McDonald's is not a Happy Place these days. Its latest earnings announcement, made last week, revealed operating income down 28 percent year over year (down 20 percent in constant currencies). Sales dropped by 2.3 percent, "reflecting negative guest traffic in all major segments," according to the earnings release. Earnings per share, down 31 percent. Take out currency losses and one-time charges and that's still 9 percent off last year.

It gets worse. Same store sales, that vital measurement of how continuing operations are doing, sank 16.5 percent. To put that into perspective, restaurant same store sales are almost universally up, according to Trinity Capital, a boutique investment banker in the restaurant industry. In its "sandwich" category, Burger King, Jack in the Box, Sonic, and Wendy's have all been up since the last quarter of 2013. McDonald's has been down since then.

The shadow of Ray Kroc falls long over the McDonald's empire, though not long enough to bolster the company's current performance and management. The former milk-shake machine salesman came across the almost machine-like burger establishment of the McDonald's brothers--clean, efficient, and drawing in a never-ending stream of blue-collar families--and realized that this was a concept that had legs longer than a modern NBA center.

Kroc instinctively understood branding, the power of marketing, and what efficiency and predictability could do for a national business. He grew the concept, slugging it out from one location to the next, charging low fees to franchisees, buying real estate to lock in positions and only leasing it to franchisees. That gave the company control and developed what would become an enormous profit line. A percentage of everyone's sales went to national advertising that helped make the brand. Still, franchise owners could make some serious money.

More importantly, beyond personally doing surprise inspections himself, Kroc realized that a business partnership required two-way communication. The franchisor has to listen, not just command. And if it does, the results can be economic magic. Although there were controls over the franchisees, there were also allowed to develop their own products and express some innovation. Here are some of the products that franchise owners created:

  • Big Mac
  • Filet-o-Fish
  • Egg McMuffin

That's right, some of the biggest hits the company ever had came from the franchisees. They could make money, be creative, and have a business. Today things are a lot different. The company orders, the franchisees do--and pay. McDonald's has high fees and then requires sole-source purchasing and acts as the landlord. (An expert in the industry once told me that he passed over any opportunities that required sole-sourcing because, even with the best of intentions to drive down costs with volume purchasing, eventually the temptation to start soaking franchise owners becomes too great.)

Many McDonald's franchisees are angry at central management because they're being squeezed so hard. The National Labor Relations Board has said that McDonald's is effectively a joint employer of all those franchise workers, many of who are protesting or striking to get higher wages and more predictable hours, because of the degree of control the central company exerts.

What McDonald's needs is a return to the past. A franchise operation has to be a partnership between the central company and all the franchise owners. Quality of brand is fine, but if you don't let all those individual businesspeople experiment, you lose much of the innovation that can create the next big thing for the company. But that will take a bigger shift in central management than the company has been willing to undertake. Maybe it's time to remember that if the franchise owners can't succeed, neither can the franchisor. Somewhere, Ray Kroc is shaking his head.

Published on: Apr 27, 2015
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