Supply Chain

Mac Attacked

In his first year as McDonald's CFO, Michael Conley has had a full plate: multiple reorganizations, fizzled marketing campaigns, burger taste wars....
Lori CalabroSeptember 1, 1997

If you ask CFO Michael L. Conley, it’s McDonald’s Corp. that deserves a break today. The fast-food giant has come under heavy criticism from Wall Street and the financial press for sagging domestic performance, confusing marketing campaigns, and insufficient attention to changing customer tastes. Yet, at the same time, the Oak Brook, Illinois-based multinational has racked up record sales and earnings for 129 consecutive quarters, thanks to its dominance in the international arena. And its stock’s compound annual total return for the five years ended in 1996 was 20 percent.

Still, getting the good news out has been difficult for the 49-year-old Conley, who took over as CFO and executive vice president of the nearly $32 billion company last October, when longtime CFO and vice chairman Jack M. Greenberg was promoted to chairman of McDonald’s USA. Small wonder. In the second quarter, the company’s U.S. operating income declined by 2 percent. One of its most successful promotions ever–April’s Teenie Beanie Babies promotion–was marred by reports of customers buying Happy Meals just for the toys, not the food. And the promotion that followed, Campaign 55, was arguably the company’s biggest marketing failure. Designed to offer large sandwiches at 55 cents as long as they were purchased with certain other products, it served only to confuse customers and anger franchisees. The scheduled long-term campaign was halted after just two months.

To Conley, however, the criticism has as much to do with the status of McDonald’s as the world’s largest fast-food provider as it does with poor performance. “You can’t control the press. So instead, we are working hard with investors and communicating where we are and where we are going,” says Conley, who joined the company in 1974 and served as corporate controller for 11 years. “We’ve told them that we aren’t happy with our U.S. performance, that we can do a lot better–and that’s what we’re trying to do.”

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How quickly McDonald’s can turn it around in the United States is another question. “We’ve set 1997 as a transition year for our U.S. business,” says Conley, pointing out that the company is retooling its kitchens and speeding up product rollouts. In addition, the company announced a major reorganization in July that saw the resignation of Edward H. Rensi, McDonald’s USA president, and realigned its domestic organizational structure.

But as Conley told CFO senior editor Lori Calabro in a recent interview, “The reorganization itself will not achieve a result. It’s an infrastructure change to better position us to get results. We have to exploit it and make it work.” In the meantime, he says, earnings will continue to be buoyed by the Golden Arches’ international appeal. “If you look at our track record outside the U.S., we’re way ahead–and we intend to stay there,” declares Conley, noting that of the 2,400 restaurants scheduled to be built this year, 80 percent will be erected overseas. As Conley notes, even giant McDonald’s serves just 1 percent of the world’s population. “There’s an unlimited market out there,” he declares.

In July, McDonald’s announced a major management reorganization–its third in two years. Why are you reorganizing again?

In the U.S., we’ve grown up to more than 12,000 stores. But we always had a staff that was centralized. Over the years, the staff got very large. And it got more bureaucratic than the demands of the business today can afford to be. We found that we couldn’t move as fast– there were too many people who had to get involved with decisions–and the line organization in the regions didn’t have enough control of enough resources to move really fast or really decisively.

The reorganization is geographic in orientation. It creates five new divisions, each of which could be a Fortune 500 company by itself. Under these divisions, we’re going to keep our regional structure of 40 regions. [But] we expect to be able to move faster, make decisions better, and take more risks.

What specific effect will the new structure have on finance?

There will be a full financial function in each region; each division will have a financial officer. The financial-processing functions won’t move out of a central place. But you don’t have to control the processing to run the business effectively.

I understand the reasoning behind this is to add more flexibility to your domestic business. Is that correct, or is it more a question of getting closer to the customer?

It’s both of those things. If you get closer to the customer, you’re going to make faster decisions, you’re going to make better decisions. It might lead you to take more risks, be more entrepreneurial.

Our international organization grew up very entrepreneurial, like the U.S. grew up. But it’s grown up within a country structure, so we have very entrepreneurial, autono-mous countries. No individual country is that big; they’re still very light on their feet. They are accountable to Oak Brook [McDonald’s headquarters], but they have all kinds of latitude to do what’s right for their business and they have all their resources within the company. So, this has been a tremendously successful model for us.

Some industry watchers say that McDonald’s is slipping, that it’s losing its edge over its domestic competitors. What’s your assessment of the company’s recent performance?

First of all, we’re having record-breaking years, year after year. I would expect 1997 to be another one. Certainly through the second quarter, we’ve grown at a pretty good clip.

Our international business is strong and vibrant. We exceed the market share of our top five global competitors. More telling than that, in the past five years, we’ve outgrown them almost two to one. In the U.S., by contrast, you can see the enormous amount of choices and competition. We’re going to work hard in four areas: food taste, execution, marketing, and market share in the U.S.

How will the reorganization affect you, your job?

My role won’t change. In addition to being responsible for the accounting, treasury, financing, tax, and information-services functions, as well as industrial relations, my role is to add value to the business wherever I can, to provide insight and to be a catalyst for improvement, pointing out opportunities and helping drive those opportunities. As part of the top management team, that’s been my track record, as corporate controller prior to CFO.

You and Jack Greenberg [chairman of McDonald’s USA] worked together for more than 10 years, when he was CFO.

McDonald’s is an operations company; it will always be an operations company. But, we’ve got strong financial people in a whole lot of areas of the company. They understand financial concepts, they understand shareholder value, and they understand operations. Jack’s background is financial, but now he’s got ketchup in his veins, as we like to say.

What role does finance play in the company’s marketing campaigns?

Extra Value Meals [discounted combination meals] is a great example. The whole thing started here in the early 1990s, and we’ve had great success with it. Now it’s a standard in the industry. I think finance contributed a significant amount to that, because we were in there from the beginning showing the opportunities and the risks. After all, it is a risk; when you lower prices, you’re taking a risk. You have to excite the customer enough to generate the additional transactions. In the case of Extra Value Meals, the customer often has to trade up from an à la carte purchase.

How did finance help plan Campaign 55?

It was a combination of the financial analysis of what the results were likely to be, coupled with the marketing. [Marketing], for example, would not move without understanding the economics of what they were doing. You can’t separate one from the other.

One of [Campaign 55’s] strengths was that it allowed consumers to right-size their meals. They could, for the first time in the industry really, order any size meal they wanted [in order to get the 55 cent sandwich]. They could combine a small fries with a quarter-pounder; they didn’t have to get the large fries, as was previously the case in the industry, us included.

The financial modeling gives [those in] the whole decision-making process the added comfort of knowing whether it’s likely to produce a good result. It’s part of the decision-making process, not the sole process. It’s an integral part of the marketing function.

How did finance view Campaign 55?

We supported it. Everybody was in concert with the decision. We were very disappointed in what happened.

What went wrong? Why was it pulled after only two months?

I think, in hindsight, that we were undermined by the press somewhat.

Because news about the campaign came out before you launched?

Yes. And I think we took a little too much for granted in terms of what the consumer would be able to understand; the message was a little bit confused. But then, it’s very hard to separate that from the press coverage having led the customers to expect they were getting something else.

At the same time, we have not abandoned the notion of finding ways to keep the right-size meal idea. There are still markets running [Campaign 55], particularly at breakfast. It’s very successful in parts of the country. The fact that we are not nationally advertising it anymore [doesn’t mean] it was a complete failure.

What would you have done differently?

Stop the leaks to the press! But that’s easy to say and hard to do. I don’t know. I can’t answer that today. I think we could have somehow–and I’m not sure how–made [Campaign 55] a much clearer message.

Let’s talk about the company’s international business. How much does it contribute to the bottom line?

It contributes about 60 percent to our operating accounts.

How much do you expect the international business to grow?

We’ve said to the Street that our objective is to grow it at a 20 percent clip over a five- year period. We think we’re capable of doing that. There’s an unlimited market out there, and compared to the U.S. business, we’re very underpenetrated internationally. I think there are only two countries that are close to U.S. penetration levels: Australia and Singapore. In Europe, it’s far away from that. We’re in 103 countries now. China–my God. There are limitless opportunities.

We’re driven to be the dominant food-service company in the world. So, you’ve got to look at McDonald’s as a global business.

McDonald’s has had between 12 percent and 15 percent operating growth internationally this past year. Is 20 percent growth realistic?

I think those objectives are kind of stretch goals. Twenty percent is a challenge for us, no question. You’ve got to adjust for the dollar, though. The dollar has been strengthening for a couple of years, and it may strengthen at least another year. So if you adjust for the currency, we are closer to 15 to 17 percent growth. We’re not that far off the 20 percent if you adjust for the currency. And, frankly, that’s the way we look at the business, because you can control for [currency fluctuations].

Eighty percent of your store openings are now overseas. Does that mean you’ve reached a saturation point in the United States?

I think that we could see that expansion rate go back up again. We have not performed the way we know we are capable of performing. The truth is, we could say that Wendy’s and Burger King have performed better [than we have] over the past couple of years. We know that. That’s what we’re out to change.

We need to grow comparable sales [sales in restaurants open more than 13 months]. If we can grow comparable sales, which you have to do to run the business, I think you’ll see our expansion policy ramp back up, because it’s much easier to open those stores when you have a sales-growth pattern emerging. The average U.S. operator owns a little more than three stores today, and when the store operators are offered new stores, their cash flow in the business needs to be going up in order for them to be encouraged to invest. Our convenience standard does not exist in a vacuum.

At the restaurant level, you are set to introduce such changes as made-to-order sandwiches, toasted buns, and machines that automatically cut fries. Obviously, with 12,000 stores, you’re talking about an incredible expense. Exactly what will it cost?

We haven’t made a final decision about the changes we are going to run with. But if you look at the history of our business and the QSR [quick-service restaurant] business in terms of investment, it’s very minor. The cash flow generated by the average restaurant easily covers the investment required. In addition, we’re strong enough and smart enough to help enable that. For example, we have always required a [$15,000] security deposit as part of our arrangement with the operators and investors. So we basically said, “Look, you guys have to make this [new] investment. We want to help enable that. So we’ll refund those deposits.” Now, the cost to McDonald’s was a cost of money, because [the security deposit] was a non-interest-bearing agreement.

Once the plan to change the stores is finalized, will you take a restructuring charge?

No. I don’t want to rule out anything, but that would amaze me. We’re not talking about ripping the stores apart. We’re talking basically about small equipment and maybe some computer software.

What is the goal of reconfiguring the kitchens–faster service? better taste?

It’s primarily taste–taste and flexibility. The production system has been stretched by new products, and getting the food hot and fresh to the customer isn’t the way it was 10 years ago. That’s the primary area for improvement.

How do you respond to critics who say that food at McDonald’s doesn’t taste as good as its competitors’?

Well, we have a large body of research that says our customers like our food. You get so much criticism that just responding to it is distracting. The latest wave of criticism is that we don’t sell food, we sell trinkets. We have been a major innovator. We introduced games. We have the kids’ franchise, the Happy Meal program. But we’ve been unfairly criticized as [substituting innovations for] taste. We wouldn’t be as big as we are if that were true.

Now, at the same time, we’ve got to meet the taste challenge. We’ve got to take our marketing budget and focus it where it counts. I think you’re going to see a movement to more food-focused advertising. You will not see our promotional activity go away. It’s part of our strength; it’s what sets us apart. The Interbrand Group [a consulting firm] named us the number one brand in the world. That’s part of being successful–you become a lightning rod [for criticism].

So it’s more a question of catering to customers’ tastes than introducing new products?

New products are part of us, and always will be. [The current] production system isn’t the optimum system to use. It has probably hurt quality a little bit, because a batch production system doesn’t work as well [when you offer] a lot of products. At the same time, in our international business, we are very careful not to introduce a plethora of new products, because we don’t have to. Without the competition [overseas], we are able to concentrate on core products and provide value pricing.

You’ve said that 1997 is a transition year in your U.S. operations. That’s a term I’ve heard used a lot with sports teams…

Don’t use the Cubs analogy, please!

What I want to say is, you’re McDonald’s. Where do you go from here? What do you transition to?

Well, you know what’s different? What’s different is that the competition has caught up, to be brutally honest. And we have to be better than we’ve been. The pace at which we’ve gotten better hasn’t been acceptable. It’s that simple. We have to take market share- -this is less than a zero-sum game. There are too many restaurants chasing too little sales. So our pace of change has to accelerate.

What’s so exciting is that we have the financial wherewithal to do it. For example, we’re unique in the industry in that we’ve captured the real estate profit. The rest of the QSR industry leases all its real estate, so some third party [captures] that profit. In addition, we have this strong, vibrant international business. In other words, we have tremendous financial strength to invest in the U.S. system.

What does Wall Street expect from McDonald’s, overall?

What we’ve told Wall Street is that our objective is to grow the U.S. business over an average five-year period–and we are off-track at this point–by at least the mid-single digits. We think we are capable of that. If you take that and combine it with our international performance, it clearly makes us a growth company.

But a lot of people will argue that you’re a mature company.

You could make that argument in the U.S.; the expansion rate here is unlikely to get over 5 percent. But 95 percent of the population isn’t here. Coke taught us that. They were a pioneer in getting investors to realize that they’re a global company, that their vision is to be ubiquitous. Our plan is very similar. Our reach is worldwide. We’re successful in 103 countries, and 95 percent of the world’s population is outside our borders.

One more question: What’s your favorite McDonald’s sandwich?

I’ve got to say the triple cheeseburger. But the quarter-pounder with cheese is a close second.

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