Why McDonald’s and Apple Investors Should Be Very Wary

Why McDonald’s and Apple Investors Should Be Very Wary

Growth Stalls are deadly for valuation, and both Mcdonald’s and Apple are in one.

August, 2014 I wrote about McDonald’s Growth Stall.  The company had 7 straight months of revenue declines, and leadership was predicting the trend would continue.  Using data from several thousand companies across more than 3 decades, companies in a Growth Stall are unable to maintain a mere 2% growth rate 93% of the time. 55% fall into a consistent revenue decline of more than 2%. 20% drop into a negative 6%/year revenue slide. 69% of Growth Stalled companies will lose at least half their market capitalization in just a few years. 95% will lose more than 25% of their market value.  So it is a long-term concern when any company hits a Growth Stall.

Growth StallA new CEO was hired, and he implemented several changes.  He implemented all-day breakfast, and multiple new promotions.  He also closed 700 stores in 2015, and 500 in 2016.  And he announced the company would move its headquarters from suburban Oakbrook to downtown Chicago, IL. While doing something, none of these actions addressed the fundamental problem of customers switching to competitive options that meet modern consumer food trends far better than McDonald’s.

McDonald’s stock languished around $94/share from 8/2014 through 8/2015 – but then broke out to $112 in 2 months on investor hopes for a turnaround.  At the time I warned investors not to follow the herd, because there was nothing to indicate that trends had changed – and McDonald’s still had not altered its business in any meaningful way to address the new market realities.

Yet, hopes remained high and the stock peaked at $130 in May, 2016.  But since then, the lack of incremental revenue growth has become obvious again. Customers are switching from lunch food to breakfast food, and often switching to lower priced items – but these are almost wholly existing customers.  Not new, incremental customers.  Thus, the company trumpets small gains in revenue per store (recall, the number of stores were cut) but the growth is less than the predicted 2%.  The only incremental growth is in China and Russia, 2 markets known for unpredictable leadership.  The stock has now fallen back to $120.

Given that the realization is growing as to the McDonald’s inability to fundamentally change its business competitively, the prognosis is not good that a turnaround will really happen.  Instead, the common pattern emerges of investors hoping that the Growth Stall was a “blip,” and will be easily reversed.  They think the business is fundamentally sound, and a little management “tweaking” will fix everything.  Small changes will lead to the  classic hockey-stick forecast of higher future growth.  So the stock pops up on short-term news, only to fall back when reality sets in that the long-term doesn’t look so good.

Unfortunately, Apple’s Q3 2016 results (reported yesterday) clearly show the company is now in its own Growth Stall.  Revenues were down 11% vs. last year (YOY or year-over-year,) and EPS (earnings per share) were down 23% YOY.  2 consecutive quarters of either defines a Growth Stall, and Apple hit both.  Further evidence of a Growth Stall exists in iPhone unit sales declining 15% YOY, iPad unit sales off 9% YOY, Mac unit sales down 11% YOY and “other products” revenue down 16% YOY.

This was not unanticipated.  Apple started communicating growth concerns in January, causing its stock to tank. And in April, revealing Q2 results, the company not only verified its first down quarter, but predicted Q3 would be soft.  From its peak in May, 2015 of $132 to its low in May, 2016 of $90, Apple’s valuation fell a whopping 32%!  One could say it met the valuation prediction of a Growth Stall already – and incredibly quickly!

But now analysts are ready to say “the worst is behind it” for Apple investors.  They are cheering results that beat expectations, even though they are clearly very poor compared to last year.  Analysts are hoping that a new, lower baseline is being set for investors that only look backward 52 weeks, and the stock price will move up on additional company share repurchases, a successful iPhone 7 launch, higher sales in emerging countries like India, and more app revenue as the installed base grows – all leading to a higher P/E (price/earnings) multiple. The stock improved 7% on the latest news.

So far, Apple still has not addressed its big problem.  What will be the next product or solution that will replace “core” iPhone and iPad revenues?  Increasingly competitors are making smartphones far cheaper that are “good enough,” especially in markets like China.  And iPhone/iPad product improvements are no longer as powerful as before, causing new product releases to be less exciting.  And products like Apple Watch, Apple Pay, Apple TV and IBeacon are not “moving the needle” on revenues nearly enough.  And while experienced companies like HBO, Netflix and Amazon grow their expanding content creation, Apple has said it is growing its original content offerings by buying the exclusive rights to “Carpool Karaoke – yet this is very small compared to the revenue growth needs created by slowing “core” products.

Like McDonald’s stock, Apple’s stock is likely to move upward short-term.  Investor hopes are hard to kill.  Long-term investors will hold their stock, waiting to see if something good emerges.  Traders will buy, based upon beating analyst expectations or technical analysis of price movements. Or just belief that the P/E will expand closer to tech industry norms. But long-term, unless the fundamental need for new products that fulfill customer trends – as the iPad, iPhone and iPod did for mobile – it is unclear how Apple’s valuation grows.

Facebook’s Surge, Apple’s Slide and Chipotle’s Stall – It’s All About Growth

Facebook’s Surge, Apple’s Slide and Chipotle’s Stall – It’s All About Growth

Growth fixes a multitude of sins.  If you grow revenues enough (you don’t even need profits, as Amazon has proven) investors will look past a lot of things.  With revenue growth high enough, companies can offer employees free meals and massages. Executives and senior managers can fly around in private jets.  Companies can build colossal buildings as testaments to their brand, or pay to have thier names on  public buildings.  R&D budgets can soar, and product launches can fail. Acquisitions are made with no concerns for price. Bonuses can be huge.  All is accepted if revenues grow enough.

Just look at Facebook.  Today Facebook announced today that for the quarter ended March, 2016 revenues jumped to $5.4B from $3.5B a year ago.  Net income tripled to $1.5B from $500M.  And the company is basically making all its revenue – 82% – from 1 product, mobile ads.  In the last few years Facebook paid enormous premiums to buy WhatsApp and Instagram – but who cares when revenues grow this fast.

Anticipating good news, Facebook’s stock was up a touch today. But once the news came out, after-hours traders pumped the stock to over $118//share, a new all time high. That’s a price/earnings (p/e) multiple of something like 84.  With growth like that Facebook’s leadership can do anything it wants.

But, when revenues slide it can become a veritable poop puddle. As Apple found out.

Rumors had swirled that Apple was going to say sales were down.  And the stock had struggled to make gains from lows earlier in 2016. When the company’s CEO announced Tuesday that sales were down 13% versus a year ago the stock cratered after-hours, and opened this morning down 10%.  Breaking a streak of 51 straight quarters of revenue growth (since 2003) really sent investors fleeing.  From trading around $105/share the last 4 days, Apple closed today at ~$97.  $40B of equity value was wiped out in 1 day, and the stock trades at a p/e multiple of 10.

The new iPhone 6se outsold projections, iPads beat expectations.  First year Apple Watch sales exceeded first year iPhone sales.  Mac sales remain much stronger than any other PC manufacturer. Apple iBeacons and Apple Pay continue their march as major technologies in the IoT (Internet of Things) market. And Apple TV keeps growing.  There are about 13M users of Apple’s iMusic.  There are 1.5M apps on the iTunes store.  And the installed base keeps the iTunes store growing.  Share buybacks will grow, and the dividend was increased yet again.  But, none of that mattered when people heard sales growth had stopped.  Now many investors don’t think Apple’s leadership can do anything right.

Growth StallYet, that was just one quarter.  Many companies bounce back from a bad quarter.  There is no statistical evidence that one bad quarter is predictive of the next.  But we do know that if sales decline versus a year ago for 2 consecutive quarters that is a Growth Stall.  And companies that hit a Growth Stall rarely (93% of the time) find a consistent growth path ever again.  Regardless of the explanations, Growth Stalls are remarkable predictors of companies that are developing a gap between their offerings, and the marketplace.

Which leads us to Chipotle.  Chipotle announced that same store sales fell almost 30% in Q1, 2016.  That was after a 15% decline in Q4, 2015. And profits turned to losses for the quarter.  That is a growth stall.  Chipotle shares were $750/share back in early October. Now they are $417 – a drop of over 44%.

Customer illnesses have pointed to a company that grew fast, but apparently didn’t have its act together for safe sourcing of local ingredients, and safe food handling by employees.  What seemed like a tactical problem has plagued the company, as more customers became ill in March.

Whether that is all that’s wrong at Chipotle is less clear, however.  There is a lot more competition in the fast casual segment than 2 years ago when Chipotle seemed unable to do anything wrong.  And although the company stresses healthy food, the calorie count on most portions would add pounds to anyone other than an athlete or construction worker – not exactly in line with current trends toward dieting.  What frequently looks like a single problem when a company’s sales dip often turns out to have multiple origins, and regaining growth is nearly always a lot more difficult than leadership expects.

Growth is magical.  It allows companies to invest in new products and services, and buoy’s a stock’s value enhancing acquisition ability.  It allows for experimentation into new markets, and discovering other growth avenues.  But lack of growth is a vital predictor of future performance.  Companies without growth find themselves cost cutting and taking actions which often cause valuations to decline.

Right now Facebook is in a wonderful position.  Apple has investors rightly concerned.  Will next quarter signal a return to growth, or a Growth Stall?  And Chipotle has investors heading for the exits, as there is now ample reason to question whether the company will recover its luster of yore.

Why Cheating is Prevalent – and We Can’t Stop It

Why Cheating is Prevalent – and We Can’t Stop It

Cheating in sports is now officially prevalent.  The World Anti-Doping Agency (WADA) last week issued its report, and confirmed that across the International Association of Athletics Federation (IAAF) athletes were cheating.  And very frequently doing so under the supervision of those leading major sports operations at a national, and international level.

Quite simply, those responsible for the future of various sports were responsible for organizing and enabling the illegal doping of athletes.  This behavior is now so commonplace that corruption is embedded in the IAAF, making cheating by far the norm rather than the exception.

Wow, we all thought that after Lance Armstrong was found guilty of doping this had all passed.  Sounds like, to the contrary, Lance was just the poor guy who got caught.  Perhaps he was pilloried because he was an early doping innovator, at a time when few others lacked access.  As a result of his very visible take-down for doping, today’s competitors, their coaches and sponsors have become a lot more sophisticated about implementation and cover-ups.

Accusations of steroid use for superior performance have been around a long time.  Major league baseball held hearings, and accused several players of doping.  The long list of MLB players accused of cheating includes several thought destined for the Hall of Fame including Barry Bonds, Jose Conseco, Roger Clemens, Mark McGwire, Manny Ramirez, Alex Rodriguez, and Sammy Sosa. Even golf has had its doping accusations,  with at least one top player, Vijay Sing, locked in a multi-year legal battle due to admitting using deer antler spray to improve his performance.

The reason is, of course, obvious.  The stakes are, absolutely, so incredibly high.  If you are at the top the rewards are in the hundreds of millions of dollars (or euros.)  Due to not only enormously high salaries, but also the incredible sums paid by manufacturers for product endorsements, being at the top of all sports is worth 10 to 100 times as much as being second.

For example – name any other modern golfer besides Tiger Woods. Bet you even know his primary sponsor – Nike.  Yet, he didn’t even play much in 2015.  Name any other Tour de France rider other than Lance Armstrong. And he made the U.S. Postal Service recognizable as a brand.  I travel the world and people ask me, often in their native language or broken English, where I live.  When I say “Chicago” the #1 response – by a HUGE margin is “Michael Jordan.”  And everyone knows Air Nike.

We know today that some competitors are blessed with enormous genetic gifts.  Regardless of what you may have heard about practicing, in reality it is chromosomes that separate the natural athletes from those who are merely extremely good.  Practicing does not hurt, but as the good doctor described to Lance Armstrong, if he wanted to be great he had to overcome mother nature.  And that’s where drugs come in.  Regardless of the sport in which an athlete competes, greatness simply requires very good genes.

If the payoff is so huge why wouldn’t you cheat? If mother nature didn’t give you the perfect genes, why not alter them? It is not hard to imagine anyone realizing that they are very, very, very good – after years of competing from childhood through their early 20s – but not quite as good as the other guy.  The lifetime payoff between the other guy and you could be $1Billion.  A billion dollars!  If someone told you that they could help, and it might take a few years off your life some time in the distant future, would you really hesitate?  Would the daily pain of drugs be worse than the pain of constant training?

Gold-medal-Olympian-talks-contamination-and-doping-scandals_strict_xxlThe real question is, should we call it cheating?  If lots and lots of people are doing it, as the WADA report and multiple investigations tell us, is it really cheating?

After all, isn’t this a personal decision? Where should regulators draw the line?

We allow athletes to drink sports drinks. Once there was only Gatorade, and it was only available to Florida athletes.  Because they didn’t dehydrate as quickly as other teams these athletes performed better.  But obviously sports drinks were considered OK.  How many cups of coffee should be allowed?  How about taking vitamins?

Exactly who should make these decisions?  And why?  Why “outlaw” some products, and not others?  How do you draw the line?

After watching “The Program” about Lance Armstrong’s doping routine it was clear to me I would never do it, and I would hope those I love would never do it.  But I also hope they don’t smoke cigarettes, drink too much liquor or make a porno movie.  Yet, those are all personal decisions we allow.  And the first two can certainly lead to an early grave.  As painful as doping was to biker Armstrong and his team, it was their decision to do it.  As bad as it was, why isn’t it their decision?  Why is someone put in a position to say it is cheating?

After all, we love winners.  When Lance was winning the Tour de France he was very, very popular.  Even as allegations swirled around him fans, and sponsors, pretty much ignored them.  Even the reporter who chased the story was shunned by his colleagues, and degraded by his publisher, as he systematically built the undeniable case that Armstrong was cheating.  Nobody wanted to hear that Lance was cheating – even if he was.

Fans and sponsors really don’t care how athletes win, just that they win.  If athletes do something wrong fans pretty much just hope they don’t get caught.  Just look at how fans overwhelming supported Armstrong for years.  Or how football fans have overwhelming supported Patriots quarterback Tom Brady, and ridiculed the NFL’s commissioner Roger Goodall, over the Deflategate cheating charges and investigation.  Fans support a winner, regardless how they win.

So, now we know performance enhancing drugs are endemic in professional sports.  Why do we still make them against the rules?  If they are common, should we be trying to change behavior, or change the rules?

Go back 150 years in sports and frequently the best were those born to upper middle class families.  They had the luck to receive good, healthy food.  They had time to actually practice.  So when these athletes were able to be paid for their play, we called them professionals.  As professionals we would not allow them to compete with the local amateurs.  Nor could they compete in international competitions, such as the Olympics.

Jim Thorpe won 2 Olympic gold medals in 1912, received a ticker-tape Broadway parade for his performance and was considered “the greatest athlete of all time.” He was also stripped years later of his medals because it was determined he had been paid to play in a couple of professional baseball games.  He was considered a cheater because he had the luxury of practicing, as a professional, while other Olympic athletes did not.  Today we consider this preposterous, as professional athletes compete freely in the Olympics.  But what really changed? Primarily the rules.

It is impossible to think that we will ever roll back the great rewards given to modern athletes.  Too many people love their top athletes, and relish in seeing them earn superstar incomes.  Too many people love to buy products these athletes endorse, and too many companies obtain brand advantage with those highly paid endorsements.  In other words, the huge prize will never go away.

What is next?  Genetic engineering, of course.  The good geneticists will continue to figure out how to build stronger bodies, and their results will be out there for athletes to use.  Splice a gorilla gene into a wrestler, or a gazelle gene into a long-distance runner.  It’s not pure fantasy.  This will likely be illegal.  But, over time, won’t those gene-altering programs become as common to professional athletes as steroids and human growth hormone are today?  Exactly when does anyone think performance enhancement will stop?

And if the drugs keep becoming better, and athletes have such a huge incentive to use them, how are we ever to think a line can be drawn — or ever enforced?

Thus, the effort to stop doping would appear, at best, Quixotic.

Instead, why not simply say that at the professional level, anything goes?  No more testing.  If you are a pro, you can do whatever you want to win.  “It’s your life brother and sister,” the decision is up to you.

If you are an amateur then you will be subjected to intense testing, and you will be caught.  Testing will go up dramatically, and you will be caught if you cross any line we draw.  And banned from competition for life.  If you want to go that extra mile, just go pro.

Of course, one could imagine that there could be 2 pro circuits.  One that allows all performance enhancing drugs, and one that does not.  But we all know that will fail.  Like minor league competition, nobody really cares about the second stringers.  Fans want to see real amateurs, often competing locally and reinforcing pride. And they like to see pros — the very best of the very best.  And in this latter category, the fans consistently tell us via their support and dollars, they don’t really care how those folks made it to the top.

So a difficult ethical dilemma now confronts sports fans – and those who monitor athletics:

1 – Do we pretend doping doesn’t exist and keep lying about it, but realize what we’re doing is a sham and waste of time?

2 – Do we spend millions of dollars in an upgraded “war on drugs” that is surely going to fail (and who will pay for this increased vigilance, by the way?)

3 – Do we realize that with the incentives that exist today, we need to change the rules on doping?  Allow it, educate about its use, but give up trying to stop it.  Just like pros now compete in the Olympics, enhancement drugs would no longer be banned.

This one’s above my pay grade.  What do you readers think?

Do Not Follow the Herd – Sell McDonald’s and Microsoft

Do Not Follow the Herd – Sell McDonald’s and Microsoft

This week McDonald’s and Microsoft both reported earnings that were higher than analysts expected. After these surprise announcements, the equities of both companies had big jumps.  But, unfortunately, both companies are in a Growth Stall and unlikely to sustain higher valuations.

Growth Stall primary slide

McDonald’s profits rose 23%.  But revenues were down 5.3%.  Leadership touted a higher same store sales number, but that is completely misleading.

McDonald’s leadership has undertaken a back to basics program.  This has been used to eliminate menu items and close “underperforming stores.”  With fewer stores, loyal customers were forced to eat in nearby stores – something not hard to do given the proliferation of McDonald’s sites.  But some customers will go to competitors. By cutting stores and products from the menu McDonald’s may lower cost, but it also lowers the available revenue capacity.   This means that stores open a year or longer could increase revenue, even though total revenues are going down.

Profits can go up for a raft of reasons having nothing to do with long-term growth and sustainability.  Changing accounting for depreciation, inventory, real estate holdings, revenue recognition, new product launches, product cancellations, marketing investments — the list is endless.  Further, charges in a previous quarter (or previous year) could have brought forward costs into an earlier report, making the comparative quarter look worse while making the current quarter look better.

Confusing?  That’s why accounting changes are often called “financial machinations.”  Lots of moving numbers around, but not necessarily indicating the direction of the business.

McDonald’s asked its “core” customers what they wanted, and based on their responses began offering all-day breakfast.  Interpretation – because they can’t attract new customers, McDonald’s wants to obtain more revenue from existing customers by selling them more of an existing product; specifically breakfast items later in the day.

Sounds smart, but in reality McDonald’s is admitting it is not finding new ways to grow its customer base, or sales.  The old products weren’t bringing in new customers, and new products weren’t either.  As customer counts are declining, leadership is trying to pull more money out of its declining “core.”  This can work short-term, but not long-term.  Long-term growth requires expanding the sales base with new products and new customers.

Perhaps there is future value in spinning off McDonald’s real estate holdings in a REIT.  At best this would be a one-time value improvement for investors, at the cost of another long-term revenue stream. (Sort of like Chicago selling all its future parking meter revenues for a one-time payment to bail out its bankrupt school system.)  But if we look at the Sears Holdings REIT spin-off, which ostensibly was going to create enormous value for investors, we can see there were serious limits on the effectiveness of that tactic as well.

MIcrosoft also beat analysts quarterly earnings estimate.  But it’s profits were up a mere 2%.  And revenues declined 12% versus a year ago – proving its Growth Stall continues as well.  Although leadership trumpeted an increase in cloud-based revenue, that was only an 8% improvement and obviously not enough to offset significant weakness in other markets:

It is a struggle to see the good news here.  Office 365 revenues were up, but they are cannibalizing traditional Office revenues – and not fast enough to replace customers being lost to competitive products like Google OfficeSuite, etc.

Azure sales were up, but not fast enough to replace declining Windows sales.  Further, Azure competes with Amazon AWS, which had remarkable results in the latest quarter.  After adding 530 new features, AWS sales increased 15% vs. the previous quarter, and 78% versus the previous year.  Margins also increased from 21.4% to 25% over the last year.  Azure is in a growth market, but it faces very stiff competition from market leader Amazon.

We build our companies, jobs and lives around successful products and services.  We want these providers to succeed because it makes our lives much easier.  We don’t like to hear about large market leaders losing their strength, because it signals potentially difficult change.  We want these companies to improve, and we will clutch at any sign of improvement.

As investors we behave similarly.  We were told large companies have vast customer bases, strong asset bases, well known brands, high switching costs,  deep pockets – all things Michael Porter told us in the 1980s created “moats” protecting the business, keeping it protected from market shifts that could hurt sales and profits.  As investors we want to believe that even though the giant company may slip, it won’t fall.  Time and size is on its side we choose to believe, so we should simply “hang on” and “ride it out.”  In the future, the company will do better and value will rise.

As a result we see that Growth Stall companies show a common valuation pattern.  After achieving high valuation, their equity value stagnates.  Then, hopes for a turn-around and recovery to new growth is stimulated by a few pieces of good news and the value jumps again.  Only after a few years the short-term tactics are used up and the underlying business weakness is fully exposed.  Then value crumbles, frequently faster than remaining investors anticipated.

McDonald’s valuation rose from $62/share in 2008 to reach record $100/share highs in 2011.  But valuation then stagnated.  It is only this last jump that has caused it to reach new highs.  But realize, this is on a smaller number of stores, fewer products and declining revenues.  These are not factors justifying sustainable value improvement.

Microsoft traded around $25/share from March, 2003 through November, 2011 – 8.5 years.  When the CEO was changed value jumped to $48/share by October, 2014.  After dipping, now, a year later Microsoft stock is again reaching that previous valuation ($50/share).  Microsoft is now valued where it was in December, 2002 (which is half its all-time high.)

The jump in value of McDonald’s and Microsoft happened on short-term news regarding beating analysts earnings expectations for one quarter.  The underlying businesses, however, are still suffering declining revenue.  They remain in Growth Stalls, and the odds are overwhelming that their values will decline, rather than continue increasing.

 

 

Why McDonald’s Can’t Save Itself – They Myth of Core

Why McDonald’s Can’t Save Itself – They Myth of Core

McDonald’s just had another lousy quarter.  All segments saw declining traffic, revenues fell 11%.  Profits were off 33%.  Pretty well expected, given its established growth stall.

A new CEO is in place, and he announced is turnaround plan to fix what ails the burger giant.  Unfortunately, his plan has been panned by just about everyone. Unfortunately, its a “me too” plan that we’ve seen far too often – and know doesn’t work:

  1. Reorganize to cut costs.  By reshuffling the line-up, and throwing out a bunch of bodies management formerly said were essential, but now don’t care about, they hope to save $300M/year (out of a $4.5B annual budget.)
  2. Sell off 3,500 stores McDonald’s owns and operate (about 10% of the total.)  This will further help cut costs as the operating budgets shift to franchisees, and McDonald’s book unit sales creating short-term, one-time revenues into 2018.
  3. Keep mucking around with the menu.  Cut some items, add some items, try a bunch of different stuff.  Hope they find something that sells better.
  4. Try some service ideas in which nobody really shows any faith, like adding delivery and/or 24 hour breakfast in some markets and some stores.

McDonalds burger and friesNeedless to say, none of this sounds like it will do much to address quarter after quarter of sales (and profit) declines in an enormously large company.  We know people are still eating in restaurants, because competitors like 5 Guys, Meatheads, Burger King and Shake Shack are doing really, really well.  But they are winning primarily because McDonald’s is losing.  Even though CEO Easterbrook said “our business model is enduring,” there is ample reason to think McDonald’s slide will continue.

Possibly a slide into oblivion.  Think it can’t happen?  Then what happened to Howard Johnson’s?  Bob’s Big Boy? Woolworth’s?  Montgomery Wards? Size, and history, are absolutely no guarantee of a company remaining viable.

In fact, the odds are wildly against McDonald’s this time.  Because this isn’t their first growth stall.  And the way they saved the company last time was a “fire sale” of very valuable growth assets to raise cash that was all spent to spiffy up the company for one last hurrah – which is now over.  And there isn’t really anything left for McDonald’s to build upon.

Go back to 2000 and McDonald’s had a lot of options.  They bought Chipotle’s Mexican Grill in 1998, Donato’s Pizza in 1999 and Boston Market in 2000.  These were all growing franchises.  Growing a LOT faster, and more profitably, than McDonald’s stores.  They were on modern trends for what people wanted to eat, and how they wanted to be served.  These new concepts offered McDonald’s fantastic growth vehicles for all that cash the burger chain was throwing off, even as its outdated yellow stores full of playgrounds with seats bolted to the floors and products for 99cents were becoming increasingly not only outdated but irrelevant.

But in a change of leadership McDonald’s decided to sell off all these concepts.  Donato’s in 2003, Chipotle went public in 2006 and Boston Market was sold to a private equity firm in 2007.  All of that money was used to fund investments in McDonald’s store upgrades, additional supply chain restructuring and advertising. The “strategy” at that time was to return to “strategic focus.”  Something that lots of analysts, investors and old-line franchisees love.

But look what McDonald’s leaders gave up via this decision to re-focus.  McDonald’s received $1.5B for Chipotle.  Today Chipotle is worth $20B and is one of the most exciting fast food chains in the marketplace (based on store growth, revenue growth and profitability – as well as customer satisfaction scores.)  The value of all of the growth gains that occurred in these 3 chains has gone to other people.  Not the investors, employees, suppliers or franchisees of McDonald’s.

We have to recognize that in the mid-2000s McDonald’s had the option of doing 180degrees opposite what it did.  It could have put its resources into the newer, more exciting concepts and continued to fidget with McDonald’s to defend and extend its life even as trends went the other direction.  This would have allowed investors to reap the gains of new store growth, and McDonald’s franchisees would have had the option to slowly convert McDonald’s stores into Donato’s, Chipotle’s or Boston Market.  Employees would have been able to work on growing the new brands, creating more revenue, more jobs, more promotions and higher pay.  And suppliers would have been able to continue growing their McDonald’s corporate business via new chains.  Customers would have the benefit of both McDonald’s and a well run transition to new concepts in their markets.  This would have been a win/win/win/win/win solution for everyone.

But it was the lure of “focus” and “core” markets that led McDonald’s leadership to make what will likely be seen historically as the decision which sent it on the track of self-destruction.  When leaders focus on their core markets, and pull out all the stops to try defending and extending a business in a growth stall, they take their eyes off market trends.  Rather than accepting what people want, and changing in all ways to meet customer needs, leaders keep fiddling with this and that, and hoping that cost cutting and a raft of operational activities will save the business as they keep focusing ever more intently on that old core business.  But, problems keep mounting because customers, quite simply, are going elsewhere.  To competitors who are implementing on trends.

The current CEO likes to describe himself as an “internal activist” who will challenge the status quo.  But he then proves this is untrue when he describes the future of McDonald’s as a “modern, progressive burger company.”  Sorry dude, that ship sailed years ago when competitors built the market for higher-end burgers, served fast in trendier locations.  Just like McDonald’s 5-years too late effort to catch Starbucks with McCafe which was too little and poorly done – you can’t catch those better quality burger guys now.  They are well on their way, and you’re still in port asking for directions.

McDonald’s is big, but when a big ship starts taking on water it’s no less likely to sink than a small ship (i.e. Titanic.)  And when a big ship is badly steered by its captain it flounders, and sinks (i.e. Costa Concordia.)  Those who would like to think that McDonald’s size is a benefit should recognize that it is this very size which now keeps McDonald’s from doing anything effective to really change the company.  Its efforts (detailed above) are hemmed in by all those stores, franchisees, commitment to old processes, ingrained products hard to change due to installed equipment base, and billions spent on brand advertising that has remained a constant even as McDonald’s lost relevancy. It is now sooooooooo hard to make even small changes that the idea of doing more radical things that analysts are requesting simply becomes impossible for existing management.

And these leaders, frankly, aren’t even going to try.  They are deeply wedded, committed, to trying to succeed by making McDonald’s more McDonald’s.  They are of the company and its history.  Not the CEO, or anyone on his team, reached their position by introducing a revolutionary new product, much less a new concept – or for that matter anything new.  They are people who “execute” and work to slowly improve what already exists. That’s why they are giving even more decision-making control to franchisees via selling company stores in order to raise cash and cut costs – rather than using those stores to introduce radical change.

These are not “outside thinkers” that will consider the kinds of radical changes Louis V. Gerstner, a total outsider, implemented at IBM – changing the company from a failing mainframe supplier into an IT services and software company.  Yet that is the only thing that will turn around McDonald’s.  The Board blew it once before when it sold Chipotle, et.al. and put in place a core-focused CEO.  Now McDonald’s has fewer resources, a lot fewer options, and the gap between what it offers and what the marketplace wants is a lot larger.

Innovating to Solve Tanqueray’s Growth Quandary

Innovating to Solve Tanqueray’s Growth Quandary

If you don’t drink gin you may not know the brand Tanqueray, a product owned by Diageo. But Tanqueray has been around for almost 190 years, going back to the days when London Dry Gin was first created. Today Tanqueray is one of the most dominant gin brands in the world, and the leading brand in the USA.

Tanqueray London Dry GinBut gin is not a growth category. And Tanqueray, despite its great product heritage and strong brand position, has almost no growth prospects.

Any product that doesn’t grow sales cannot generate profits to spend on brand maintenance. Firstly, if due to nothing more than inflation, costs always go up over time. It takes rising sales to offset higher costs.  Additionally, small competitors can niche the market with new products, cutting into leader sales. And competitors will undercut the leader’s price to steal volume/share in a stagnant market, causing margin erosion.

Category growth stalls are usually linked to substitute products stealing share in a larger definition of the marketplace. For example sales of laptop/desktop PCs stalled because people are now substituting tablets and smartphones. The personal technology market is growing, but it is in the newer product category stealing sales from the older product category.

This is true for gin sales, because older drinkers – who dominate today’s gin market – are drinking less spirits, and literally dying from old age. In the overall spirits market, younger liquor drinkers have preferred vodkas and flavored vodkas which are “smoother,” sweeter, and perceived as “lighter.”

Smirnoff Vodka Group

So, what is a brand manager to do? Simply let trends obsolete their product line? Milk their category and give up money for investing somewhere else?

That may sound fine at a corporate level, where category portfolios can be managed by corporate vice presidents. But if you’re a brand manager and you want to become a future V.P., managing declining product sales will not get you into that promotion. And defending market share with price cuts, rebates and deals will cut into margin, ruin the brand position and likely kill your marketing career.

Keith Scott is the Senior Brand Manager for Tanqueray, and his team has chosen to regain product growth by using sustaining innovations in a smart way to attract new customers into the gin category. They are looking beyond the currently dwindling historical customer base of London Dry Gin drinkers, and working to attract new customers which will generate category growth and incremental Tanqueray sales.  He’s looking to build the brand, and the category, rather than get into a price war.

Building on demographic trends, Tanqueray’s brand management is targeting spirit drinkers from 28-38. Three new Tanqueray brand extensions are being positioned for greatest appeal to increasingly adult tastes, while offering sophistication and linkage to one of the longest and strongest spirits brands.

Tanqueray Rangpur#1 – Tanqueray Rangpur is a highly citrus-flavored gin taking a direct assault on flavored vodkas. Although still very much a gin, with its specific herb-based taste, Rangpur adds a hefty, and uniquely flavored, dose of lime. This makes for a fast, easy to prepare gin and tonic or lime-based gimlet – 2 classic cocktails that have their roots in England but have been popular in the US since before prohibition. And, in defense of the brand, Rangpur is priced about 10-20% higher than London Dry.

Tanqueray Malacca#2 – Tanqueray Old Tom and Tanqueray Milacca appeal to the demographic that loves specialty, crafted products. The “craft” product movement has grown dramatically, and nowhere more powerfully than amongst 28-42 year old beer drinkers. Old Tom and Milacca leverage this trend.  Both are “retro” products, harkening to gins over 100 years ago. They are made in small batches and have limited availability. They are targeted at the consumer that wants something new, unique, unusual and yet tied to old world notions of hand-made production and high quality. These craft products are priced 25-35% higher than traditional London Dry.Tanqueray Old Tom

#3 – Tanqueray No. 10 is a “super-premium” product pointed at the customer who wants to project maximum sophistication and wealth. No 10 uses a special manufacturing process creating a uniquely smooth and slightly citrus flavor. But this process loses 40% of the product to “tailings” compared to the industry standard 10% loss. No. 10 is the high-end defense of the Tanqueray brand (a “top shelf” product as its known in the industry) priced 75-90% higher than London Dry.

Tanqueray no 10

No. 10 is being promoted with “invitation only” events being held in major U.S. cities such as New York, Chicago and Atlanta. No. 10 “trunk events” bring in some of the hottest, newest designers to showcase the latest in apparel trends, accompanied by hot, new musical talent. No. 10 is associated with the sophistication of super-premium brands – individualized and rare products – in a members-only environment. Targeted at the primary demographic of 28-38, No. 10 events are designed to lure these consumers to this product they otherwise might overlook .

Rather than addressing their gin category growth stall with price cuts and other sales incentives, which would lead to brand erosion, price erosion, and margin erosion, the Tanqueray brand team is leveraging trends to bring new consumers to their category and generate profitable growth.  These innovative brand extensions actually build brand value while leveraging identifiable market trends.  Notice that all these sustaining innovations are actually priced higher than the highest volume London Dry core product, thus augmenting price – and hopefully margin.

Too often leaders see their market stagnate and use that as an excuse lower expectations and accept sales decline. They don’t look beyond their core market for new customers and sources of growth. They react to competition with the blunt axe of pricing actions, seeking to maintain volume as margins erode and competition intensifies. This accelerates product genericization, and kills brand value.

The Tanqueray brand team demonstrates how critical sustaining innovation can be for maintaining growth at all levels of an organization. Even the level of a single product or brand.  They are using sustaining innovations to lure in new customers and grow the brand umbrella, while growing the category and achieving desired price realization.  This is a lesson many brands, and companies, should emulate.

Myths Can Hide Trends – Budweiser & The Craft Beer Fallacy

Myths Can Hide Trends – Budweiser & The Craft Beer Fallacy

It is that time of year when many of us celebrate with an alcoholic beverage.  But increasingly in America, that beverage is not beer.  Since 2008, American beer sales have fallen about 4%.

But that decline has not been equally applied to all brands.  The biggest, old line brands have suffered terribly.  Nearly gone are old brands like Milwaukee’s Best, which were best known for being low priced – and certainly not focused on taste.  But the most hurt, based on volume declines, have been what were once the largest brands; Budweiser, Miller Lite and Miller High Life.  These have lost more than a quarter of their volume, losing a whopping 13million barrels/year of demand.  These 3 brand declines account for 6% reduction in the entire beer market.

The popular myth is that this has been due to the rise of craft beers.  And there is no doubt, craft beer sales have done well.  Sales are up 80%. Many articles (including the WSJ)tout the growth of craft beers, which are ostensibly more tasty and appealing, as being the reason old-line brands have declined.  It is an easy explanation to accept, and has largely gone unchallenged.  Even the brewer of Budweiser, Annheuser-Busch InBev, has reacted to this argument by taking the incredible action of dropping clydesdale horses from their ads after 81 years – in an effort to woo craft beer drinkers, which are thought to be younger and less sentimental about large horses.

This all makes sense.  Too bad it’s the wrong conclusion – and the wrong actions being taken.

Realize that craft beer sales are up from a small base, and today ALL craft beer sales still account for only 7.6% of the market.  In fact, ALL craft beers combined sell only the same volume as the now smaller Budweiser.  The problem with Budweiser sales – and sales of other big name brand beers – is a change in demographics.

Drinkers of Budweiser and Lite are simply older.  These brands rose to tremendous dominance in the 1970s.  Many of those who loved this brand are simply older – or dead.  Where a hard working fellow in his 30s or 40s might enjoy a six pack after work, today that Boomer (if still alive) is somewhere between late 50s and 70s.  Now, a single beer, or maybe two, will suffice thank you very much.  And, equally challenging for sales, today’s Boomer is more often drinking a hard liquor cocktail, and a glass of wine with dinner.  Beer drinking has its place, but less often and in lower quantities.

Dos Equies Most Interesting Man

Meanwhile, Hispanics are a growing demographic.  Hispanics are the largest non-white population in America, at 54million, and represent over 17% of all Americans.  With a growth rate of 2.1%, Hispanics are also one of the fastest growing demographic segments – and increasingly important given their already large size.  Hispanics are truly becoming a powerful buying group in American economics.

So, just as decline in Boomer population and consumption has hurt the once great beer brands, we can look at the growth in Hispanic demographics and see a link to sales of growing brands.  Two significant (non-craft volume) beer brands that more than doubled sales since 2008 are Modelo Especial and Dos Equis.  In fact, these were the 2 fastest growing brands in America, even though the first does no English language advertising at all, and the latter only lightly funds advertising with an iconic multi-year campaign.  Together their sales total almost 5.4M barrels – which makes these 2 brands equal to 1/3 the ENTIRE craft beer marketplace.  And growing 33% faster!

Chasing the myth of craft sales is doing nothing for InBev and MillerCoors as they try to defend and extend outdated brands.  On the other hand, Heineken controls Dos Equis, and Constellation Brands controls Modello Especial.  These two companies are squarely aligned with demographic trends, and well positioned for growth.

So, be careful the next time you hear some simple explanation for why a product or service is declining.  The answer might sound appealing, but have little economic basis.  Instead, it is much smarter to look at big trends and you’ll likely see why in the same market one product is growing, while another is declining.  Trends – such as demographics – often explain a lot about what is happening, and lead you to invest much smarter.

Coca-Cola, How a Giant Company Starts Losing Relevance

Coca-Cola, How a Giant Company Starts Losing Relevance

I’m a “Boomer,” and my generation could have been called the Coke generation.  Our parents started every day with a cup of coffee, and they drank either coffee or water during the day.  Most meals were accompanied by either water, or iced tea.

But our generation loved Coca-Cola.  Most of our parents limited our consumption, much to our frustration.  Some parents practically refused to let the stuff in the house.  In progressive homes as children we were usually only allowed one, or at most two, bottles per day.  We chafed at the controls, and when we left home we started drinking the sweet cola as often as we could.

It didn’t take long before we supplanted our parent’s morning coffee with a bottle of Coke (or Diet Coke in more modern times.)  We seemingly could not get enough of the product, as bottle size soared from 8 ounces to 12 to 16 and then quarts and eventually 2 liters!  Portion control was out the window as we created demand that seemed limitless.

Meanwhile, Americans exported our #1 drink around the world.  From 1970 onward Coke was THE iconic American brand.  We saw ads of people drinking Coke in every imaginable country.  International growth seemed boundless as people from China to India started consuming the irresistible brown beverage.

santa-claus-coca-cola

My how things change.  Last week Coke announced third quarter earnings, and they were down 14%.  The CEO admitted he was struggling to find growth for the company as soda sales were flat.  U.S. sales of carbonated beverages have been declining for a decade, and Coke has not developed a successful new product line – or market – to replace those declines.

Coke is a victim of changing customer preferences.  Once a company that helped define those preferences, and built the #1 brand globally, Coke’s leadership shifted from understanding customers and trends in order to build on those trends towards defending & extending sales of its historical product.  Instead of innovating, leadership relied on promotion and tactics which had helped the brand grow 30 years ago.  They kept to their old success formula as trends shifted the market into new directions.

Coke began losing its relevancy.  Trends moved in a new direction.  Healthfulness led customers to decide they wanted a less calorie rich, nutritionally starved drink.  And concerns grew over “artificial” products, such as sweeteners, leading customers away from even low calorie “diet” colas.

Meanwhile, younger generations started turning to their own new brands.  And not just drinks.  Instead of holding a Coke, increasingly they hold an iPhone.  Where once it was hip to hang out at the Coke machine, or the fountain stand, now people would rather hang out at a Starbucks or Peet’s Coffee.  Where once Coke was identified and matched the aspirations of the fast growing Boomer class, now it is replaced with a Prada handbag or other accessory from an LVMH branded luxury product.

Where once holding a Coke was a sign of being part of all that was good, now the product is largely passe.  Trends have moved, and Coke didn’t.  Coke leadership relied too much on its past, and failed to recognize that market shifts could affect even the #1 global brand.  Coke leaders thought they would be forever relevant, just do more of what worked before.  But they were wrong.

Unfortunately, CEO Muhtar Kent announced a series of changes that will most likely further hurt the Coca-Cola company rather than help it.

First, and foremost, like almost all CEOs facing an earnings problem the company will cut $3B in costs.  The most short-term of short-term actions, which will do nothing to help the company find its way back toward being a prominent brand-leading icon. Cost cuts only further create a “hunker-down” mindset which causes managers to reduce risk, rather than look for breakthrough products and markets which could help the company regain lost ground.  Cost cutting will only further cause remaining management to focus on defending the past business rather than finding a new future.

Second, Coca-Cola will sell off its bottlers.  Interestingly, in the 1980s CEO Roberto Goizueta famously bought up the distributorships, and made a fortune for the company doing so.  By the year 2000 he was honored, along with Jack Welch of GE, as being one of the top 2 CEOs of the century for his ability to create shareholder value.  But now the current CEO is selling the bottling operations – in order to raise cash.  Once again, when leadership can’t run a business that makes money they often sell off assets to generate cash and make the company smaller – none of which benefits shareholders.

Third, fire the Chief Marketing Officer.  Of course, somebody has to be blamed!  The guy who has done the most to bring Coca-Cola’s brand out of traditional advertising and promote it in an integrated manner across all media, including managing successful programs for the Olympics and World Cup, has to be held accountable.  What’s missing in this action is that the big problem is leadership’s fixation with defending its Coke brand, rather than finding new growth businesses as the market moves away from carbonated soft drinks.  And that is a problem that requires the CEO and his entire management team to step up their strategy efforts, not just fire the leader who has been updating the branding mechanisms.

Coca-Cola needs a significant strategy shift.  Leadership focused too long on its aging brands, without putting enough energy into identifying trends and figuring out how to remain relevant.  Now, people care a lot less about Coke than they did.  They care more about other brands, like Apple.  Globally.  Unless there is a major shift in Coke’s strategy the company will continue to weaken along with its primary brand.  That market shift has already happened, and it won’t stop.

For Coke to regain growth it needs a far different future which aligns with trends that now matter more to consumers. The company must bring forward products which excite people ,and with which they identify. And Coke’s leaders must move much harder into understanding shifts in media consumption so they can make their new brands as visible to newer generations as TV made Coke visible to Boomers.

Coke is far from a failed company, but after a decade of sales declines in its “core” business it is time leadership realizes takes this earnings announcement as a key indicator of the need to change.  And not just simple things like costs.  It must fundamentally change its strategy and markets or in another decade things will look far worse than today.

Two Lessons For Us All from Crumbled Crumbs Bake Shop

Two Lessons For Us All from Crumbled Crumbs Bake Shop

Crumbs Bake Shop – a small chain of cupcake shops, almost totally unknown outside of New York City and Washington, DC – announced it was going out of business today.  Normally, this would not be newsworthy.  Even though NASDAQ traded, Crumbs small revenues, losses and rapidly shrinking equity made it economically meaningless.  But, it is receiving a lot of attention because this minor event signals to many people the end of the “cupcake trend” which apparently was started by cable TV show “Sex and the City.”

However, there are actually 2 very important lessons all of us can learn from the rise, and fall, of Crumbs Bake Shop:

crumbs cupcake

1 – Don’t believe in the myth of passion when it comes to business

Many management gurus, and entrepreneurs, will tell you to go into business following something about which you are passionate.  The theory goes that if you have passion you will be very committed to success, and you will find your way to success with diligence, perseverance, hard work and insight driven by your passion.  Passion will lead to excellence, which will lead to success.

And this is hogwash.

Customers don’t care about your passion.  Customers care about their needs.  Rather than being a benefit, passion is a negative because it will cause you to over-invest in your passion.  You will “never say die” as you keep trying to make success out of an idea that has no chance.  Rather than investing your resources into something that fulfills people’s needs, you are likely to invest in your passion until you burn through all your resources.  Like Crumbs.

The founders of Crumbs had a passion for cupcakes.  But, they had no way to control an onslaught of competitors who could make different variations of the product.  All those competitors, whether isolated cupcake shops or cupcakes offered via kiosks or in other shops, meant Crumbs was in a very tough fight to maintain sales and make money.  It’s not you (and your passion) that controls your business destiny.  Nor is your customers.  Rather, it is your competition.

When there are lots of competitors, all capable of matching your product, and of offering countless variations of your product, then it is unlikely you can sustain revenues – or profits.  There are many industries where cutthroat competition means profits are fleeting, or downright elusive.  Airlines come to mind.  Magazines. And many retail segments.  It doesn’t matter how much passion you have, when there are too many competitors it’s a lousy business.

2 – Trends really do matter

Cupcakes were a hot product for a while.  And that’s great.  But it wasn’t hard to imagine that the trend would shift, and cupcakes would be displaced by something else.  Whatever profits you might have when you sit on a trend, those profits evaporate fast when the trend shifts and all competitors are fighting for sales in a declining market.

Remember Mrs. Field’s cookies?  In the 1980s an attractive cook and her investment banker husband built a business on soft, chewy, warm cookies sold in malls and retail streets across America.  It seemed nobody could get enough of those chocolate chip cookies.

But then, one day, we did.  We’d collectively had enough cookies, and we simply quit buying them.  Mrs. Fields (and other cookie brand) stores were rapidly replaced with pretzels and other foodstuffs.

Or look at Krispy Kreme donuts.  In the 1990s people went crazy for them, often lining up at stores waiting for the neon sign to come on saying “hot donuts”.  The company exploded into 400 stores as the stock flew like a kite.  But then, in a very short time, people had enough donuts.  There were a lot more donut shops than necessary, and Krispy Kreme went bankrupt.

So it wasn’t hard to predict that shifting food tastes would eventually put an end to cupcake sales growth.  Yet, Crumbs really didn’t prepare for trends to change.  Despite revenue and profit problems, the leadership did not admit that cupcake sales had peaked, the market was going to decline, competition would become even more intense and Crumbs would need to find another business if it was to survive.

Few trends move as fast as tastes in sweets.  But, trends do affect all businesses.  Once we bought cameras (and film,) but now we use phones – too bad for Kodak.  Once we used copiers, now we use email – too bad for Xerox.  Once we watched TV, now we download from Netflix or Amazon – too bad for NBC, ABC, CBS and Comcast. Once we went to stores, now we order on-line – too bad for Sears. Once we used PCs, now we use mobile devices – too bad for Microsoft.  These trends did not affect these companies as fast as shifting tastes affected Crumbs, but the importance of understanding trends and preparing for change is a constant part of leadership.

So Crumbs Bake Shop failure was one which could have been avoided.  Leadership needed to overcome its passion for cupcakes and taken a much larger look at customer needs to find alternative products.  It wasn’t hard to identify that some diversification was going to be necessary.  And that would have been much easier if they had put in place a system to track trends, observing (and admitting) that their “core” market was stalled and they needed to move into a new trend category.

Embracing a Higher Minimum Wage – to Win

Embracing a Higher Minimum Wage – to Win

There is a definite trend to raising the minimum wage.  Regardless your political beliefs, the pressure to increase the minimum wage keeps growing.  The important question for business leaders is, “Are we prepared for a $12 or $15 minimum wage?”

President Obama began his push for raising the minimum wage above $10 a year ago in his 2013 State of the Union.  Since then, several articles have been written on income inequality and raising the minimum wage.  Although the case to raise it is not clear cut, there is no doubt it has increased the rhetoric against the top 1% of earners.  And now the President is mandating an increase in the minimum wage for federal workers and contractors to $10.10/hour, despite lack of congressional support and flak from conservatives.

Whether the economic case is provable, it appears that public sentiment is greatly in favor of a much higher minimum wage.  And it will not affect all companies the same.  Those that depend upon low priced labor, such as retailers like Wal-Mart and fast food companies like McDonald’s have a much higher concern.  As should their employees, suppliers and investors.

A recent Federal Reserve report took a specific look at what happens to fast food companies when the minimum wage goes up, such as happened in Illinois, California and New Jersey.  And the results were interesting.  Because they discovered that a higher minimum wage really did hurt McDonald’s, causing stores to close.  But….. and this is a big but…. those closed stores were rapidly replaced by competitors that could pay the  higher wages, leading to no loss of jobs (and an overall increase in pay for labor.)

The implications for businesses that use low-priced labor are clear.  It is time to change the business model – to adapt for a different future.  A higher minimum wage does not doom McDonald’s – but it will force the company to adapt.  If McDonald’s (and Burger King, Wendy’s, Subway, Dominos, Pizza Hut, and others) doesn’t adapt the future will be very ugly for their customers and the company.  But if these companies do adapt there is no reason the minimum wage will hurt them particularly hard.

The chains that replaced McDonald’s closed stores were Five Guys, Chick-fil-A and Chipotle.  You might remember that in 1998 McDonald’s started investing in Chipotle, and by 2001 McDonald’s owned the chain.  And Chipotle’s grew rapidly, from a handful of restaurants to over 500.  But then in 2006 McDonald’s sold all its Chipotle stock as the company went IPO, and used the proceeds to invest in upgrading McDonald’s stores and streamlining the supply chain toward higher profits on the “core” business.

Now, McDonald’s is shrinking while Chipotle is growing.  Bloomberg/BusinessWeek headlined “Chipotle: The One That Got Away From McDonalds” (Oct. 3, 2013.) Investors were well served to trade in McDonald’s stock for Chipotle’s.  And franchisees have suffered through sales problems as they raised prices off the old “dollar menu” while suffering higher food costs creating shrinking margins.  Meanwhile Chipotle’s franchisees have been able to charge more, while keeping customers very happy, and maintain margins while paying higher wages.  In a nutshell, Chipotle’s (and similar competitors) has captured the lost McDonald’s business as trends favor their business.

So McDonald’s obviously made a mistake.  But that does not mean “game over.”  All McDonald’s, Burger King and Wendy’s need to do is adapt.  Fighting the higher minimum wage will lead to a lot of grief.  There is no doubt wages will go up.  So the smart thing to do is figure out what these stores will look like when minimum wages double.  What changes must happen to the menu, to the store look, to the brand image in order for the company to continue attracting customers profitably.

This will undoubtedly include changes to the existing brands.  But, these companies also will benefit from revisiting the kind of strategy McDonald’s used in the 1990s when buying Chipotle’s.  Namely, buying chains with a different brand and value proposition which can flourish in a higher wage economy.  These old-line restaurants don’t have to forever remain dominated by the old brands, but rather can transition along with trends into companies with new brands and new products that are more desirable, and profitable, as trends change the game.  Like The Limited did when selling its stores and converting into L Brands to remain a viable company.

Now is the time to take action.  Waiting until forced to take action will be too late.  If McDonald’s and its brethren (and Wal-Mart and its minimum-wage-paying retail brethren) remain locked-in to the old way of doing business, and do everything possible to defend-and-extend the old success formula, they will follow Howard Johnson’s, Bennigan’s, Circuit City, Sears and a plethora of other companies into brand, and profitability, failure.  Fighting trends is a route to disaster.

However, by embracing the trend and taking action to be successful in a future scenario of higher labor these companies can be very successful.  There is nothing which dictates they have to follow the road to irrelevance while smarter brands take their place.  Rather, they need to begin extensive scenario planning, understand how these competitors succeed and take action to disrupt their old approach in order to create a new, more profitable business that will succeed.

Disruptions happen all the time.  In the 1970s and 1980s gasoline prices skyrocketed, allowing offshore competitors to upend the locked-in Detroit companies that refused to adapt.  On-line services allowed Google Maps to wipe out Rand-McNally, Travelocity to kill OAG and Wikipedia to kill bury Encyclopedia Britannica.  These outcomes were not dictated by events.  Rather, they reflect an inability of an existing leader to adapt to market changes.  An inability to embrace disruptions killed the old competitors, while opening doors for new competitors which embraced the trend.

Now is the time to embrace a higher minimum wage.  Every business will be impacted.  Those who wait to see the impact will struggle.  But those who embrace the trend, develop future scenarios that incorporate the trend and design new business opportunities can turn this disruption into a big win.