McDonald's fights slowdown in Europe, U.S. with value initiatives

In meetings with American securities analysts in Germany and Poland, McDonald’s Corp. officials detailed the value-focused initiatives meant to manage through depressed consumer confidence domestically and in Europe, revealing what is likely to be a long, difficult road ahead.

Two analysts, Sara Senatore of Bernstein Research and Jeffrey Bernstein of Barclays Capital, concluded in separate research notes that, despite leading both Germany’s and Poland’s quick-service sectors in market share, McDonald’s would face pressure on its sales growth and profit margins as consumers pull back on their spending. The analysts met with McDonald’s chief executive Don Thompson, chief operating officer Tim Fenton and McDonald’s Europe president Doug Goare while touring the chain’s restaurants in Munich, Germany, and Warsaw, Poland, recently.

In the near term, McDonald’s is moving decisively in the direction of more value in Europe to grow traffic and market share, though officials acknowledged it is too early to tell how soon this strategy would lead to stable sales and profit growth. They also disclosed plans for an intensified value focus in the United States in the fourth quarter.

Germany, Poland drag down European results

In McDonald’s European division, which contributes 38 percent of the company’s annual global operating profit, Germany and Poland are emblematic of the economic havoc wrought on the region by high unemployment and declining consumer confidence.

“Polish customers’ confidence reflects the continued uncertainty around the strength of the euro and global demand,” Senatore wrote, “while German consumer sentiment appears to have worsened since July, as consumers calibrate what it will mean to bail out the rest of Europe.”

Bernstein noted that the informal-eating-out market is contracting in Germany and has stalled in Poland. While inflation for food, labor and rent continues to rise, “McDonald’s is not willing to pass along enough price to offset, leading to compression of margin and profit growth,” he wrote.

In both countries, McDonald’s is building up its value platforms and emphasizing that in its marketing. The chain is also laying the groundwork for sales of premium products in the future with carefully timed limited-time offerings to help offset some of the margin erosion inherent to a value push, Bernstein noted.

“Interestingly, after the introduction of value platforms, customers will often heavily use the value menu based on the perception that the platform is short-term in nature and will soon no longer be an option,” he wrote. “Once customers realize the value emphasis is longer-term in nature, they increasingly use other portions of the menu, helping in the recovery of both the average check and restaurant margin.”

That dichotomy is on display at Germany’s 1,420 McDonald’s locations in the form of the SMS value menu, similar to the U.S. Dollar Menu, and the McDeal combo meal, which launched in June. According to Bernstein’s research note, the SMS menu — which sells items for 1 euro to 1.49 euro — accounts for 20 percent of sales in Germany. The McDeal offering includes a choice between two sandwiches, plus fries and a drink, for 3.79 euro.

Senatore noted that McDeal was a response to competitors’ aggressive discounts in Germany, where McDonald’s wishes to avoid a race to the lowest price point.

“McDonald’s responded with McDeal because of consumers’ preference for full-meal options,” she wrote. “Notably, despite its dramatic scale advantages, McDonald’s has proved reluctant to engage in price wars because Germany represents a much bigger share of its profits than for other multinationals like Burger King.”

At its 290 restaurants in Poland, McDonald’s is pushing everyday affordability with its two-year-old value menu and a “2 for You” value combo for 5 zloty, equivalent to about $1.50. The offering pairs a sandwich and coffee at breakfast or a cheeseburger and French fries the rest of the day.

“This offer has effectively led to trade-up from the 3.75-zloty value menu, with the consumer seeing it as a better value,” Bernstein wrote, “though the addition of fries not offered on the value menu leads to a better gross margin for McDonald’s. The combination of the traditional value platform and the more recent ‘2 for You’ represents 26 percent of sales.”

Though value initiatives like these may maintain traffic and market share in Germany and Poland, McDonald’s still may not be getting ahead until a wider economic recovery across the continent materializes, Senatore noted.

“While we believe McDonald’s continues to execute well,” she wrote, “the evidence suggests the company will have to work harder just to stay in place in the face of substantial macro pressures on the consumer.”

A view to domestic plans

The same could be said for the business in the United States, where McDonald’s operates or franchises more than 14,000 restaurants. In his research note, Bernstein wrote of the perspective Thompson shared on the company’s domestic business while they toured Europe, revealing a similar plan to dial up the value on the menu and in the marketing portfolio.

Officials told analysts that McDonald’s underperformance in same-store sales in the United States, which rose 4.8 percent year-to-date, was largely “self-inflicted.”

“The primary driver through the first half of 2012 was the limited Dollar Menu advertising, based on the fear of food inflation’s impact on restaurant margins,” Bernstein wrote. “Other shortfalls include the emphasis on beverages rather than the core menu, along with the decision not to introduce [limited-time offer] the Pub Burger [nationally] due to consumer feedback in test. As an alternative, a premium chicken sandwich was introduced and did not achieve desired results.”

At the same time, some of the chain’s largest competitors like Taco Bell, Burger King and Wendy’s have improved their same-store sales markedly during 2012, but McDonald’s officials note that the brand’s scale lets it withstand rivals’ attempts to take market share.

“The largest of those peers would need to generate an incremental 4 percentage points of comparable-sales gains to negatively impact McDonald’s by 1 percentage point, all else equal,” Bernstein wrote. “Some of the peers’ success is attributed to heavy new-product news, which will need to be lapped. McDonald’s typically opts for a more steady and consistent new-product introduction approach.”

Brand executives expect to put a greater emphasis on everyday value and to intensify the media weight behind the Dollar Menu for the balance of 2012, Bernstein noted.

“In addition,” he wrote, “specific to the fourth quarter, the focus will be on a new premium burger, a return of the McRib and a return of the Monopoly promotion.”

Oak Brook, Ill.-based McDonald’s operates or franchises more than 33,500 restaurants worldwide.

Contact Mark Brandau at [email protected].
Follow him on Twitter: @Mark_from_NRN