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As McDonald's Sales Slide, Franchisees Seek Action

A red convertable at a McDonald's drive-thru
There's not only a missing customer, but drive-thru speed has slowed at McDonald's. Photo by Thomas Hawk

OAK BROOK, Ill. – McDonald's Corporation last week announced disappointing results for its first quarter ending March 31, 2014. McDonald's same restaurant sales in the United States decreased 1.7 percent.

For McDonald's Corporation, worldwide revenues increased by only 1 percent, while its operating income declined 1 percent from a year ago. The quarter reflected negative comparable guest traffic at the Golden Arches amid severe winter weather.

But some analysts and consultants aren't pinning all the blame on the weather. Restaurant consultant Richard Adams, who worked for McDonald's Corporation for over 20 years and was once a franchisee, observes, "While weather truly was a factor in the first quarter, the typical McDonald's in the United States is bogged down during the peak periods with an overly complicated menu and too many customer choices."

The company is also facing increasing competition from Burger King, Wendy's, and fast casual better burger concepts. In March Mexican-cuisine chain Taco Bell elbowed its way into the breakfast daypart. But McDonald's president and chief executive officer of the past two years, Don Thompson, noted that his brand is used to new breakfast offers from competitors. He doesn't think they've taken a bite out of the chain's breakfast offerings. "We have not seen an impact relative to the most recent competitors that entered the space," he stated during an earnings call last week.

Trying to invigorate breakfast with free coffee and by marketing McDonald's cooking

Nonetheless, the brand has reacted strongly to the prospect of new breakfast competitors. "Sometimes when these entrants come in, it forces us to focus even more on being aggressive relative to breakfast," said McDonald's CEO. He adds, "I know you have just recently seen the coffee execution in the U.S. and our free coffee offers, which really are about supporting our breakfast and supporting our breakfast foods as much as they are about reintroducing Americans to a delicious cup of McCafe coffee."

But franchise owners who fly the McDonald's flag are less than sanguine about the free coffee initiative. In a survey by Janney Capital Markets of 27 McDonald's franchise owners who collectively own over 200 restaurants, there were a host of issues. "Free coffee, yeah, that'll do it!" sarcastically comments one franchise owner, referring to McDonald's attempt to increase traffic and bump up slumping store sales by requiring franchises and corporate stores to serve free coffee from March 31 to April 13. Another franchise owner in the Janney survey said that he did not see any gain in sales from the mandatory loss leader of the coffee giveaway.

The Golden Arches has further plans to differentiate itself from Taco Bell's or Subway's breakfast fare by emphasizing that its morning meal is actually cooked at the restaurant. "We grab fresh eggs. We grill sausage," says CEO Thompson. "We bake biscuits and we toast muffins, all to serve up a delicious breakfast that is accompanied by our outstanding McCafe coffee." The burger chain leader adds, "These things truly set us apart and position us to continue growing this daypart into the future."

McDonald's plans to provide customized toppings by upgrading kitchen tables

Amidst the publicly sagging results of the day, the CEO optimistically points to the future, saying that the company's goal is to ensure that it remains a relevant and trusted brand by serving great-tasting, high-quality, affordable food and creating memorable experiences for consumers. "By leveraging a deeper understanding of what our customers want with the power of our business model, our investments in restaurant capabilities and modernization, and our hard-earned competitive advantages, we will grow McDonald's business and deliver enduring profitable growth over the long term," Thompson declared.

The company anticipates that enabling its consumers to customize their burgers and food is its way to a brighter future. With 90 percent of the chain franchised in the United States, McDonald's is requiring franchise owners to flip the bill to upgrade their kitchen tables. Franchise owners are hinting to this journal that their out-of-pocket expense for the upgrade is roughly $15,000 or higher. That is a comparatively small one-time cost, less than 1 percent of an average McDonald's restaurant's $2.7 million in sales, but franchise owners are concerned that the necessary downtime will affect them.

Don Thompson. Photo: McD website

"It gives us the flexibility to have some new toppings that will help us to be able to customize some of the food products that we have," says Thompson. The customization sounds similar to better burger chain Five Guys Burgers and Fries, where customers can decide what sorts of toppings to put on their burgers, such as A1 sauce, onions, mushrooms, pickles or bell peppers. "When you have a number of builds in the restaurant, basically what you are doing is you are leveraging the various condiments and products in the restaurant to build those sandwiches," says the Mickey D CEO. "If you can go to a more streamlined menu board approach and then still have those condiments so the customers can customize a bit, it will help in terms of reducing, if you will, complexity."

But for Richard Adams, president of Franchise Equity Group, that thought does not make sense. He retorts that the brand cannot offer customized menu offerings without increasing the complexity of operations, slowing the throughput of orders and increasing store costs. "McDonald's is making some tweaks to the kitchens, but they are focused on 'customization,' which will only make matters worse," says Adams. "Sales will not improve in the United States until the menu is simplified and the restaurant operation streamlined," the consultant asserts.

Another concern of franchisees, who are supposedly independent business owners, is the deeper involvement of McDonald's Corporation in their businesses. Thompson wants to "reset" the franchised restaurants with more efficient hiring and staffing. "Our franchise and company-owned restaurants are engaged in what we call a reset, which emphasizes the importance of proper staffing, scheduling and positioning of crew to build restaurant capacity, particularly during peak hours," he says.

Consultant Adams explains that the corporation would like store owners to schedule more crew in the restaurants to work both sides of the kitchen table during peak hours. Franchisees, who feel the pain of using too many employees on their bottom line, may wince. Nowadays, through point-of-sales and software, McDonald's is better able to monitor and influence the staffing decisions of its independent businesses.

But the more influence McDonald's Corporation exerts on the scheduling, managing and positioning of the crew of a franchised restaurant, a supposedly independent business, the more the franchisor may be in legal danger of being considered the real, behind-the-scenes employer. Franchisee attorney Carmen Caruso of Chicago-based law firm Caruso & Roeder LLC cautions,"The franchisor is flirting with becoming an employer and also being held liable for injuries on the [franchise] premises."

Franchisee satisfaction with franchisor at its lowest levels

"As we begin the second quarter, global comparable sales for the month of April are expected to be modestly positive," declares McDonald's CEO about short-term prospects.

Restaurant analyst Mark Kalinowski with financial services firm Janney Montgomery Scott thinks that last statement by CEO Thompson is actually not so positive. "While this may sound favorable at first, it may actually represent a bit of a step back on apples-to-apples terms, as the global trading-day adjustment for March was negative 1.1 percent, and for April is positive 0.2 percent," says Kalinowski.

Kalinowski thinks more worrisome is McDonald's sluggishness in improving speed in drive-thru results. He is referring to a survey by QSR Magazine/ Insula Research in which McDonald's saw its slowest time in 15 years for processing orders through its drive-thru service. That sluggishness "in turn makes same-store traffic growth that much more difficult to achieve," says the analyst.

Some franchisees think that upper management has lost the edge because of its lack of experience and acumen in running stores. "Upper management needs someone at the helm to understand operations today," exasperatedly declares one franchisee.

Another states, "Upper management and supporting departments are out of touch. We're spending like crazy on new equipment. Very little return. We keep adding more products and expecting different results on service times. We are 8-10 seconds slower than last year."

Restaurant owners hope that the officers of the franchisor will change their ways and listen to them during the franchisee global conference this week in Orlando.

McDonald's has a traditional franchise governance structure in which corporate decides brand issues. On the other hand, franchisees have an advisory council in which franchisee representatives dispense advice to the company from their perspective as restaurant operators. This week's worldwide franchisee conference is an opportunity for corporate management to try to persuade franchisees of the wisdom of their choices. On the flip side, it is a chance for McDonald's to listen to the general body of franchisees.

Analyst to McDonald's: Do you need to change your decision-making process?

For the moment, the company's methods of listening to franchise owners are producing poor results. In 62 surveys that span more than 10 years, McDonald's franchisees typically rank McDonald's between fair and good at 2.2. However, the March survey resulted in franchisees ranking the relationship with their franchisor at a 1.73 on a scale of 1 to 5, 1 being poor and 5 being excellent. That's slightly up from the lowest recorded ranking of franchisee satisfaction, 1.7, which was recorded at the end of 2013.

Such poor scores are important markers, says Kalinowski. "Corporations who have franchisees on board and enthusiastic about senior management's plans/strategy tend to fare better than those that don't enjoy this type of a situation," observes the analyst.

Another franchise owner pointed out that besides branding issues for the chain there is a fundamental economic issue for McDonald's franchisees that must be addressed — namely, the high rent that the franchisor charges its franchisees for occupying their commercial property. Some argue that McDonald's property lease fees are so extraordinarily high that they cannot make money as owners. "[It] doesn't matter about speed or number, the math doesn't work," wrote a franchisee. "Rent too high, sales too slow." Restaurant owners argue that profitable franchisees are the backbone of the entire system.

But Thompson worries that focusing too much on profitability for franchisees or the company takes the brand's focus off the task at hand – satisfying the customer. "I don't think we could have better franchisees, but just like us within the company, we've got to make sure that we all stay focused on the customers," said the CEO during last week's earnings call to analysts.

Virtual card for buying Burger King food items
Burger King's iPhone app includes a digital wallet

The marketing juggernaut is receiving criticism from within about its branding efforts as well. "McDonald's needs to figure out (quickly) who we want to be as a brand and knock off this 'be-all to everybody' immediately," writes a franchisee. "Also, we need to become flatter as an organization and be able to respond quicker to technology. It's time to innovate convenience and quality!"

Part of that cry for action is about McDonald's slowness in using digital technology. The company hired its first chief digital officer only last October. Meanwhile, Burger King and Wendy's have blazed new trails in developing apps, online loyalty programs and even customer purchase of meals through mobile technology. McDonald's has conspicuously been missing in action. Its app lags way behind, simply allowing users to peruse a menu or find the nearest location.

Sounding somewhat like the franchise owners, analysts also are focusing on the system's franchisees, management's grasp of operational issues and the need for speed in adapting to the modern market. John Ivankoe, analyst at JP Morgan, asked Thompson, "Do you need to change kind of your entire decision-making process and how things get implemented at the store level as we are clearly in the market that's moving much faster than it was over the past decade or so?"

Thompson responded that McDonald's will continue to use its market teams and know-how to focus first on satisfying customers.


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