Can McDonald's Shape Up?

By Daniel Eisenberg

McDonald's opens a new store somewhere around the globe every eight hours, but these days the fast-food giant is trying to attract attention to the demolition of one of its 30,000 outposts. In a Chicago suburb just a few miles down the road from corporate headquarters, the head of McDonald's USA hired a band and had balloons strewn about before a Caterpillar backhoe clawed down the walls of one of the company's older locations. After 24 years, the Hinsdale branch, like the rest of McDonald's, looks a bit tired and frayed at the edges. In a few months, it will be replaced by something that looks more like a historic New England bed-and-breakfast than your typical cookie-cutter Mickey D's.

In the next couple of years, more than 1,000 other aging McDonald's outlets may get the bulldozer treatment, and 6,000 others could be given a face-lift. But rebuilding the company's formerly sizzling burger business in the U.S., which accounts for half its $40 billion in global sales, will be much more difficult. In July and August, revenues at its U.S. stores open for at least 12 months shrank 2.7% from the year before. The company has suffered declining profits for six of the past seven quarters and just lowered its earnings expectations for 2002. Wall Street's indigestion over the news pushed McDonald's once dependable blue-chip stock down to a seven-year low, helping sink the Dow Jones average close to a four-year nadir of its own.

The challenges facing McDonald's come supersized. Its home market is all but saturated, its sterling reputation for fast, friendly service and cleanliness is tarnished, and customers are putting a growing premium on freshness and taste, neither of which McDonald's is renowned for. It hasn't come up with a new blockbuster product since Chicken McNuggets in 1983, and its aging slogan, We Love to See You Smile, hasn't made many people happy on either side of the counter in quite a while.

Remodeling more than half its 13,099 U.S. restaurants, which could cost the company as much as $800 million over the next two years, is only part of CEO Jack Greenberg's latest plan to get bloated old Ronald McDonald back in shape. Greenberg is trying to lead a renewed commitment to fast and friendly service, to roll out a national "dollar value menu" and a fresh $20 million national ad campaign. To lay the foundation for future growth, Greenberg is experimenting with all kinds of new restaurant formats: an expanded McDonald's with a sit-down diner serving meat loaf or chicken-fried steak, a three-in-one outlet offering burgers and fries along with Boston Market chicken and Donatos pizza (both of which McDonald's owns), and small snack bars with limited menus inside a Home Depot or a Wal-Mart. He is even considering using McDonald's vast real estate to sell additional merchandise, which could mean everything from toys to videos.

While acknowledging the company's poor performance, Greenberg, an affable former accountant who has been CEO since 1998, told Wall Street analysts in a conference call last week, "We have a brand everybody would trade for." That brand, however, is not as powerful as it was, and Greenberg, who some critics say needs to go, may not have much time left to return it to its former glory. After expanding for much of the past decade, McDonald's market-leading share of the $46 billion fast-food burger industry in the U.S. has lately flattened out at around 43%. Wendy's, boasting a popular line of premium salads and a strong reputation for freshness, grew its share to 13.2% in 2001, up a point and a half since 1998, according to industry research group Technomic. (Perennial runner-up Burger King's share dropped to 18.5% from 20.4% during the same period.) Heightened competition from the likes of Subway, which has dethroned McDonald's as nationwide champ in total stores with 13,101, has added to the McWoes. Subs and other custom-made sandwiches are growing 12% a year as a fast-food category vs. a paltry 2% to 3% for burgers. Meanwhile, a range of upstart "fast casual" restaurants such as Panera Bread and Baja Fresh, which serve up a slightly more upscale dining experience, "have raised the bar for the fast-food industry," says Robert Sandelman, president of Sandelman & Associates, a market-research firm.

McDonald's is doing its best to cash in on changing tastes. Its Grilled Chicken Flatbread sandwich, introduced this summer on a limited basis, was more popular than the company anticipated, so it briefly had to stop promoting the sandwich because outlets were running out of, what else, flatbread. In response to an outcry, McDonald's has changed its cooking oil to cut down on cholesterol-raising trans-fatty acids. Always known more for convenience and kid-friendliness than for taste--except, many would argue, when it comes to its superior fries--McDonald's still has a food problem. Despite shelling out hundreds of millions of dollars to install a new made-to-order cooking system that banished heat lamps from the kitchen, McDonald's consistently gets low ratings for the quality of its food. In a 2001 consumer survey conducted by Sandelman & Associates, the company came in dead last out of 60 chains for taste and quality of ingredients.

Worse yet, the made-to-order system, which is supposed to give the kitchen flexibility to add new menu items, has made some McDonald's slower--adding precious seconds, if not minutes, to a customer's wait at the counter or the all-important drive through, which accounts for about half the chain's sales. A small but vocal number of franchisees--who invested thousands of their own dollars in the kitchen changes--are seething. And customers are also losing patience. "Since they took away the heat lamps, it takes forever--and the food still isn't hot," an Atlanta lawyer groused at a McDonald's on Peachtree Street.

For now, McDonald's seems to be devoting most of its time and energy to improving its service, not its food. A company memo sent to franchisees in North Carolina in July bluntly summed up the situation: "We are meeting our speed of service standard only 46% of the time, and 3 out of 10 customers are waiting more than four minutes to complete their order. Our 800 number has confirmed that...the number of complaints...for rude service, unprofessional employees and inaccurate service has risen steadily."

Spearheaded by U.S. division president Mike Roberts, the company is embarking on a crash program to clean up its act. It's keeping much closer tabs on its employees by sending what it calls "mystery shoppers," who have made 121,000 visits so far this year, to spy on restaurants' operations. In addition to the usual tutorials on how to pile on the ingredients for a Big Mac, McDonald's is for the first time giving its employees thorough hospitality training. The company is also offering cash incentives to more visible, effective store managers. "We're making progress but not fast enough," says Roberts.

The breakneck pace of new-store construction--which only a few years ago had franchisees fuming about nearby newcomers cannibalizing their sales--has eased. Only about 300 new stores are expected to open in the U.S. this year, compared with 1,100 in 1995. But there are critics who say that even that is too many and that McDonald's needs to weed out the worst franchisees and shut down some of the underperforming restaurants. "They've stretched the store managers. There are 1,000 of them that are marginal at best," says Howard Penney, an analyst at SunTrust Robinson Humphrey, who thinks McDonald's should close 500 to 1,000 branches. "They have to stop growing."

Some franchisees agree that slackers should get the boot. "They're dragging the brand through the mud," says Edward Bailey, who owns 44 stores in Dallas and has helped keep his business booming by decorating some of them with Ralph Lauren wallpaper and marble bathrooms. Others disagree, claiming that McDonald's is simply making scapegoats out of franchisees and that discounting helps the corporation at the franchisees' expense, since McDonald's takes in royalties on total sales, even as individual owners are stuck with shrinking profit margins. Though stressing that McDonald's will no longer shy away from forcing out bad owner-operators, Roberts dismisses the notion of scaling back McDonald's presence in the U.S. Says he: "We've got to be accessible to customers."

But for McDonald's to get cooking again, its marketing also has to be accessible. For the past several years, a virtual revolving door of corporate executives and an overreliance on regional campaigns have resulted in a diffuse, largely ineffective message. "Our marketing has become too democratic," says Irwin Kruger, a New York City franchisee, who this week will open his massive McDonald's in Times Square, complete with a video-laced menu board, flat-panel displays with subway maps and movie schedules, and his own creation, Mini McDonuts.

McDonald's new national ad campaign will revolve around a national "dollar value menu" that will eventually include the Big 'N' Tasty burger, the McChicken sandwich and special sizes of fries, soda, salad and various desserts. It may not strike anyone as anything particularly new, but it will transmit a unified, consistent message about a bargain. By moving away from sporadic deep discounting in favor of a permanent two-tier menu that keeps signature products like the Big Mac at the top, Mickey D's is following the model that Wendy's has successfully used to lure in penny-pinching customers and then sell them on costlier items. The problem with occasional promotions is that "you train customers to come only when there's a blue-light special," says Chris Clouser, global marketing officer at Burger King, which has launched a 99-c- value menu, backed up by an offbeat, Candid Camera-esque ad campaign that shows bemused consumers reacting to a talking menu board.

As for the restaurants, McDonald's may have to do more than just open up a dual drive-through lane or replace the brown-shingled roof with a red metal one. Some of its most successful locations seem to be the ones that stand out from the pack--whether it's the Orlando, Fla., outlet with a pool table and an air-hockey table, or the one near Chicago with a fireplace and leather armchairs. "McDonald's is a restaurant, not a hamburger stand, and we need to treat it as such," says Chicago-area franchisee David Bear. Who knows, some operators may even take a hint from France, of all places, where the company has helped entice more customers with a wide range of unorthodox decors, including a mountain-chalet-style store with wooden beams lining the ceiling and natural-grain wooden tables on the floor. France is one of the few bright spots in McDonald's flagging European business, and maybe that's a sign of hope. If a burger chain demonized by activists as the symbol of American imperialism and poor taste can win over the French, maybe it can rebuild its business at home. --With reporting by Matt Baron/Chicago, Leslie Berestein/Los Angeles, Desa Philadelphia/New York, Mark Schultz/Atlanta and Adam Smith/Paris

With reporting by Matt Baron/Chicago, Leslie Berestein/Los Angeles, Desa Philadelphia/New York, Mark Schultz/Atlanta and Adam Smith/Paris