McDonald’s: 24/7 Wall St. Company of the Week

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In December 2008, 24/7 Wall St. named the CEO of McDonald’s Inc. (NYSE: MCD) its CEO of the year. James Skinner, who retired as the company’s CEO last summer, was credited with converting McDonald’s stores into several food retailers wrapped into one set of locations. And that was even before the company’s shares really took off, which occurred about a year later.

By the time Skinner retired, McDonald’s share price had risen nearly four-fold during his tenure. McDonald’s veteran and new CEO Don Thompson did not have an easy act to follow, particularly given the slowing growth in the global economy when he took over last July.

To Thompson’s credit he managed to pull the stock price to an all-time high earlier this month, but much of that is due to the missteps and misfortune of McDonald’s chief competitor, Yum! Brands Inc. (NYSE: YUM), in China. And the competition is turning on what happens in China.

In 2011 Yum held about 40% of the Chinese, with McDonald’s in second place holding about 16%. Those percentages are virtually the same today. Yum’s KFC and Pizza Hut stores outnumber McDonald’s stores by about 3 to 1 in China. McDonald’s cannot beat Yum in China unless it closes that gap.

McDonald’s goal is to operate 2,000 restaurants in China by the end of this year, but sales growth in the company’s Asia Pacific Middle East Africa (APMEA) region has slipped from 6% in 2010 to 4.7% in 2011 to 1.4% in 2012. Same-store sales in APMEA for the first quarter of this year actually fell 3.3% and operating income was down 1%. April sales are also expected to continue “slightly negative.”

It’s not Thompson’s fault, of course, that the global economy took a turn south just as he arrived at the corner office, but so far he has not succeeded at halting the company’s sliding sales by chasing the twin goals of “enhancing” menus or “the overall customer experience.”

Competition has heated up in the value space that McDonald’s carved out for itself in 2009 and 2010 and McDonald’s has not come up with an adequate response. Pushing the value space harder may only erode margins without pulling up sales.

McDonald’s can financially afford to sit tight and ride out the current weak sales numbers. But far better would be to use the company’s financial muscle to squeeze its competitors with an offer that none of them can match. One obvious point to attach is China, where Yum’s KFC stores are suffering from an earlier bout with tainted chicken and a current bout with a new strain of bird flu.

Yum embarked on an expansion into China’s second-tier cities last year, but the company might have to retreat if the bird flu threat is not quickly resolved. That could offer McDonald’s a chance to pursue an expansion program in places where KFC does not have store.

It’s worth noting that there are about 170 cities in China with populations greater than 1 million, and only four of those are considered “first-tier:” Beijing, Shanghai, Guangzhou, and Shenzhen. There’s a lot of opportunity lurking here. And many lower tier cities have populations the size of San Francisco or Seattle, large enough to support plenty of value-priced restaurants as well.

Something creative has to happen at McDonald’s. It’s almost as if former CEO Skinner picked off the low-hanging fruit and left his successor with few choices to grow the business. But if McDonald’s is going to thrive, then company needs to look at something other than value menus and improving the customer experience. It’s time for a new, big idea.

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