Last November, McDonald’s announced a 2% decline in same-store sales for the first nine months of the year. This caused a flurry of concern among investors, who had come to expect steady growth from the world’s largest hamburger chain.
What should McDonald’s do? Well, its instructive to go back to the late-1990s, when the company was feeling the heat from the healthy-food lobby, and had over-extended itself with too many new stores. In 1999 it made its first ever job cuts, and it embarked on a series of acquisitions into adjacent areas: Chipotle, Aroma Café, Donotas Pizza, and Boston Market, as well as a 33% stake in Pret a Manger. None of these new businesses helped at all. The company reported its first-ever quarterly loss in 2002. A new team was brought in, and the “I’m Loving it” campaign, launched in 2003, helped to refocus on the core business. The non-core businesses were gradually sold off, but a lot of money and executive attention was wasted in the process of experimenting with them.
Many companies face this dilemma. The market for the core product matures, competition gets tougher, and there are no obvious pathways to growth. But the stock market expectations are such that the management team feel compelled to seek out new sources of revenue in increasingly risky areas. The result is usually failure, retrenchment, and a pledge to refocus on the core business. This is what happened to McDonalds in 1999-2003. Lego went through a similar turnaround in the same period of time.
So what is the alternative? A much better approach is to be honest about what you are good at, and to keep on doing it better than anyone else. I don’t believe McDonald’s shareholders wanted the management team to dabble in new business areas in 1999; they wanted Mcdonald’s to be the best burger restaurant in the world, and to make lots of money doing it. Of course, this isn’t as sexy a strategy as trying out new formats and acquiring companies in adjacent markets, but it’s actually a much smarter long term bet.
Here is an example of what I am talking about: UK high street retailer, WH Smith, has faced a decade of falling sales in its core market. It must have been tempting for its CEO, Kate Swann, to try something radical – a move into online selling, new shop formats, a big acquisition – but instead she stuck to what the company knew best. She focused on operational efficiencies, pushed higher-margin products like confectionary, and sought out growth in the few segments where it was possible, such as airports. From 2004 to 2012, WH Smith’s net profits grew by 90% while its top-line revenues shrank by 15%. An impressive feat – not glamorous at all, but highly effective, and exactly what the shareholders wanted.
There is a delicate tension between what shareholders really want from their CEOs and what CEOs find alluring. It is often claimed that executives are only pushing for growth to satisfy their shareholders demands, but actually this is not correct. Shareholders are very good at differentiating between the shares they buy for growth, and the ones they buy for their dividend. McDonald’s and WHSmith are mature, well-run companies that are leaders in their respective industries and generate good cashflows. Shareholders don’t want their management teams to take excessive risks, they are content with a steady and predictable performance in line with the market.
So let’s hope McDonald’s has heeded the lessons from its own experiences a decade ago. The bottom line is simple: when you are operating in a mature market, going for growth is a risky game. New business developments rarely work out well, and they can be a massive distraction. You are typically far better off refreshing your offerings to your core customers, and adjusting your shareholders expectations to the realities of the market you are operating in.