Background
McDonalds is an American icon to say the least. From humble self-serve drive-in roots at its founding in
1948 in San Bernardino, California, the company has since expanded into a global phenomenon. It has been at the heart of innovations in food, service and operations. The fast food concept itself was an innovation that McDonalds helped to define as it emerged in the 1950s. It has “proven to be a revolutionary force in American life.” The industry and company have combined to change culture – from diet, to eating habits, marketing approaches, to service expectations – and now represents over
$100B in annual sales globally. McDonald’s history and strategy provide important context for the discussion of its current operational innovations.
Ray Kroc first experienced the drive-in in 1954 in California and promptly franchised a location. A year later, he opened his first McDonalds in Des Plaines, Illinois. The Golden Arches generated $316.12 in sales on the first day of operations. Success then followed and franchises spread. In a mere three years,
McDonalds had sold its 100 millionth hamburger and opened its 100th location. As the company grew, its leaders emphasized operations and training in order to provide a standard experience across all stores. In the early 1960s, Hamburger University, a new training innovation, opened and began offering a Bachelor of Hamburgerology degree. This accredited university has more than graduates 80,000 graduates at a current run rate of 5,000 per year. The training is rooted in McDonald’s mission of quality, service, cleanliness and value. In the same time period, eating was moved indoors, store expansion continued and Ronald McDonald made his first television appearance.
The company went public on its 10th anniversary and set its global roots with restaurants opening in
Canada and Puerto Rico. In 2009, McDonalds served 60 million customers per day at 32,478 restaurants in 117 countries. McDonalds is primarily a franchiser, with 80% of restaurants operated under franchise agreements. It generated $22.7B in revenues at the corporate level, plus $56.9B in franchised sales.
McDonalds is the largest owner of retail real estate worldwide. It is the largest buyer of beef, pork and potato products. Employment has been so large that an estimated 1 in 8 American workers have had a stint at McDonalds at some point in their careers.
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Current Strategy
Facing market saturation and world domination, McDonalds has had to adapt its strategy. It began a turnaround in 2003 to reinvigorate its brand, relevance and sales. The initiative was called Plan to Win, or “better, not bigger.” It focused on five key areas that impacted business results – people, products, place, price and promotion. Although McDonalds CEO Jim Skinner notes that “There is nothing profound about [it],” the strategy provides a customer-centric global framework with the capacity for adaptation at a local level. The goal is alignment across the supply chain, across stores and within stores. Seven years in, meaningful financial results have been achieved including growth in customer numbers, visits, and sales. “McDonald’s turnaround over the course of the past seven years has been nothing less than remarkable, returning this iconic brand back to a pedestal it once fell off.”
Plan to Win has three main strategic initiatives. First is leveraging technology to enable employees to deliver fast, accurate customer service. The second initiative is a multi-year restaurant reimaging to refresh store exteriors and interiors, install wireless and lengthen operating hours. One third of US interiors and one quarter of US exteriors have been completed, with a total of 500 additional renovations planned for 2010. The final initiative is focusing on menu innovation to adapt to customer needs. The goal is to increase sales across the three main buckets of menu items—the core, new offerings and value-priced options. McCafé premium coffee and smoothies are a critical example of menu innovation, and we now turn to the context, approach and operationalization of those innovations.
Traditional Competition: Fast Food Restaurants
In naming competitors to McDonalds, most will cite Burger King as its key rival. After all, both companies built their brands around the prized hamburger as sustenance on the go. But with operational, product, and service innovation comes a slew of new competitors. Furthermore, there are several dimensions on which a competitor can be evaluated: total franchise revenues, total product sales volume, number of locations, and more. And finally, concentration is considered low in the fast food industry, with the top four players accounting for less than 35% of market share.
1
1
IBISWorld “US Fast Food Restaurants Industry Market Research Report.” October 2010.
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In evaluating competitors based on market share, top players in the fast food industry have performed as follows, as of year-end 2009:
Table 1 – Competitor Market Share, Locations, Sales
Company
McDonalds Corporation
Yum! Brands (KFC, Pizza Hut)
Wendy’s/Arby’s Group
Starbucks Corporation
Burger King Corporation
Doctor’s Associates (Subway)
Market
Share
12.7
9.7
6.6
5.9
5.1
5.0
# Locations
32,478
33,000
10,259
16,600
11,925
33,048
Global Sales
(YOY change)
$22.7B (
$10.8B (
3.3%
3.9%
$3.5B (N/A)
$9.7B ( 5.0% )
$2.5B (3.3%)
9.37B (3.9%)
)
)
Yum! Brands: with strong presence in chicken, pizza, Mexican, and seafood fast food concepts, Yum! has strength with a diverse portfolio of brands. The company owns, franchises and licenses its brands across
110 countries around the globe, lending another source of diversification that helps balance profitability and sales. In particular, a relatively strong position in China has allowed Yum! to grow revenues and capture more market share.
Wendy’s / Arby’s Group (‘Wendy’s): with a large focus on quality, Wendy’s works to differentiate its products based on consistent, high quality ingredients and preparation. Low penetration in international markets represents a significant opportunity for growth if Wendy’s is able to expand its concept to high growth regions such as China. Furthermore, Wendy’s will seek to build its franchised units, incenting investors with lower operating costs and more favorable contracts.
Starbucks Corporation: operating in the coffee shop niche, Starbucks had long focused on excellent coffee and community experiences. With growing demand came new concepts and Starbucks began to introduce standard food items in its retail locations, making it a more direct competitor to other fast food chains. Arguably the pioneer of highly customized coffee innovations, Starbucks created a new generation of coffee drinkers, and so invited competition from local coffee shops and mass fast food retailers, such as McDonalds’ McCafé concept. Starbucks beverages are prepared as ordered.
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Burger King Corporation: allowing patrons to “Have it your way,” Burger King’s strong brand recognition, particularly for its Whopper product, is critical to the company’s strategy. Burger King also prides itself on innovation and has released new products/concepts over the last 24 months, including
Whopper Bars, Fresh Apple Fries, and more. Most recently, Burger King announced a new partnership in
Canada with Starbucks’ Seattle’s Best Coffee, likely an introductory response to McDonald’s McCafé concept and as a way to gain more market share for coffee-on-the-go buyers.
Doctor’s Associates: with franchised Subway outposts only, Doctor’s Associates maintains a lean headquarters team. Focused on offering healthy alternatives to the usual fat-filled fast food fare,
Subway continues to get mileage out of its brand icon, Jared, who shed and has kept off weight based on a Subway diet. The company also differentiates itself operationally, preparing all foods in front of the customer, to the customer’s specification.
In addition to competing against other fast food restaurants, McDonald’s also competes with fast casual restaurants, other sit-down dining options and grocery stores. Every meal and snack is an opportunity for McDonald’s to capture a sale, and this is the lens McDonald’s uses to filter innovation. Competitive success depends on executing against key trends and delivering what the customer wants while leveraging McDonald’s operational advantages. Thus, it is critical for McDonald’s to monitor trends and identify the point at which an innovative menu item begins to appeal to the mainstream. Two key trends that McDonald’s has watched for several years and recently executed against are premium coffee and smoothies.
Broader Trends: Premium Coffee
Americans drink an average of three cups of coffee a day, so coffee has been a mainstay on restaurant menus for as long as restaurants have existed. However, the “Starbucks effect” has created more discerning consumers who are looking for higher quality coffee.
2 Starbucks and premium coffee have become nearly synonymous in the thirty years since the company was founded. By pursuing a calculated growth strategy, Starbucks not only made premium coffee available on every corner but trained consumers to pay more for their coffee.
2
Mintel, Restaurant Beverage Trends
– US – April 2009
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Broader Trends: Smoothies
Made-to-order smoothies emerged as a trend in the mid-1990s and reached $2.45 billion in sales by
2007.
3 Increased availability and selection fueled this growth, as the number of locations offering madeto-order smoothies doubled between 1997 and 1999.
4 As health-conscious consumers searched for refreshing snacks and meal alternatives, it seemed as though they were never far from a Jamba Juice or
Smoothie King.
Smoothies became popular as a healthy, refreshing snack and the trend emerged along with an increased focus on health and wellness. Smoothie shops capitalized on this trend by adding vitamin supplements to the smoothies to promote overall wellness or specific health benefits like weight loss or increased energy. However, smoothie sales have declined in recent years along with overall restaurant sales as consumers cut discretionary spending. Smoothie consumption also suffered as consumers embarked on low-carb diets. Regardless, smoothies have become a staple in the American diet and their broad availability both reflects and reinforces that position.
From an innovation standpoint, McDonalds seeks to source and develop new concepts in house. As its website states, “It is our company’s policy not to consider unsolicited ideas from outside the McDonald’s system. Because we are always working on new ideas and strategies within the Company, we do not review ideas from outside McDonald’s to avoid confusion over the origin of an idea. We realize that we may be missing out on a few good ideas, but we had to adopt this policy for legal and business reasons.”
Menu Innovation
Menu innovation was launched in the 1960s and has continued since: BigMac (1968), Quarter Pounder
(1973), Egg McMuffin (1975), Happy Meals (1979), salads (1987), Big N’ Tasty Sandwich (2001), Premium
Salads (2003), Snack Wrap (2006), McCafé Coffee (2009), Smoothies and Frappes (2010). Some research suggests that McDonald’s menu changes are primarily driven by a desire to create diversification between core products of competing chains, to drive temporary traffic increases with seasonal products, and to accommodate economic pressures on its customers 5 . Additionally, changes come about due to responses to government intervention, consumer demands, and food illness outbreaks. Yet, McDonald’s
3 Mintel, Smoothies – US – March 2008
4 Mintel, Smoothies & Yogurt Drinks - US - December 2002
5
Mintel
– QSR Trends 2007
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menu changes are not new food concepts all together but alternative burger options that have been adapted to McDonald’s style of fast food.
Historically, the primary drivers for menu innovation are based on the need of McDonald’s as a publicly traded company to continue to grow and produce improved earnings every quarter. In order to make those numbers, McDonalds must continually find ways to attract people into their stores instead of the competition and alternative dining options. One such way to get diners to choose McDonalds over other options is to have menu items that are unique to McDonalds. The classic example would be the
Big Mac. But this isn’t enough because every chain has its signature burger (Burger King’s Whopper,
Jack-in-the-Box’s Jumbo Jack, etc.), so further diversification is needed which led to the McGriddle, a breakfast sandwich. The McGriddle, maple syrup pancake-like buns with your choice of meat in the middle, launch has played a role in increasing breakfast time store traffic.
Additionally, McDonald’s releases seasonal options throughout the year as a way to generate enthusiasm and drive trial visits. The McRib is likely the biggest success for McDonald’s in this area based on a dedicated website for menu sightings and large number of fan sites. It’s so popular, that after 16 years, the McRib will finally launch nationwide for about six weeks starting November 2, 2010.
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People have been known to travel for hours to purchase these sandwiches, but executives feel that consumers will tire of the sandwich if it were to become a long-term menu item.
Today, one of the more relevant reasons for instituting menu changes is due to the economic situation of McDonald’s customers. The downward pressure of the economy on budgets has increased traffic by bringing those who can no longer eat at more expensive establishments as well as those who were already struggling. Thus, we have seen an increase in low cost items such as the limited time $1 beverages and expansion of the all-day dollar menu as well as items that appeal to those who are just stepping down to McDonald’s such as its $2 premium Angus snack wrap.
Ecosystem Drivers
Fast food restaurants have been fairly resilient to claims of making people fat and promoting bad eating habits, so these other motivators have yet to prove to be the strongest drivers in menu changes.
6 Jargon, Julie and Kesmodel, David. “Bona Fide Fans Chase Rib-Free Rib Sandwich.” The Wall Street Journal. 11 October 2010.
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Thus far government intervention has been primarily limited to nutritional labeling of foods at a national level. State level governments have also moved against the use of trans-fat oils as several have required labeling and California the only state to ban the use of trans-fat. The food industry would prefer more national regulation that they have lobbied for instead of patchwork states laws that have become increasingly more directive as to what they will allow restaurants to serve. Yet, nutritional labeling has been around on grocery product and most parents still buy very fatty foods and serve them to their families. Therefore, studies remain inconclusive as to whether calorie listings in restaurants will actually change dining habits of Americans. One hypothesis is that each purchase decision is considered an onetime affairs and not aggregated; thus, consumers do not think of cumulative benefits but only shortterm benefits of choosing between a 200 calorie side and an 800 calorie side dish.
On the other hand, from 2007 to 2010 it has been shown that there is a significant increase in healthier dining options in the USA.
7 This increased interest has led to customers demanding healthier options, especially for children, and thus McDonald’s responding by incorporating healthier side options that allow people to replace the fries with a salad or diced apples. However, it is more expensive to provide healthy more perishable items or organic items and it has yet to be seen that the mass market is willing to pay for that difference in food health quality. Thus, we can see why McDonalds would wait until a proven, low-cost yet healthy food option became popular. In particular, this is where the addition of smoothies fits into the McDonalds strategy.
Chance of becoming sick has also been factoring more into dining choices of consumers. Recent outbreaks of illnesses due to bad lettuce, tomatoes, and beef have created some upward pressure on raw food prices to McDonald’s and are encouraging consumer to consider other options instead of the typical burger. These results are also prompting menu changes because the margin on the double cheeseburger declined as beef prices rose and we saw consumers switching more frequently to chicken sandwiches. Since this is a more recent phenomenon, we cannot say that avoiding the challenges of food borne illnesses is a major driver of menu change.
Operational Innovation
In terms of food service, McDonald’s has been an innovator since its inception in San Bernardino, CA in
1948. McDonald’s was originally founded in the 1930’s as a drive-in restaurant, however, the McDonald
7
Mintel, Healthy Dining Trends
– US – May 2010
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brothers saw an opportunity to streamline their operations through a self-service model, which was completely innovative at the time.
The operations were pristine and efficiencies gained through the streamlined operations were passed along to the customers. “Each worker's steps had been carefully choreographed, like an assembly line, to ensure maximum efficiency. The savings in preparation time, and the resulting increase in volume, allowed the McDonalds to lower the price of a hamburger from 30 cents to 15 cents.” 8 In 1973,
McDonald’s began selling breakfast with the introduction of the Egg McMuffin 9 . With the introduction of breakfast came coffee. In spite of all the innovation within its food menu, McDonald’s spent the next several decades without any major changes to its drink selection, which boiled down to fountain sodas and coffee.
In the 1990’s McDonalds’ took its eye off the ball from an innovation perspective. Instead of continuing to innovate within its operations and within its menu, the company focused on a land-grab, which peaked in 1997 when it was opening 2,000 restaurants per year, much of that internationally. Domestically, McDonald’s began investing in other chains, such as Chipotle and Boston
Market as a way to further expand its real estate holdings beyond what it could do with just the McDonald’s brand.
As a result of this expansion phase, McDonald’s products and service began to slip. Internal reviews had it ranking behind Wendy’s and Burger King in blind taste tests.
10 As a result, McDonald’s CEO decided in 2003 “to reinvent McDonald’s by becoming ‘better, not just bigger’… and refocus our efforts on restaurant execution—with the goal of improving the overall experience for our customers.” 11 This meant returning to its roots as an innovative leader in the fast food industry.
At the same time, in the late 1990’s and early 2000’s chains like Starbucks were able to establish themselves as the go-to place for morning coffee and the 3:00 coffee break. Coffees costing $4 went from a ridiculous idea to something that was expected by consumers. “Customers visit [Starbucks] 15-
8 http://www.fundinguniverse.com/company-histories/McDonalds-Corporation-Company-History.html
; accessed 10/19/10
9 Ibid
10 Ibid
11 Skinner, Jim. “McDonald’s Corporation Annual Report 2009.”
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20 (and sometimes more) times per month. This is approximately double the frequency of core
McDonald's customers.” 12 Seeing this trend, McDonald’s realized they needed to be in the premium coffee game.
At first, McDonald’s simply created a new blend and rebranded their standard drip coffee. For most of the US this meant rebranding to McDonald’s Premium Roast Coffee. In New England, McDonald’s switched to Green Mountain Coffee’s Newman’s Own brand. The company did not stop there however.
They embarked upon “product and convenience initiatives [with the] installation of automatic sugar and milk mixing technology, which provide[d] drive-thru customers with the added convenience of having a
‘pre-treated’ cup of coffee to their liking.” 13 This initiative allowed McDonald’s to compete at the low end of the market for premium coffee with Dunkin Donuts and Tim Horton’s. However, the real innovation was finding a way to compete with Starbucks for the $4 espresso-based coffee market – this became the McCafé initiative.
Much as it did with hamburgers in the late 1940’s, McDonald’s utilized its operational expertise to create a new system that would produce Starbucks style coffee beverages without the typical labor and training required to produce them. “The key to fitting the new system into McDonald's highly regimented operation is that it will be simpler to operate than a Starbucks setup.” 14 The result, pictured to the right, was an elegant push button system that required some additional training, but nowhere near the level required by Starbucks systems.
McCafé: Specialty Coffee Initiative
The growth in premium and specialty coffee is now a well-established trend with a meaningful consumer base. Starbucks was a first mover in institutionalizing beverages such as the latte in the
US. McDonalds has followed the trend, tracking ethnographic research, and seeks to capitalize on it now that the consumer base is established.
12 Palmer, David. “Why Coffee Upside is Significant for McDonald's”. UBS Research Report. 22 June 2005.
13 Ibid
14 http://www.businessweek.com/bwdaily/dnflash/content/jan2008/db2008019_036171.htm
. Written 9 January 2008. Accessed 19
October 2010.
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According to McDonald’s consumer insights director, its strategy is “optimizing the product.” 15 This includes offering comparable quality at a lower price, combined with the convenience of the McDonalds experience. Today, McDonald’s sells ~2.7 million cups of coffee each day, including premium blend and specialty coffees.
16
McDonald’s took a multi stage approach to the coffee rollout, validating success at each juncture. First, the McCafé concept and branding was tested internationally in the late 1990s/early 2000s in markets where specialty coffee was established. Australia was the first test market where concept was either an extension of a McDonald’s restaurant or kiosk with a modern and sophisticated feel. As specialty and premium coffee reached critical mass in the US, McDonalds took the McCafé brand and paired it with a new premium coffee blend. This was launched in the first quarter of 2006. Premium coffee was produced with operational gains from automatic sugar and milk mixing technology.
With success proven, it then launched the specialty coffee rollout in 2009 that added the product line to all McDonalds locations in the US market. Products included lattes, cappuccinos, and mochas. Drinks were priced at a 15-18% discount to Starbucks. The rollout was supported by technology where by employees work automated espresso machines. Full marketing and promotion support was put behind the launch, making it the largest product launch in
McDonald’s history. Overall, the estimated marketing and promotion costs are estimated at $100 million.
17 On the marketing side, McDonald’s launched a campaign targeting the national market in the US for “McCafé your day.” The estimated budget was $30-50mil and included print, radio and TV advertisements.
18 This was coupled with heavy promotion including local in-store marketing, coupons, product sampling, and sponsorships like Chicago’s Fashion
Week. The timing of the specialty coffee rollout coincided with the global recession. It hoped to position itself for consumers who were looking for cheaper alternatives than Starbucks. McDonald’s believes it offers a strong value proposition given pricing and convenience.
15 Cebrzynski, Gregg. “Starbucks-dominated category wakes up and smells McD’s espresso rollout.” Nation’s Restaurant News. 21
January 2008.
16 Mintel. “Quick Service Restaurants – US.” August 2010.
17 York, Emily. “Marketing blitz for McCafé is on the way.” Advertising Age. 5/4/2009, Vol 80, Issue 16.
18 West, Jason. Greenberg, Marc. “Specialty Coffee Analysis.” Deutsche Bank Securities Inc. Equity Research. 15 April 2009.
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The specialty coffee rollout took a significant resource commitment by both McDonald’s Corporation and its franchisees, including capital investment and training. The machine installation and remodeling is estimated to have cost $1.4B, funded at $540 from McDonald’s and $840 million from franchisees. From an individual store’s financial standpoint, it cost about $100,000 to enable a restaurant for this product line. The specialty coffee machines cost $25,000. The required remodeling of the store cost $75,000 on average. Franchisees were required to pay the machine cost as well as
60% of the remodeling expense (McDonald’s funded the rest).
19 These expenses created financial pressure on the company and franchisees given the rollout occurred during the recession. To respond,
McDonalds Treasury Group added 100 lenders to their portfolio to finance the expansion.
20
The initiative was expected to bring strong financial performance.
Same store sales are a key metric followed by investors in this industry and analysts forecast a 1-2% increase from McCafé products. In addition, coffee drives frequency as coffee chain customers visit stores 2x the number of times that core fast food users do.
21 The initiative was also expected to have margin contribution given product margin and the increase in average ticket sales. Specialty coffee is estimated to be $1B in revenue for McDonalds in 2010 and about $75K per restaurant
Specialty coffee was also expected to follow the McDonalds model. McDonalds could compete on speed with technology. At a Starbucks or equivalent, beverage preparation takes 3-4 minutes on average.
McDonalds equipment pours specialty coffee drinks in 22 seconds. It could also deliver on consistency and quality. Coffee was pre-packaged to ensure consistency.
22 A rigorous, standardized process was used in training employees. It could also deliver value, as the products were priced at a discount to specialty coffee retailers like Starbucks (this fact was noted during the rollout in test markets, where
Starbucks pricing fell, an indication of a competitive response.
23 ). McDonald’s believes that they have a convenience advantage in specialty coffee given their large number of stores with prime retail locations.
19
Ibid.
20 “Serving a New Line despite Crisis: McDonalds.”
21 Palmer, David. “Why Coffee Upside is Significant for McDonalds.” UBS Investment Bank. 22 June 2005.
22 Sgro, Lindsay. “McDonald’s and the McCafé Coffee Initiative.” University of Western Ontario. 2002.
23 West, Jason. Greenberg, Marc. “McDonald’s Coffee Talk.” Deutsche Bank Securities Inc. Equity Research. 20 May 2008.
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The specialty coffee rollout was well received by market, which is validated in the revenue and same store sales increases the coincided with the launch. In addition, customer and investor feedback has been positive. “Most important product launch in the US in 2009” 24 “A game-changing event for the US specialty coffee industry” “We believe McDonald's could evolve into Starbucks' SBUX fiercest rival in the specialty coffee segment.” 25
McCafé: Smoothie Initiative, a Product Extension
The launch of smoothies in summer 2010 was a beverage line extension under the McCafé sub-brand. The rollout followed a similar path, including test markets and a national rollout supported by marketing and promotion support. From an operational standpoint, it involved a second machine placed in close proximity to the automated espresso machine for specialty coffee.
Smoothie consumption growth has been significant and is now a well-established trend. US sales of smoothie products were $2.45B in 2007, of which $2.3B were sales of made-to-order smoothies.
Category growth is up 140% from 2002 and the projected CAGR over the next 5 years is nearly 70%. The demographics of smoothie consumers are also favorable. Individuals aged 18-24 are the largest consumers of smoothies and
Hispanics overall – both are important demographics for McDonalds.
26
According to competitor Jamba Juice’s CEO James White, “We see McDonald’s entry into the smoothie category as validation of the market’s overall growth potential.” 27 Competitors are expected to benefit from the marketing of smoothie offerings by McDonalds.
28
As with the specialty coffee launch, McDonalds first tested the concept internationally. The test market was the UK where stores stocked pre-packaged Innocent branded smoothies, which were available primarily in Happy Meals. The pairing was a success and continued beyond the six month trial period in
24
Ibid.
25 Hottovy, RJ. “McDonald’s Corporation: MCD.” Morningstar Equity Research. 9 August 2010.
26 Mintel. “Smoothies – US.” March 2008.
27 Harlin, Kevin. “McDonald’s Pushing Smoothies to Boost Margins, Customers.” Investor Business Daily. 7 September 2010.
28
Ibid.
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2007.
29 It also tested smoothies in European markets with a “one shot” machine that produced made to order smoothies. In the US, machines were installed to produce Mocha and Caramel frappes in the first part of 2010.
Given testing success, McDonalds launched the product on a national basis in the US this summer
(2010). Smoothies are available in two flavors, Strawberry Banana and Wild Berry, and consist of a blend of real fruit, fruit juice, yogurt and ice. The only option for customization is for yogurt or non-yogurt. The drink is offered in three sizes: 12 ounces, 16 oz, and 22 oz. The resource commitment was much less intense given the store remodeling and brand launch had already been completed, the requirement was for an incremental machine only. We believe the space was accounted for in the remodeling plans.
Smoothies are expected to drive beverage revenue and same store sales. Early indications are positive.
As one analyst notes, smoothies “helped to drive impressive U.S. comparable sales of 5.7% in July
(compared to a 3.7% increase in June) and a 7.0% increase across the globe (up 4.8% in June)… smoothie sales are tracking well ahead of expectations.” 30
Market reception was positive. The company cancelled a planned giveaway in July 2010 because it was unsure it could meet demand. Per McDonald’s Chief
Marketing Officer, “The McCafé Real Fruit Smoothies are an absolute hit with our customers and we’re experiencing unprecedented demand.” 31 Some nutritional concerns have been voiced on calorie count and sugar levels as a small smoothie has 210 calories and a large one 330 calories (more than a burger) and 70g of sugar. Competitors have also responded. Jamba Juice launched two campaigns, one that paired the company with Dole, emphasizing the use of fresh fruit.
32 It then launched a mocking online ad campaign for “Cheeseburger Chill smoothies.”
29 DataMonitor. “Food Market Watch.” June 2007.
30 Hottovy, RJ. “McDonald’s Corporation: MCD.” Morningstar Equity Research. 9 August 2010.
31 Convenience Store News. “McDonald’s Nixes Smoothie Samples.” 8/16/2010. Vol 46, Issue 11, Page 18.
32 Newman, Eric. “Jamba Juice Wants to Stay Top Banana in Smoothies.” Brandweek. 5/5/2008, Vol 49,Issue 18.
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McCafé Coffee and Smoothie Ecosystem Map
Figure 1 – Ecosystem Map
Indirect
Suppliers
• Coffee
Plantations
• Dairy Farms
• Fruit
Growers
Direct
Suppliers
• Coffee
Packager
• Smoothie
Mix
Distributor
Restaurants
• Prepare coffee
• Blend smoothie
• Setup
McCafe
Customer
• Order
Beverage
Because McDonald’s realizes that it doesn’t need to be a leader in delivering this beverage experience, there is little innovation risk outside of the McDonald’s McCafé setups inside the restaurants. Since there is no huge payoff for the winner of the snack time beverage battle, McDonald’s can leverage the ecosystem knowledge laid down by numerous coffee and smoothie shops jockeying for leadership around the country by following behind competitors such as Starbuck’s and/or Jamba Juice.
The biggest risk to McDonald’s is a “reach” risk rather than a loss of “first-mover advantage” or “best-ofbreed” risk. However, this reach risk is one that makes some sense because it’s in a relatively attractive space that will drive an increase in business for its other menu items and this reach is non-core, or context based. To elaborate, McDonald’s can stop selling coffee and smoothies and even get rid of the
McCafé altogether without losing the drivers that make its core business successful. The McCafé menu and store innovations for McDonald’s offer a way to enhance its market knowledge and experience with hardly any worry about damaging its core business. In fact, McDonald’s already has a long history of introducing and removing menu items which seem to help increase seasonal store traffic.
As McDonald’s watches new product trends evolve and mature, select competitors have opted to develop new products, either earlier than McDonald’s or as a competitive response. Dunkin’ Donuts and
Starbucks provide the richest examples in comparing and contrasting new product developments. While
Wendy’s, Burger King, Subway, and other fast food players have had launched new product platforms and innovations, Dunkin’ Donuts and Starbucks’ timing and product selections present the most interesting comparison.
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Dunkin’ Donuts
Long heralded by New Englanders as their favorite coffee, Dunkin’ Donuts built a brand first around sugary donuts and tasty coffee. Catchy advertising (the 1982 launched “Time to make the donuts” campaign featuring quirky Fred the Baker), pushed sales across franchise locations, but the company long-remained a donut and coffee shop. Not until 1996 did the company materially expand its product line-up with freshly baked bagels. Just three years after launch, Dunkin’ Donuts earned the unexpected position of selling the most bagels in the country, with $130M of the company’s $2B in sales coming from bagels.
33
In 2002, Dunkin’ Donuts made its most direct competitive move by launching its so-called “espresso revolution” with an expanded line of coffee offerings, including espressos, lattes, and cappuccinos.
34
When asked if the company was attempting to compete directly and fiercely with coffee giant Starbucks,
Chief Executive Jon Luther commented disagreed, noting that Dunkin’ Donuts was just trying to share more of the coffee space.
35 While the product offering shared some similarities with Starbucks’ espressos offerings, the experience associated with the new Dunkin’ Donuts espresso line-up was quite different. Cup sizes remained the traditional small, medium, and large, coffee drinkers were not encouraged to linger with free wireless internet access, and Dunkin’ Donuts shops did not switch out their usual hard plastic furniture in favor of comfy coffee shop fittings. Instead, the company focused their efforts on competing on price and preparing a speedy cup of coffee on the go.
Finally, in 2006, Dunkin’ Donuts launched its Smoothie line in an effort to continue to expand its offerings to capture on-the-run meal needs other than breakfast. Capitalizing on the popularity of smoothies in the broader market (Jamba Juice, Elixir, etc.), Dunkin’ Donuts again developed a product to compete based on price and on-the-go customer needs. All three product launches remain part of the
Dunkin’ Donuts product line-up, and continue to be expanded upon with new flavors, sizes, and promotional offers.
Starbucks
Bringing coffee from the United States’ Pacific Coast, Seattle-based Starbucks is credited with developing coffee house culture in mass. The company focused on outstanding coffee bean selection,
33 Campbell, Douglas. “Krispy Kreme puts the cabosh on bagels.” The Business Journal, 4 June 1999.
34 www.dunkindonuts.com
. Accessed 9 October 2010.
35 Campbell, Douglas. “Krispy Kreme puts the cabosh on bagels.” The Business Journal, 4 June 1999.
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roasting, and preparation and became known for preparing the most personalized cup of coffee. Though other coffee chains (Caribou Coffee, Pete’s, etc.) offered exotic coffee drinks, Starbucks earned widespread recognition for training coffee drinkers around the world to look for flavored lattes, giant
Frappuccino’s®, and other coffee concoctions.
But as competitors entered not only the traditional coffee market, but also the more complicated espresso space, Starbucks found itself searching for ways to boost revenues and profits, despite a deteriorating economy. With the premium coffee market saturated, the company responded in 2008 by launching its more economical Pike Place Roast™ line in an effort to appeal to more price-conscious consumers. Priced at just around $2, it is marketed as a ‘signature coffee’ that is freshly brewed every 30 minutes. Intended to satisfy the taste buds of consumers who found Starbucks coffee burnt and bitter, the line is largely considered mild, and not surprisingly, was met with mixed reviews.
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In 2008, making a play for more health-conscious customers, Starbucks entered the smoothie space and launched its line of Vivanno Smoothies, with flavors such as Orange Mango Banana or Banana
Chocolate. The smoothies are free of artificial flavors, dyes, and High-Fructose corn syrup, and are intended to be a source of energy for customers who are on the go all day.
37 In the same year, Starbucks developed “The Perfect Oatmeal” as a healthy breakfast alternative, which quickly become the company’s top-selling breakfast food.
38
Figure 2
– Product Innovation Timeline
1996 1998 2000 2002 2004 2006 2008
Dunkin’
Donuts
Bagels
Dunkin’
Donuts
Smoothies
Dunkin’
Donuts
Espresso
Starbucks
Pike Place
Roast™
Vivanno
Smoothies
36 Poniewozik, James. “Starbuck’s New Brew.” TIME, Inc., 9 April 2008.
37 www.starbucks.com
. Accessed 9 October 2010.
38 Sterrett, David. “McDonald’s oatmeal test follows Starbucks’ breakfast hit.” The Chicago Tribune, 26 February 2010.
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Starbucks’ most recent response is a change in process, not product. In an unexpected reaction to
McDonalds’ coffee market penetration, Starbucks is asking its baristas to slow down their beverage preparation. Instructed to prepare no more than two beverages at once, Starbucks baristas have been instructed to adjust their work process in order to return to the “fine art of coffee making,” which the company expects will ultimately make beverage preparation faster.
39 This new direction is in stark contrast to other coffee retailers’ aim to mechanize food and beverage preparation.
Over the last decade, the pace and type of innovation which McDonald’s has undertaken has shifted significantly. What started out as product innovations, such as the McGriddle and the Big N’ Tasty, in the early part of the decade, largely gave way to process innovations that we have seen in the back half of the decade. McDonald’s has a stated policy, on its website, of only accepting new ideas from within the company. As a result, the company found itself creating variations on existing themes – the
McGriddle was a new version of the Egg McMuffin, while the Big N’ Tasty was just another burger. Each of these incremental product innovations was not creating or expanding the market for McDonald’s food; it was simply cannibalizing existing products within the portfolio.
While McDonald’s has continued to stick to its policy of only accepting innovations from within the company, it wisely began to look into the marketplace for inspiration about
Figure 3 – Innovation as Function of Time, McDonald’s Coffee
consumer tastes. By the time
McDonald’s finally came around to
Dominant Design Reached the premium coffee craze, Starbucks had been a raving success for more
McDonald’s Enters Market than a decade. Refocusing its efforts with the “Plan to Win” and “Better, not Bigger”, the company began to see itself as a restaurant again, and thus should be catering to the tastes
Time
Product Innovation Process Innovation of the consumers is was trying to attract and serve.
39 Jargon, Julie. “At Starbucks, Baristas Told No More Than Two Drinks.” The Wall Street Journal, 13 October 2010.
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Instead of focusing on product innovations which may or may not be successful, they instead focused on their core assets and leveraging those assets to bring proven products to market. In this case, the scale and reach of the McDonald’s network is unparalleled by competitors such as Starbucks and Dunkin
Donuts. By putting systems in place that could leverage the existing investments in real estate and labor, McDonald’s would be able to get to scale in the premium coffee game much more quickly than its predecessors and the existing market leaders. In addition, pulling new consumers into its stores for its premium coffee products would have ancillary benefits on boosting sales across the menu.
McDonald’s Entry into the premium coffee market came at an interesting point in the evolution of the coffee market more broadly. In particular, the flavors and innovations within premium coffee had been well defined by Starbucks several years before. From a range of espresso-based coffee options, to a variety of smoothie-like cold drinks, the Dominant Design of consumer tastes had been reached by the late 1990’s. By the time that McDonald’s actually picked up on the trend of premium coffee, Starbucks was already well down the road of creating process innovations that could improve the throughput of its operations, and further standardize their product offering.
McDonald’s picked up where Starbucks left off in this process innovation process. While Starbucks stopped at the grinding and Figure 4
– Product Quality/Choice as Function of Time, McDonald’s steeping of the espresso shots,
McDonald’s spent its energy further automating the
process. McDonald’s new processes and equipment for making coffee beverages did require some new training of its existing employees, however, the training was incremental and success was driven by the simplicity of implementation.
Time
Starbucks Innovation
Customer Requirements
McDonald’s Innovation
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As important in the process innovation arena was the creation of a “good enough” product. Where
Starbucks created nearly limitless consumer choices through its expansive options menus, McDonald’s was able to capture the vast majority of the market by focusing on a select number of options. This was key to both the creation of a simplified process, and also to making it possible to train employees in an efficient and effective manner. Ultimately, the creation of this “good enough” product was what caught
Starbucks off guard.
Innovation Strategy, making sense of uncertainty
Under this framework, we can see the genius of the approach from McDonald’s perspective as the level of uncertainty attached to such process innovation is definitely not large.
Table 2 – Innovation and Uncertainty
Theme Level of Uncertainty
There are high chances that McDonalds will be able to apply their process expertise to the delivery of a new
Technological Low
Market Low-to-medium product with little technological innovation/uncertainty needed. There is just a slight uncertainty on how the
Competitive Low-to-medium
Operational Low market will receive the new product coming from
McDonalds as their competitors in this race are offering
Organizational Low generally a premium product. However the other advantages given by McDonalds are in the game to offset this initial amount of uncertainty in the market.
In the same sense, the new products by McDonalds may provoke reactions from the main competitors.
However, as McDonalds is using its core competency of operational and distribution expertise, it is starting the battle with some clear advantage. There is almost no uncertainty on the operational side as
McDonalds works a first rate operations system that has been tested with similar challenges multiple times in the past.
The level of organizational uncertainty is also low. McDonalds can sell the new products idea somehow easily to its franchises. It does require very little for them to adapt and the returns look promising although not guaranteed. There is little downside for the franchisees to adopt the new product and that in sum reduces the organizational uncertainty.
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From a strategy point of view there are several aspects that make the process innovation approach attractive to McDonalds as it is aligned with other aspects of their overall strategy. Focusing on process innovation and operations delivery is in line with one of McDonalds corporate strengths. Competitors will find much more difficult to parallel the muscle and expertise that McDonalds possess in streamlining processes from the beginning to the value chain to its end customers. McDonalds through this expertise is able to offer a quality enough product at a reduced price while offering a convenient and fast customer service.
Serves customer retention
Customers of McDonald’s tempted to go to one of the competitors because of the attractiveness of some new products (e.g. Starbucks coffee) can still find McDonald’s traditional products in their usual fast food restaurant plus substitutes of those new products from the competitors. The customer service experience aligned with the way the new substitute products are served add to the customer retention strategy.
Customer salience
New products offered by McDonalds that have been successfully tested in the market by competitors have a high chance of increasing the salience at McDonalds. As a result the number of times and the volume of the purchases per client at McDonald’s would be favorably impacted.
In conclusion, McDonald’s current innovation strategy focuses on launching new products in proven categories, such as coffee and smoothies, to expand offerings in new day parts. Once McDonald’s identifies these opportunities, they align their ecosystem and leverage their operational expertise and economies of scale to make products available to mainstream consumers at lower price points than the competition. Overall, McDonald’s has been successful and intensified competition in these product categories.
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