Case 40 Desread’s ‘On January 24, 2007, McDonalds CEO Jim Skinner stated that the total revenue for the fast food chain had risen by 11 percent during 2006 to $21.6 billion. Net profits had climbed by 36 percent to $3.6 billion, These results indicated that the firm had managed to make signi- ficant improvements to its performance since announc- ing its first quarterly loss ever in early 2003. The stock for McDonald’s had risen to almost $45, representing a threefold increase in value since pulling out of a nosedive three years ago. “To state the obvious, McDonald's is on a bit of a roll,” the firm's chief financial officer Matthew Paull told analysts! (see Exhibits 1 and 2 for income statements and balance sheets). Skinner was the second person to take over the com- pany since James R. Cantalupo had died unexpectedly of a heart attack in 2004. Cantalupo had been replaced by Charlie Bell, who also resigned a few months later in order to fight his recently discovered cancer. In spite of these changes in leadership, the firm has continued to push on the turnaround strategy that had been initiated by Cantalupo in order to ad- dress McDonald's lackluster performance. The strategy, commonly refereed to as the “Plan to Win” tried to target ‘various critical areas that needed to be addressed. In fact, Skinner attributed the firm's consistent growth in sales and profits to the successful development of Cantalupo’s early turnaround efforts. Asa result of these, McDonald has ‘managed to achieve 44 straight months of higher same-store sales, Much of the momentum has been generated in the United States, the firm’s single largest market, where new ‘menu items, refurbished outlets, late-night hours and cash- less payments have boosted sales. The firm has also shown some improvement in its sales in Europe, where it had failed to show much growth for several years. But Skinner was acutely aware that the problems at MeDonald’s went way beyond cleaning up restaurants and revamping the menu. The chain has been squeezed by long-term trends that are threatening to leave it marginal- ized. MeDonald’s is facing a rapidly fragmenting market, ‘where changes in the tastes of consumers have made once- exotic foods like sushi and burritos everyday options. ‘Many of its fast-food customers are also looking for food that is healthier and better tasting. Furthermore, competi- tion has been coming from quick meals of all sorts that can be found in supermarkets, convenience stores, and even vending machines, Many analysts believe that MeDonald'’s must con- tinue to work on its turnaround strategy in order to meet these challenges. But they acknowledge that the firm has pushed hard to transform itself, and they are encouraged “Thin case wa developed by rofsio Samal Shamsie, Michigan State Univer, with th estence of Professor Alan B. Ber, ace University. Matec is bee da fom pbishotsouses tobe used fo lass dco, Copyright © 2007 Jamal Stomsie& Alun B. Eisney by the results that it has achieved over the ast three years. “They have experienced a comeback the likes of which has been pretty unprecedented,” sid Bob Golden, execu- tive vice-president of Technomic, a food service consul- taney. “When restaurants start to slide, it really takes a lot to turn them around.” Experiencing a Downward Spiral Since it was founded more than 50 yeats ago, MeDonald’s hhas been defining the fast food business. It provided mil- lions of Americans their first jobs even as it changed their cating habits, Itrose from a single outlet in 2 nondescript Chicago suburb fo become one of the largest chains of outlets spread around the globe. But it had been stum- bling over the past decade (see Exhibit 3), ‘The decline in MeDonald’s once-vaunted service and quality can be traced to its expansion of the 1990s, when headquarters stopped grading franchises for cleanliness, speed, and service. By the end of the decade, the chain ran into more problems because of the tighter labor market. ‘McDonald's began to cut back on training as it struggled hard to find new recruits, leading to a dramatic falloff in the skills ofits employees. According to a 2002 survey by market researcher Global Growth Group, McDonald's came in third in average service time behind Wendy's and sandwich shop Chiek-fil-A Ine. ‘MeDonald’s also began to fail consistently with its new product introductions, such as the low-fat MeLean Deluxe and Arch Deluxe burgers, both of which were ‘meant to appeal to adults. It did no better with its attempts to diversify beyond burgers, often because of problems ‘with the produet development process. Consultant Michael Seid, who manages a franchise consulting firm in West Hartford, pointed out that McDonald's offered a pizza that didn’t fit through the drive-through window and salad shakers that were packed so tightly that dressing couldn't flow through them. In 1998, after McDonald's posted its first-ever decline in annual earnings, CEO Michae! R. Quinlan was forced out and replaced by Jack M. Greenberg, a 16-year veteran of the firm, Greenberg did try to cut back on McDonald's expan sion as he tried to deal with some of the growing problems. But his efforts to deal with the decline of MeDonald’s were slowed down by his acquisition of other fast food chains such as Chipotle Mexican Grill and Boston Market, ‘On December 5, 2002, after watching McDonald's stock slide 60 percent in three years, the board ousted Greenberg, He had lasted little more than two years. His short tenure had been marked by the introduction of 40 new menu items, none of which caught on big, and the purchase of a handful of nonburger chains, none of which helped the firm to sell more burgers. Indeed, his critics say that by trying so many different things and executing them poorly, Greenberg allowed the burger business fo continueExhibit1 Income Statement Cee SCL Rene a 2006 Pd CUR abut) Revenues Sales by Company operated restaurants $16,082.7 $14,726.6 $13,755.2 Revenues from franchised and affliated restaurants, 55037 _ 51059 4838.8 Total revenues 25084 19.9325 18,5940 Operating Costs and Expenses Company-operated restaurant expenses Food & paper Payroll & employee benefits Occupancy & other operating expenses Franchised restaurants —occupancy expenses Selling, general, & administrative expenses Impairment and other charges (credits), net Other operating expense net Total operating costs and expenses Operating income | Interest expense—net of capitalized intrest of $5.4, $49 and $4.1 Nonoperating income, net Income from continuing operations before provision for income taxes Provision for income taxes Income from continuing operations Incame from discontinued operations (net of taxes of $96.8, $04 and $0.7) Net income Per common share—basic: Continuing operations $ 233 S$ 206 $ 181 Discontinued operations 054 001 — Net income S287 $§ 206 $ 1.81 Por common share—diluted: Continuing operations $ 230 $ 203 $ 173 Discontinued operations 053 oot - Netincome S283 $204 Dividends per common share $100 $067 Weighted-average shares outstanding—basic 12340 1,260.4 Weighted-average shares outstanding—diluted 1251.7 1.2742 Souee: MeDowaldExhibit 2 Balance Sheets CS eee ne 2006 ey (in $ millions, except per share data) Assets Current assets Cash and equivalents Accounts and notes receivable Inventories at cost, not in excess of market Prepaid expanses and other current assets Discontinued operations Total current assets Other assets lavestmentin and advances to affiliates, Goodwill net Miscellaneous Total other assets Property and equipment Property and equipment, at cost ‘Accumulated depreciation and amortization ‘Net property and equipment Total assots Liabilities and Shareholders’ Equity Current liabilities Notes payable Accounts payable lncome taxes Other taxes Accrued interest Accrued payroll and other fiabiities Current maturities of long-term debt Discontinued operations Total curront liabilities ‘Long-term debt Other fong-term liabilities Deferred income taxes ‘Shareholders’ equity Preferred stock, no par value, authorized—165. milion shares issued—none Common stock, $.01 par value authorized—3.5 billion shares; issued—1,6606 million shares 166 166 Additional paid-in capital 3,485.0 27202 Retained earings 25,8456 23.5160 ‘Accumulated other comprehensive income (loss) (296.7) (733.1) Common stock in treasury at cost 456.8 and 397.4 milion shares (13,552.2) (10,3736) ‘Total shareholders’ equity 15,4583 15,146.) ‘Total liabilities and shareholders’ equity $290238 $29,988.86 ‘Sextce MeDoald