Case Studies

by Simon Lord

last updated 22/04/2010

Simon Lord is editor of Franchise New Zealand magazine & website. He has worked in franchising for over 25 years, including five years in the fast food industry in the UK.

Re-Inventing McDonald's

by Simon Lord

last updated 22/04/2010

Simon Lord is editor of Franchise New Zealand magazine & website. He has worked in franchising for over 25 years, including five years in the fast food industry in the UK.
September 2009 - In the last 10 years McDonald's has changed from fast food fatty to green salad goody. Why was it necessary - and how were franchisees persuaded to make huge reinvestments in their businesses?

RonaldMcDonaldJugglingMcDonald’s is the food business that people love to hate – some people, anyway. According to Mark Hawthorne, the managing director of McDonald’s Restaurants in New Zealand, ‘Research shows that 30 per cent of New Zealanders love us and 25 per cent hate us. “Hate” is a strong word, but they mean it. Yet even those 25 per cent still visit one of our restaurants twice a year!’

That’s just one of the many contradictions that McDonald’s has had to address over the past ten years. It has been an eventful decade that has seen the company make some of the most momentous changes in its 50-year history. The burger-and-fries giant has suddenly become one of the biggest sellers of pre-packaged salads in the world. The infamous bun chute, which kept cooked food warm and wilting for up to 20 minutes, has been replaced by a made-to-order system. In the old days, only those desperate for a caffeine fix would drink the stewed coffee – now, McDonald’s only uses arabica beans from Rainforest Alliance certified farms. And even the hallowed burgers themselves are undergoing an upgrade with the launch of two new premium Angus beef products that take McDonald’s into the gourmet burger market.

The revolution has meant a huge reinvestment not just by the company itself but by every one of its franchisees. But what was the reason for the changes – and have they paid off?

Taking a long hard look

Mark Hawthorne is frank about the challenges that McDonald’s had to face. The energetic 37 year-old Australian joined McDonald’s on his 15th birthday as a crew member and has been with the company almost ever since.

‘I think there were a number of problems that forced us to look at what we were doing in a fresh light,’ Mark says. ‘The first was that we became a target for the obesity issue. We’d stuck our head in the sand for a while on that one. After all, obesity isn’t just the result of eating habits; it’s also because kids these days sit in front of a computer all day, so we’d convinced ourselves that it wasn’t our fault and we weren’t addressing it. The problem was that everybody else thought it was our fault.

‘From that point of view, the McLibel trial (the UK court case against two environmental protestors which McDonald’s won at considerable cost to its own reputation) was a real wake-up call for the McDonald’s system. We realised that you didn’t just have to win in court – you had to win in the consumer’s world, too, and that meant making changes. At that time, when it came to things like animal welfare, we probably weren’t the best in the world but we were as good as everyone else. When you’re the number one target, though, that isn’t good enough.’

The issues struck closer to home, as well – in fact, right to the heart of the QSC (Quality, Service, Cleanliness) mantra on which McDonald’s was founded. ‘Many of our restaurants were looking tired, with old plastic furniture and cracked tiles. The service time in the drive-thru lanes was far too long – over five minutes, on average. And we believed that the food wasn’t as important to our customers as low prices, fast service and clean toilets. In fact, only 20% of customers thought our food was good!’

With criticisms coming from all directions, McDonald’s had to act. The company multiplied its research budget by ten to find out what customers wanted then set about delivering it.

Fixing the menu

In 2003, McDonald’s attracted considerable attention when it amended its Happy Meal kids’ boxes to include the options of milk, water or a fruit drink rather than the traditional high-sugar carbonated drink. At the same time, it added cereals to its breakfast menu. It was the start of a revolution.

Over the next few years, the company would add fruit bags and pasta to the kids’ menu and salads and freshly-toasted filled rolls and wraps in the new DeliChoices range. In 2007, a new range of combos called Lighter Choices was launched and the Made to Order cooking platform introduced. Suddenly, the McDonald’s menu looked very different.

But it was behind the scenes that some of the biggest menu changes were taking place. The traditional beef shortening for frying was replaced first by vegetable oil and then by a canola/sunflower blend that is virtually trans-fat free. Sugar levels in buns were reduced by around 40 per cent. Sugar-free drink options were rolled out. Bottled water was added to combos. And, of course, the continuing growth of the McCafé add-on offered consumers even more choice. 

Such is the popularity of McDonald’s with New Zealanders – it serves over a million meals a week here – that these changes had quite an impact. The oil change, which reduced saturated fat in fried foods by 83 per cent, apparently removed a remarkable 727,000 kilograms of saturated fat from the food supply. Other changes have removed more than 300 tonnes of sugar from the supply chain.

Fixing the restaurants

While the menu changes were critical to the company’s image and ongoing acceptability, upgrading the restaurants themselves was in many ways a much bigger task. Of the company’s 148 restaurants in New Zealand, 115 are franchised, meaning that refitting was certainly not a simple corporate decision. ‘To give you some indication of the scale of the changes, just changing from pre-prepared to the “Made for You” platform cost around $100,000 per restaurant,’ Mark says. ‘We have significantly more items on the menu than we used to have, and they require specialist equipment. The new Angus burgers meant that 50 restaurants had to buy a new grill at $30,000 a time. That’s just in the kitchen – the cost for refitting an entire restaurant with new furniture and décor, even without creating a McCafé, is many times that, and then you need to train crew in the new menu items too. It all adds up.’

Part of the re-imaging was aimed not just at delivering the new menu but delivering a better experience, particularly when it came to improving service times. ‘We know that people get irritated if they have to wait longer than three-and a-half minutes, so we set out to reduce service times across the board to three minutes or less. Drive-thru sales average over 50% of our total, so they were critical.’

McDonaldsDriveThruScoreboardJust how critical is obvious when you walk into Mark Hawthorne’s office. On one corner of his desk a huge monitor displays a constantly changing display of green, amber, red and black cells (see picture). This display shows the average time it is taking to serve customers at every one of the hundred McDonald’s Drive-Thru’s around the country. A similar screen is in every drive-thru and on every franchisee and manager’s desk – it can even be accessed via iPhones and other devices – and enables restaurants to see at a glance how they are performing compared to their target and other selected locations. ‘The good old Kiwi competitive spirit really kicks in at the busy times,’ Mark smiles. ‘We’re now serving people two minutes faster than we were two years ago, and that’s good for everyone.’

And many restaurants have now moved to 24 hour opening. That’s been made more possible by the made-to-order approach, but is it really economic? ‘It’s not that profitable all through the night, but it’s a good brand statement. It removes people’s uncertainty about when we’re open so those hours between 10pm and midnight are much better.’

Managing the change process

Given the scale of the changes that McDonald’s has instituted as it has re-invented itself, how has it managed to convince franchisees to re-invest in the brand to such an enormous extent?

‘First, we were somewhat blessed that we had a number of markets around the world that were already demonstrating that the things we wanted to do actually worked and provided a return,’ Mark explains. ‘Secondly, 20 percent of our restaurants are actually company-owned, so I was able to deploy all our strategies in the company-owned restaurants here. That made another rather big business case to demonstrate to the franchisees that the changes would be effective.

‘Our franchisees hold us to quite a high standard but they have always shown that they are willing to spend money as long as the return on investment is there. We also have a number of vehicles for consultation with our franchisees that enable us to discuss such things constructively. For a start, we have the KLT – Kiwi Leadership Team. This comprises eight franchisees elected by themselves who meet with us once a quarter to talk about major issues in the business. We have a Marketing Executive of all 52 franchisees who get one vote each. We treat the company restaurants as a single franchise, so we only have one vote as well. This means the franchisees actually own the marketing decisions. We also have a National Co-operative three times a year with all franchisees and, lastly, we have four meetings every year when the entire senior team heads out and has a small forum with the franchisees in each region. This averages about 13 franchisees and 8 executives in each forum, so there’s plenty of opportunity to share information, ideas and concerns.’

While the business case for change might have been compelling, there was still the major issue of raising the finance – and this is where McDonald’s unusual financial model came to the fore.

‘The way our model works is that the company owns the land and the building while the franchisee owns the equipment package,’ Mark details. ‘We charge the franchisee a rent which is a percentage of sales for the use of our land and building. The average rent in NZ is 12%. We do charge a royalty or service fee of 5% as well, but we don’t make any money off that because running the office and paying the US fee costs about 6% so we actually lose money on every sale!

‘This means that overall we get about 17% of any increase in sales, so if a franchisee reinvests in the business, we get a higher income stream as well. We recognise that that is in everybody’s best interests, so we actually contribute to reinvestment. For example, if a franchisee has spent $1 million on re-imaging their restaurant, which is about the average spend, we would contribute about a third of that. In other words, it’s basically like a joint venture every time they do a major re-investment. This is a standing programme, not something we introduced specially for the recent changes, and it’s proved very effective. It’s available for any major sales-building initiative over $50,000.’

And there’s another angle to help persuade franchisees too. ‘The dream for most of our franchisees is to own more than one restaurant. That has a number of advantages for franchisees: it increases profitability, increases return and diversifies risk. We actually have a three-year strategy to increase the average number of stores per franchisee from 1.8 to 3 by the end of 2011. Re-imaging is part of that, and the 30 new restaurant openings we plan will give us more than enough vehicles to do it. It means that we can aggressively reward the franchisees who re-invest and re-image their existing restaurants. Re-imaging is an individual decision and I don’t expect to get 100% of the changes in 100% of the locations, but the case for doing it is so strong that it’s hard not to do.

Have the changes worked?

So what has been the impact of the changes on turnover and profitability – particularly given that a lot of re-investment took place just before the downturn? ‘There’s no such thing as a recession-proof business, but we’re pretty recession-resistant,’ says Mark. ‘And all the changes have contributed to that by broadening our appeal.

‘Sales in 2007 and 2008 were up by approximately 10 percent each year. In 2009 so far, we’re up by 6-7 percent. In fact, July was our second-busiest month ever in New Zealand, so we’re in pretty good shape. We’ve grown our market share of the informal eating-out market by about 2% this year so McDonald’s is now successfully competing with non-fast-food restaurants.’

And while he won’t be drawn on profitability as opposed to sales, the figures from Australia – where a similar programme has been introduced – suggest that the changes have not come at the expense of margins. There, while outlet numbers are up just 2.6% year-on-year, operating profit has reportedly increased by a massive 28.9%.

But has the popular perception of McDonald’s changed yet? ‘These things take time,’ Mark points out. ‘People still talk about “Would you like fries with that?” and we haven’t asked that in over 20 years. It’s the same with the menu. Look, we can make all the changes but while obesity is an issue we’ll be a target whatever we do. McDonald’s is the biggest single brand, sure, but in terms of size then fish and chips is still the largest part of this market. If you’re serious about addressing the obesity issue, find a way to get people to change the cooking oil in the fish and chip shops. We only use 5% of the cooking oil in NZ and we’re using something very low in saturated fats. But we’re the biggest brand so we’re the one that is always singled out, no matter how many changes we make.

‘For a recent planning application where there was local concern about a McDonald’s opening, we went to the six nearest outlets to our proposed site – chains and independents – and sent their most popular menu items to the lab for testing. The Big Mac meal came out lower in saturated fat than any of them. We’ve come a long way.’

Ray Kroc, the founder of the McDonald’s franchise, probably never envisaged salads, wraps and fruit forming part of the menu, let alone bottled water, but it says much for his vision that the corporation and its franchisees have been willing to change and able to adapt so effectively. It all bears out the truth of something he used to tell people in the 1950s: ‘I don’t know what we'll be selling in the year 2000, but we'll be selling more of it than anybody else.’

This article was first published in Franchise New Zealand magazine Volume 18 Issue 3

How much does it cost to buy a McDonald's franchise?

Simon Lord is editor of Franchise New Zealand magazine & website. He has worked in franchising for over 25 years, including five years in the fast food industry in the UK.
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