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WIKI ANALYSIS
With over 35,000 locations in 100 countries, McDonald’s (NYSE: MCD) is the world's largest fast food restaurant chain. McDonald's operates its own restaurants and franchises its brand to local businesspeople (about 70% of the world's McDonald's are franchised[1].) The company experienced a dramatic turnaround in 2003, driven by a two-pronged strategy. In the U.S., McDonald's focused on increasing sales at existing locations by renovating stores, expanding menu options and extending store hours. Internationally, McDonald's expanded aggressively, opting to franchise rather than operate its new locations which provides new income with little overhead.
Both strategies have paid dividends- despite its size, sales have grown by a third since 2003[2]. Domestically, McDonald's continues to perform strongly despite a pullback in consumer spending and is even benefiting as consumers trade-down from more expensive eating options. At the same time, international operations are driving profit growth. A growing global middle class, particularly in emerging markets like China, India and Latin America, is a massive opportunity for McDonald's. McDonald's aggressive efforts to expand its global presence- most notably in 2008 Beijing Summer Olympics- have produced strong comparable sales and profit growth.
Business Overview
Business Model
McDonald's makes money by operating its own restaurants and franchising to third parties. Of the 31377 McDonald’s restaurants around the world, 20505 (65%) are operated by franchisees, 3966 (13%) are operated by affiliates, and 6906 (22%) are company-operated. In the last few years, McDonald’s has sought to enfranchise more and more restaurants. For example, in 2007, it sold its businesses in Brazil, Argentina, Mexico, Puerto Rico, Venezuela and 13 other Latin American/Caribbean countries to one franchisee[3]. Steering in this direction has resulted in greater cash flow (which increased by 12% in 2007)[4], reduced spending on operations, and less corporate exposure to rising commodities prices.
Business Strategies
McDonald’s has pursued two strategies since 2003. To keep up with rapidly changing consumer preferences, demographics and spending patterns, McDonald's has introduced new items (Premium Chicken sandwiches and the Angus Beef Burger) and campaigns to create more healthy foods (Premium Salads). The strategy reflects the philosophy that novelty, as opposed to loyalty to traditional products, is the key determinant of sales in the fast food industry.
McDonald’s has also focused on increasing sales at existing restaurants instead of opening new ones[5]. To do so, McDonald's has remodeled many restaurants, kept stores open longer and increased menu options.Nevertheless, new McDonald’s restaurants are still opening around the world at a rapid rate - the company plans to open about 1,000 units in 2008, and continues to grow its new restaurants at a 1%-2% rate each year.[6]
Size Matters
McDonald's size has three key advantages:
- Uniform menu offerings can be mass produced, lowering production costs.
- Bargaining power with suppliers lowers input costs and boosts margins.
- Large advertising budget means lots of domestic and international exposure.
International Expansion
McDonald’s is well-established in Europe, Asia/Pacific Islands, the Middle East, and Africa. Its growth in Europe is mainly driven by France, Germany and the United Kingdom. In Asia, the general management has indicated that there is significant potential in the China market. The corporation has adapted its menu items to local cultures, such as the Teriyaki Mac in Japan, variants of Filet-O-Fish in China, and using lamb instead of beef in India.
In neighboring China, McDonald’s has been selected as the Official Restaurant of the Beijing 2008 Olympic Games - an honor that will further bolster its global reputation.
| Geographic Region | Percent of Total Revenues |
|---|---|
| US | 35%[7] |
| France, Germany, UK | 21%[8] |
| Rest of Europe | 14%[9] |
| Australia, China, Japan | 8%[10] |
| Rest of Asia, the Middle East, Africa | 8%[11] |
Current Financials
McDonald's revenue decreased by 7% to $5.65 billion in Q2 09 (ending March 31st, 2009), a decrease from $6.08 billion the previous year. However, operating income increased 2% over the previous year, from $1.65 billion to $1.68 billion. Much of the decline in revenue can be attributed to company-operated restaurants, whose revenue numbers decreased by 10% from $4.3 billion in the previous year to $3.8 billion. Revenue from franchised restaurants, on the other hand, actually increased 1% from $1.78 to $1.80 billion.[12] Since the margins on franchised restaurants are higher than those of company-operated restaurants, the higher contribution from franchised restaurants in the revenue mix positively impacted McDonald's operating margins (from 27.2% to 29.8%).
McDonald's also noted that McCafe, which they labeled as a "long-term home run", had met sales expectations and has benefited from the high level of advertising that McDonald's has committed to it. Coffee sales now make up 5% of McDonald's total sales.[13] McDonald's reported a July sales gain of 4.3%, in part due to large growth in European orders of 7.2% on the month. McCafe sales continued to increase and now make up 5% of McDonald's total revenues.[14]
In August 2009, McDonald's reported sales growth of 2.2% for existing restaurants, including 1.7% growth in the United States and 3.5% growth in Europe. The U.S. numbers missed analyst projections of 2.8-3%, causing McDonald's shares to fall 1.6%. During this recession, McDonald's has benefited as an increasing amount of diners choose the lower-priced meals meals that McDonald's offers. However, McDonald's has seen less sales in its "non-essential" beverages and breakfasts segments.[15]
Key Trends and Forces
McDonald's looks to compete in the high-margin beverages market with "McCafe"
In 2008, McDonald's introduced the McCafe to select stores, where customers can purchase espressos and cappuccinos. These drinks, which are priced in the $2-4 range, represent McDonald's foray into the high-margin caffeinated beverages market, currently dominated by Starbucks. McDonald's expects to eventually add $1 billion to annual sales through McCafe-related beverages[16]
Analysts have taken notice of this threat and expect McCafe to have a negative impact on Starbucks' same-store sales.[17] While the results of this "Coffee War" are not yet set in stone, some analysts believe that the two competitors will eventually settle into separate niches, with McDonald's being the better value proposition and Starbucks offering more of a quality experience.[18]
Strong International Growth is Driving Sales
McDonald's has a sizable international presence; 61% of sales occur outside of the United States. In addition to developed markets like the U.K., Canada, South Korea and Australia, McDonald's operates in fast growing emerging markets like China, India, Russia and Eastern Europe. By tapping into a growing global middle class, the company's international operations have consistently posted strong same-store sales growth. China is a particularly promising opportunity. In FY 2007, McDonald's launched the breakfast menu, extended store hours to 24 hours in major cities, and implemented drive-thru in China in its efforts to capitalize on this huge market[19].
Changes in consumer preferences could decrease sales
Consumer preferences that gravitate towards more nutritional food (see Natural & Organic Foods Consumption and Health & Wellness) decrease the appeal of eating at McDonald’s. As these consumer trends continue to shift towards the mainstream, public perception of McDonald's becomes increasingly negative. These changes may climax in lawsuits or media publications like Super Size Me, which criticizes McDonald’s products for causing obesity, and Fast Food Nation, which decries McDonald's business practices. Since McDonald's is the most recognized brand name in the fast food industry, these negative publicity events have widespread impact on its brand equity. Furthermore, because there are many alternatives to fast food (such as cheap dine-in restaurants, street vendors and convenience stores), the corporation's sales depend on its ability to maintain its brand name and attract new customers. The introduction of salads and public nutrition campaigns are examples of McDonald's efforts to adapt its business model to changing trends in the market.
Commodity Costs can Impact Margins
McDonald's earnings are sensitive to prices of commodities such as beef, corn, cheese and poultry. Since 2005, food prices have increased substantially, but competition has prevented McDonald's from passing costs along to customers. Thus, increasing input prices have come at the expense of margins.
Sensitive to the Dollar
McDonald's is also sensitive to the relative strength of the dollar. Although the company is based in the US, McDonald's does 60% of its business overseas. As foreign currencies strengthen relative to the dollar, goods sold in foreign markets are suddenly worth more dollars back in the US, boosting earnings. On the other hand a strengthening dollar reduces the value of sales from abroad.
Competition
Although McDonald's is the clear leader of the fast food industry in terms of revenues generated and restaurants established, it faces competition from other fast food chains, which are introducing new products themselves.
Major direct competitors in the (hamburger-based) fast food industry include:
- Burger King Holdings is the second largest hamburger fast food chain. Although more of Burger King’s restaurants are franchised than McDonald’s restaurants, Burger King franchise revenues trail behind that of its competitor, mainly due to the McDonald’s size advantage.
- Wendy's is the third largest hamburger fast food chain. It has a lower operating margin that McDonald’s, so it is likely to be more negatively impacted during a recession.
- Yum! Brands runs Kentucky Fried Chicken, Taco Bell, Pizza Hut, Long John Silver’s, and A&W All-American Food Restaurants. Currently, Yum! brands are dominating the China market, posing a challenge to McDonald's attempts to enter the market. While McDonald’s Corporation focuses on its flagship brand, Yum! splits its resources among a wide variety of restaurants.
In addition to the above competitors, McDonald’s also competes with non-hamburger-based fast food restaurants (such as Panera Bread Company (PNRA), Panda Express and Qdoba), local and national dine-in restaurants (such as Red Robin’s and Shari’s), pizza parlors, coffee shops (Starbucks), street vendors, convenience stores and supermarkets.
Market Share
The major players in the fast-food market, which generates around $120B[20] in annual revenues, are: Domino's, Inc.[21], Burger King Corporation[22], Wendy's International, Inc.[23], Jack in the Box, Inc.[24], Yum! Brands, Inc.[25], Doctor's Associates, Inc.[26], and McDonald's Corporation[27]. As can be seen, the fast food industry is somewhat fragmented. The seven major competitors only account for 45% of total revenues.
The Fast Food Hamburger Restaurant industry, on the other hand, is dominated by McDonald's, who possesses approximately 90% of the market share for this component. The FFHR is a $67 billion segment. Burger King is second behind McDonalds with a 4% share of the segment. The QSR segment and FFHR category are extremely competitive because each FFHR restaurant offers similar menus and prices.
References
- ↑ McDonald's Investor Relations- About McDonald's
- ↑ WSJ.com McDonald's Annual Earnings
- ↑ MCD 10-K 2007, Item 7, pg. 11
- ↑ MCD 10-K 2007, Item 6, pg. 9
- ↑ MCD 10-K 2007, Item 1, pg. 3
- ↑ MCD Q4 2007 Earnings Call
- ↑ MCD 10-K 2007, Item 7, pg. 1
- ↑ MCD 10-K 2007, Item 7, pg. 1
- ↑ MCD 10-K 2007, Item 7, pg. 1
- ↑ MCD 10-K 2007, Item 7, pg. 1
- ↑ MCD 10-K 2007, Item 7, pg. 1
- ↑ McDonald's Delivers Strong Second Quarter Results
- ↑ McDonalds reports 8p decline in second-quarter profits
- ↑ McDonald’s July Sales Gain 4.3% on Burgers, Coffees
- ↑ McDonald's August same-store sales rise 2.2 pct
- ↑ McDonald's owners eye Starbucks with McCafe drinks
- ↑ Deutsche Bank Cuts Starbucks to Sell, Says McDonald's McCafe Rollout to Hurt Company
- ↑ Starbucks, McDonald's carve coffee niches
- ↑ MCD 10-K 2007, Item 5, pg. 12
- ↑ Fast Food Industry Abstract
- ↑ Domino's Corporate Website
- ↑ BKC 10-K 2007, Item 6, pg. 36
- ↑ WEN 10-K 2007, Item 6, pg. 44
- ↑ JBS 10-K 2007 pg. 19
- ↑ YUM 10-K 2007 pg. 19
- ↑ Subway's Corporate Website
- ↑ MCD 10-K 2007, Item 6, pg. 9
- ↑ Burger King Company Report
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