I am currently in the process of researching and writing a long article on the restaurant industry, or more specifically Steak n Shake, McDonald’s, and In-N-Out Burger. I should have it finished in a few weeks or so. In the mean time, please enjoy the following excerpt of the article on McDonald’s:
As Ray Kroc sat in his car, he watched a miracle unfold. The parking lot was full, the lines were long, and customers were leaving with an arm-full of food and a smile on their face. Kroc stopped a few to see what was going on: “You’ll get the best hamburger you ever ate for fifteen cents. And you don’t have to wait and mess around tipping waitresses.” He had travelled the country selling milkshake machines, visiting countless restaurants of all types. But he had never seen a merchandising operation like this. It was 1954; fourteen years after the McDonald brothers opened their small burger drive-in in the town of San Bernardino, California.
The brothers—Mac and Dick McDonald—had started the fast-food stand in 1940, but didn’t achieve real success until eight years later. It was then that they turned the kitchen into a mechanized assembly line—with each step in the cooking process being stripped down to its essence and accomplished with minimum effort. They got rid of the carhops and indoor seating, replacing them with a system where customers would order directly through outdoor service windows. By concentrating their efforts on keeping costs down, the brothers could maintain low prices for a consistently good product. This inevitably led to a high rate of customer turnover. “Our whole concept was based on speed, lower prices, and volume,” Dick McDonald recalled. “We were going after big, big volumes by lowering prices and by having the customer serve himself.” By 1954, they had haphazardly licensed ten other drive-ins, many of which were poorly managed and had no consistent system. They were McDonald’s only by name.
This is where Ray Kroc, a spunky salesman from Illinois, entered the picture. Kroc was a visionary. No matter what kind of business he had pursued over his life, he dreamt big. From selling milkshake machines to flipping real estate in Florida, his goal was always to be the best. There was no settling for second place. So when he pitched his franchise idea to the McDonald brothers (he had already tried with Carl Karcher and Harry Snyder), he didn’t hesitate to think big. “Visions of McDonald’s restaurants dotting crossroads all over the country paraded through my brain,” Kroc later recalled. At first, the brothers politely declined. They were content with the decent living they made running just one store in California. Kroc persisted, explaining that he would help open all the stores—doing all the hard work—and the brothers would just sit around and collect royalties. They agreed. A contract was drafted that day, and Kroc was on his way back to Chicago.
Before he could begin selling franchises, Kroc had to build his own McDonald’s to perfect all the procedures. He went fifty-fifty with a friend on a location in Des Plaines, Illinois, which opened its doors on April 15, 1955. All the cost and time saving mechanisms had to be the same—the layout of the griddles and fry vats were essential to the operation’s efficiency. But most of all, Kroc was adamant about maintaining the consistent quality of the food. They had some initial difficulties replicating the San Bernardino store’s success. Leaving the potatoes outside in California, it turned out, produced a completely different french fry than in Illinois. Kroc’s attentiveness paid off: “Ray, you know you aren’t in the hamburger business at all,” one of his suppliers told him. “You’re in the french-fry business. I don’t know how the livin’ hell you do it, but you’ve got the best french fries in town, and that’s what’s selling folks on your place.”
Although the Des Plaines location wasn’t doing as well as the California McDonald’s, it had made money from day one, and Kroc now had the confidence to start lining up franchisees. Just over a year after the 1955 opening, there were already eleven franchised stores across the country. Another year later, in what would become the beginning of a breakneck growth pace, there were twenty-five more units opened.
Through his agreement with the McDonald brothers, Kroc was earning a paltry 1.9 percent of the gross revenues of all McDonald’s franchises and 25 percent of that went to the brothers. (In 1960, despite having system-wide revenue of $75 million, McDonald’s earned only $159,000.) Something had to be done to earn extra income. Harry Sonneborn, the company’s financial wizard, came up with the idea of purchasing the real estate under franchised locations and leasing it back to the operator. Franchise Realty Corporation was set up in 1956 to act as the landlord to current and future franchisees. As the operators began paying ever-increasing monthly rent, Franchise Realty soon became one of McDonald’s biggest generators of profit.
In 1959, the decision was made that the company should build and operate ten or so locations in addition to their franchise operations. To finance the expansion, they received a loan from three insurance companies for $1.5 million in exchange for 22½ percent of McDonald’s stock. After the first McOpCo (McDonald’s Operating Company) store was established, the loan would provide the basis for McDonald’s rapid growth during the sixties.
Despite the new income from McOpCo and Franchise Realty, Kroc was unhappy about his agreement with the McDonald brothers. In 1961, he asked them to name their price, and bought the company and the name for $2.7 million. At the time, he balked at the price and viewed the brother’s offer as outlandish. Yet in hindsight, the buyout would turn out to be one of the best investments Kroc would ever make.
Kroc stepped down as C.E.O. in 1968, but he still played an active role in the company. Despite a bad economy during the seventies, he pressured the company’s leaders to increase the rate of growth. “Hell’s bells, when times are bad is when you want to build!” Kroc screamed to his executives. “Why wait for things to pick up so everything will cost you more?”
At the time of Kroc’s death in 1984, the McDonald’s system had grown to just under eight thousand restaurants in thirty-two countries around the world. Using the same methods that Kroc obtained—and perfected—from the McDonald brothers, the company continues to maintain its role at the top of the fast-food world. In 2008, it narrowly inched-out Subway in terms of the number of total locations—coming in at 31,672. With average sales per store of $2.2 million, McDonald’s remains the undisputed leader with system-wide sales of over $70 billion. That seventy billion in volume comes from serving over twenty-one billion customers in 2008—meaning that, on average, every person on the planet visited a McDonald’s three times last year. Even Ray Kroc couldn’t picture that.
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So, aside from great leadership and the luck that is inherent in any success story, how did McDonald’s achieve these results? Examining the company’s history, there are three elements that stand out: their franchising model, their leadership in cost and time efficiency, and their ability to convey those benefits into the minds of customers.
Once you have a good brand and model that works well with customers, the concept of franchising is very appealing to any businessman. You provide the name, image, procedures, product and some training, they do the rest of the work and you receive perpetual royalties. The amount of capital needed to grow a franchising operation is minimal, which makes it even more appealing from a return on investment standpoint.
With McDonald’s, from day one, Ray Kroc made sure that franchising was the main focus. “[T]he corporation is in the hamburger restaurant business, and its vitality depends on the energy of many individual owner-operators,” Kroc reminded his colleagues. “We are an organization of small businessmen. As long as we give them a square deal and help them make money, we will be amply rewarded.” During his tenure at McDonald’s, Kroc maintained a delicate balance between top-down, system-wide standards and a decentralized, entrepreneurial environment at both the franchise and corporate level.
Throughout its history, McDonald’s has been intimately involved in the development of their operator’s locations. By the time Kroc left the company, franchise owners were asked to spend five-hundred hours working in another location first, and to attend Hamburger U, the company’s training facility for managers and operators. At times, the company scouted real estate locations for their operators years in advance.
But the franchise relationship was a two-way street. Over the years, operators developed successful additions to the menu such as the Big Mac, Filet-O-Fish, and Egg McMuffin. In 1963, the marketing idea of two Washington D.C. operators was soon used across the entire chain, and has been promoting the company ever since. Ronald McDonald, the “Hamburger-Happy Clown,” was created by Willard Scott, a local television announcer, to appeal to kids and their families. Always a fan of catchy marketing gimmicks, Kroc loved the idea.
However, without a great concept in the first place, franchising falls flat on its face. The ability of McDonald’s to have both the fastest and most cost efficient procedures gave them a persistent advantage over rival fast-food chains.
In the 1960s, they realized the need for more sophisticated mechanical equipment and electronic aids to help speed up the food preparation process and make their products more uniform. The McDonald’s Research and Development Laboratory was established to address these issues. Technicians and engineers worked on everything from a dispenser that gave the exact right amount of ketchup every time, to the Fatilyzer—a testing device that allowed operators to analyze meat shipments as they were delivered. With regard to continually lowering costs and improving operations, Kroc was relentless. “[P]erfection is very difficult to achieve, and perfection was what I wanted in McDonald’s. Everything else was secondary for me.”
But all the cost and operational efficiencies wouldn’t matter if they didn’t bring in more customers. When someone thinks of McDonald’s, it is likely they think of cheap, fast, consistently quality food. (And by quality, I mean a good, not great or healthy meal.) There’s no sitting down and waiting—you order from the wide variety of options, get your food almost immediately, and go.
In Kroc’s autobiography “Grinding it Out,” he succinctly describes some of the reasons why McDonald’s works so well with both customers and franchisees:
We wanted to build a restaurant system that would be known for food of consistently high quality and uniform methods of preparation. Our aim, of course, was to insure repeat business based on the system’s reputation rather than on the quality of a single store or operator. This would require a continuing program of educating and assisting operators and a constant review of their performance. . . . the key to uniformity would be in our ability to provide techniques of preparation that operators would accept because they were superior to methods they could dream up for themselves.
In the minds of customers, creating a uniform and consistent product is one of the most important aspects of McDonald’s success. No matter where you go, once you see the ubiquitous “golden arches” you know exactly what you’re going to get. Especially when you’re in a hurry, why take the chances with someplace else? They’re not known for high quality food, service, or atmosphere—but as evident from the enormous amount of customers they serve, McDonald’s is the clear leader in cost, speed and consistency.