Understanding McDonald's: Comprehensive company primer and profitability analysis (Part 15 of 21)
Ronald McDonald is a nostalgic clown character that represents the McDonald’s brand globally in electronic, print, and television marketing materials. (For many, the clown is rather terrifying, especially if you’re as scared of clowns as I am!) This mascot inhabits a fantasy world called McDonaldland and has adventures with his friends, the Hamburglar, Mayor McCheese, Grimace, Birdie the Early Bird, and the Fry Kids. Ronald has been around since 1963, modeled after Willard Scott, who played Bozo the Clown on WRC-TV in Washington, DC, at that time. Like Ronald, we believe McDonald’s strategy still generates value for its consumers and investors, but it’s becoming old and less effective as each year goes by. To continue to grow nominal sales at 3-5% each year, McDonald’s will have to keep innovating in both the U.S. and abroad.
McDonald’s core strategy focuses on five key pillars: people, product, place, price, and promotion. More specifically, over the past three years, the company has been focusing on optimizing its menus, modernizing its experience, and broadening its accessibility. It has been able to implement new strategies in a three-step process it describes as “Learn, Share, Scale,” through which it first conducts market research and shares its knowledge with management and franchisees, and then scales and implements new products.
The company modernized 2,400 restaurants in 2012, all with modernized exteriors. Our team at Market Realist visited five new locations and was pleasantly surprised by the decor and modern appeal.
The company’s customer-focused “Plan to Win,” initiated in 2003, provides a common framework for its global business while allowing for local adaptation. Through the execution of multiple initiatives surrounding the five pillars of its plan—people, products, place, price, and promotion—it has enhanced the restaurant experience for customers worldwide and grown global comparable sales and guest counts in each of the last nine years. This plan, combined with financial discipline, has delivered strong results for its shareholders since its inception. To measure its performance as it continues to build the business, it has the following long-term average annual constant currency financial targets.
- System-wide sales growth of 3% to 5%
- Operating income growth of 6% to 7%
- ROIIC in the high teens
Comparable sales are impacted by guest counts, product mix shifts, and menu pricing. Specific menu pricing actions across its system reflect local market conditions as well as other factors—notably food away from home and food at home inflation indices. In its company-operated restaurants, it manages menu board prices to ensure value at all price points, increase profitability, and mitigate inflation—all while trying to grow guest counts. To accomplish these objectives, it uses a strategic pricing tool that balances price and product mix. Franchisees also have access to (and many use) this strategic pricing tool. In general, the company believes franchisees employ a similar pricing strategy. It looks to optimize product mix using a menu with entry-point value plus core, premium, and promotional offerings. McDonald’s also introduces new products to meet customers’ needs, which can expand its average check and increase guest counts.
Return on incremental invested capital (ROIIC)
Return on incremental invested capital (ROIIC) is a measure reviewed by management over one-year and three-year periods to evaluate the overall profitability of the business units, the effectiveness of capital deployed, and the future allocation of capital. The return is calculated by dividing the change in operating income plus depreciation and amortization (numerator) by the cash used for investing activities (denominator), primarily capital expenditures. The calculation uses a constant average foreign exchange rate over the periods included in the calculation.
In analyzing business trends, management considers a variety of performance and financial measures, including comparable sales and comparable guest count growth, system-wide sales growth, and returns.
The factors affecting McDonald’s global pricing strategy include exchange rate differences, government regulations, economic climate, and the cost of living—to name a few.
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