CASE ANALYSIS

MCDONALD’S
On April 15, 2004, James R. Cantalupo, the chairman and CEO of McDonald’s died
unexpectedly of a heart attack on his way to a biennial meeting of the firm’s executives,
franchisees, and suppliers in Orlando, Florida. Cantalupo had come out of retirement only
the year before to help improve upon McDonald’s lackluster performance. During his brief
tenure, he had started to turn things around, as reflected in strong growth in sales over the last
three quarters. Reflecting on Cantalupo’s performance, Peter Oakes, an analyst at Piper
Jaffray, stated: His impact over the 16-month period was as meaningful as any chief
executive’s at McDonald’s who preceded him and that includes the big guy, Ray Kroc.

The turnaround at McDonald’s could partly be attributed to some new additions that
Cantalupo had made to its menu. The chain had a positive response to its increased emphasis
on the healthier foods, lead by a revamped line of fancier salads. But a bigger success came
in the form of the McGriddles breakfast sandwich which was launched nationwide in June
2003. A couple of syrup-drenched pancakes, stamped with the Golden Arches, acted as top
and bottom of the sandwich to hold eggs, cheese, sausage, and bacon in three different
combinations. McDonald’s has estimated that the new breakfast addition has been bringing
in about one million new customers every day.

However, Cantalupo’s efforts were not limited to changes in the firm’s product offerings. He
understood that unless he could address more fundamental issues, McDonald’s might be at
the end of a long run as a growth company. In fact, Cantalupo was attempting to lay the
groundwork for the revival of this growth by tackling some of the firm’s more pressing
problems. He had cut back on Mc Donald’s expansion plans, trying instead to concentrate on
improving the firm’s relationships with existing franchisees. He had also forced the firm to
focus on its core hamburger business to get rid of the other underperforming subsidiaries.

It was clear to Cantalupo that the problem at McDonald’s went well beyond cleaning up
restaurants and revamping the menu. The chain has been squeezed by long-term trends that
threaten to leave it marginalized. It was facing a rapidly fragmenting market, where changes
in the tastes of consumers have made once-exotic foods like sushi and burritos everyday
options. Furthermore, competition has been coming from quick meals of all sorts that can be
found in supermarkets, convenience stores, and even vending machines.

Amid these changes, McDonald’s may be facing its greater challenge from the ‘fast-casual’
restaurant category. This fast-growing segment includes several newcomers such as Cosi, a
sandwich shop, or Zuizno’s, a gourmet sub sandwich chain, where customers find the food
healthier and better tasting. According to Mats Lederhausen, recently appointed to revamp
the menu at McDonald’s: “We are clearly living through the death of the mass market.”

EXPERIENCING A DOWNWARD SPIRAL

Since it was founded more than 50 years ago, McDonald’s has been defining the fast-food
business. It provided millions of Americans their first jobs even as it changed their eating
habits. It rose from a single outlet in a Chicago suburb to become one of the largest chain of
outlets spread around the globe. But the company had been stumbling over the past decade.

The decline in McDonald’s once-vaunted service and quality can be traced to its expansion of
the 1990s, when headquarters stopped grading franchises for cleanliness, speed and service.
By the end of the decade, the chain ran into more problems because of the tighter labor
market. McDonald’s began to cut back on training as it struggled hard to find new recruits,
leading to a dramatic falloff in the skills of its employees. According to a 2002 survey by
market researcher Global Growth Group, McDonald’s came in third in average service time
behind Wendy’s and sandwich shop Chick-fill A Inc.

McDonald’s also began to fail consistently with its new product introductions, such as the
low-fat McLean Deluxe and Arch Deluxe burgers, both of which meant to appeal to adults. It
did not better with its attempts to diversify beyond burgers, often because of problems with
the product development process. Consultant Michael Seid, who manages a franchise
consulting firm in West Hartford, Connecticut, pointed out that McDonald’s offered a pizza
that didn’t fit through the drive-through window and salad shakers that were packed so tightly
that dressing couldn’t flow through them.

In 1998, after McDonald’s posted its first-ever decline in annual earnings, CEO Michael R.
Quinlan was forced out and replaced by Kack M. Greenberg, a 16 year veteran of the firm.
Greenberg tried not only to cut back on McDonald’s expansion but also to deal with some of
the company’s growing problems. But his efforts to deal with the decline of McDonald’s
were slowed by his acquisition of other fast-food chains such as Chipotle Mexican Grill and
Boston Market Corporation.

On December 5, 2002, after watching McDonald’s stock slide 60 percent over three years,
the board ousted Greenberg. His short tenure had been marked by the introduction of 40 new
menu items, none of which caught on big, and the purchase of a handful of nonburger chains,
no of which helped the firm to sell more burgers. Indeed, critics said that by trying so many
different things and executing them poorly. Greenberg allowed the burger business to
continue with its decline. According to Los Angeles franchisee Reggie Webb, “We should
have been better off trying fewer things and making them work.”

MANAGING A TROUBLED FRANCHISE

Until a few years ago, franchisees had clamored to become part of McDonald’s growing
empire. But during 2002, 126 franchisees left the system in an exodus that had been unheard
of in the past. Of these, 68, representing 169 restaurants, were forced out for poor
performance. The rest left because they were unhappy with the profits they were making.
Since then, as many as 20 franchisees have been leaving McDonald’s every month, according
to Richard Adams, a former franchisee and a food consultant. The firm buys back franchises
if they cannot be sold; thus, forcing out a franchisee can be expensive. McDonald’s took a
pretax charge of $292 million to close 719 restaurants during 2002 and 2003.
In many cases, franchisees that have seen the chain as stuck n a rut have been jumping ship to
faster-growing rivals. Paul Saber, a McDonald’s franchisee for 17 years sold his 14
restaurants back to the company in 2000 when he realized that eating habits were shifting
away from McDonald’s burgers to fresher, better tasting food. He moved to rival Panera
Bread Company, a fast growing national bakery café chain. “The McDonald’s type fast food
isn’t relevant to today’s consumer,” said Saber.

One of the biggest sore points for franchisees has been the top-down manner in which
Greenberg and other past CEOs have attempted to fix pricing and menu problems. Many
owner-operators still grumble over the $18,000 to $100,000 they had to spend in the late
1990s to install company-mandated “Made for You”, kitchen upgrades in each restaurant.
The new chickens were supposed to speed up orders and accommodate new menu items. In
the end, they actually slowed service.

Webb, who operates 11 McDonald’s restaurants in Los Angeles, claimed that his sales have
dipped by an average of %50,000 each of his outlets over the past 15 years. “From my
perspective, I am working harder than ever and making less than I ever had on an average-
store basis,” said Webb. Most franchisees have seen their margins dip to a paltry 4 percent,
from 15 percent when McDonald’s was at its peak.

Franchisees have also complained about McDonald’s addiction to cutting prices in order to
drive up sales. When McDonald’s cut prices in a 1997 price war, sales actually fell over the
next four months. “Pulling hard on the price level is dangerous. It risks cheapening the
brand,” said Sam Rovit, a partner at Chicago consultant Bain & Company. Yet McDonald’s
has been sticking with the $1 menu program that it had introduced in 2002. Although the
tactic has been squeezing the sales of its rivals, the $1 menu has done little to improve
McDonald’s results.

PINNING HOPES ON A NEW TEAM

By the beginning of 2003, consumer surveys were indicating that McDonald’s was headed
for serious trouble. Measures for the service and quality of the chain were beginning to lag
far behind those of its rivals. To deal with its deteriorating performance, the firm decided to
bring back retired vice-chairman James R. Cantalupo, 59, who had overseen McDonald’s
successful international expansion in the 1980s and 1990s. Cantalupo, who had retired only a
year earlier, was perceived to be the only candidate with the necessary qualifications, despite
shareholder sentiment for an outsider. The board of directors, however, believed that the
company needed someone who knew the company well and could move quickly to turn
things around.

A few weeks after Cantalupo had taken control, he had to announce McDonald’s first
quarterly loss in its 47 year history. There were clear indications that sales at outlets open at
least a year were continuing to drop after showing a decline of 2.1 percent in 2002. (Exhibits
2 and 3). Cantalupo clearly realized he had no time to lose.

One of the first steps that Cantalupo took was to assemble a fresh team to help McDonald’s
work itself out of its rut. He chose to bring up younger McDonald’s executives, who he felt
would bring energy and fresh ideas to the table. “Any company today has to be very vigilant
about their business model and will to break it, even if it’s successful, to make sure they stay
on top of the changing trends,” said Alan Feldman, who had just quit as COO for domestic
operations at McDonald’s.

For starters, Cantalupo appointed as chief operating officer Charles Bell, 42, an Australian
who was also designated as his successor. Bell had become a store manager in his native
Australia at 19 and then risen through the ranks. He eventually launched a coffeehouse
concept called McCafe that attained considerable success. When he became president of
McDonald’s Europe, he similarly abandoned McDonald’s cookie-cutter orange-and-yellow
stores for individualized ones that offer local fare like the ham-and-cheese Croque McDo.

The second top executive Cantalupo recruited was a bona fide outsider, at least by company
standards. Mats Lederhausen, a 39 –year old Swede, held an MBA from the Stockholm
School of Economics and worked with Boston Consulting Group for two years. However, he
jokes that he grew up in a French-fry vat because his father introduced McDonald’s to
Sweden in 1973. Lederhausen was given charge of growth and menu development.

Besides assembling a management team wi9th a fresh perspective, Cantalupo also searched
for new ideas from some of the better-performing franchisees. McDonald’s best hope for
revival may lie with its most innovative franchisees. One of these, Irwin Kruger, opened a
17,000 square-foot showcase unit in New York’s Times Square with brick walls, theatrical
lighting, and video monitors showing movie trailers. “We’re slated to have sales of over $5
million this year and profits exceeding 10 percent,” said Kruger.

SCRAMBLING FOR A NEW STRATEGY

Cantalupo realized that McDonald’s often tended to miss the mark on delivering critical
aspects of consistent, fast, and friendly service, and an all around enjoyable experience for
the whole family. He understood that its franchisees and employees alike needed to be
inspired as well as retained on their role in putting the smile back into McDonald’s
experience. When Cantalupo and his team laid out their plan for McDonald’s in the spring of
2003, they stressed getting the basics of service and quality right, in part by reinstituting a
tough “up or out” grading system that would kick out underperforming franchisees. “We have
to rebuild the foundation. It’s fruitless to add growth if the foundation is weak,” said
Cantalupo.

New product additions to the menu were one of the key elements of Cantalupo’s new strategy
for McDonald’s. His team began to add new items such as the McGriddles breakfast
sandwich that would draw in new customers and lure back old ones. Lederhausen was
working on other possible items that could be added to the chain’s menu. The revamped
menu was promoted through a new worldwide ad slogan”I’m loving it,” which was delivered
by pop idol Justin Timberlake through a set of MTV-style commercials.

But Cantalupo had also been keen to build upon the ideas that Bell had tried out in Australia
and Europe. The chain had been developing plans to test some outlets in Coral Gables,
Florida, with much fancier contemporary décor. Modeled after the stores that Bell had
opened in Paris, the seats would have cushion and wood composite tabletops instead of
plastic. The walls were to be decorated with colorful art instead of Ronald’s face. “This is
all part of becoming more relevant to our customers, said company spokesman Walt Riker.
“When a customer enters our restaurant, they enter our brand.”

Cantalupo was also thinking about experimenting with some local variations on the
McDonald’s theme. Based on the success that Bell had with McCafe in Australia, he wanted
to adapt some of McDonald’s outlets to local themes. An example of this is the Arch Bistro,
complete with chandeliers, leather couches, and soft lighting that McDonald’s opened in
downtown New Orleans. The menu offers everything from Louisiana shrimp to Panini bread
filled with chicken Cordon Bleu.

McDonald’s was also planning to exploit its brand name by globally relaunching its
marginally successful McKids line and to expand it well beyond children’s clothing and toys
into interactive videos and books. Under Cantalupo, the firm was in the process of making
deals to get some royalties for these items from Mattel, Hasbro, and Creative Designs. While
McDonald’s was expected to keep some money on these offerings, they were designed to
keep the brand prominent in the minds of kids. “McDonald’s wants to be seen as a lifestyle
brand, not just a place to go to have a burger,” said Marty Brochstein, executive editor of the
Licensing Letter.

As the firm moves into these new areas that build upon its brand, Cantalupo was thinking of
divesting the nonburger chains acquired by his predecessor. Collectively lumped under the
Partner Brands, these consisted of Chipotle Mexican Grill, Donatos Pizza, and Boston
Market. The purpose of these acquisitions had been to find new growth and to offer the best
franchises new opportunities for expansion. But these acquired businesses had not fueled
much growth and had actually posted considerable losses in recent years.

CONTINUING WITH ITS TURNAROUND

During his 16-month tenure, Cantalupo had attempted to turn McDonald’s around by cutting
back on expansion plans, reducing operating costs, and introducing new products. By taking
these steps, he had managed to boost the firm’s financial performance, particularly in the
domestic market. But McDonald’s was still working hard to improve on the basics of
providing tastier burgers, faster service, and cleaner restaurants. “We haven’t made as much
progress as we could on service,” Cantalupo had acknowledged.

Just months before he died, Cantalupo had announced one of McDonald’s most controversial
changes. In response to concerns about growing obesity among Americans, Cantalupo had
stated that the firm would phase out supersizing by the end of 2004. The supersizing option
allowed customers to get a larger order of French fries and a bigger soft drink by paying a
little bit extra.

Within hours of the announcement of Cantalupo’s unexpected death, McDonald’s announced

the appointment of Charles Bell as the new CEO. As president and chief operating officer, he
had been selected by Cantalupo as his successor. A 43-year old Australian, Bell was the
youngest and the first non-American to head the firm. He generally shared Cantalupo’s focus
on customer experience and stated that he intended to adhere closely to the strategy
developed by his predecessor.
Above all, Bell must try to build on the moves that Cantalupo had been making in
McDonald’s core burger business. Winning back customers for its burgers may even be
getting more difficult as a result of increased competition from newer entrants such as the
California-based In-N-Out chain. The long-term success of the firm may depend on its
ability to compete with rival burger chains. “The burger category has great strength,” added
David C. Novak, chairman and CEO of Yum! Brands, parent of KFC and Taco Bell. “That’s
America’s food. People love hamburgers.

At the same time, Bell must deal with some of the other critical issues facing the firm. He
must figure out how to continue to build sales after the initial excitement generated by new
products such as the McGriddles sandwich has worn off. Some franchisees are also upset
that recent steps taken by McDonald’s have had little effect on the steady decline in their
profit margins. Finally, McDonald’s efforts to move into children’s clothing and toys is
risky, given that the firm had little success with its previous attempt to launch the McKids
line.

Like Cantalupo, Bell realizes that McDonald’s may not have many shots at trying to get its
strategy working. The firm needs to figure out what steps it must take to get its sales and
profits growing again. “They are at a critical juncture and what they do today will shape
whether they just fade away or recapture some of the magic and greatness again,” said Robert
S. Goldin, executive vice-president at food consultant Technomic Incorporated.