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Introduction to Management Studies

Exam 2015 – December 2nd 2015


Georg Wernicke & Henrich Dahlgren

BSc in Business Administration and Service Management


Copenhagen Business School, 2015

Group 1
Angelique Navarro –
Anton Moritz
Christian Doest –
Laura Violina Dragan –

Page count
54,917 STU
23 pages
Table of Contents

1. Introduction ............................................................................................................................................ 3

2. Foundation of the firm ........................................................................................................................... 4


2.1. Mintzberg’s Configuration Theory ..................................................................................................
5
2.2. Greiner’s Life Cycle model ...............................................................................................................
7

3. Horizontal and vertical boundaries ...................................................................................................... 10


3.1. Horizontal boundaries ................................................................................................................... 10
3.2. Vertical boundaries ....................................................................................................................... 11
3.3. Transaction Cost Economics .........................................................................................................
12
3.4. Diversification ................................................................................................................................
14

4. Corporate governance .......................................................................................................................... 15


4.1. Agency theory ................................................................................................................................
15

5. Firm strategy and competitive environment ....................................................................................... 16


5.1. Industry analysis ............................................................................................................................
16
5.2. Industry Life Cycle .........................................................................................................................
17
5.3. Herfindahl Index ............................................................................................................................
18
5.4. Porter’s Five Forces .......................................................................................................................
18
5.5. Resource based view ..................................................................................................................... 20
5.6. SWOT Analysis ...............................................................................................................................
22

6. Conclusion .............................................................................................................................................
24

7. References ............................................................................................................................................
26

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1. Introduction

Over the past couple of years, McDonald’s has experienced challenges resulting in a decrease in
revenue and profits. Reports show that the industry McDonald’s operates in, including its competitors,
are seeing a change of demand, shifting toward a healthier segment of fast food. This report aims at
analyzing and accounting for why McDonald’s is declining in revenue, both in their internal and
external environment. It will account for McDonald’s on a global scale, where in specific sections,
such as regarding corporate governance and when discussing the Herfindahl Index (pp. 18), it will
instead focus on the U.S. market for a more precise analysis.

This paper starts by presenting the initial foundation of McDonald’s, as well as the liability of newness
and application of Boeker’s imprinting and traditionalizing forces. From there, Mintzberg’s
Configuration Theory and Greiner’s Life Cycle Model, with accounts of Penrose’ release of managerial
resources, are discussed to show the structural change and the leadership crises McDonald’s has
encountered. Also how there is a clear correlation between Mintzberg and Greiner. Furthermore, the
horizontal and vertical boundaries are reviewed, together with Williamson’s Transaction Cost
Economics. The last analysis section will focus on the industry lifecycle and Porter’s Five Forces,
where also the resource-based view is explored, including the VRIN and SWOT models. Lastly, a
discussion about the concluding findings will be provided.

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2. Foundation of the firm

The liability of newness was not a factor for Ray Kroc in the same way as for many other new
companies (Boeker, 1989; Stinchcombe, 2000). When Kroc joined McDonald’s, the brothers had
already created the initial structure, with the kitchen fitted for mass production, and lower prices than
their competitors (Wilson, n.d.). Furthermore, he had personal experience within marketing and sales
from his time in the restaurant machine supply industry (“The Ray Kroc Story”, n.d.). From the
beginning, Kroc had a vision and strategy for McDonald’s, including high quality food, outstanding
service, cleanliness and value (“The Ray Kroc Story”, n.d.). This vision is still intact today and is
considered as one of the core pillars of McDonald’s strategies and vision (“Hamburger University”,
n.d.).

According to Boeker, three strategic types exist (Boeker, 1989). Arguably, McDonald’s started as the
first mover in the fast-food industry, due to their development of new techniques not previously seen in
the restaurant business, providing McDonald’s with a competitive advantage. Boeker argues that the
companies using the first mover strategy rarely change their initial strategy. However, this is not the
case with McDonald’s, as competitors were quick to utilize the new mass production approach in the
fast food industry, not letting McDonald’s achieve the same advantage of their technology as earlier.
McDonald’s can today be identified as the low cost producer, as they achieve a relative cost advantage
over competitors through economies of scale in both manufacturing and other aspects of their business
which is elaborated in the Horizontal Boundaries section (pp. x).

Other than the strategy types, Boeker mentions that history plays an important role in shaping
company strategy, along with political and cultural conditions at the time of the founding, (Boeker,
1989). Looking at these factors at the time of founding, the U.S. economy experienced high
productivity and high employment rate due to many newly opened factories (Douglas & Nowak,
1977). This increased the amount of people eating out and also the growth of McDonald’s.

Furthermore, the technological environment saw several advancements during the time where
McDonald’s was founded, especially concerning the television. Kroc utilized this to promote and
market through TV commercials, focusing his campaigns toward the youth, and families (Douglas, &
Nowak, 1977, pp. 344-355).

Regarding imprinting forces, several aspects affect the chance of success, including their personal
experience, network, goals and visions (Boeker, 1989). Kroc and the McDonalds brothers all had

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resources within these factors, where for example, as mentioned earlier, the founding brothers had
personal experience with the new technology adopted to their food production. Kroc had prior
experience with sales and marketing, and together they all had a strong vision and goal.

When looking at McDonald’s today we can see that their vision and goal serve as a traditionalizing
force, due to it being sustained through time. Furthermore, the technology of McDonald’s and their
food preparation still revolves around mass production, but doesn’t give the same competitive
advantage as it used to. This led McDonald’s to a change of their initial first mover strategy to the low
cost strategy. As mentioned before, quality food, outstanding service, cleanliness, and values were
early McDonald’s values which remain the same today. McDonald’s still seek to optimize their
customer focus and satisfaction, also supported by their upcoming business restructuring which is
elaborated in coming sections of this paper.

2.1. Mintzberg’s Configuration Theory


Mintzberg’s Configuration Theory, also referred to as Structures in Fives, is a cross-sectional and
revolutionary theory (Mintzberg, 1983). According to Mintzberg, the company will throughout its
lifetime and growth adapt to these configurations, because efficient organizations require a close fit
between contingency factors such as the firm’s size, age, technical system, strategy, environment,
and the congruence hypothesis such as organizational structure (Mintzberg, 1983, pp. 110, & pp.
122). Furthermore, Mintzberg’s configuration hypothesis also states that “[…] effective structuring
requires an internal consistency among the design parameters.”, such as the coordination mechanism
(Mintzberg, 1983, pp. 122). With these hypothesizes in mind, Mintzberg has then combined the
congruence and configuration hypothesizes into a single extended hypothesis; “[…] effective
structuring requires a consistency among the design parameters and contingency factors.”
(Mintzberg, 1983, pp. 122).

Analyzing McDonald’s to find the pure configurations present in their structure throughout time, have
proved difficult. It can be argued that McDonald’s always has had a strong machine bureaucracy with
focus on the company’s ‘technostructure’, with standardized work processes, specialized and
formalized behavior, and functions with a clear level of hierarchy. Furthermore, McDonald’s have
grown into a global business and therefore adapted to the divisionalized structure, with the global
market divided into different divisions, formerly determined by geographical measures. In 2015, these
divisions were restructured into four new ones which, rather than being determined by geographical

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measures, combines the markets of McDonald’s with similar needs, challenges, and opportunities for
growth (McDonald’s Press Office, 2015).

Within this divisionalized form, machine bureaucracy is still present within each division, and
therefore also supports Mintzberg’s statement that a pure configuration is rarely found within a
company. It is because of simplified configurations and theories of such, where real companies are of a
far more complex nature (Mintzberg, 1983, pp. 283-297).

When applying Mintzberg’s configuration theory to McDonald’s, it can be argued that McDonald’s
started out with the “simple structure” configuration, where the founders were managing, controlling
and directing their single Californian restaurant employees through direct supervision and a clear set of
values (“McDonald’s History”, n.d.; Mintzberg, 1983, pp. 157). As they developed their barbecue
restaurant and engineered the first McDonald’s restaurant in 1948, the brothers transitioned into a
partial “machine bureaucracy”, including standardization of work processes and division of labor,
combined with a restaurant engineered for the purpose of efficiency and mass production. They did
however still perform direct supervision of the employees as they only had a single restaurant
(Mintzberg, 1983, pp. 163; Wilson, n.d.).

Ray Kroc joined in 1954 where they afterwards experienced significant growth, and opened their
100th restaurant just five years later (“McDonald’s History”, n.d.). In order to remain efficient, they had
to adapt the “machine bureaucracy” structure due to no longer being able to perform the same control
of quality, or directing all of their restaurants through direct supervision themselves. They had
developed a strong set of standardized work processes, division of labor, formalized behavior and
technology, which supported the mass production vision and would secure the efficiency and quality of
their restaurants through the continuous growth. The changes and growth resulted in need for vertical
centralization of power in order for the restaurant managers to take charge and perform direct
supervision in each respective restaurant. In order to secure the quality of not only their services and
products, but also their managers during this growth, they introduced “Hamburger University” in 1961.
This university focused on developing consistent restaurant procedures with
goals of educating managers through a shared vision of quality, service, cleanliness and value
(Hamburger University, n.d.).

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McDonald’s has later grown into a divisionalized form, with a global market divided into different
divisions, as mentioned in the beginning (Mintzberg, 1983, pp. 215). This is further explored with
Greiner’s Life Cycle, where an analysis of McDonald’s and their current structure is presented.

2.2. Greiner’s Life Cycle model


While it is possible to refer to Mintzberg’s configuration theory to explain the different structures
adopted through McDonald’s growth, it is also possible to refer to Greiner’s life cycle model to explain
the different leadership crisis’s that McDonald’s experienced during the growth of the company and
which factors made their structure no longer efficient to the company. In this section Greiner’s
Lifecycle model will be applied in correlation to Mintzberg’s configuration model (Greiner, 1972;
Mintzberg, 1983).

As stated earlier, Richard and Maurice McDonald started with only one restaurant. This stage exists in
close correlation to Greiner’s first phase, easily compared to the simple structure of Mintzberg’s
configuration (Mintzberg, 1983, pp. 157). During the first phase, the founders experienced growth
through their creative and innovative idea of implementing mass production, known from
manufacturing companies, into the restaurant concept (Wilson, n.d.). During the natural growth of their
restaurant and the addition of franchising with Ray Kroc, it was decided to open up new restaurants in
order to expand the company. This point in time is in correlation to Greiner’s first crisis; the
“Leadership Crisis” (Greiner, 1972, pp. 42). Operations could no longer be managed by the three alone.
They needed staff in not only the food preparation area but also amongst the middle line managers.

In order for this transition to work, a need for vertical power decentralization to the line managers
arose. Also a need for a formal communication system. This is because they no longer could rely on
direct supervision from themselves, or mutual adjustment as the coordinating mechanism. When this
was successfully implemented, the brothers once again experienced a steady growth in the restaurants’
revenue.

As Ray Kroc joined in the 50’s, the growth and expanding of McDonald’s evolved at high speed.
Kroc created franchises throughout the entire U.S. where the second phase of Greiner can be found;
growth through direction with a close resemblance to Mintzberg’s machine bureaucracy (Greiner,
1972, pp. 42; Mintzberg, 1983, pp. 163). The leadership crisis emerging at this phase is called the
“Autonomy Crisis” (Greiner, 1972, pp. 42). The growth of McDonald’s happened with such a speed
that it was necessary for a more formalized and specialized structure of the company to avoid

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information overload of the middle management. Standardized work procedures and a clear division
of labor were created together with the Hamburger University (Hamburger University, n.d.). It was a
school created to centralize and unify management training. It also gave the managers the feeling of
appreciation and control as they were instructed in how to operate the outlets. With these changes to
the structure, McDonald’s was prepared for the next growth period.

Greiner’s third phase talks about growth through delegation, and resembles the divisionalized form of
Mintzberg (Mintzberg, 1983, pp. 215). The divisionalized form is also the current configuration of
McDonald’s operating structure. As McDonald’s grew into a company with a vast global presence, it
was divided into several divisions of diversified markets. In each division they had the same structure,
functions, division of labor and positions which would make it easier for further growth. In this phase
the growth would be determined by delegation of decentralized power to the division managers, which
in return would run each respective market while the top managers of McDonald’s started to focus on
long-term corporate strategy (Greiner, 1972, pp. 43). These released managerial resources
of McDonald’s, allowed them to focus on other investments and growth opportunities (Penrose,
1995).

The growth of McDonald’s with released managerial resources can be exemplified by McDonald’s
investments in several companies such as Chipotle, Donatos Pizza and Boston Market (Capitalcube,
2012). The crisis of this third phase is the “Control Crisis”, which can be argued to be the crisis that
McDonald’s currently is positioned in (Greiner, 1972, pp. 43). The past years of McDonald’s have
shown a negative progression in revenues and profits but in 2015 the newly elected CEO Steve
Easterbrook presented a turnover strategy for McDonald’s where the restructuring of the entire market
divisions plays a major role and the changes implemented by Easterbrook should increase the payout to
shareholders and increase the net G&A savings to $300 million annually. (McDonald’s Press Office,
2015). Easterbrook states in a global press release;
“[…] We will restructure our business into four new segments that combine markets with similar
needs, challenges, and opportunities for growth.” (McDonald’s Press Office, 2015)

It can be argued that McDonald’s currently are trying to partially vertically centralize the power as
Easterbrook is restructuring their business for a more customer based focus (McDonald’s Press Office,
2015). Looking at Greiner’s Life Cycle model and his definition of the control crisis, companies
might seek to control the entire company to overcome this crisis of control, but in the end they must
still decentralize decision power; those who do this will be able to progress into the next growth
phase

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(Greiner, 1972, pp. 43). Patterns following Greiner’s model and how to overcome the control crisis,
can be seen in McDonald’s behavior. During the newly customer focused restructure of the divisions,
Easterbrook has formulated a plan to decentralize power to each division, increase the accountability
of management and hopefully including faster decision making.

Furthermore, Easterbrook talks about the restructure and how it will be supported by streamlined
teams. These will consist of fewer layers, less bureaucracy, and focus on positioning their
management talent within the new structure, in a way that capitalizes their skill sets. It will again
strengthen the autonomy of each division (McDonald’s Press Office, 2015).

Greiner’s Lifecycle model includes two additional phases which McDonald’s not yet has reached.
Overcoming the control crisis will, according to Greiner, allow McDonald’s to grow through
coordination. The leadership crisis of the fourth phase is the “Redtape Crisis” (Greiner, 1972, pp. 43).
Even though McDonald’s has not reached this phase, it is still possible to identify certain elements of
this crisis within the corporation. Some franchise owners have expressed trust issues and frustration
toward McDonald’s leadership, including complaints about the new menu upgrades and how they are
bankrupting them, and that they will further complicate an already oversized menu (Peterson, 2015).
Richard Adams, a franchise consultant who have worked for McDonald’s more than two decades
stated;

"They are going in a bunch of different directions and trying to be all things to all people. That's been
their problem for the last five or six years." (Lutz, 2015)

The final phase of Greiner is “Growth Through Collaboration” (Greiner, 1972, pp. 43). As stated
earlier, McDonald’s has not yet evolved through phase four and thus cannot be recognized with this
phase either. Although some main characteristics of this phase consist of; combined teams across
functions, the headquarter staff experts are reduced in numbers and then reassigned into teams to
begin consulting with the field units rather then directing them (Greiner, 1972, pp. 43 – 44).
What have become very evident while analyzing the development and growth of McDonald’s, which
is also formulated by Mintzberg, is that a pure configuration and the appliance of the Life Cycle model
can not be applied with a perfect match to a given company. Hybrids will emerge and different patterns
will be analyzed depending on the company and its history.

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3. Horizontal and vertical boundaries

3.1. Horizontal boundaries

Economies of scale
Through more than their 36,000 worldwide restaurant outlets, McDonald’s achieve economies of scale
on several aspects of business. McDonald’s achieve economies of scale at the firm level through high
production capacity and bulk purchases as mentioned under the second key benefit; higher profit
margins. This will result in lower per unit costs as the fixed costs will be divided through a large
production as mention in the first key benefit; increased market share.

Furthermore, they achieve economies of scale at the restaurant level. This is achieved through the
division of labor, improving their effectiveness, and through the more products and services can be
processed in the same time span (McEachen, 1997).

They also achieve economies of scale on areas such as their advertising and their R&D, but these two
will be elaborated further in the resource based view section, under the VRIN-model (pp. 20). The
accumulated experience and knowledge gathered by McDonald’s from decades of hamburger sales
and service development is shared with their centralized and standardized training programs.

Economies of scope
It has two key benefits to firms;
1. Lower average costs: where McDonald’s has diversified its product line into a range of
multiple offerings, such as burgers, fries, shakes and salads. This allows them to achieve a
lower average cost per unit by spreading their overall bulk costs across their product lines.
Lower average unit costs also allow companies to enjoy higher profit margins on each
product sold, and also lower the price charged to customers to increase market share
(“Economies of Scope”, n.d.). In order to maintain their brand value and global market share
of >50%, McDonald’s has achieved economies of scope, succeeding in higher profit margins
and lower retail prices (Euromonitor International, 2013).
2. Diversified revenue streams: often achieved by acquiring other firms in order to extend a
firm’s current business and market portfolio. McDonald’s major revenue stream is divided
onto their products, franchising real estate and through their external McCafé outlets.

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A clear example of economies of scope is the example of McDonald’s breakfast. Until the 1970’s
McDonald’s did not fully utilize their real estate capacity. This was because McDonald’s did not serve
breakfast at this point in time and therefore would not open for service until later in the day, resulting in
many hours of zero productivity.

Because of McDonald’s global reach, it is of utmost importance for them to take cultural differences
into consideration (McEachern, 1997, pp. 162-163). In certain areas of the world, regular hamburger
and fries do not appeal to the public, and the need for product development is needed (Table 1.1.,
Appendix A). Corporate McDonald’s is in charge of developing and marketing these new products on
a global scale. Taking advantage of the same technology and knowledge to create new menus support
McDonald’s achievement of economies of scope (“Franchising at McDonald’s”, 2008).

3.2. Vertical boundaries

Supply chain management


McDonald’s use a vast supply network all over the world, with different suppliers in each region.
There are possibilities for them to use global suppliers, with many of their current local suppliers
acting global as well, except McDonald’s is a huge promoter of locally grown produce and
sustainability. From the start there have been strict rules, and sort of the supply mantra of
McDonald’s, which the suppliers have to live up to; quality, service and cleanliness (QSC). They
have again and again been honored as being one of the highest and best kept standards of the fast-
food industry (“Meet our Suppliers”, n.d.).

In areas where they have troubles finding an adequate enough supplier, they build their own network.
When McDonald’s were planning on extending their global franchises to the Indian market as well,
they worked for seven years to build a supply network and engineer a cold chain from scratch
(Euromonitor International, 2013, pp. 11). They trained local farmers to live up to the expected
standards in correlation to QSC, pioneered farming methods for the Indian climate and worked with
distributors to develop new storage facility techniques. This mindset and vision gave McDonald’s
access to markets that previously were unreachable to competitors (Euromonitor International, 2013,
pp. 10).

For two years in a row, McDonald’s has been chosen as the world’s second best supply chain, just
after Amazon (Gartner, 2015). Their largest distributor, Martin-Bower LLC, has the challenge of

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delivering supplies for McDonald’s 15,000 outlets in North America. Martin-Bower LLC together with
McDonald’s other suppliers face and must live up to McDonald’s three E’s of supply; ethical-,
environmental- and economic responsibility. Factors for them being one of the world leaders are mainly
because of their chain transparency which were further achieved with the 2013 UK horse meat scandal
including Burger King, Pizza Hut and Taco Bell. The UK government performed a review of the whole
industry, where it showed that McDonald’s was one of the few major fast-food chains whose tests were
negative for horse meat (Elliot, 2014, pp.110; Posel, 2013; University Alliance, n.d.).

Vertical Integration
Traces of both forward and backward vertical integration can be seen when looking through
McDonald’s vertical integration. As mentioned in the supply chain, McDonald’s has a very close
partnership with their suppliers. This partnership is based on trust, in which McDonald’s entrust their
raw materials being handled according to their demands (“Meet our Suppliers”, n.d.). McDonald’s has
very strict guidelines and demands that in order to fulfill these requirements, the suppliers and
McDonalds need to work in close collaboration. Which means that McDonald’s has a great power
over the suppliers, however since they are not fully integrated into McDonald’s company, they still act
as an independent company (McDonald’s Supplier Code of Conduct, 2012). Since McDonald’s have a
close relationship with their suppliers the transactions have a high frequency, this reduces that chances
of the supplier acting opportunistic for the reason of them handling with big amounts of quantities. It
can therefore truly be argued that there is to some extend traces of partially backward integration. Such
partnership could in such case be considered as a hybrid of backward vertical integration

3.3. Transaction Cost Economics


Transaction cost economics seeks to explain the governance of transactions. The theory consists of
three C’s; contact, contract, control and some dimensions such as the asset specificity associated with
the production such as technical specificity, the complexity of the task and the frequency of the
transaction. The combined cost of these three factors and the dimensions mentioned will help
McDonald’s decide what is the optimal transaction. The assumption of human behavior within this
theory, is that people are bounded rational and opportunistic (Williamson, 1979).

Transaction cost applied to McDonald’s consist of the fact that they must calculate and estimate
transaction cost’s in every action they make in order to maximize their profits. If the cost of buying
from suppliers is higher then the costs of producing the materials themselves, then they will choose

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to vertically integrate this function in their supply chain. If it is not, then they will buy from the market
instead. This means that McDonald’s needs to make several “make or buy” decisions. So looking at
the fact that McDonald’s use suppliers, they have estimated that the cost of using suppliers is lower
then vertically integrating the function (Williamson, 1979).

An example showing that companies can choose sub-optimal transaction costs over a period of time
as an investment, can be found when McDonald’s were planning their Indian market venture. As
earlier stated, it took them seven years to train Indian farms and farmers, and develop new techniques
appropriate to the culture and market landscape (Euromonitor International, 2013, pp.
10-11). The question arises on whether or not McDonald’s made the right decision considering they
did not choose the optimal transaction costs. McDonald’s could have penetrated the Indian market
using company-owned and company-staffed farmers instead of training locals to do the same.
McDonald’s have an overall focus on sustainability and locally grown products which is why they
chose not to use company owned and company staffed farmers. Even if McDonald’s transaction costs
might have been bigger when assisting in developing India and the agriculture, it has still benefitted
McDonalds’ overall brand. Furthermore, this involvement in India allowed McDonald’s to be the first-
mover in an untapped market which therefore made it possible to achieve the market leader position
early on.

India is a market where McDonald’s has gained more than 12% market share, making them the
country’s market leader, against well-known competitors such as Yum! Brands and Domino’s Pizza
(Euromonitor International, 2013, pp. 32). With half of the country’s population being under 25 years
old, McDonald’s has positioned themselves as a popular youth chain toward the usual culture of
independent restaurants. With a CAGR of 16%, a large youth population, the current brand image
positioning and the massive market size, combined with low foodservice spending, India has become a
major focus for McDonald’s (Euromonitor International, 2013, pp. 33). Some investments, such as
making all-vegetarian outlets and continuously ensuring that the agricultural industry lives up to
McDonald’s QSC values, can inflict higher transaction costs. However, viewing McDonald’s
otherwise globally high revenue and profit margins together with their large financial assets, allows
them to support these sub-optimal transaction costs, and see them as an investment in India, in order to
retain their brand image and attraction in the country.

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3.4. Diversification

Diversification pattern
In order to diversify its portfolio and extend their successful franchise development, McDonald’s
bought a major share in the Mexican “fresh-food” firm, Chipotle, in 1998. By 2005 McDonald’s
controlled a 90% share in Chipotle and had helped them grow from 14 locations to 500 (Peterson,
2015). One year later the companies parted ways, due to multiple disagreements from Chipotle’s
side.

Other than this, McDonald’s diversification is no longer focused on acquiring other businesses or
ventures, but more specifically on geographical and product diversification. Besides their own fast-
food (or as McDonald’s calls it, ‘informal eating out’), McCafé, their in-house or separate coffee shops
focused on beverages and pastries, plays a major role in McDonald’s diversification (Jones, 2014).

High-margin specialty coffee- and espresso-based drinks are a major part of McDonald’s’ continuing
growth strategy. Through its McCafé outlets, the company competes in specialist coffee shops in
many markets, either through dedicated outlets or defined areas in existing stores (Jones, 2014). Jones
also argues that the McCafé format has played an integral role in helping McDonald’s compete for
specialist coffee shop demand; the fastest-growing global category.

With the launch of McCafé back in the 90’s, McDonald’s was able to tap into the $17B specialist
coffee shops market, with Starbucks as one of the major competitors, and the $1.3B market of
juice/smoothie bars. Now accessing two pools of demand that were non-existent and previously
unsupplied by the major fast-food vendors (Euromonitor International, 2013; Magee, 2011). Since
then, many other fast-food chains have taken after McDonald’s initiative in this matter, and are now
competing for the coffee, smoothie and juice shares in the market.

Even though McDonald’s overall sales has been in decline the past couple of years, McCafé’s global
share has been increasing immensely throughout 2007-2012 and is now well-placed in the market to
take on the top two category leaders, Starbucks and Costa Coffee (Euromonitor International, 2013).
While McDonald’s definitely is taking on Starbucks on the US market through their McCafé beverages,
they do not operate any stand-alone outlets. Outside the US however, McCafé has successfully grown
to a genuine global competitor. They claim a 10% value share in western Europe, and a 20% share in

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Australasia, where it actually outranks Starbucks nine times over. Globally seen, McCafé has a chain
value of 3.2% (Euromonitor International, 2013).

Diversification analysis
By using the Ansoff Matrix model (figure 1.2, Appendix A), we can identify McDonald’s
diversification development over time. When it came to their products, McDonald’s used to be rather
persistent, focusing on their core product lines. At the same time, they kept to their existing markets,
meaning they pursued the strategy of market penetration.

When reviewing McDonald’s today, it shows that they are continuously trying to change their
products through their immense achievement in economies of scope. Their menu is no longer
persistent. Most importantly, they are still operating in the same industry as they always had, but
with some product line variations. When identifying their current strategy, we can conclude that they
pursue product development.

However, when assessing their future strategy there are signs of diversification. Especially with their
McCafé success and their healthy food alternatives. In theory this leads McDonald’s to a new market,
taking them away from their inherited cheap fast-food. Yet if they changed their product focus in such
way, this might affect their strategy from product development to diversification. Particularly to
concentric diversification where new products are introduced to new target groups, but still share
technological similarities to current products. This also have coherence with the fact that the fast
food industry is experiencing a shift in demand from the customers. The demand is shifting to a
broader focus on healthier fast food, which have also been the theme of several of McDonald’s new
product developments.

4. Corporate governance

4.1. Agency theory


Within corporate governance, agency theory is based on the concept of the principal-agent
relationship to understand the links between agents and principals (Grossman, & Hart, 1983).
McDonald’s is listed on the New York stock exchange, including a corporate structure with various
stakeholders (New York Stock Exchange, n.d.), primarily the shareholders who act as the
principals, the CEO as the agent, and the board of directors as the body.

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When different interests arise between the principal and agents, it can eventually cause
miscommunication and disagreements, which in turn may be a source of internal conflict. In
McDonald’s case, the former CEO, Don Thompson, presented in 2014 a restructure agreement for the
U.S outlets, as a solution to the declining sales. This inflicted badly with the shareholders who argued
for it being a sub-optimal plan, and argued that Thompson was acting opportunistically and not taking
the shareholders’ interests into consideration (Jargon, 2014). This drove a wedge between the
stakeholders, caused inefficiency, and if not solved could have turned into even more financial loss. It
had evolved into a classic principal-agent problem; which companies should seek to minimize through
solid corporate policy (Grossman, & Hart, 1983). It is also why the shareholders demanded a
replacement of Thompson as CEO, letting the board of directors elect a new one (Baertlein, 2015).

This is where corporate governance plays a major role where it is used to change the rules under
which the agent operates in, and to realign the principal’s and agent’s interests. Incentives are often
created, with the ones encouraging wrong behavior must be removed, and rules discouraging moral
hazard have to be in place (Grossman, & Hart, 1983).

Doeringer and Piore argues for the market being divided into a primary and secondary market in their
paper “Internal Labor Markets and Manpower Analysis” (1970). Those in the primary market are
usually compensated in correlation to their performance, while the ones in the secondary market are
compensated according to market standards. When applying agency theory onto McDonald’s restaurant
outlets instead of corporate McDonald’s, and especially the 57% of outlets that are global franchises
(“Company Profile”, n.d.), the principals can now be seen as the franchise managers and the franchise
employees as the agents. Additionally, the compensation in the divided markets, which Doeringer and
Piore talks about (1970), now exists in close correlation to where the managers are compensated on a
level with the franchise performance, while the employees are compensated in order with, for example,
the U.S. minimum wage.

5. Firm strategy and competitive environment

5.1. Industry analysis


In McDonald’s case the industry they operate in is defined as the “fast-food industry.” The industry is
also known as quick service restaurants which is defined as delivering food in a short period of time.
The main competitors in this industry are on the same global scale, containing companies like Yum
Brands, who owns the well-known restaurants such as Pizza Hut, Taco Bell and KFC. In a lower scale,

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McDonald’s competes against local food service companies, even including local hotdog stands or
pizzerias.

The industry is experiencing a change in demand. People are more health-oriented today and are
conscious about what they consume (Beck, & Schatz, 2014). This trend is triggered by the millennials,
who prefer cheap and convenient food but are willing to pay extra in order to get fresh and healthier
food (Hoffman, 2012). This trend has influenced the fast food industry that serves unhealthy food for
inexpensive prices. Looking through the fast food industry McDonald’s are one of the companies who
have been significantly influenced by this change in preference (Choi, 2015).

This change in preference in the industry was the ending of a 30-year streak of continuous growth for
McDonald’s, as they had their first decrease in system wide sales from 2013 to 2014 (“Regional
revenue”, Appendix B; Euromonitor International, 2015). In correlation to this McDonald’s has tried to
adapt to the new preferences, which has resulted to the identity crisis of McDonald’s.

5.2. Industry Life Cycle


McGahan explained that an industry goes through a lifecycle of four phases (McGahan, 2004). The
fast-food industry’s current position in the lifecycle model is the third phase, the maturity phase. The
industry is undergoing a change where consumers are demanding less unhealthy food and healthier
alternatives (Olinga, 2014). The industry has been positioned in this phase for some time and even
though the industry is experiencing changes, it still grew by 3% in 2014 (Euromonitor International,
2015). The companies in this industry are no longer differentiated from each other regarding neither
technology nor product lines of burgers and fries. Customers can easily navigate between various
fast-food restaurant brands based on their price and quality. Brands focus on differentiating
themselves through process innovation and product diversification, which helps identifying the
maturity phase.

A limitation of the lifecycle mode is when the environment is of a more complex nature. Meaning that
when applying the life cycle model, McDonald’s industry needs to simplified. Thus, the lifecycle
model shall be used on the fast food industry with focus on only the companies that are franchising.

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5.3. Herfindahl Index
In Appendix A (Figure 1.3), the Herfindahl Index has been calculated and compared between 2011
and 2014. In 2011, McDonald’s’ U.S market share peaked, while the most recent number found was
from 2014. What this calculation shows is how McDonald’s has experienced a decrease in market
share. This can be related to many factors, including an increase of number of competitors in the
industry. It is supported by the HHI decrease from 3.244,95 to 2.777,07 furthermore when an index
exceeds 2.500 points the market is considered highly concentrated. From 2014, the lower HHI and
market share is due to that McDonald’s experienced their first annual decrease of domestic system-
wide sales. This was the first time in 30 years of business (reference found in conclusion section).
What can be concluded after analyzing the findings, the industry of fast food is developing into a
more competitive environment with an increase of smaller competitors competing for shares of the
market.

5.4. Porter’s Five Forces

Threat of new entrants


The first force discussed in Porter’s model is the threat of new entrants (Porter, 2008). When looking at
this force, one of the factors which needs to be assessed are the entry barriers. The most common
element to consider is the capital requirement when entering this specific industry. One could argue
that in order to open a restaurant you will need various types of resources, such as knowledge, skills
capital etc. However, compared to other industries, opening up a place where you can prepare and sell
food does not require large financial resources (Marketline, 2015), hence the low entry barriers of this
industry. The barriers are therefore not that substantial for new players, making it relatively easy to
enter the industry. In this case the threat of new entrants is therefore set to be high.

Buyer bargaining power


Following the threat of new entrants is Porter’s second force; the power of the buyers. Porter argues
that if the industry’s product or service is standardized or undifferentiated, then buyers could always
find equivalent products other places (Porter, 2008).

McDonald’s operates in an industry where there are numerous players who offer more or less the same
service and products, meaning customers have several other alternatives and can therefore afford to be
price sensitive. The customers can easily be reluctant to spend their money other places if they are not
satisfied. This grants the buyers a certain power to demand “more for less” because of

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the low switching costs that they now have. Thus, the power of the buyers in this industry is very high,
because of the saturated market with many players.

Supplier bargaining power


Another force discussed in Porters five forces is the power of suppliers (Porter, 2008). McDonald’s
operates in an industry where there are countless suppliers competing against each other. The
switching costs in such industry tend to be lower because of the voluminous suppliers. As mentioned
earlier, under the vertical boundaries (pp. 11), McDonald’s is very big promoter of locally grown
products and although there are numerous suppliers, there are still local guidelines and corporate
policies, which needs to be fulfilled in order to be a supplier of McDonald’s (“Meet our Suppliers,
n.d.). This factor increases the power of the supplier, as they need to meet certain requirements.
The products supplied are very similar, however as mentioned above, the suppliers need the meet
certain requirements which not all can fulfil which results in the bargaining power of suppliers being
moderate.

Threats of substitution
The threat of substitution is the fourth force in the model (Porter, 2008). As mentioned earlier, the
fast food industry consists of many players, increasing the threat of substitutions. Therefore,
customers can easily find other alternatives to meet their demands, making it important for firms to
consider the substitutable products of their industry. Where some fast food guests eat out for the
experience’s sake, others might do it because of lack of cooking skills. In such case, other methods
could easily be substituting the need of eating out. When discussing substitution, it is therefore not
only other restaurants in the fast food industry that can act as a substitution, but also home cooking
and other entertainments such as going to the movies or a bar (Marketline, 2015). Based on these
arguments, the threat level of substitution is rather high.

Competitive rivalry
Assessing the findings of the other forces, will confirm whether the competitive rivalry is high or low.
The low entry barriers will attract new entrants to the industry, thus increasing the numbers of
competitors. This leads to buyers having many alternatives, giving them an advantage when
discussing bargaining power. The suppliers have a moderate bargaining power. The suppliers offer
undifferentiated products with low asset specificity, but the strict requirements of McDonald’s has
lead to an increase in their power, as only a limited amount of suppliers can meet these

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requirements. It can therefore be concluded that McDonald’s operates in an industry where there are
numerous competitors, where the homogeneity of the products is rather high.

According to Porter, price competition is more likely to occur when products or services of rivals are
close to identical and there is few switching cost for buyers (Porter, 2008). It can be concluded that the
fast food industry, in which McDonald’s operate, is very price competitive. The difficulty in such
industry is that rivals compete on the same attributes, hence turning the competition into a zero-sum
competition (Porter, 2008).

Throughout the analysis and appliance of porters five forces on the fast food industry, It can be
concluded that the competitive rivalry is very high, not only within the industry where they are
competing against incumbents but they also compete against companies from other industries.

5.5. Resource based view


Within the resource-based view a company is seen as resourceful and each firm has different kinds of
resources and capabilities, which can be used differently due to various perspectives., also called
resource immobility. The theory can be used to assess the competitive advantage of a given firm by
analyzing a resource through the VRIN-model (table 1.5., Appendix A).

Brand
The brand of McDonald’s is the biggest strength, which they possess. The arguments for it being an
advantage for McDonald’s is further explained in the SWOT-analysis.

“The hamburger assembly line”


The VRIN – model have, on this specific resource, been used to compare the competitive advantage of
the resource from back when the company was founded and the resource in the present. This is
presented in order to show that while earlier it was a competitive advantage, whereas it might not be an
advantage today.

Back in the day when Richard and Maurice opened their first McDonald’s restaurant they wanted to
introduce the concept of mass production, like it was known from the manufacturing industry
(Wilson, n.d.). This was an unseen feature in the restaurant business, and the implementation of a
small menu of 9 items from an earlier 25 items and a kitchen specially designed for division of labor,
allowed the brothers to reduce the price for a hamburger to ¢15 from ¢30.

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They were the first to introduce this concept and it gave them a huge competitive advantage, not only
could they lower the prices, but it also improved their efficiency allowing them to serve their customers
faster.

Today this “hamburger assembly line” or more known as division of labor is widely copied throughout
the competitors, and it might prove hard to find anyone not utilizing this way of production. Therefore,
what was earlier a huge competitive advantage for McDonald’s through knowledge and know-how,
have now been learned and implemented throughout the industry and can no longer be seen as a
competitive advantage.

Economies of scale
McDonald’s have successfully achieved economies of scale in many aspects of business, as mentioned
in the vertical boundaries section in this report. McDonald’s economies of scale can be considered a
competitive advantage, and maybe even sustainable competitive advantage; McDonald’s have
economies of scale advantages compared to other economies of scale companies regarding both
advertising and R&D (McEachern, 2012, p. 162). McDonald’s have more then 36.000 locations world
wide, and are the second largest franchise globally only beaten in size by Subway (McDonald's
Franchise Cost & Fees, n.d.).

When McDonald’s choose to advertise at e.g. the Olympic games, all of the costs associated to this
advertisement would be split throughout the 36000 locations and therefore minimize the costs for
each of the restaurants. Besides Subway, the closest competitor in size is KFC with close to 19.000
franchises, not only is the cost divided through almost double the amount of locations, furthermore,
McDonald’s have a bigger chance of have having a restaurant close to the people seeing the
advertisement.

The same thoughts apply to the R&D part of McDonald’s which is exemplified in the economies of
scale section of the report (McEachern, 2012, p. 162). They use a huge amount of money on research
& development and the improvements of processes and production techniques etc. The costs of this
R&D department is also shared throughout the entire company and franchises. This allows
McDonald’s to develop new and improved techniques and processes. Afterwards McDonald’s are able
to share the knowledge with all of their franchises, resulting in increased efficiency at a lower cost
compared to what minor franchises can manage.

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5.6. SWOT Analysis

Strength: Strong value brand


The McDonald’s brand is considered valuable and also one of their greatest strengths; it is well
established and recognized globally. It is one of the world’s most valuable brands and the only
restaurant in the top ten brands worldwide (Badenhausen, 2015). It has a brand value of more than
$81 million, making it the highest valued one in the fast food industry (Statista, 2015). Their strong
brand value has made them the market leader with a market share of 17% in the US (Jones, 2015).

According to this paper’s VRIN model (pp. 20), the McDonald’s brand can be considered rare, as
everyone knows what it is and what they stand for. More specifically their ‘golden arches’ logo and
standardized products, where customers can expect the same products and price levels offered
regardless where they are in the world. These qualities have sustained throughout the years, leading to
building an even stronger brand for McDonald’s.

Weakness: Brand name associated with negative and cheap food


Even though the brand name is one of McDonald’s greatest strengths, it is also one of the main
weaknesses. This is caused by the associations that the McDonald’s brand may have. Many consider
the products of McDonald’s being unhealthy and of poor quality (Sutton, 2015). This can further
restrict McDonald’s possibilities regarding diversification towards healthier food as an initial
impression can be hard to change.

Widespread documentaries and books such as “Super Size Me” and “Fast Food Nation,” show
consumers the effects caused by McDonald’s unhealthy food, as well as reveal previously uncovered
parts of their marketing strategies and manufacturing process. Due to McDonald’s vast size and
impact, they are often the fast-food chain to take the blame, regardless of whether or not the industry
competitors act and operate similarly. Because of this, there is undeniably a perception that
McDonald’s food is bad for you (James, 2014).

Opportunity: McCafé
The product diversification of McDonald’s has allowed them to explore other markets, where McCafé
was the result of McDonald’s initial diversification growth strategy. This successful action has not
helped McDonald’s with their declining fast-food sales, but rather their rising in-house or external
specialist coffee and pastry sales (Euromonitor International, 2013, pp. 21). Furthermore, McCafé’s

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continuous growth can also be linked to the large groups of youths that now see it as a popular place
to go (FlorCruz, 2014).

Threat: Intense competition


Out of Porter’s five forces it was concluded that the overall competitive rivalry was high. The intensity
of competition between other fast-food restaurants and other substitutes are increasing significantly.
New markets are emerging and threatening McDonald’s which can be seen in their decreasing revenue.
Furthermore, it correlates with the declining Herfindahl Index between 2011 and 2014, indicating that
the fast food industry is getting more competitive (“Total Revenue”, Appendix B;
Figure 1.4., Appendix A; Kasperkevic, 2015).

Threat: Changing preferences


In developed markets such as the U.S. and Europe, a changing trend of consumer preferences towards
healthier and better quality meals can be identified. The youth who once saw McDonald’s as a popular
place to go, are now replaced by the millennials, who instead prioritize the quality and healthiness of
the food higher than the price and convenience. Reports surveyed by the Consumer Reports National
Research Center show that restaurants are a major part of the social structure, where people prefer to
spend more money on quality meals than spending less on worse quality (Consumer Reports National
Research Center, 2011; 2014).

This trend correlates to the U.S. personal disposable income which has increased with more than
$1,500 billion from Q1 2013 to Q3 2015 (U.S. Department of Commerce, 2015). Overall, people have
more money to spend, making lesser quality fast-food chains such as McDonald’s less appealing,
whereas food chains featuring healthy and high-quality food, including Chipotle and Chick-fil-A,
become more popular according with the trends (Consumer Reports National Research Center, 2014).

This is where the weakness of having one of the world’s strongest brand images shows. While
McDonald’s tries to product diversify in order to keep up with the changing trend, they are restricted
by the inherited values and brand that consumers associate with low quality fast-food (Euromonitor
International, 2015, pp. 6).

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6. Conclusion

Referring to the problem formulation, it can be verified that the overall demand of the industry is
shifting from unhealthy fast food towards a healthier segment. Due to McDonald’s being the second
largest fast-food chain in the industry, this consumer preference change has significantly influenced
McDonald’s and their revenue. McDonald’s had their first decrease in system wide sales from 2013 to
2014 (“Regional revenue”, Appendix B; Euromonitor International, 2015), ending a 30-year streak of
continuous value growth.

Together with the findings of the report, it can be concluded that the fast-food industry is experiencing
a change of preference towards a healthier fast food alternative. As seen in the industry analysis, it is
positioned in the maturity phase, with a 3% industry growth in 2014, but at the same time,
McDonald’s is one of the companies experiencing a decline in revenues.

From the report, several factors can be identified as contributing to this decline; one being that
McDonald’s is experiencing an identity crisis. They announced simplification to their product line,
even though they keep increasing customization possibilities. They seek to offer cheap and affordable
products, yet they still offer menus with more expensive gourmet foods to meet the shifting
demands.

What can be seen is McDonald’s failing attempt to diversify themselves from their classic standardized
menus, introducing healthier gourmet food. As discussed in the SWOT analysis, the McDonald’s brand
image is a huge factor to this, where the brand serves as both one of their greatest strengths, but also as
their greatest weakness in the shifting industry. Their brand is associated with cheap, affordable meals
of unhealthy context. This has been the case ever since the first McDonald’s opened in 1948, and
therefore the change of preference in the industry is hard to accommodate by McDonald’s. People’s
impression of McDonald’s is something they have inherited, and is proving very hard to shift the
thoughts of McDonald’s to healthier associations.

As an answer to the declining revenues, Steve Easterbrook was picked as McDonald’s new CEO in
early 2015. One of his first acts as CEO was to announce a transformation of the business model in an
attempt to regain lost revenue and profits. Easterbrook’s restructuring plan will focus on consumers
and lower the amount of corporate owned outlets to 10% by 2018, while increasing the number of
franchises, which provide a more stable and predictable income. Furthermore, the changes should
increase the payout to shareholders and increase the net G&A savings to $300 million annually.

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Finally, the reasons to McDonald’s decline in revenue is of both internal and external factors. The
industry’s demand is shifting to healthier alternatives, and McDonald’s has unsuccessfully tried to
shift their products in correlation with it. The severe attempts to accommodate market demands
have furthermore frustrated the franchises who have shown trust issues toward McDonald’s
management, stating that the constant product changes which deviate from the original standardized
are ruining them. Easterbrook’s job is now to reunite the franchises, regain their trust and share
McDonald’s mission, vision and goals once again.

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