Mar 18, 2015

Eyes on the Fries

Name: Kellogg School of Management
Price range: $

By Kellogg Insight | Based on the insights of Gad Allon

McDonald’s has had an inauspicious start to 2015. After a year of declining sales, lower-than-usual profits, and reports of french-fry shortages in Venezuela and Japan, CEO Don Thompson left the company on March 1, making way for Steve Easterbrook, former chief brand officer. The change in leadership occurs at a time when the industry at large is seeing the rise of “fast casual” chains like Chipotle, Panera, Five Guys, and Shake Shack. For the moment, at least, McDonald’s seems to have lost some of its luster.

There is, however, at least one reason not to write off the company. “Let’s remember why people buy McDonald’s,” says Gad Allon, a professor of managerial economics and decision sciences at the Kellogg School. “More than anything else,” he says, “people buy McDonald’s for the consistency. It’s not as fast as the others&mdmdash;Wendy’s, for example, is faster. And it’s not as cheap as all of its competitors. But it’s amazingly consistent.”

Maintaining this consistency on a global scale requires standardized operations, which is why each franchise has to follow specific guidelines on everything from sourcing potatoes to freezing patties. “McDonald’s is a supply-chain company more than anything else,” Allon says. “The previous CEO used to say that when he visited any location, he could tell how successful they would be by examining one of their french fries—for color, for texture, for how it breaks. The slogan was always: ‘we keep our eyes on the fries.’”

Occasionally, this commitment to consistency can lead to temporary issues. When McDonald’s ran out of fries in Venezuela, for example, it was because the company insisted on importing them rather than using local potatoes, and Venezuela’s import laws are uniquely troublesome. As Allon sees it, this was an isolated case; overall, McDonald’s does not have an operations problem. “It’s a firm that does extremely well in their ability to execute,” he says.

It does, however, face competition from higher-end burger chains like Five Guys and, more recently, Shake Shack, whose shares doubled in their first day of trading back in January, leaving the company worth an estimated $1.6 billion despite having only 63 locations. Its global presence includes restaurants in Moscow, Dubai, and Istanbul, and burger aficionados say the taste speaks for itself. But how effectively the business can scale is still an open question.

“Shake Shack has done extremely well,” Allon says. “But they cannot be as consistent if they go for higher quality, and it’s not a scalable model to the level McDonald’s is. When it comes to quality, price, and consistency, there is always going to be a trade-off. One of the main issues it has is speed. They have a new store located in an airport, and the delay this week was 11 minutes. This is clearly unacceptable for this kind of service.”

As Allon sees it, fast casual companies are ultimately more like service establishments, in the sense that they rely on employees as much as operations. This poses a challenge to the companies’ global ambitions. Shake Shack may have a youthful following and an effective social-media strategy, but that is no guarantee that it can maintain quality and speed everywhere it goes.

In recent years, McDonald’s has taken steps to address the consumer trends that led to the rise of fast-casual restaurants in the first place. It has experimented with snack-wraps, salads, cappuccinos, and made-to-order burgers, all of which have strained its supply chain in one way or another. And yet, as Allon points out, these are not fundamental changes to the company’s value proposition. “It’s still a minority of what they do,” he says. “They don’t offer customization at the drive-through, and drive-through accounts for at least two-thirds of their sales. Yes, they have salads, but the salads are only there for the one person in a group who doesn’t want to have a burger. It’s still primarily a burger company.”

Despite the leadership change, Allon does not expect a major shift in operations—the supply chain is already well established. It seems more likely, he says, that McDonald’s will focus on promoting its brand both domestically and internationally—a task the new CEO should be uniquely qualified to handle. During this year’s Super Bowl, for example, McDonald’s announced a “Pay with Lovin’” promotion, which offered free food to customers in exchange for “an act of lovin.’” For some, this was symbolic of McDonald’s struggle to win back the loyalty of domestic consumers. Allon takes a broader perspective. “The best-performing store for McDonald’s last year wasn’t Times Square—it was Moscow,” he says. As long as the company continues to deliver consistent quality on a global scale, it is hard to imagine McDonald’s being pushed out of the market.