Beyond burgers

This article is more than 2 years old.

Walk into almost any McDonald's in the U.S. these days and you'll find something new: Instead of getting a sandwich that's been assembled, wrapped and parked under a heat lamp, it will be custom-assembled for you in just one minute, the bun toasted in exactly 11 seconds instead of being nuked. Want a real treat? Visit one of the stores in the Sacramento, California, area, where the chain is testing a new gimmick called McChoice. You can order your chicken sandwich, and eventually burgers, too, with one of several new baked-in flavors.

McDonald's new Made-For-You marketing is a shameless ripoff of Burger King's Have-It-Your-Way promotion. But McDonald's chief executive, Jack M. Greenberg, doesn't care. Greenberg, 57, a former Ernst & Young accountant who has been chief executive of the firm for a year, is a man who knows how to read numbers.

McDonald's is a powerhouse in foreign markets, which account for half its $36 billion in systemwide sales (includes company-owned and franchised stores) and 56% of its operating profits. Overseas it is gaining huge chunks of business every week, much faster than rival Burger King (see box, p. 30).

But on McDonald's $18 billion home turf, the numbers Greenberg sees are not so rosy. One day--maybe not next year or in five years, but eventually--the Big Mac will flatline in the U.S. The evidence: In the past four years McDonald's has averaged only 1% annual same-store sales growth, trailing the 4% average for its main burger rivals.

The primary reason is that the McDonald's menu is stale. The last successful new product it introduced was Chicken McNuggets, in 1983. Nearly every new menu offering since then has come and gone, with only a burp to remember it by.

Maybe it had to happen. After 44 years as one of America's great growth companies, McDonald's is finally arriving at U.S. market saturation. This year McDonald's will add only 150 new U.S. stores, down sharply from the 1,100 it opened four years ago. The mid-1990s binge angered McDonald's 2,800 franchisees, some of whom saw sales decline by as much as 20% from cannibalization. They were further irked by the operations bosses in Oak Brook, Illinois, who had issued an 80-page directive, called "Franchise 2000," that tied a lot of new and onerous regulations to mandatory store reviews.

Greenberg doesn't need to panic. The company expects to earn a healthy $2 billion this year on $13 billion in store sales and franchise fee revenue. Thanks to strength overseas, earnings should come in at $1.40 a share this year and climb to $1.60 the next.

The slow sales growth and virtual halt to expansion in the U.S. explain why Greenberg is so eager to bring in new customers. Hence the Made-For-You pitch, which Greenberg has been rolling out nationally since late 1998, spending $162 million to put the necessary equipment in every one of the chain's 12,600 U.S. restaurants.

Thus three other key deals in the past 20 months: $10 million for a minority interest in Chipotle Mexican Grill, a popular Denver, Colorado-based chain of 25 Mexican restaurants; an estimated $70 million purchase of Donatos Pizza, a 140-store chain based in Columbus, Ohio; and the estimated $15 million acquisition of Aroma, a stylish coffee-and-sandwich bar in London with 23 outlets.

But before anything else, Greenberg, a self-effacing, amiable schmoozer, has had to fix Oak Brook's formerly ugly franchisee relations, which had fallen into disrepair under predecessors Edward Rensi and Michael Quinlan.

Greenberg threw out the Franchise 2000 rule book and has let the locals have more say in what shows up on the menu. This has turned McDonald's into a variety show: a McLobster Roll in New England, a hot-mustard-laden Homestyle Burger in Texas and, for Ohioans, the Brutus Buckeye Burger.

What does McDonald's bring to pizza or burritos? Like a Dell Computer or a Wal-Mart, McDonald's realizes that success depends not on a superior product but on a superior process. Says Greenberg: "Can we build [Donatos or Chipotle] into global brands? Why not? At the very least it creates more growth opportunities for all our people."

Ray Kroc's true achievement over all those years was to knit his suppliers, employees and franchisees into the world's most efficient ecosystem for feeding people. No-thing is left to chance in a McDonald's kitchen. The 75-page operations manual Fred L. Turner drafted in 1958 has grown into a 4-kilogram, 732-page tome. Every hamburger comes out of a stamping machine weighing exactly 45 grams, with its thickness measured to the thousandth of a centimeter.

Running all of these stores are owners and managers still required to go to Hamburger University either in Oak Brook or one of four overseas campuses. Training at HU and in the field can last for two years before a prospective franchisee gets a store. The raw materials network, run with militaristic precision, is independently owned but entirely dedicated to the Golden Arches.

Greenberg looks at the system Kroc and Turner built and sees it in terms of excess capacity. If it works for burgers, why not try it on some new concepts? "Look, we can sit back and wait for someone else to capture feeding opportunities, or we can do it. We owe it to ourselves to see how we can apply those other concepts globally," says James Cantalupo, McDonald's vice chairman and international chief.

How will the pizza and burrito chains fit in? McDonald's had never acquired another restaurant chain intending to run it. Greenberg was attracted to Donatos and Chipotle because they are proven winners run by entrepreneurs very much in the mold of Ray Kroc--driven, passionate control freaks.

James Grote started Donatos in 1963 with a single pizza parlor. He stuck with only one store for the first 11 years because he didn't trust anyone else to make the pizzas the way he did. Now William Rose, formerly McDonald's station chief of a region between India and China, has been dispatched to become the new chief executive for Donatos. His mission is to take it from a 143-store regional player to a 1,000-store national one.

Early money says there is more potential from Chipotle, which sells things like carnitas burritos, a $4.55 dish of heavily seasoned braised pork shoulder served inside warm flour tortillas with black beans, cilantro-lime rice, cheese and salsa. It appeals to exactly the kind of higher-priced, higher-quality crowd that McDonald's has been missing.

McDonald's has already populated Chipotle with a chief financial officer, chief operations officer, a purchasing chief and several regional managers. The resources are flowing freely. Chipotle will grow to 100 stores by the end of next year, from 17 two years ago.

Greenberg isn't saying so, but the odds are that Chipotle will soon become a 100% owned subsidiary, like Donatos. Chipotle is opening 30 new stores this year, averaging $1.3 million in sales; Donatos will open 35, averaging $930,000.

Together these new outfits would account for 30% of McDonald's U.S. sales growth next year. That doesn't even include the additional revenue from the 23-store, wholly owned Aroma, which plans to add 50 new cafes in the next 12 months, each grossing $720,000.

In Aroma, Greenberg sees a chance to penetrate a business it has been completely missing. At $5 billion, the U.K.'s cold-sandwich market is almost double the size of the burger segment and growing twice as fast. No fears of cannibalization here: Aroma's largely single, health-conscious and female customer-base has a mere 3% overlap with the Happy Meal crowd.

Since buying Aroma in June, McDonald's has installed as its chief executive David Gerrard, the soft-spoken 35-year-old controller from its U.K. subsidiary. He's ambitious, planning on 150 stores by 2002.

And he's already fine-tuning the menu: London rival Pret A Manger was getting higher marks from lunch crowds, since its sandwiches are made fresh in the stores; Aroma's come from a central commissary. So Gerrard made his $3 roast ham sandwiches bigger and will start baking pastries for the morning crowd to make the stores as appealing to the senses as Pret's.

Will the diversification work? Ever the politician, Greenberg is quick to play down the resources being spent on sandwiches and pizza. Why spook the franchisee base and Wall Street into thinking that his attention is being diverted from burgers and fries?

But he needs innovations. Greenberg has promised earnings increases of between 10% and 15% a year over the next three years. Trading at 27 times next year's earnings, the stock doesn't leave much room for stand-pat strategies.
