company now recognises that most of its loss in consumer visits was to competing fast food restaurants, not its healthier rivals. Peter Thiel in his book Zero to One said a company needs to think for itself and focus only on its product, not to move with the crowd which McDonald’s fell for by misdiagnosing its millennial problem by attempting to move with its younger rivals in offering food not associated with McDonald’s. Indeed, its highly promoted premium salads contributed only 2-3% of revenue at best.

It’s near-suicidal for a company to re-define itself at a startup level; for McDonald’s to attempt this was a huge mistake. The company would be better served by sticking to what made it successful for the past 70+ years. Convenience, price and fast service. Easterbrook has cut down the menu to roughly forty items and pursued an aggressive price promotion. A smaller menu lowers capital cost and it simplifies the operations of the company. This strategy has rewarded the company with one of the shortest average waiting times amongst its competitors and with 70% of US sales from drive-thru customers, it’s been revenue-accretive too.

Source: QSR

Millennial food preferences go beyond healthiness as a generation which is increasingly cognizant of food preparation, sourcing and its environmental impact. Here, McDonald’s has made several smart moves to meet this preference. This includes its announcement to remove antibiotics from its McNuggets, to use only cage-free chicken eggs by 2025 and from 2018 it will only use fresh beef patties in all burgers worldwide.

Making these changes will improve the image and go a long way in regaining lost customers who viewed McDonald’s food practices as abhorrent. Though it may increase input costs in the long-run (10+ years) as the company is sensitive to commodity price changes with 75% of its food bill coming from 10 commodities.

In the short term, the company can get away with virtue signalling moves as global food deflation for the past c. 18 months gives the company freedom to try costly items. In the long-run, with competition fiercely intense in food (including non-traditional market participants such as grocery stores and deli counters) and to ensure costs don’t get too out of hand, the company must leverage its unparalleled supply network, economies of scale and incumbency advantage against its smaller rivals to negotiate favourable supply terms, the proceeds of which could be passed onto the consumer or used internally.

Source: McDonald’s

Healthy Franchisee-Franchisor Relationship

As a pointer, McDonald’s revenue model consists of two streams. (1) The company receives profits from the restaurants it directly owns and (2) upfront franchise fees, rent and royalties from franchised restaurants as a % of turnover. Since the company is 85% franchise owned, it recognises its “success…depends on the willingness and ability of…independent franchisees to implement major initiatives”.

When McDonald’s imposes change, it expects franchisees to bear the cost. But the company is increasingly trying to get franchisees on board with national campaigns by ponying up a big chunk of the money for upgrades that can cost anywhere from $150,000 to $700,000 depending on location. This includes up to 55% of costs linked to its ‘Experience of the Future’ initiative, aimed at digitalising the McDonald’s eating atmosphere via. This reinvestment plan by McDonald’s reflects a shift in the relationship in aligning the operational and promotional efforts of the system (company, franchises, suppliers).

Compared to rivals, such as Burger King, KFC, Pizza Hut, etc. McDonald’s dwarfs them in restaurant count and worldwide reach. However, it is relatively under-franchised with a higher percentage of restaurants owned by the company than a lot of its competitors. Long-term, the company aims to re-franchise to 95%. This would provide the company with a more regular revenue stream from franchisees and lowers both operating risks and costs and is less capital-intensive a strategy for the company as it transfers financing responsibilities to franchisees. Furthermore, it could use the handful of restaurants it directly owns as a laboratory to pilot test new recipes or strategies which could then be rolled out to every restaurant.

Source: Public Filings

One area which the company smartly anticipated future trends was the expansion of delivery services. With various delivery startups such as Postmates, Seamless and Grubhub, competition for McDonald’s has intensified as consumers have a greater number of substitutes to choose from delivery, on top of existing competition.

Yet, the company already has a wealth of experience from delivery in growth markets such as China and the Middle East, it can use this knowledge to easily scale its delivery services to meet untapped demand as it has already done in thirteen countries via UberEats.

Conclusion

Currently, the market validates the CEO’s campaign to turn the company around. But fixing McDonald’s image problem with younger generations requires a long-term vision by management of what they want the company to be and how they can remain unique in an increasingly competitive food scene.

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