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McDonald’s flips fortunes with back to basics approach

Steve Easterbrook, CEO McDonald, poses with Ronald McDonald.
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Steve Easterbrook, CEO McDonald, poses with Ronald McDonald.

It is the "dead zone" lull between lunch and dinner, yet McDonald's is bustling with customers tapping their orders on huge screens. The Chicago store is acting as a blueprint for an overhaul of the world's biggest fast-food chain in its biggest market. A glass case displays freshly baked apple pies and croissants. Smiling employees, dressed all in black, carry trays of burgers and fries to minimalist tables. "It doesn't even smell like a McDonald's," says a colleague.

When asked why he is spending $2bn to remodel thousands of US restaurants to mimic this one, Steve Easterbrook, McDonald's chief executive, is interrupted by a customer who asks for his Instagram handle. "You have IG, right?", he shouts, waving his iPhone. He is an aspiring photographer looking for social media followers, and his question answers mine — this is the consumer the 62-year-old burger chain is chasing.

Mr Easterbrook, a soft-spoken British accountant, has worked at the fast-food chain the more than two decades. He took over in 2015 charged with reviving its reputation and regaining some of the half a billion customer orders it had lost in the US since 2012 and made it his mission to reinvent McDonald's as a "modern, progressive burger company".

It is a phrase he used with investors when he first took the top job a month after the company reported its first annual drop in same-store sales in the US in 12 years. At the time observers declared the company, which helped define American diets, had lost its identity. Mr Easterbrook repeated the words throughout subsequent earnings calls.

"That was sort of their North Star," says Sara Senatore, an analyst at Bernstein. A former employee is more blunt, describing it as a "cliché phrase" that could mean "anything and everything".

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However vague the plan remains, it does appear to be working. It is a challenging time for the US restaurant business. The industry has seen "little to no" growth in visits to restaurants in the past two years, according to market researchers NPD Group, while trade publication QSR declared last year the worst for restaurants since the financial crisis, after sales dropped sharply in the second half of the year. Grocery price deflation has made a stronger case for cooking at home, and a glut of restaurants has given people more choice if they do decide to go out.

But after four years of shrinking traffic, McDonald's this summer lured people back through its doors, posting a rise in customer visits in the second and third quarters. Comparable sales rose between 4 and 7 per cent each quarter this year. Investors have lauded Mr Easterbrook's progress: the company's share price has soared 70 per cent to $168 since he took over. The makeover has already been rolled out in much of Europe, with about one-third of French and German restaurants having been remodelled.

McDonald's feeds nearly 70m people every day, making the tale of how it dug itself out of "staggering" customer losses a case study for the business of eating. McDonald's executives insist the success is built on a return to low prices and convenience, rather than chasing the whims of diners. With $25bn in annual sales and one of the most recognisable brands, the odds were in its favour to stage a comeback. But the way in which McDonald's achieved it came as a surprise even to its own bosses.

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Back in 2014 the prevailing wisdom was that McDonald's was being dethroned by new rivals such as Chipotle Mexican Grill, in a sector dubbed "fast casual". These outlets emerged after the financial crisis with price points a few dollars higher than traditional fast food, but with a perception that the food might be healthier.

Growth in global same-store sales for McDonald's had been hovering around zero for the past few years, with demand sagging across the US, Asia and Europe, before plunging more than 3 per cent towards the end of 2014. This compelled Don Thompson, then chief executive, to promise "decisive action to fundamentally change" its business.

He pledged to slash costs by $300m and open fewer stores, before being replaced by Mr Easterbrook four months later. Its market share of US fast food slipped from 17.4 per cent in 2012 to 15.4 per cent in 2016, according to Euromonitor.

Last year Mr Easterbrook hired Lucy Brady, a longtime Boston Consulting Group executive, to investigate what was going wrong. She led a wide-ranging study to dissect where people were eating. Her results, which Mr Easterbrook describes as "frustrating, but actually reassuring", showed that the majority of the missing McDonald's customers were going to other burger chains, such as Wendy's and Burger King rather than rival fast casual outlets.

Customers didn't stop wanting fast food, they just didn't want McDonald's fast food. Mr Easterbrook's response was to adapt the "modern progressive" doctrine and adopt a less aspirational focus: "the day-to-day basics". This has materialised in cutting prices for coffee and soda, serving breakfast all day, offering mobile ordering and delivery, and improving the quality, if not the nutritional value, of its food.

"To Steve's credit, he is not stubborn," says Larry Light, McDonald's former chief marketing officer. "Instead of trying to come up with new kale and bean salads, fix the familiar. Fast food is not in decline, and I think it will always be the number one way the world eats."

To walk through the McDonald's campus is to go back in time. Four levels of faded brick balconies envelope a 1970s atrium, making it feel more like a bare bones public library than the headquarters of a $136bn burger company. The group is about to shift its offices to downtown Chicago, where its neighbours will include the likes of Google, after six decades sprawled across 150 wooded acres in suburban Illinois.

Since first opening in 1955, McDonald's has billed itself as a place to eat cheaply. It embedded fast food into American diets as the US industrial farm system developed to make $1 cheeseburgers feasible.

McDonald's executives, former employees and analysts all agree that pricing is one reason the company has bled customers.

"McDonald's lost the plot on value," says Ms Senatore. "After the company stopped marketing its dollar value menu in 2013, they never came up with anything that was equally compelling." The dollar menu accounted for about 14 per cent of total US sales at the time.

After keeping a lid on prices for years, rising commodity costs and wages put pressure on the independent franchisees who operate most of its 37,000 worldwide restaurants. They began increasing prices, which "destroyed the overall value message", says Richard Adams, former director of franchising for the western US, who has since sold his restaurants and now consults for other franchisees. "They couldn't advertise the dollar menu [nationally] because franchisees had raised prices way above that."

Wendy's and Burger King churned out deals such as four items for $4, helping each preserve a market share of about 11 per cent of the US fast food market, while growth in smaller chains such as Sonic Burger and Jack in the Box loosened McDonald's grip on the market.

Some question the wisdom of the company's decision to begin customising its menu by region in 2004. Mr Light, who led the effort, says it was internally "controversial" for a company who had codified its menu down to how many pickles are placed on different burgers.

By 2014, facing fast casual insurgents, McDonald's took it one stage further, offering mixed and sometimes awkward messages about its menu. The company put clementines into Happy Meals and avocado on chicken sandwiches, while still trying to tap into burger nostalgia with adverts mocking the new lifestyle trends. "There will never be kale here," declared a 2015 advert for the Big Mac.

Under Mr Easterbrook's watch, the company has taken a "barbell approach" to its menu, beefing up its offers on both the low and high end of prices. Discounts are a core part of the Easterbrook ethos, with McDonald's churning out $1 and $2 offers for coffee and soda.

In a nod to more health conscious consumers the chain has also promised to strip antibiotics from its chicken meat and corn syrup from bread buns, replaced butter with margarine and is working towards using fresh beef in its Quarter Pounders.

But can the food be cheap and higher quality? "It's about balance," says Mr Easterbrook. "You can't just go all in on the premium end, because then you disenfranchise more price-driven customers." A new "value menu" will be unveiled next year, with price points of $1, $2 and $3.

The premium offerings are not necessarily healthy. Its maple-bacon dijon sandwich with buttermilk crispy chicken contains 740 calories and 1,780mg of sodium, nearly 80 per cent of the recommended daily intakes. "American palates have become more sophisticated," says Ms Senatore. "It's not necessarily about lower calories, it's about using whole foods, and McDonald's is playing to that. But fundamentally the food is still pretty indulgent."

Mr Easterbrook spent much of his tenure in the UK defending the golden arches' image, going so far as to request the Oxford English Dictionary change its definition of the phrase McJob from "an unstimulating, low-paid job". The OED refused. But his tactics paid off, and he was credited with reviving British sales in 2006.

For decades the company has taken flak for its implied role in the global obesity crisis. Governments are stepping up their healthy eating campaigns, which analysts warn could threaten McDonald's recovery. They caution that the company is not out of the woods. "We may have seen the end of market share losses," say analysts at RBC. "[But] in the past, headlines related to the obesity epidemic have resulted in negative publicity for McDonald's."

Any new regulations, such as mandated calorie counts, could "negatively impact margins", they added. Still, analysts who cover McDonald's remain bullish: more than two-thirds rate it as a "strong buy" even after its stock has already soared by more than 40 per cent in the past year.

The trend towards organic, customised products has jolted large consumer groups from PepsiCo to Procter & Gamble. While fielding online questions ranging from "do you even sell real food?" to "do you use pink slime in your burgers?", McDonald's now assures customers that it uses freshly cracked eggs in its Egg McMuffins and ground pork shoulder in its McRib sandwiches.

"One of the most significant changes for all businesses since the financial crisis is consumers are more demanding and expect to know more about you," Mr Easterbrook says. "They are more questioning of all authority . . . you are no longer in control of your message."

Bernstein's Ms Senatore says it is "hard to argue that they haven't improved the perception among at least some customers".

"Two years ago the question was whether [Mr Easterbrook] could bring what he did in the UK to the US, because it was such a bigger market," she says. "It turned out that he could."

Squeeze on chains: Casual dining vulnerable to Americans' frugality

Ten years after the global financial crisis, America's lopsided recovery can be seen in restaurants across the country. Unemployment has reached historic lows and wages are slowly rising, but consumers are still cautious with their money. The compound annual growth rate for the US restaurant industry was 6.4 per cent from 1970 to 2007, but that rate has slowed to about 4.3 per cent a year since the crisis.

As the gap has widened between income groups, middle-of-the-pack restaurant chains such as Chili's and Applebee's are now struggling. With higher price points and largely outdated menus, analysts say these "casual dining" restaurants, where a customer can buy dinner at the mall for about $15, are more likely to have been the losers of the rise of Chipotle rather than McDonald's.

Meanwhile, "the price part of value remains the greater part of the overall restaurant selection decision, particularly with lower income consumers", says Bill Fahy of Moody's.

This has supported fast-food sales, which have been resilient even as a cut-throat battle has broken out in the $800bn US restaurant industry. Executives say there are simply too many restaurants, and a lot of them are mediocre. There are now more than 600,000 places to eat and drink in the US, which has grown at nearly double the rate of the population, according to the Bureau of Labor Statistics.

One of the biggest offenders in overbuilding has been the shiny new trend "fast casual", as more and more companies have tried to replicate Chipotle's success.

However, it seems supply has outpaced demand, with the number of fast casual restaurants growing by 9 per cent last year, while sales in the segment slipped two per cent.