The Internationalization of McDonald s

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Walter Strickland
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1 The Internationalization of McDonald s Today McDonald s is one of the world s best-known global brands. McDonald s operates in 117 countries around the world and serves on average 70 million customers a day in more than 35,000 restaurants. However, its path to internationalization was far from smooth, and the early missteps might have discouraged a leader who was less determined than Ray Kroc. Now honoured as the true founder of McDonald s, Ray Kroc was actually the first McDonald s franchisee. He sold milkshake machines in the 1950s, and his largest customer was a hamburger stand in California owned by the McDonald brothers, which bought eight machines. He was so impressed by the speed of their service and the large number of customers they served that he asked them to let him franchise their model. By 1965, when he bought out the brothers and took the company public, he had built a chain of 710 restaurants in 44 states, primarily suburban, family-oriented restaurants to which families could easily drive. Most observers see the key to McDonald s success in its rigorous application of standardized systems to the production of food and to the delivery of fast food service. The first large-scale branded fast-food restaurant, McDonald s pioneered the restaurant franchise, in which entrepreneurs could buy a McDonald s franchise (or several) and, using McDonald s systems and suppliers, build a business. McDonald s applied the assembly-line process to the production of food, and, by using part-time and low-skilled labour and standardized inputs purchased in large quantities, kept the prices of its meals extremely low. From very early in its history, McDonald s welcomed children (unlike other restaurants of the time), attracting them with the clown Ronald McDonald and appealing to parents with its cleanliness, its predictability, and its low prices. 1

2 Its franchisees were required to adhere rigorously to McDonald s standards and procedures for operating, and the company made sure that franchisees had no excuse for not understanding and applying the systems. In 1961, the company established Hamburger University near its Oak Brook, Illinois, headquarters, and required every franchisee and every store manager to undergo a two-week training programme there. The first Hamburger University was in the basement of a specially-built restaurant, but it moved into an expanded facility in 1968, and in 1983 into a $40 million facility with a 30-member faculty. By the late 1960s, growth in the U.S. market was slowing, and Ray Kroc decided to expand internationally, although many people inside and outside the company thought this was a mistake. McDonald s was deeply rooted in its home market. Its menu was quintessentially American (hamburgers, fries, milkshakes), and its restaurants were part of the American suburban landscape, catering to families with small children who wanted a fast, cheap meal at a restaurant easily accessible by automobile. It relied on entrepreneurial franchisees who cherished the American dream of building and owning one s own business and who could flourish in a system that tightly controlled operations (including service standards) but expected considerable initiative from franchisees in marketing. It also relied heavily on a small group of U.S. suppliers who had started as small businesses but had grown with McDonald s and were dedicated to meeting its stringent requirements (the giant suppliers such as Kraft had been unwilling to meet McDonald s demands for a sharper cheddar, for example, so Kroc turned to a small Wisconsin cheese producer which has grown today into a major global supplier). Few people would have predicted that within two decades McDonald s would conquer the world, as a 1994 Fortune article put it, 1 because its initial efforts were resounding failures. Following a common pattern, McDonald s first expanded into foreign markets close to home: the Caribbean (1965) and western and eastern Canada (1967). The company used developmental franchises that were very different from the standard U.S. franchise agreements: the company sold a territorial license in each of these three regions, in which the licensee took responsibility for finding locations, building the stores, recruiting franchisees and managers, and establishing the supply chain. McDonald s simply took an upfront license fee and charged a royalty on sales. By 1970, all three territories were losing a lot of money, and McDonald s bought out the licensees (a move opposed by most directors and many shareholders, since McDonald s seemed to be paying good money for operations that should simply be allowed to go bankrupt). McDonald s top executives remained committed to international growth, but concluded that the company needed to be as involved in overseeing its foreign restaurants as in its U.S.operations. 2 The next effort at expansion targeted Europe, and selected Holland as the first entry point, through a 50/50 joint venture with the country s leading supermarket chain, Albert Heijn. This was even less successful: in the words of one analyst, The Netherlands experiment turned into a series of small mistakes that added up to a long-term disaster. 3 The stores were set up in the suburbs, on the U.S. model, but since eating establishments in Holland were clustered in town centres, few people came. And under pressure from the local partner, the menu was localized (e.g. deep-fried chicken 1 Andrew Sewer and John Wyatt, McDonald s conquers the world, Fortune Vol (October 17, 1994), pp John F. Love, McDonald s: Behind the Arches (New York: Bantam Books, revised edition 1995), p Ibid., p

3 croquettes and no Quarter Pounder). After five years of steady losses, McDonald s bought out its partner. The first successful venture was, surprisingly, in a market that seemed to be one of the most difficult in the world for a restaurant like McDonald s Japan and the lessons learned there provided the key to McDonald s later successful expansion in Europe and elsewhere. The principal teacher in this learning was Den Fujita, a Japanese entrepreneur who in 1971 persuaded Kroc to set up a joint venture to bring McDonald s to Japan. Fujita insisted on not localizing the menu, focusing instead on marketing Mak-ku-do-na-ru-do s as a new experience in eating, in part on the grounds that McDonald s standardized operating systems were weakened when the menu was localized. He also set up a Japanese Hamburger University to train managers and staff, on the model of McDonald s Illinois Facility. But he resisted McDonald s advice on location and marketing strategies. Fujita insisted on opening his first McDonald s store on the Ginza, Japan s most fashionable (and most expensive) shopping area. Despite widespread predictions of disaster, it proved an enormous hit with young Japanese, especially teen-agers, and McDonald s soon became a fixture in Japan. Today Japan ranks second after the US in terms of number of stores and single-country sales. The first Japanese McDonalds opens on the Ginza, Japan s premier shopping district One of the major problems McDonald s faced in going international was obtaining the kind of standardized inputs in high volume on which McDonald s built its operating model in the U.S. (e.g. Idaho potatoes of a standard size and moisture quota, hamburger buns of a particular shape and consistency, pickles of a specific flavour and size). After four decades of experience in internationalization, McDonald s has developed strong capabilities in building and managing its supply chain. When McDonald's first enters a country, it often has to import many of its supplies. Then the company tries to source locally as quickly as possible. Sometimes it contracts with local suppliers: for example, a German mustard and mayonnaise company that started with a $100 order some 20 years ago now sells McDonald's $40 million of condiments annually. But McDonald s has also, from very early in its history, taken its U.S. suppliers with it when it goes abroad. For example, Chicago-based meat supplier OSI Industries now owns 45 factories in 18 countries, several of them joint ventures in which it works with local companies to produce McDonald's hamburgers. McDonalds in Canada and Europe has followed its U.S. model of a mix of wholly-owned stores (about 15%) and franchises to local entrepreneurs, although it has learned from experience that identifying trustworthy franchise operators can be difficult in different cultural contexts, and it now has an experienced and sizeable organization to screen and approve franchise applicants. In other locations, it has followed its Japan pattern of forming a joint venture with a local entrepreneur with 3

4 the financing and experience to run the franchising operations in that country. About 80% of the company's stores worldwide are franchised. As in the U.S., potential franchisees go through a twoyear screening process. They must work at a store and go through training before gaining final approval, upon which they put up a substantial payment (around $50,000) and sign a 20-year contract that guarantees McDonald s a royalty of 4% of sales, 8% rent for the facility, plus 4% of sales for advertising. McDonald s operators organize themselves into regional service groups to pool advertising expenditures and ideas. McDonald s does not accept a franchisee who will not be significantly and directly involved in operations and are committed to maintaining the standardized operating procedures, using McDonald s supply chain, and personally ensuring the standards of cleanliness and service prescribed by McDonald s. As McDonald s expanded even more widely into Russia, China, and India it not only had to educate employees; it also had to train customers, who had to be prepared to stand in queues, place their orders quickly, take their trays to their tables, and clean up their own tables. Moreover, entry into these markets often involved difficult negotiations and some departures from previously established patterns. In Russia, for example, the entry effort was led by McDonald s Canada, and took over a decade before a partnership agreement was reached in 1988 with the municipal authorities in Moscow not the kind of partner that had made McDonald s so successful in Japan and it took two years to build the supply chain, develop the staff, and get the store built. However, the 1990 opening of the Moscow restaurant was the most successful opening in the company s history. The fact that the Russian entry was managed by the Canadian subsidiary team rather than by headquarters illustrates an ongoing challenge for McDonald s: its American identity. Sewer and Wyatt in the 1994 Fortune article describe how McDonald s publicly deals with this issue: For all its brand recognition, McDonald's has to walk a fine line between being perceived as global or local and American. "People are more the same than they are different," says the head of International, whose charge it is to sow the company's stores like seed around the world. "I don't think our food is seen as American. It's seen as McDonald's." A lot of very intense preparation before entering a market, including the hiring of local managers, helps make this most American of brands seem pretty local too. Before entering Poland in the early 1990s, for example, the company planned for 18 months. Locations, real estate, construction, supply, personnel, legal, and government relations were all worked out in advance. Finally, in June 1992, the American in charge of the Poland entry charged in with a team of 50 from the U.S., Russia, Germany, and Britain. Two years later, all except him had been replaced by Poles in what McDonald's calls a sunset program. Each country McDonald's enters presents its own problems--or opportunities. German law prohibits special promotions like "buy one, get one free" and advertised discounts. Labor unions in France recently accused the company of cheating workers out of overtime pay. Coping with foot-dragging officials sometimes requires McDonald's to take the offensive. In Germany a recent Chinese food promotion worked so well that the company ran out of spring rolls. "I tried to order more from our supplier in Denmark," explains Hans Griebler, the affable head of purchasing in Germany, "but he told us his company needed permission from the government to work on the weekends. I called the 4

5 Danish labor minister and got it." 4 McDonald s has expanded its menu over the years, and many of the most successful innovations have come from franchisees: the Big Mac, the Filet o Fish sandwich, the Egg McMuffin, for example, came from U.S. franchisees. Increasingly, however, innovations are being picked up from the international franchisees. The Dutch created a pre-fab modular store that can be moved over a weekend. The Swedes came up with an enhanced meat freezer. And satellite stores, or low-overhead mini-mcdonald's, were invented in high-rent Singapore. At the Beijing Olympics, McDonald s offered a spicy China Mac that became a major hit in Asia. McDonald s is clear on one thing, however: new items must be adapted to its standard operating procedures, not slow down the production or service process, and must have a consistent quality. McDonald s internationalization has not, however, been an unmixed record of success. Since 1995, McDonald s struggled to make inroads in South Africa, against strong competition. In 2010, it signed what looked very much like the old developmental franchise agreements with Cyril Ramaphosa, a former leader of the South African National Congress who left politics when he failed to win the ANC leadership and went into business. He headed a highly diverse portfolio of businesses that benefited from his wide networks and multiple directorships. He did not resemble the entrepreneurial, hands-on operator favoured in earlier internationalization efforts. Under the agreement, Ramaphosa owned the existing 132 McDonald s outlets in South Africa and would have a 20-year franchise with a mandate to expand McDonald s business in the country. McDonald s also struggled in Latin America, where it has failed to build a profitable and substantial presence. In 2007, a year in which the company reported its first overall loss in four years and came under severe pressure from shareholders and analysts to generate better returns, it sold almost 1600 restaurants in Latin America and the Caribbean. The buyer was a group that included Woods Staton, the Colombian owner of a number of McDonald s operations in the region, and a consortium of private equity investors, who paid $700 million for a regional master franchise agreement that will give it control of the existing restaurants and the mandate to expand significantly, paying McDonald s a royalty of 5% of gross sales. Whether this move will prove in the long run to be more successful than the developmental franchises of the 1960s is still an open question. 4 Sewer and Wyatt, op. cit. 5

6 In 1996, McDonald s entered India, a country that many thought would never see a McDonald s because of the Hindu prohibition on eating beef. Expansion was slow: the 100 th McDonald s restaurant was opened in 2006, a decade after the first. McDonald s India had to make many adjustments to its menu and to its services (for example, in 2006, it introduced McBicycle home delivery services). Expanding the supply chain in India was been challenging: the dominance of very small farms, for example, meant that in order to develop a supply of Idaho potatoes with the right characteristics and in the very large volumes required for its French fries, McDonalds called on the Canadian company, McCains. The major supplier world-wide of potatoes for McDonalds, McCain s had to foster the development of a network of small Indian farmers to produce the required size, quality, and amount of potatoes and had to develop its own product range in India (such as frozen spicy McCain s fries) to build scale. The success of McDonald s international expansion brings its own set of problems: as it has extended its reach into so many markets, can it continue to grow? Discussion Questions: 1. The culture of food is among the most locally differentiated aspects of culture, with great differences not only across countries but across localities within countries. Yet McDonald s has managed to build what is widely seen as one of the most global companies in this very locally responsive industry. How has it managed to do this? 2. How has McDonald s been influenced by the institutions and culture of its home country? Has that influence declined over the decades as it has become a global company? 3. What are the main institutional differences that McDonald s has had to content with as it has expanded internationally? What are the main institutional pressures it is facing today? 4. McDonald s is facing serious challenges in continuing to grow, and even to maintain its competitive position. What are the principal institutional pressures it is currently facing? What advice would you give McDonald s as it struggles to adapt, especially with regard to framing? (Draw on Bach and Blake s California Management Review article.) 6

RAY KROC: THE FAST FOOD KING

RAY KROC: THE FAST FOOD KING 1. BEFORE YOU READ. You are going to read an article about the founder of the McDonald's chain of hamburger restaurants. Before you read the text, match the ten words in A with their definitions in B.