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McDonalds - When the chips are down

After a long run of success, the worlds largest fast-food chain is flounderingand activist investors
are circling
Jan 10th 2015 | CHICAGO | - The Economist

IN A brand-new McDonalds outlet near its headquarters in Oak Brook, Illinois, customers do not
have to queue at the counter. They can go to a touch screen and build their own burger by choosing
a bun, toppings and sauces from a list of more than 20 premium ingredients, including grilled
mushrooms, guacamole and caramelised onions. Then they sit down, waiting an average of seven
minutes until a server brings their burgers to their table.
The company is planning to roll out its Create Your Taste burgers in up to 2,000 restaurantsit is
not saying whereby late 2015, and possibly in more places if they do well. McDonalds is also trying
to engage with customers on social media and is working on a smartphone app, as well as testing
mobile-payment systems such as Apple Pay, Softcard and Google Wallet.
All this is part of the Experience of the Future, a plan to revive the flagging popularity of
McDonalds, especially among younger consumers. We are taking decisive action to change
fundamentally the way we approach our business, says Heidi Barker, a spokeswoman.
After a successful run which lifted the firms share price from $12 in 2003 to more than $100 at the
end of 2011, McDonalds had a tricky 2013 and a much harder time last year. When it announces its
annual results on January 23rd, some analysts fear it will reveal a drop in global like-for-like sales
(ie, after stripping out the effect of opening new outlets) for the whole of 2014the first such fall
since 2002.
In the past year Don Thompson, the firms relatively new boss, has had to fight fires around the
world, some of them beyond his control. Sales in China fell sharply after a local meat supplier was
found guilty of using expired and contaminated chicken and beef. Some Russian outlets were
temporarily closed by food inspectors, apparently in retaliation for Western sanctions against Russia
over its military intervention in Ukraine. And a strike at some American ports left Japanese
McDonalds outlets short of American-grown potatoes, forcing them to ration their portions of fries.
(More recently several Japanese customers have reported finding bits of plastic, and even a tooth, in
their food.)
However, the biggest problem has been in Americaby far McDonalds largest market, where it has
14,200 of its 35,000 mostly franchised restaurants. In November its American like-for-like sales were
down 4.6% on a year earlier. It had weathered the 2008-09 recession and its aftermath by attracting
cash-strapped consumers looking for a cheap bite. But more recently it has been squeezed by
competition from Burger King, revitalised under the management of a private-equity firm, from other
fast-food joints such as Subway and Starbucks, and from the growing popularity of slightly more
upmarket fast casual outlets (see article).

In response, McDonalds has expanded its menu with all manner of wraps, salads and so on. Its
American menu now has almost 200 items. This strains kitchen staff and annoys franchisees, who
often have to buy new equipment. It may also deter customers. McDonalds stands for value,
consistency and convenience, says Darren Tristano at Technomic, a restaurant-industry consultant,
and it needs to stay true to this. Most diners want a Big Mac or a Quarter Pounder at a good price,
served quickly. And, as company executives now acknowledge, its strategy of reeling in diners with a
Dollar Menu then trying to tempt them with pricier dishes is not working.
McDonalds says it has got the message and is experimenting in some parts of America with a simpler
menu: one type of Quarter Pounder with cheese rather than four; one Snack Wrap rather than three;
and so on. However, this seems to run contrary to the build-your-burger strategy it is trying
elsewhere, which expands the number of choices. That in turn is McDonalds response to the
popularity of better burger chains, such as Shake Shack, which has just filed for a stockmarket
flotation.
Some analysts think that McDonalds should stop trying to replicate all its rivals offerings and go
back to basics, offering a limited range of dishes at low prices, served freshly and quickly. Sara
Senatore of Sanford C. Bernstein, a research outfit, notes that Burger King, having struggled against
its big rival for years, has begun to do better with a simpler and cheaper version of the McDonalds
menu. For the third quarter of 2014 Burger King reported a like-for-like sales increase of 3.6% in
America and Canada compared with a decrease by 3.3% of comparable sales at McDonalds. That
said, sales at an average McDonalds in America are still roughly double those of an average Burger
King. So the case for going back to basics remains unproven.
So far, McDonalds looks as if it is undergoing a milder version of its last crisis, in 2002-03. Then, an
over-rapid expansion had damaged its reputation for good service, its menu had become bloated and
customers were drifting to rivals claiming to offer healthier food. Now, once again, McDonalds has
a huge image problem in America, says John Gordon, a restaurant expert at the Pacific Management
Consulting Group. This is in part because of its use of frozen factory food packed with
preservatives. In 2013 a story about a 14-year-old McDonalds burger that had not rotted received
huge coverage. Even Mike Andres, the new boss of the companys American operations, recently
asked bemused investors: Why do we need to have preservatives in our food? and then answered
himself: We probably dont.
McDonalds doesnt seem to be cool any more, especially among youngsters. Parents say their
teenage children have been put off after seeing Super Size Me, a documentary about surviving only
on McDonalds food; and Food, Inc, another about the corporatisation of the food industry; and by
reading Fast Food Nation: The Dark Side of the All-American Meal. It is hard to imagine the new
McDonalds initiatives getting the reaction Shake Shack got when it opened its first outlet in
downtown Chicago in November: for the first two weeks it had long queues of people waiting
outside in the freezing cold.

A lot of the negative PR that McDonalds gets is the flipside of being the worlds biggest and most
famous fast-food chain. This has made it the whipping-boy of food activists, labour activists, animalrights campaigners and those who simply dislike all things American. In America it has been the focus
of a campaign for fast-food workers and others to get a minimum salary of $15 an hour and the right
to unionise. Last month the National Labour Relations Board, a federal agency, released details of 13
complaints against McDonalds and many of its franchisees for violating employees rights to
campaign for better pay and working conditions. The alleged violations relate to threats, surveillance,
discrimination, reduced hours and even sackings of workers who supported the protests. McDonalds
contests these charges, while arguing that it is not responsible for its franchisees labour practices.
Not all the criticism McDonalds gets may be meritedor at least it should be shared more fairly with
its peers. However, the companys troubles have begun to attract the attention of activist
shareholders, who may prove somewhat harder to brush aside than labour or food activists. In
November Jana Partners, an activist fund, took a stake in the firm. Then in December its shares
jumped, on rumours that one of the most prominent and determined activists, Bill Ackman, intended
to buy a stake and press for a shake-up.
McDonalds says it welcomes all investors and is focused on maximising value for its shareholders.
Even so, Mr Thompsons new strategy needs to deliver results quickly. Mr Ackmans Pershing Square
Capital has done well out of its 11% stake in Burger King, because the chains main shareholder, 3G
Capital, has pushed through a drastic cost-cutting programme and a merger with Tim Hortons, a
Canadian restaurant group. If McDonalds were run like Burger King, the stock would go up a lot,
Mr Ackman mused recently. It looks like Mr Thompson may soon have to fight on another front.

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