Variety at McDonald's: Growth Vs. Complexity

| About: McDonald's Corporation (MCD)

By Gad Allon

The Wall Street Journal had an excellent article on the trend to increase variety at McDonald’s (NYSE:MCD) and its perils (“On McDonald’s Menu: Variety, Caution“).

Since early 2003, McDonald’s has posted 30 straight quarters of same-store sales increases. But at the same time, the chain’s peak lunch-hour business has been flat for several years, according to an email reviewed by The Wall Street Journal. How do they do it?

An increasingly diverse menu, with some items priced at a dollar and others as high as almost $5, has lured more cost-conscious customers while preserving profit margins. That’s a departure from the days when McDonald’s largely catered to so-called heavy users—customers who queue up to eat fast-food several times in a week… The new menu choices are so plentiful that the Oak Brook, Ill., company has been running ads to remind customers that it still sells Big Macs and Quarter Pounders.

This is only one side of the story. As the sales increase, there are of course costs associated with these products. Furthermore, since 90% of the stores are franchised, the costs are incurred by small businesses that are trying to justify the investments required to add these products:

Our business is driven by keeping things simple and being able to deliver in a fast and efficient manner,” says a McDonald’s franchisee in the Southwest interviewed by the Journal. “So the more complexity you bring into the system, the more challenges you’ll have,” he says.

This story is not entirely new: McDonald’s suffered during the '90s from similar issues when it introduced too many lines of products. At a Kellogg (NYSE:K) event two years ago, Jim Skinner, the CEO of McDonald’s said that the chain has to “keep its eyes on the fries”. Why it is so difficult to resist going through this path again?

First, we have to understand that there is a constant pressure on firms such as McDonald’s to grow. As the article points out:

You may be leading the industry,” says Jeffrey Bernstein, restaurant analyst at Barclays Capital. “But if you have a deceleration from where you were…investors might rather pursue a greater risk/reward scenario” with the potential for “more meaningful upside.

This usually drives the introduction of new products, or going after new segments or industries. Usually, this means increasing the complexity and usually increasing the complexity of managing the operations. How do you manage this properly? I am not sure there is a one solution, but my colleague, Jan Van Mieghem and I wrote a case, together with HP (NYSE:HPQ), on how they manage this type of interface between marketing (pushing for more products with a larger coverage of the market) and the operations (pushing for a more compact offering). I will leave the details to the classroom, but say that HP uses Operations Research models and tools to strike the right balance. We do not know the process by which McDonald’s decides on these issues, but it is reassuring to see that the people there balance the marketing side and with operational one:

Ms. Fields says the company tries not to stray too far afield with new items. In 2005, McDonald’s halted testing of Oven Selects submarine sandwiches, partly because they took too long to make, partly because “market data told us that it’s not a product customers recognize McDonald’s for,” Ms. Fields says. “We tried pizza at one time but people didn’t recognize us for pizza, either.

The debate, of course, only begins:

Now that consumers are starting to open their wallets again, it’s more tempting to be everything to everybody. “If McDonald’s sticks to one thing, consumers will go somewhere else,” says John Glass, restaurant industry analyst for Morgan Stanley. “It’s a delicate balance between being simple and not responding to what consumers want.