MCD: Boom, Like That

“If you’re not a risk taker, you should get the hell out of business.”

– Ray Kroc

 

There has never been a time in the history of McDonald’s where following advice of its legendary founder has been more critical than it is today.  Importantly, if anyone within the organization knows what Ray Kroc meant by this, it’s the 84-year old Non-Executive Chairman, Andrew J. McKenna.  The company has made it clear that Mr. McKenna told Mr. Easterbrook he has the mandate of the board to fix McDonald’s at all costs.  Only time will tell how big and how deep the changes will be.

 

While McDonald’s restructuring plan will be a significant event for the company, it will also have significant implications for the industry.

 

Since the announcement of the new CEO, the news flow on MCD has been confusing and has supported our short thesis.  Sometime between now and the beginning of the summer, MCD will announce a comprehensive strategic turnaround plan.  We don’t want to be SHORT going into the announcement.

 

Below we offer up our opinion on rumors that are flying around as to what might happen at MCD.

 

Shrink to Grow

The number one priority is clearly to reset the sales trends in key markets.  Returning these markets to positive same-store sales growth will result in the greatest creation of shareholder value.  We will wait and see what the company plans to do, but the overarching theme here is that MCD must focus on the mantra “shrink to grow.”  The company must make a concerted effort to shrink the menu, which will likely call for the elimination of the most expensive mistake in the history of the company: espresso based beverages.  It’s time for McDonald’s to focus on being itself instead of pretending to be something it is not.

 

Financial Engineering

The street seems obsessed with the notion that the company will enhance shareholder value by leveraging its balance sheet or forming a REIT.  Taking on additional leverage while margins are declining will put unnecessary pressure on profitability and will perpetuate unnecessary financial risk.

 

G&A Rationalization

This will be the biggest challenge for the new CEO.  It will be critical for Mr. Easterbrook to make bold changes in inefficient and unnecessary operational areas.  While some of the cuts will fall to the bottom line, the company must better maximize its resource allocation (human capital and financial resources) and re-invest in the business to bring the company back to life. 

 

Addressing Franchise Concerns

The new CEO must reestablish the company’s connection with its owner/operators.  For the first 20 years of McDonald’s (under Ray Kroc), there was no franchisee advisory group since franchisees could directly speak to Mr. Kroc about anything.  In the 1970’s, as the corporate bureaucracy started to grow, the franchisees were left to the devise of various corporate regional managers.   At that time, franchisees felt the need to form the first McDonald’s Operator Association (MOA).  Senior management (Ray Kroc and Fred Turner) resisted this idea of an independent group and instead formed a panel sponsored by the corporation called the NOAB (National Operator Advisory Board).  During the rapid growth years, the NOAB essentially functioned as designed, until the first major McDonald’s restructuring/downsizing under CEO Jack Greenberg.  At this time, the NOAB was renamed the NLC (National Leadership Council) and was significantly reduced in size and scope.  Since the Jack Greenberg days, the perception of its “elected” franchisee members have been those closely aligned to the company and did not truly represent franchisee interests.

 

Given the changing dynamics of the advertising marketplace, the critical issue facing the new CEO is how to make OPNAD more effective.  OPNAD is a voluntary U.S. cooperative of McDonald’s owner/operators known as the Operator’s National Advertising Fund.  McDonald’s and the owner/operators combine their marketing dollars to fund national television advertising.  Given that OPNAD was formed in 1967 and the inefficient use of advertising dollars, the question is should the company restructure similarly to how the company purchases media?  For many years, every store paid 1% of sales into OPNAD plus another 2-3% locally.  This went to 2% in the early 1990’s and to around 1.6% today.  With a more regional approach to marketing, that probably needs to come down and the franchisees are talking about bringing some money home to spend locally.

 

Innovation, Innovation, Innovation

Over the past five to seven years, the company has lost its tolerance for risk.  They must become more innovative with every aspect of the enterprise.

 

Create Your Taste

Innovation has its limits – McDonald’s needs to stop the madness.

 

Mobile Ordering

Mobile ordering – which is very advanced in the restaurant space – is a great example of how slow the company is to innovate and change.  It’s appalling to see how far behind McDonald’s is.  This is a real black eye for the company and especially the Board of Directors.  The company recently said a global app should be ready to launch in the next few months, though the launch date and exact functionality of the application will be the decisions of McDonald’s management in each country.  The app will likely rollout in the U.S. sometime this summer.  The lack of technological innovation is just one of many areas that can be tied directly to failure at the board level to drive shareholder value.

 

We look forward to seeing what the new MCD will look like.  But until then, the stock will tread water.

 

MCD: Boom, Like That - 999


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