Getting Deep-Fried in the Burger Wars

After McDonald’s Corp. disclosed more dismal news last week, Merrill Lynch & Co. analyst Peter Oakes sent a note to clients saying that when the fast-food giant’s new top managers take over Jan. 1, he expects them to announce that “everything is on the table.”

There was definitely no pun intended.

Something has to change at the world’s biggest restaurant chain. McDonald’s sales are flat, its profits are falling, its market is saturated with rivals, and its stock -- a component of the Dow Jones industrial average -- has plummeted to a seven-year low.

McDonald’s executive suite is in turmoil for the second time in four years. Critics say its service is slowing and its food still too fatty. McDonald’s “dollar menu” has sparked a price war with competitors that’s eroding nearly everyone’s earnings.

McDonald’s said last week that, because of restructuring charges, it expects a loss for the current quarter -- its first since the Oak Brook, Ill.-based concern became publicly held 37 years ago. The stock closed Friday at $15.75 a share, up 11 cents for the day, on the New York Stock Exchange.

McDonald’s is facing one of its toughest periods since Maurice and Richard McDonald opened their first 15-cent-hamburger outlet at a San Bernardino intersection 54 years ago this month. A few years later, Ray Kroc, who supplied milkshake mixers to McDonald’s, persuaded the brothers to let him expand their fast-food concept across the country. The rest is history, but the expansion that made McDonald’s an American icon is now a major burden. Having swelled to 30,780 restaurants in 120 countries, McDonald’s is a lumbering behemoth struggling to add to its annual systemwide sales (in both company-owned and franchised stores) totaling $41 billion.

It’s a problem that’s festered for several years. Despite McDonald’s rapid expansion and Americans’ mass-migration from their kitchens to fast-food restaurants, the company’s performance keeps sagging. In recent years, it has added items to its familiar menu of Big Macs and Happy Meals, overhauled its food-preparation techniques at great expense and slashed prices. Little has worked.

Profit has dropped in seven of the last eight quarters. The only reason sales are growing -- and barely at that -- is because of McDonald’s relentless opening of new stores. In the nine months ended Sept. 30, sales at its U.S. restaurants open at least a year -- a key gauge of retail growth -- fell 1.6% compared with the same period in 2001. Global same-store sales were off 2.1%.

McDonald’s said last week that same-store sales still are falling, down 1.3% in October and November. The company also said it would take a $390-million charge to cover its plans for closing up to 175 restaurants, cutting as many as 600 corporate jobs and other restructuring steps. That will produce the net loss for the quarter.

To be sure, McDonald’s is still a profitable business excluding that charge, and could earn more than $1 billion this year. But that’s down from a $2-billion profit in 2000.

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What Next?

Industry analysts, franchisees and customers are divided over what McDonald’s should do first -- scuttle its cheap prices, improve the taste of its existing fare, expand the menu further or improve the quality and speed of its service.

“In some cases I think the service has slipped,” Kathy Belden of Glendale said last week while eating at a McDonald’s in Downey. The restaurant, one of about 1,100 McDonald’s in California, is the oldest surviving outlet in the chain.

Larry Tripplett, who owns seven McDonald’s in the San Francisco Bay Area and chairs the National Black McDonald’s Operators Assn., said he hopes the price-cutting ends. “There’s no profit in selling a huge sandwich for a dollar,” he said.

McDonald’s last week said that its new chief executive, Jim Cantalupo, a former CEO of McDonald’s International who came out of retirement, “is aggressively reviewing all aspects of the business” and will comment further next month.

The company declined to elaborate on its plans until then.

But Cantalupo’s task is further complicated because the whole fast-food industry has gone stale. The $115-billion U.S. market will grow an average of only 2% in dollar terms for the foreseeable future, said David Rose, an analyst at JMP Securities in San Francisco. That means that if anyone gains market share, they’ll have to take it from someone else.

With its dollar menu, McDonald’s sparked an “unprecedented” price war that’s wreaking havoc in the industry, Robert Nugent, chairman of Jack in the Box Inc., said Thursday. The San Diego-based chain slashed its profit estimates for next year, and said its same-store sales for its fiscal first quarter ending Jan. 19 will drop more than expected, by 2.7%. Jack in the Box’s stock then plunged 20%.

CKE Restaurants Inc., the Santa Barbara-based parent of the Carl’s Jr. chain, also blamed the price wars for a 5% drop in same-store sales for its fiscal third quarter ended Nov. 4. Wendy’s International Inc. this month scaled back its earnings outlook, though it has been gaining market share from McDonald’s and others.

Burger King, the No. 2 burger chain behind McDonald’s, was sold by parent Diageo a few days ago to a private investment group -- only after the acquisition price was cut by more than a third, to $1.5 billion. The chain’s value tumbled in part because relentless fast-food discounting has eroded its profit margins.

With the market growing slowly, the big chains are having to wrestle for market share not only with each other, but with a growing list of smaller competitors that trumpet their meals as fresher and healthier, such as Quizno’s and Panera Bread.

Another California-based company, In-N-Out Burgers of Irvine, is by most accounts still thriving. But In-N-Out is an anomaly in the world of McDonald’s and Burger King. It has only about 150 locations, no franchisees and is family owned.

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Management Shuffle

McDonald’s mounting woes prompted a shuffling of top management this month. Jack Greenberg, the company’s chief executive since 1998, abruptly stepped down after making such changes as adding new menu items and overhauling McDonald’s kitchens to cook food to order.

But his effort couldn’t stop the company’s slide. To succeed Greenberg, McDonald’s tapped the 59-year-old Cantalupo. It also named Charlie Bell, president of McDonald’s Europe, as president and chief operating officer of the whole company. Bell, 42, has vast overseas experience with McDonald’s and is thought by many to be the heir apparent for the CEO’s job.

Just how much change they bring remains to be seen. But one problem they’ll have to address quickly is McDonald’s reputation among consumers, noted marketing professor Claes Fornell at the University of Michigan. His school publishes the American Customer Satisfaction Index, a public-opinion survey, and McDonald’s has finished last among its peers every year since the poll began in 1994.

McDonald’s food is “no longer what customers consider a good product, except the fries still get good marks,” Fornell said. “And now you also have problems with friendliness and speed” in the restaurants, he added. “If you combat these two” issues with price cuts, “you’re shooting yourself in the foot.”

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Times staff writer Karen Robinson-Jacobs contributed to this report.