Feb 182009

I am sitting here, sipping my free cup of coffee at McDonald’s, looking across the parking lot at the huge going-out-of-business banners strung across the entrance to my local Circuit City store. “I wonder,” I joke with the McDonald’s manager, who I know pretty well, “if they had to pay for those banners up front and in cash?”

A couple of years ago, I wrote about Circuit City’s inability to manage its enterprise risks:

I wouldn’t be surprised to see the company sold in a few years, or at the very least, its top management replaced.

At the time I wrote that Circuit City had decided that it would replace its higher-paid employees with lower-paid ones. Those who were laid off were told that they could reapply for their positions or similar ones in 10 weeks, but at a lower wage. Far from a winning strategy, it turned out to kill what was left of employee morale, and anger the few remaining loyal Circuit City customers. Things just went from worse to impossible after that.

Alas, I was too optimistic in thinking someone would actually buy the chain. Even though much of the executive management was eventually replaced, in these tough economic times the company was unable to find a buyer. Its assets are now in liquidation, and as the banners shout out loudly, everything must go and all sales are final. Within the next few weeks, Circuit City is going to be a faded memory, except perhaps as a trivia entry on Wikipedia and as a mandatory business school case study about how to kill a once prosperous brand.

What strikes me as I sit here is that McDonald’s has faced the same threat several times and yet has managed to adapt, survive, and — most of all — thrive. Few remember that in the late 1980s McDonald’s was struggling, and its demise was being forecast far and wide. The company franchises’ operating income was declining by almost 7% after inflation from previous years, while such rivals as Wendy’s and Taco Bell were growing robustly. Franchise owners were also selling their McDonald’s, believing that if they continued to hold on to them, their investments would soon become valueless.

The reason for the decline was that McDonald’s management was focused on milking a very lucrative cash cow. McDonald’s prices had matched or exceeded inflation in nine of the previous 17 years, making eating at McDonald’s expensive in comparison to its competitors. It also cut staff, which increased service waiting times, something contrary to the idea of “fast food.” The public went along, until it finally had had enough.

To save itself, McDonald’s revamped its menu, increased staff, and upgraded its drive-through window-ordering process and technology to speed service. These changes worked for a while at least and McDonald’s regained a lot of its lost ground — but not all of it.

By the late 1990s, McDonald’s was in trouble once more. Customer fast-food tastes had changed during the 1990s. People wanted healthier foods, as well as foods that tasted better. McDonald’s had also expanded so much that it was often competing against itself. Profitability suffered, as did McDonald’s stock price. To boost its profitability — and its stock price — McDonald’s reverted back to its cost-cutting ways. It scrimped on ingredients by changing long-held recipes, including what was in the “special sauce” on its Big Mac sandwich. It also encouraged stores to reduce staffing levels. In conjunction with its cost-cutting moves, McDonald’s tried to increase revenue by opening up thousands of new stores backed by huge amounts of advertising that focused on promoting sales and new menu items.

The results were disastrous. The McDonald’s new menu items, including pizzas and deli sandwiches, tasted terrible; stores became dirty and unkempt; new franchises cannibalized older franchises’ sales, causing friction between McDonald’s corporate and its longtime franchisees; and the excessive advertising did nothing but call attention to a once-great brand that had lost its way.

In 2003, McDonald’s posted its first quarterly loss, and was considered a place to go to eat only if nothing else was available.

Finally, the company was forced by disgruntled major stockholders to oust its executive leadership and bring in a new team to rebuild the McDonald’s brand from the ground up. McDonald’s examined with a cold eye its complete spectrum of enterprise risks — everything from its special sauce recipe to the number of stores it was opening per year.  It then created a new strategy it called, “Plan to Win,” which it set out to aggressively follow.

Among the things that management decided was to slow the opening of new stores; instead, it spent money upgrading the look of existing stores as well as closing hundreds of failing restaurants — something that it had not done before. It started improving the management of individual stores to make them operate more professionally. The menu was revamped to include healthier food, and the scrimping on ingredients ended. The focus was on offering “hot, high-quality food at a great value at the speed and convenience” that McDonald’s was once known for. Advertising was focused on rebuilding the brand, instead of promoting sales.

Once the plethora of enterprise risks was managed as a complete whole, things completely turned around for McDonald’s. It has seen same-store sales increase for 56 straight months. Stores are cleaner and service is generally faster. It isn’t gourmet eating by any means, but people are no longer ashamed to say they had lunch at McDonald’s. And, accounting for inflation, a family of four can eat there for less than it could in 1990.

McDonald’s is now in the final process of opening higher-end coffee cafes inside its stores to compete directly against Starbucks. Hence, my free cup of coffee — the first of a two-part promotion to attract more traffic to McDonald’s. The current promotion lasts through February — enough time, the company hopes, to get people in the habit of coming to McDonald’s every morning. Another promotion is planned in May, once every McDonald’s is ready to offer espresso-based drinks.

Time will tell whether this latest strategy will be a boom or a bust. But McDonald’s has learned a lesson that Circuit City never did: when you are in trouble, you need to totally and objectively rethink the whole of your enterprise risks: strategy, operational, and financial. Once you do that, you have to implement that new strategy with the aggressive and determined passion that you had when you started the company.

Circuit City, once a brand held in the highest esteem (Jim Collins highlighted the company in his best-selling book, Good to Great), is soon to be no more. I, on the other hand, am going to get another cup of free coffee.


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