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McDonalds Case Study(management)

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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McDonalds Case Study(management)

  1. 1. 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
  2. 2. 2 of 32 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
  3. 3. 3 of 32 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.
  4. 4. 4 of 32 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
  5. 5. 5 of 32 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
  6. 6. 6 of 32 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.).
  7. 7. 7 of 32 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
  8. 8. 8 of 32 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
  9. 9. 9 of 32 (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.
  10. 10. 10 of 32 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.
  11. 11. 11 of 32 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
  12. 12. 12 of 32 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
  13. 13. 13 of 32 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.
  14. 14. 14 of 32 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
  15. 15. 15 of 32 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.
  16. 16. 16 of 32 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,
  17. 17. 17 of 32 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.
  18. 18. 18 of 32 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
  19. 19. 19 of 32 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
  20. 20. 20 of 32 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.
  21. 21. 21 of 32 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.
  22. 22. 22 of 32 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
  23. 23. 23 of 32 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).
  24. 24. 24 of 32 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.
  25. 25. 25 of 32 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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