MCD: Millennials Aren't the Problem

MCD is a financially healthy company, but its business model is broken and in desperate needing of a fixing.  Alas, merely changing the service style is not the answer and could, in fact, create additional friction within the franchise system.  More importantly, McDonald’s does not have a Millennial problem, as it hinted on Tuesday’s earnings call.  The real issue is the food it is serving.  Food that is, for the most part, inferior to that of its competitors.  It simply doesn’t resonate with consumers, and it will take much more than a “myth buster” for this to change. 

 

McDonald’s recent earnings call lacked clarity.  To their credit, management is trying to stem the sales decline and even conveyed a sense of urgency in doing so.  The issue, however, is that management can’t properly communicate what the actual problem is, rendering their solution haphazard.  But, perhaps more concerning is the reactionary nature of these initiatives.

 

Both management and analysts alike were focused on the fact that Millennials are skipping out on McDonald’s to go to chains such as Chipotle.  Last night, Sonic reported a +4.6% same-store sales increase and, interestingly enough, didn’t mention the word Millennials once on the earnings call.  Wendy’s, another brand that has been resonating lately, isn’t particularly focused on Millennials either.  Why then is it necessary for McDonald’s to pin its troubles on Millennials?  The company’s issues run far deeper than this and it will take some serious soul-searching for it to regain the momentum it once had.

 

The message sent to the McDonald’s franchise system yesterday was loud and clear: we will do what it takes to grow sales and you better get on board.  The current plan, as it stands, will be very expensive for franchisees and will not impact sales until sometime in 2016.  It also fails to address the issues that have been plaguing the system for the better part of the past three years.

 

McDonald’s CEO, Don Thompson, said on the call:

 

“The reality is we haven’t been changing at the same rate as our customers’ eating out expectations, or more specifically, their expectations of us at McDonald’s.  So we’re changing, and we’re changing aggressively as we refocus on building the business for the McDonald’s system and four our shareholders.”

 

Listen, we know why he said this – everyone wants to hear it.  But what does he really mean?

 

While we are delighted to see management recognizes the need for change, we find it slightly disingenuous that it has taken them this long to admit it.  Same-store sales have been declining for two straight years, which it why we find it odd that management has finally realized that customers wanted the ability to personalize their meals.  McDonald’s installed the made-for-you system 10 years ago for this very reason – customization. 

 

Also of note is the company’s commitment to having leading edge point-of-sale systems, mobile technology, and free Wi-Fi.  This isn’t a competitive advantage, in our view.  Nowadays, it’s more like… normal.  We agree that integrating Apple Pay across 14,000 U.S. restaurants is a good move, although we don’t know the impact it will have on drive-thru speed of service. 

 

The company has already tested a multiple order point strategy and self-order kiosks which, to their credit, have limited some of the front-of-counter confusion, but it is far from being the panacea. 

 

If you recall, the made-for-you rollout was initially a disaster that took several years to get right.  It makes sense, therefore, to assume that the cost and the installation of new technology will be a disrupting force within the McDonald’s system.

 

Yesterday, management officially announced they are accelerating the development of a new service style called, “Create Your Taste,” which combines a custom premium burger platform with new service enhancements.  According to Thompson, this new service experience will ultimately create the “McDonald’s Experience of the Future.”  However, we view these initiatives as defensive and fail to see how they will meaningfully separate McDonald’s from the competition.

 

The company plans to fully activate this new experience in three markets a little less than a year from now, and will roll it out to additional markets as permits.  In Australia, plans are already in place to scale this experience across the entire country by next year.

 

It will take years for the company to rework the system to this new service style and it will only impact approximately 40% of the business.  The other 60% of the business is generated by the drive-thru, where customization is not an option.

 

Noticeably absent from the call was an in-depth discussion revolving around enhancing the food and the menu.  In fact, it seems as though the current strategy is to simply tell consumers how good the food is at McDonald’s.  There appears to be no plan to actually change, or upgrade, the food to offer the quality consumers are seeking.  Merely, engaging in dialogue with consumers is unlikely to alter the secular decline in sales the company is experiencing.

 

Management has plans to simplify the menu next January, which we applaud, but to what extent is largely unknown.  According to them, the goal is to “highlight customers’ favorites and to make the experience faster and easier for our customers and our crew.”  But, by summer 2014, they plan to introduce different new tastes on a regional basis, essentially complicating things all over again. 

 

There are many issues with McDonald’s, which makes it odd that they would try to pin it on its disconnect with Millennials.  While it’s a convenient excuse, the reality is they don’t have a Millennial problem.  They have a cultural problem.  Consumers are looking for high quality food served fast, fresh, and in a clean and enjoyable environment.  Sounds more to us like they have a multitude of problems; problems that will likely take a long time to fix.

 

Howard Penney

Managing Director

 

Fred Masotta

Analyst


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